The Cycle of Deflation continues to develop

Economic growth

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Deflation.pngIn January, the blog suggested that political issues would continue to gain increased importance. Its argument was that the strong economy between 1982-2007, when the US suffered just 16 months of recession, meant political and social issues took a back seat. Money was easily available to ‘solve’ most problems.

Since then the global economy has continued with its L-shaped recovery, despite the best efforts of policymakers. And political leadership is now more inward-looking, as voters become more worried by more difficult economic conditions. The main elections during 2012 have confirmed this lack of a consistent vision for the global economy:

• The US remained deeply polarised, with politicians still arguing over the ‘fiscal cliff’
• China has announced new leaders, who will perhaps push the reform agenda harder
• Japan’s new government, however, seems set to return to the failed ways of stimulus spending
• France’s new Socialist leadership are rolling back even Sarkozy’s small reforms
• Russia elected Putin who is strongly committed to a state-driven economy
• Italy appointed Monti as a technocrat leader, but he has now lost his parliamentary majority

Overall, politicians have continued to rely on more and more short-termist measures, and an escalation of competitive devaluations. We are moving back to the world of ‘beggar-my-neighbour’ as the Governor of the Bank of England noted last week in New York:

“My concern is that in 2013 what we will see is the growth of actively managed exchange rates as an alternative to the use of domestic monetary policy….you can see month by month the addition of the number of countries who feel that active exchange rate management, always of course to push their exchange rate down, is growing.”

At the same time, some countries are moving on to adopt more obviously protectionist measures. Brazil, for example, has recently increased tariffs of polyethylene to 20% from 14%, whilst ethylene glycol tariffs rose to 20% from 2%.

Sadly, therefore, as we end 2012, the blog sees no reason to change its analysis that we have moved into a Cycle of Deflation. Excess production capacity build up during the SuperCycle has not been shut down. Instead, countries are all seeking to boost domestic growth by increasing exports and reducing imports. Falling prices are therefore the inevitable result.

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