Full article by Ed Yardeni of Deutch Bank can be accessed at http://www.yardeni.com/weain.html Henry C.K. Liu DEFLATION WATCH Central Bankers Vs. Deflation. Central bankers around the world finally understand that deflation is no longer a risk: It is a clear and present danger. From Frankfurt to New York to Beijing, interest rate cuts are in fashion. Will monetary reflation work? Investors have been well served over the years by the simple mantra, “Don’t fight the Fed.” I suppose that there is even more cosmic power in the new global mantra, “Don’t fight the world’s central banks.” I’m not fighting, but I am questioning this consensus view. Deflation occurs when there are too many goods and services chasing too few consumers. Central bankers hope that easier credit conditions will revive demand relative to supply. However, they might actual prop up supply more than they will boost demand. In this perverse case, lower rates would actually worsen the long-term deflationary prospects. Easier credit conditions in Japan will permit many insolvent businesses to stay open. The recent cut in China’s lending rates was aimed at helping insolvent state-owned companies stay in business. A Quick Tour Of Deflation Around The World. Commodity prices continue to show a decidedly deflationary bias, with many major indexes falling to lows not seen in over 20 years (Exhibits 1, 2, and 3). Both oil and copper prices are especially weak of late (Exhibits 4 and 5). Only 2% of purchasing managers reported that prices were higher in November than in October. The overall price index compiled by the National Association of Purchasing Management remains around 35, a reading associated with past economic and profits recessions (Exhibits 6, 7, 8, and 9). Overseas, German import prices and wholesale prices are down by more than 5% from a year ago (Exhibit 10). CPI inflation rates are under 1% Germany and France (Exhibit 11). Internet may have the most deflationary long-term potential. For the here and now, the Asian recession is a major source of deflationary pressures. The latest real GDP figures for Hong Kong and South Korea show year-over-year declines of 7% (Exhibit 12). I doubt that these economies are about to rebound. I also doubt that the worst is over for Japan (Exhibit 13). The latest international bank loan data collected by the Bank for International Settlements show that bank credit fell sharply in Asia during the first two quarters of 1998. A serious credit crunch occurs when your bank won’t lend you more money. A severe credit crunch occurs when your bank wants the return of the money they have already lent you. In Asia, the credit crunch is very severe. In Latin America, it is just serious according to the latest B.I.S. loans data (Exhibits 14 and 15).
