Abandon all hope once you enter deflation Abandon all hope once you enter deflation
Posts 1 to 7 of 7
  1. #1

    I Am Legend

    BrilloPad has reached the peak. Play again?


    Join Date
    Aug 2006
    Posts
    103,255

    Default Abandon all hope once you enter deflation

    http://www.telegraph.co.uk/finance/c...deflation.html

    Deflation is sometimes likened to Dante's Inferno. "Abandon all hope" once you step into that Hellfire.

    We are not there yet but Mervyn King, the Governor of the Bank of England, says it is now "very likely" that the UK retail price index will turn negative next year. This is a drastic reversal of the oil and food spike that played such havoc with monetary policy over the summer. "The world changed in September," said the Governor.

    The Bank's fan charts point to zero inflation at current interest rates of 3pc, but the startling new feature is that price falls could gather pace. This is a clear signal that the Monetary Policy Committee will cut rates again in December – perhaps by a full point to the historic low of 2pc, last seen in the Great Depression.

    Mr King let slip yesterday that there is "obviously" a risk of deflation, although he remains sure it can be averted by a pre-emptive monetary blitz. Let us hope he is right.

    The curse of deflation is that it increases the burden of debts. Incomes fall: debts stay the same. This way lies suffocation. It was bad enough in the early 1930s when US farmers faced a Sisyphean Task trying to meet mortgage payments on their land as crop prices kept sliding. They suffered mass foreclosure and fled West, as recounted in John Steinbeck's Grapes of Wrath.

    We forget, however, that overall borrowing was modest in the 1930s. The great credit bubble of the last 20 years has pushed debt levels in Britain, the US and other Western societies to unprecedented highs. UK household debt reached a record 165pc of personal income last year. This is almost 50pc higher than the burden at the onset of the recession in the early 1990s. Our sensitivity to debt deflation is therefore greater.

    "It is going to be absolute murder in Britain if inflation turns negative," said Professor Peter Spencer from York University. "The big difference with past episodes is that we are now much more heavily indebted. Few people owned their own houses in 1930s. Debts were miniscule."

    Deflation has other insidious traits. It causes shoppers to hold back. They wait for lower prices. Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop.

    It also redistributes wealth – the wrong way. Savings appreciate, which is nice for the "rentiers" with capital. The effect is a large transfer of income from working people with mortgages to bondholders. (These may be pension funds, of course).

    The modern warning to us all is the "Lost Decade" in Japan, a loose term for the on-again, off-again slump that ultimately led to zero interest rates and – when that failed – to the printing of money. After 18 years, the Nikkei stock index is now trading at 8,700 – down from a peak of nearly 40,000. House prices have fallen by half. Yet after all the stimulus, the country is once again tipping back into deflation.

    Governor King said Britain was likely to avoid this fate. "We've taken action much earlier than was the case in Japan," he said.

    Not everybody agrees, even after the shock and awe cut of 1.5 percentage points by the MPC. Albert Edwards, global strategist at Société Générale, has long warned that central banks in the Anglo-Saxon countries have stored up trouble by stoking credit booms, and may find it harder than they think to engineer a soft-landing.

    "This could easily go the way of Japan. It is true that Bank of England has moved faster, but Japan was a local bubble. This time it is the 'great unwind' on a global scale with leverage spaghetti everywhere," he said.

    "The monetary authorities don't have foggiest idea themselves whether this is going to work. They're crossing their fingers and hoping," he said.

    Nor is it clear whether rate cuts are gaining much traction. The average rate of tracker mortgages has risen 72 basis points since last month, and credit card rates have been rocketing. The Bank's transmission mechanism is not working properly. This a variant of the 1930s struggle when the central banks found themselves "pushing on a string", in the words of John Maynard Keynes. He called for public works to lift the economy out of its liquidity trap. This is more or less what the US, Japan, China, and parts of Europe are now doing – with more in store after the G20 this weekend. Britain has pitifully limited scope on this front. We had a budget deficit of 3pc of GDP at the top of the cycle – when we should have been in surplus – and we are heading for over 8pc. This is already nearing the danger level. If the Government now lets rip on fiscal policy, we could face a 'gilts strike' as foreign investors retreat from UK debt.

    The Bank of England has not run out of ammo yet. It can cut rates to zero if necessary and then escalate to direct infusions of money by purchasing bonds – or indeed by buying a vast range of securities, assets and even houses if necessary. Ultimately it can print money to cover the budget deficit.

    As the late Milton Friedman put it, governments can drop bundles of banknotes from helicopters. If they really want to defeat to deflation, they can. Mr Friedman may have overlooked the fact that gunmen can shoot down the helicopter – the Bank of France in October 1931, when it ditched the dollar; perhaps Asian bond investors today? – but that is to quibble.

    Professor Spencer says the Bank of England has learned the hard lessons. Without the constraints of the ERM, Gold Standard, or any other fixed exchange system, it retains great freedom of action.

    "They are very aware of the deflation risk. They are cutting rates very fast, and if necessary they too will turn to helicopters. But in the end they will keep the wolf from the door," he said.

  2. #2

    I Am Legend

    BrilloPad has reached the peak. Play again?


    Join Date
    Aug 2006
    Posts
    103,255

    Default

    Good comment from the site :-

    Only in the UK would an economist state that money being distributed to prudent savers with cash deposits as "the wrong way". As if economies work best and properly when money and wealth accumulates with debtors. You really don't need to hear anything else to understand why the UK is in a dire mess and why the rest of the world is selling off the pound at record numbers. Sad, but the UK is well and truly on its own in a downward spiral unlike any other country in the West today.

  3. #3

    More fingers than teeth

    TimberWolf is too good to be a permie

    TimberWolf's Avatar
    Join Date
    Oct 2007
    Posts
    17,505

    Default

    Those of you still living in the UK that did not emigrate to Oz, NZ, Canada when you had the chance have failed. Welcome to the losers club

  4. #4

    My post count is Majestic

    AtW is a fount of knowledge

    AtW's Avatar
    Join Date
    Jul 2005
    Posts
    51,392

    Default

    It's Japanese scenario going to happen in the UK, only I think deflation might not be that high due to imports and pound dropping quickly. Good for tourism though - there will be need for more Beefeaters in Loooooonddddoooooon.

  5. #5

    Super poster

    SantaClaus has more data than eek

    SantaClaus's Avatar
    Join Date
    Dec 2005
    Location
    #JeSuisGeorge
    Posts
    3,442

    Default

    Quote Originally Posted by AtW View Post
    It's Japanese scenario going to happen in the UK, only I think deflation might not be that high due to imports and pound dropping quickly. Good for tourism though - there will be need for more Beefeaters in Loooooonddddoooooon.
    Hey, I'm looking forward to all the branches of Starbucks turning back into the greasy spooners of the 1970's.

    Milky tea in a styrofoam cup instead of a double latte machiatto chai watcha-call-it with hazelnut syrup.

  6. #6

    I Am Legend

    BrilloPad has reached the peak. Play again?


    Join Date
    Aug 2006
    Posts
    103,255

    Default

    Quote Originally Posted by AtW View Post
    It's Japanese scenario going to happen in the UK, only I think deflation might not be that high due to imports and pound dropping quickly. Good for tourism though - there will be need for more Beefeaters in Loooooonddddoooooon.
    Another reason deflation will not last is capacity for UK citizens to spend spend spend at every opportunity.

    How do I become a beefeater?

  7. #7

    My post count is Majestic

    AtW is a fount of knowledge

    AtW's Avatar
    Join Date
    Jul 2005
    Posts
    51,392

    Default

    Quote Originally Posted by BrilloPad View Post
    How do I become a beefeater?
    I think one needs to wait until one of them dies for the vacancy to become available...

Posting Permissions

  • You may not post new threads
  • You may not post replies
  • You may not post attachments
  • You may not edit your posts
  •