Back in October 2009, we talked about the possible deflation and inflation scenarios that could play out. See link below -
http://brightassetmgmt.blogspot.com/2009/10/puzzle-pieces.html
In this piece there were two scenarios that were likely -
Scenario 1: Dollar decline, lower bond prices, higher stock prices, higher commodity prices, higher gold
Scenario 2: Dollar rises (as of function of deleveraging), higher bond prices, lower stock prices, lower commodity prices (as a function of a reduction in global demand.)
While Scenario 1 dominated during the second half of 2009 and into the beginning of 2010, Scenario 2 has been playing out over the past few months as debt and financial concerns in the Eurozone are creating expectations for deflation.
Remember, deflation is the contraction (reduction) of money and credit. It occurs when an economic system is carrying too much debt to be supported by the level of income generated by economic activity - both in private and public sectors. It occurs because too much debt has been incurred to create unproductive assets that don’t generate income. Deflation is a corrective process, it’s simply the market not being able to service debt, so the debt must be forfeited.
Inflation is just the opposite involving the expansion (creating) of money and credit. Since the 1950's, central banks and accepted economic theory are all about creating debt to grow economies (artificially), so periods of inflation (creating money-debt and credit) last a very long time. Debt is accumulated slowly and incrementally during periods of economic expansion until there is just too much of it.
The current job of global central banks is to fight deflation. Hidden behind the bailouts, stimulus packages, zero interest rate policies, mortgage workouts, housing credits, and working groups are politicians attempting to engineer a business and economic recovery while fighting off the forces of deflation.
While these plans seemingly worked over the past year, none of these plans will affect the larger deflationary credit contraction. Debt deflation is occurring outside of the Fed’s control at many of the world’s money center banks. This process will probably take several years to work out but will ultimately yield positive results. The destruction of debt will allow world economies to build a solid foundation for future expansion that is entirely more secure than what we currently have in place at the present time.
There are no easy answers but there are certainly simple truths - truths that don't get politicians re-elected, however.
