Fighting deflation globally ain’t easy

By J Saft
November 21, 2008

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

With the U.S., Japan and Britain — nearly 40 percent of the global economy — facing the threat of deflation, it’s going to be just too easy for one, two or all three of them to get the policy response horribly wrong.

The global economy is so connected, and our experience with similar situations so limited that the scope for error is huge.

Think of it as having three pilots flying a jet plane, one each operating a wing and the third managing the tail.

Oh yeah, and they all work for different airlines.

Though there will be much talk of international coordination in the next year, and though the central banks and governments of the world will likely be rowing in the same direction, their ability to gauge the effects of monetary policy and government spending on their own economies will be pretty limited, and even more so on the whole.

Failure when fighting a global recession, a global balance sheet adjustment, a global banking recapitalization, debt deflation and very possibly actual deflation can take many forms.

“It’s very hard to calibrate and it’s awfully easy to overshoot or undershoot, both of which would be disastrous,” said Lena Komileva, London-based strategist at Tullett Prebon.

Under clubbing the response to falling prices means you could slip into a self-reinforcing deflation, making your debts, be they consumer, housing or government, heavier and setting up a cycle where businesses and consumers defer consumption and investment.

Over-reacting risks fomenting a new bout of inflation and potentially causing a new bubble. (Who knows what that would be — dirt, water, baseball cards?)

And remember too, when deflation was last an issue on this scale globally during the 1930s, the global economy was nowhere as near as integrated.

As for now, the signs are clear: deflation is a growing threat in much of the world’s economy, though still to be sure not the central forecast.

U.S. producer prices dropped by 2.8 percent in October, the largest decline on record. Core intermediate goods and core crude goods prices, which show inflation at earlier stages in the production cycle, fell by a big 1.7 and a staggering 17 percent, respectively.

Consumer prices, which are usually sticky on the way down, fell at a record rate in October, down one percent and even falling by 0.1 percent in the month when plunging food and energy prices are excluded. That will kill corporate profits and shows a business community racing with consumers to see who can capitulate fastest.


Inflation is falling rapidly in Britain too, with overall consumer price inflation down 0.2 percent in October, the first monthly fall since the annual January sales and the first in October since 2001, just after 9/11.

Japan meanwhile has slipped back into recession, domestic demand is weakening, wages are falling and deflation may develop some time next year, a scenario Barclays Capital rates as a 40 percent chance.

Even China, where inflation has tumbled to 4.0 percent in October from a 12-year peak of 8.7 percent in February, has moved its focus to averting deflation.

Be in no doubt, central banks have the tools to fight deflation; while interest rates can only be cut so much, officials can step up the quantitative easing now happening, they can commit to hold rates at zero for an extended period of time, they can drive down their own currency by purchasing foreign bonds or finally, simply print money and drop it from the famous helicopters.

The issue is not the tools, but the speed of the printing presses or size of the bond purchases needed to get the right result, especially when it is interacting with what will be huge tax cuts and deficit spending.

A mix of monetary and fiscal policy will work, but it’s got to be the right mix and it has to be reasonably well coordinated internationally.

None of this is without risk. Remember the last deflation scare in the U.S. in the early part of this decade, which in retrospect caused the monetary bubble which was nursemaid to the housing bubble.

Print money or borrow excessively and you could lose the confidence of the currency market and experience a run, which certainly will help to fight deflation but is no-one’s idea of good policy.

In theory the amount the state will need to borrow will be in part offset by the amount individuals save, or more to the point pay down in debt and decline to invest privately. That theory will be put to the test by the number of governments who are going to be selling a very large number of bonds, which will after all have to be paid back.

Next year is looking as if it will be as unconventional as it is scary.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –

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Uhh, the pathetic results of the refusal to accept any other than Machiavellian politics in the past 60 years – and the denial of the inevitable consequences of a $US fiat currency backed by force and the credit bubble created to pay for the wanton expenditure of the military-industrial complexes of the world.

What has happened in the past 20 years policy-wise has guaranteed failure. Just as the Vietnam war and the Korean war were both actually known to the people there as “the American war”, this is the collapse of the American financial order and will be known as the American financial crisis and the American economic disaster.

Posted by FreedomLand | Report as abusive

Young news columnists with their journalism diplomas are always so clever and all-seeing. I can’t imagine why Obama isn’t naming some to his cabinet.

Posted by Ken | Report as abusive

The rich get richer and the poor get poorer except for the poor who get richer and the rich who get poorer.

Posted by PVR | Report as abusive

A little deflation might not be a bad thing. Housing prices have to deflate until they reach historic levels. The median house historically costs about 2x to 3x the median income. That number got up to 4 for the US nationally, and as high as 10 in some markets. That’s the housing bubble, and it has to collapse.

When bubbles collapse, they collapse all the way. Once the decline starts, the prospective value associated with appreciation goes to zero. A house is only worth what you can make renting it. House prices have been way above that level for years. That’s over.

Deflation has other benefits. It encourages saving. Before the crash, we had 5% inflation and 2% yields on CDs, for a real yield of -3%. Now we have -1% inflation and 4% CDs, for a real yield of 5%. Putting money in the bank pays again.

Deflation and tight credit forces companies to hoard their cash and use it intelligently. It discourages M&A activity, which historically benefits management but not stockholders. There’s been too much liquidity sloshing around the financial system.

The argument that deflation causes inflation seems bogus.

To all those that say the American financial system along with the Federal reserve are all to blame for the crisis, you need a serious reality check! If the American free market system is soooo fundamentally unsound, how the hell did America build the biggest and greatest interstate freeway system? Did the New York skyline get built on an unsound economy? Did the world’s biggest and greatest military complex get built by a crap system? The sheer mass of physical infrastructure that America has built in the last 100 years would never have been built if the free market capitalist system was flawed. There will always be the ever-controlling rich as a minority and the ever-helpless poor as a majority. Deal with it. You can either whine your life away, or you can adapt and grow rich. There is always less and less space as you travel to the top of any pyramid. Nobody said this struggle would be easy.

Just because the economy has a really bad year or two doesn’t mean we need to change everything!! If your son or daughter were clinically depressed for more than 2 years, would you get rid of them? The world is not going to end. What we have here is a natural oscillation toward the negativity end of the spectrum. We’ve had a good couple of decades…and now we’ll have the displeasure of being collectively depressed and focused on negative thoughts…but we always oscillate back into the light of progress and positive vibes. The world is not ending…but it may feel like it. Everyone is born with the ability to persevere ANY circumstance, it’s only a matter of will power and self-motivation.

Posted by John Kunick | Report as abusive

Not sure one could call the collapse of a ponzi scheme deflation… the devaluing of “real” goods is , imho , just a short term result of forced liquidations , necessitated by the collapse of worthless paper. It really is just a matter of time before the massive injections of printed fiat gain velocity through the system and lead to inflation … inflation is the only option left to the Fed. for the survival of the US dollar , deflation would cause a US debt default.

Posted by andre lotz | Report as abusive

I realize that this is no an interactive thread, but if someone would respond to a question, I would appreciate it.

It appears that, at least in the US, we have a consumer driven, credit based economy. Is that a fair simplification? If so, what would happen to this economy if everyone decided not to ever use credit cards again and defaulted on their credit card debt? I realize that their “credit ratings” would tank, but wouldn’t this also cause industry to rewrite its business models based upon cash based consumer spending? What impact would this have?

Posted by azdog1 | Report as abusive

Most readers here probably know from history that nations with a strong middle class are known to handle tough national challenges with more likelihood of success. We know too, again from history, that whenever the income-gap between “the rich and the rest” gets too great that country is headed straight toward history’s trash heap–a little matter that Bush and buddies forgot, I believe? Let’s hope policymakers from here on out will study every proposal–every one–as to its effect on that gap. (Hint: Getting back to the Constitution might help.) Why ignore history–why reinvent the wheel?

Posted by June | Report as abusive

The economies in the western world are now in free fall with various governments in panic mode such as the British government which have unveiled their latest strategy to spend its way out of the recession, Its instructed the banks which have been nationalized to get lending back to 2007 levels. The US bail out is just another example that the governments have no option but to keep spending but this cannot continue the west is bankrupt and the future is grim, governments will fall the wealth will be removed from the rich and at present the powerful the outlook is for a break down in law and order.

Posted by SiscolinjamesOBE | Report as abusive

The potential devastation of an economic depression is so great that deflation will be attacked at all costs. Authorities will err on the side of inflation, rather than risk a prolonged period of deflation. The cash dropping helicopters have been scrambled.

Deflation is good. It’s like the jugglers dropped the balls allowing us time to notice the pickpockets. End of story.

Isn’t this the plan? All the world is crying for a unified Global Economic system, including one currency. We may skip nationalism and move straight past that to Globalism. People are misinformed. Having a global economic system is not going to be better. Maybe in the short term people will feel as though they are all contributing to some Utopian good, but in the end, it’s the real world…and unless you’re handing out boxes of Soma while you ask people to take the mark of the beast, people will react in angst against this system. I pray for Divine Intervention! but then again, I cling to my Bible.

Posted by Jeremiah | Report as abusive

There have been many intelligent and interesting arguments listed above concerning the economic mess we now find ourselves in.

In my 54 years as a U.S. citizen, I have only experienced persistant inflation, one bout of high inflation and several modest recessions. A little deflation now sounds like a good process to help keep things balanced. I am lucky to have avoided anything like the great depression of the 1930′s.

Over the last 15 years, I’ve tried to save/invest 5-10% of my income in a mixture of stocks, bonds and CDs. I paid off my modest house off 13 years ago and made the decision that buying a huge McMansion was not a good idea financially. I pay off my credit card each month. I purchase plenty of sensible insurance. I only have one debt, a small car loan. I live conservatively within my means and try to realistically plan for an unpredictable future. I resent that the Fed has kept interest rates so low for the last 8 years. I see too many people that have been living a false financial dream that is now, rightly, turning into a nightmare for them.

I would bet that the U.S. will continue to print more money and lower interest rates again to try to get us out of this mess. People seem to tolerate inflation more because it is stretched out over time. Printing more money means debts are more easily paid off with cheaper dollars. It will give us all the illusion that the economy can get back on-track so that we can mindlessly consume even more stuff. People who think that saving money for tough times is a prudent thing (like me) will continue to be suckers. Inflation will continue to eat away at your savings.

There’s always some convenient reason to keep lowering interest rates and printing more money. This time the reason is a month or two of deflation … oooohhh …. so scary!

Don’t bet on our government finding a balanced solution to this mess. In the long run (2 years???), inflation will again rear it’s ugly head in a bigger way. Too many U.S. dollars spread around the world will come back home to roost. I don’t have much trust in the U.S. dollar.

My advice is to invest in anything you think will be a good hedge against inflation.

Posted by Gary Peters | Report as abusive

I do not quite understand that how far these speculators can go. It is understandable that economy is in big problem. There is not a single economist could emerge with a solution.However, the speculators are taking advantage of this confusion.
Americans vote for President Bush. Now the economist burn their brain to solve these masses. Why not those Americans who vote for President Bush they solve them. It is easy to interupt the economy but it is not easy to run it.

I’m glad that everyone is starting to understand that a debt-based monetary policy wasn’t the way to go, well everyone except John Kunick. Is there a coincidence that both Peter Schiff and Ron Paul knew that the American Economy was going to collapse? Absolutely not. Any student of the Austrian School of economics could have told you that. Visit

Posted by Henry Melgar | Report as abusive

Just months ago we were in the midst talking about rising inflation. Now the frozen credit market and scare of deflation is looming. Things change a lot quickly.

Funny thing is as much i would like to see how this whole thing works out to better, i cant wonder and see it going horribly wrong.

With fingers crossed for a happening 2009 (in a better way)

Regards ThinkJayant

I just hope the Democrats stop spending really fast as soon as we return to inflation. I don’t want to hear, “Gee, isn’t it still happy hour?”

Incidentally, why is there so little talk of derivatives? I already suggested that James do a column on them. We seem to have derivatives in the amount of 8x-20x Gross World Product (yes, world). What the hey are these things, options to buy unicorns? Realistically, how many have to go “poof” and whose pocket catches fire?

Posted by Pete Cann | Report as abusive

The thing nobody seems to be asking is what happens when there’s no more room to cut rates because we’ve hit 0%? People assume things will get right before then, but if the solution is also the source of the problem (printing more money out of thin air), then why would anything change?

Posted by TheCaptain | Report as abusive

But, people ARE spending. The demand side of the economic equation has changed/is changing.

Leading edge consumers are opting for more sensible product. Spam company is working seven days two shifts but can’t keep up with incoming orders. Long-term food supplies have a 6-10 week waiting lead time. Ebayers are frantically buying silver at twice the mark prices. Retro-seventies gardening, animal husbandry, and do-it-yourself books, tools, equipment have doubled in price due to demand. In a down real estate market, prices of good farmland have tripled. The list of such grand anomalies grows daily. Demand is not apt to be a future problem when mainstream retailers (suppliers) stop fishing with the wrong bait. (Just how many belly-rings does a family of four require?)

We have all been looking in the wrong direction. The US public needs value for their dollar, not more garbage for landfills: a vehicle built to be dependable with generic parts available–a vehicle the owner can keep running. An appliance that works flawlessly for more than two years. Tasteful clothing that wears well.

Never mind bailing banks and slippery stocks–put our money into retooling for an economy that offers essential product/fair wage/incentives to save. How hard could it be to do things open and right with the best interests of all? Such a business model can’t be more complicated than the underhanded one we are emeshed in now!

Why should America continue to buy and buy and re-replace items that won’t last. When will the throw-away society with its throw-away mentality end. It’s ending now. Never thought I’d live to see it.

re: “…potentially causing a new bubble. (Who knows what that would be — dirt, water, baseball cards?)”

I wouldn’t be surprised if, in our lifetimes, someone links growth-investments to water somehow. Seriously. Yes, I understand that you, the author, meant to be humorous, ridiculing market tendencies to overvalue the fad of the moment. But… Water sources are decreasingly public, increasingly private. Trading risk and profit opportunities, based on which company is best able to exploit public need (a.k.a. potential of drought and scarcity) isn’t as ridiculous as we may wish it were, and may indeed become the cause of a new bubble in our lifetimes. I realize it sounds like future-fiction, but if the way things are set up now remain and are perpetuated, the likeliest outcome is that competing capitalist interests will be fighting over water rights soon. (Need I mention that it’s a global problem with vast economic impacts, and historic precedents, too?)

A Google search of ‘water wars’ brings up more links and suggestions than I would have imagined. With a quick glance at some of the items I found:
– the site
– a / / article about water issues in the U.S. mdispatch/2008/09/water-wars-in-america. html and
– “about the struggle for water around the world.”

I’m no expert, but do think it’s in the public interest that more citizens pay attention to water rights, even if you’ve never had more problems with getting water than leaky faucets. It’d be best if we pay attention, educate ourselves, and are diligent about protecting water for humanity’s future. [yeah, that's a vague conclusion, but this is just a posted comment.]