Sunday, 31 May 2009

Sidestepping the inflation/deflation dichotomy

Adversarial contests are one way to get attention and setting up a conflict between the hyper-inflation school and the deflation school of economists is one way of the financial media trying to compete with the likes of America/Britain's Got Talent etc. However it may be a phony dichotomy.

Perhaps we will end up with - "a scenario of financial asset deflation (stocks, real estate, etc) and commodity price inflation (gold, oil, agricultural goods) combined with either stagnation of GDP or negative GDP growth." This is the suggestion from a well-balanced article at SeekingAlpha.

The author tackles the conflicting views of inflation and deflation with refreshing honesty and candour because, as alleged, none of the experts or financial technocrats really know.

For what it's worth I would slightly paraphrase his summary above and suggest that we may end up with a combination of zombie bank balance sheets plus growing evidence that the alleged global elasticity of demand for commodities (i.e. without the US consumer sector acting as the dynamo that it has been in the past ) has been mis-understood. If the supply of resources is reaching a plateau and if the demand is more inelastic than currently believed, then the absence of a voracious US consumer, may not be a deflationary force for commodity prices. Alas the real elasticity of demand may be for labor in the developed world which will, in turn, act as a major restraint on incomes and drag on the recovery of the creditworthiness of major Western banks.

Coupled with an increased desire by central banks and other investors to seek out a safe haven alternative to over-dependence on the US dollar and the integrity of the Treasury market, it is not hard to see why there will be a growing appetite for commodities and hard assets. Longer term the real challenge for global markets is to find a global reserve unit of account which cannot, like any national fiat currency, be printed ad infinitum .

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