Thursday, 21 August 2008

Deflation is Here

Back in December I posed the question; Inflation or Deflation? Since then I have maintained that deflation will become the more dominant in 2008.

Yes but what about the rampant price inflation we have seen over the last 12 months, in particular food and energy? Firstly any discussion of inflation and deflation should define what they actually are. Here's what I wrote back in December:

Firstly what is deflation? Typically it is a decrease in the money supply or amount of credit in the system and a decrease in the demand for goods related to the inability to access credit. Sounds like the opposite of inflation doesn't it? Funny that.

OK so what exactly has been happening to the money supply? An interesting article in the UK Telegraph surfaced on Tuesday addressing this very topic.

Sharp US money supply contraction points to Wall Street crunch ahead
The US money supply has experienced the sharpest contraction in modern history, heightening the risk of a Wall Street crunch and a severe economic slowdown in coming months.

Data compiled by Lombard Street Research shows that the M3 ''broad money" aggregates fell by almost $50bn (£26.8bn) in July, the biggest one-month fall since modern records began in 1959.

"Monthly data for July show that the broad money growth has almost collapsed," said Gabriel Stein, the group's leading monetary economist.

On a three-month basis, the M3 growth rate has fallen from almost 19pc earlier this year to just 2.1pc (annualised) for the period from May to July. This is below the rate of inflation, implying a shrinkage in real terms.

The growth in bank loans has turned negative to a halt since March.

"It's obviously worrying. People either can't borrow, or don't want to borrow even if they can," said Mr Stein.

Monetarists say it is the sharpness of the drop that is most disturbing, rather than the absolute level. Moves of this speed are extremely rare.

The overall debt burden in the US economy is currently at record levels, raising concerns that a recession - if it occurs - could set off a sharp downward spiral.

Click on the link above for the full story. A contracting money supply and deflating home and stock prices, looks like deflation is well and truly here. Yes but how about price inflation? I think Kevin Depew of Minyanville summed it up well on Tuesday:
the obsessive focus on inflation is like a weird obsessive focus on the sun setting in your rear view mirror while you drive straight over a cliff.