James Spence, Managing Partner at Cerno Capital comments on the deflations worries surrounding our economy.
Comments surrounding the report of negative inflation for the UK are designed to insinuate that negative inflation does not equal deflation. One reason for this confidence is the recovery of the oil price, not present in these numbers, due to the lag between wholesale and petrol markets.
Indeed, some commentators have gone far enough to suggest that deflationary worries have been quashed and that the ECB needs to be less committed to its unbounded plans of creating electronic money.
Whilst we retain our belief that outright debt deflation is a low probability outcome, it is easy to conflate two distinct phenomena, leading to confusion of the issue.
When commentators reference deflation, they sometimes mean a phenomenon more expressly termed debt deflation, balance sheet deflation or debt spiral. This only occurs as a consequence of a great rent in the fabric of financial infrastructure, accompanied by, or caused by, a systemic failure of the banking system to sustain liquidity and credit.
Whilst this is indeed possible – and we brushed up against this outcome in 2008 – lined against it are society and government as it would be an anathema to both.
The second, less pernicious phenomenon is a period of super low or negative inflation, technically construed to be deflation (as the semantics determine that negative inflation is referred to as deflation). This second phenomenon need not involve deficient liquidity, or the choking of credit, or any failure to mediate the savings base into the credit pools required to keep our great capitalist project afloat.
If you insert an economist at this point of the debate, most would suggest that what matters are inflationary expectations such that benign deflation does not commute into destructive debt deflation.
Western world economic agencies publicly hold to the belief that they can prevent this from happening. They all work to the same play book, which could be entitled “What Went Wrong in Japan and How We Can Prevent This”.
Whilst we continue to ascribe a low probability to outright debt deflation, we should confess that Japanese outcomes (persistently low inflation, low growth and low interest rates) are well within our grasp. The news therefore is only partly good.