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We have written before about the perceived
threats of deflation and why it is feared by central bankers and others. The
worry is that in a time of falling prices people will defer purchases in order
to benefit from yet lower prices in the future. The idea is that this threatens
consumer spending and the beneficial effects it has on economic growth.
However, there are always many sides
to any story and I am grateful to Paul Hannon and his colleagues
of the Wall Street Journal for the following insights on the issue. Hannon
writes:
“Consider
the kinds of purchases you would delay if you expected prices to fall in coming
months. Not food, because you have to eat, or energy, because you have to heat
or cool your home. But you might think about delaying the purchase of a new
car–it’s a big expense, and you may not absolutely have to have the latest
model right away”.
But, as he also points out, auto sales in the US
are actually increasing. The same is true of Europe (see above). So this
expense is not being postponed. Intuitively, it can be assumed that such things
as vacations will also be indulged in, because life is too short to be putting
them off. The housing market is a law unto itself and, in any event, mortgage
payments apart, does not figure in the official inflation statistics.
Then there are the components of inflation to be
considered. We have shown the chart below previously, which indicates that the
main driver of low inflation is the energy factor. This is hardly surprising given
the drop in the price of oil that has been underway for some time, and which is
set to continue. Low energy prices are actually a boon to most economies.
One thing that deflation, or the threat of it, does achieve, is it provides an incentive for monetary easing. Put simply, low inflation gives central banks like the US Federal Reserve the ability to maintain low interest rates for longer, which they are minded to do anyway in light of the worries that still exist in regard to possible slack in the US economy.
This, in turn, provides us with a
bias towards a weaker US dollar. Already, what might just turn out to be a substantial
retrace in the EURUSD exchange rate might be coming into being for this very
reason. The chart above shows a series of higher highs and higher lows on the
recent four hour chart. These always indicate a rising trend. How long this one
will last is another question, but the matter of the effects of low inflation
must be taken into account.
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