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Deflation is Back… Will It Lead to Another Market Crash?

Stock-Markets / Financial Crash Dec 26, 2015 - 10:26 PM GMT

By: Graham_Summers

Stock-Markets

Central Bankers are flummoxed.

Having cut interest rates over 600 times since 2009 (and printed over $15 trillion), they’ve yet to generate the expected economic growth.

Despite these failures, the ECB, and the Bank of Japan are currently engaging massive QE programs. The Fed is the only major Central Bank not rapidly expanding its balance sheet.


Why, after six years, are we still seeing such aggressive policies?

Because deflation, the bad kind, is once again lurking around the corner.

Anyone with a functioning brain knows that deflation is a good thing. No one complains when they are able to buy something at a lower price, whether it is a home, gasoline, or computer.

However, debt deflation is a different story. Debt deflation means that future debt payments are becoming more expensive. This means that debt servicing will become more difficult, eventually leading to default and debt restructuring.

It is debt deflation that remains the primary focus for the global Central Banks. Indeed, if you consider the threat of debt deflation, every Central Bank move makes sense. ZIRP, NIRP, and QE all have the same goal in mind: to lower interest rates and push bonds higher (thereby making sovereign debt loads more serviceable).

With this in mind, even a whiff of debt deflation is enough to give Central Bankers nightmares. It’s also why they are so fond of inflation via currency devaluation, as it permits them to render massive debt loads more serviceable.

Unfortunately, the great “reflation experiment” is failing. Indeed, as Societe General has noted, it appears the developed world may be “turning Japanese” i.e. moving into a long-term deflationary cycle similar to that which has plagued Japan for the last 20 years.

To whit, inflation expectations are collapsing globally.

In Europe, despite three cuts into NIRP, the announcement of QE and an extension of QE, inflation is barely positive at 0.2%.

euro-area-inflation-cpi-1

Then of course there is the US.

There, one of the better measures of inflation expectations is the 5 Year, 5-Year Forward Inflation Expectation Rate. That is simply a long way of saying that this chart measures where investors expect inflation to be in five years… and running for five years after that date.

GPC1221152
As you can see, inflation expectations have collapsed in the latter half of 2015. Post-2008, any time this measure has fallen below the Fed’s desired threshold of 2%, it has launched a new monetary policy. In 2010 it was QE 2. In 2011 it was Operation Twist.

We’re now well below that level. And this is AFTER six years of ZIRP and $4 trillion in QE!

Deflation is back… and as it rears its head again in the west, Western Central Banks will soon be forced to answer the question.

Can we actually stop deflation?

Unfortunately for them, the answer is likely no.

Consider Japan.

Japan has engaged in NINE QE programs since 1990. Since that time, the country’s GDP growth has been anemic at best. Indeed, even its latest MASSIVE QE program (a single monetary program equal to 25% of Japan’s GDP) only boosted Japan’s GDP for two quarters before growth rolled over again. Indeed, Japan is once again back in technical recession as of our writing this.

japan-gdp-growth

The reality is slowly beginning to sink in that Central Banks cannot put off the business cycle. They’ve spent over $15 trillion and cut interest rates over 600 times and all they’ve generated is one of the weakest recoveries on record.

What happens the next time global GDP takes a nosedive when Central Banks have already used up all of their ammunition?

Two works: Markets Crash.

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Graham Summers

Phoenix Capital Research

http://www.phoenixcapitalmarketing.com

Graham also writes Private Wealth Advisory, a monthly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500.

Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.

© 2015 Copyright Graham Summers - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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