The Tentacles of Deflation Are Wrapped Around the Globe

Economies the world over are seeing weaker pricing power for goods and services, even in China where growth has slowed. In debt-ridden Europe, consumers are cautious and some economies are already contracting. In the U.S., excluding volatile food and energy prices, the July Consumer Price Index barely budged. The tentacles of deflation are wrapped around the globe and squeezing ever harder, as you can glean from this Reuters excerpt:

Further evidence of weak price rises globally shows that deflation is a growing, if small, threat.

U.S. consumer prices held steady in July, and are up just 1.4 percent in a year, while the core CPI, which strips out volatile food and energy prices, edged up just 0.1 percent in the month.

About a third of the items in the shopping basket that makes up the CPI fell in price in the month, up by more than half from earlier this year. While capacity utilization is now at an almost-normal 79 percent, the evidence today shows companies have little, if any, pricing power, a situation which, if it persists, may flag production cut-backs, not to mention profit warnings, in the future.

There are two interlocking drivers here. On a fundamental basis, as we've seen in Japan for more than a decade, an over-leveraged economy trying to become a less leveraged one is simply going to have sluggish economic growth and a tendency for weak price gains, if not outright deflation. More immediately, real weakness in Europe, and concern about the potential for extreme outcomes, is radiating outward.

Industry is contracting in much of Europe, with a striking fall in German factory orders, which are down almost 8.0 percent over a year. Despite a policy of capping Swiss franc strength against the euro, Switzerland is in outright deflation, with prices down 0.7 percent on a year ago. Japan too continues to see deflation, and like Switzerland is suffering from a strong yen.

Looking at China, growth there is cooling incredibly rapidly, with producer prices in a headlong fall and consumer inflation at just 1.8 percent on the latest reading, the lowest in 30 months. Export growth in July collapsed, falling to just 1.0 percent, from 11.0 percent the month before. Prices of exported goods fell by 0.5 percent. It should surprise no-one that the yuan is now a two-way risk, as likely, or even more likely, to fall as appreciate.

Though the sheer size of developed market indebtedness would likely mean sluggish growth anyway, it is important to understand the way in which uncertainty about the outcome in Europe is driving a preference for safety, driving up currencies that are relatively safe and driving down bond yields. This drive for safety is really just a wave of deflationary force coming out of Europe, one which will only reverse when investors become confident in a relatively benign outcome.

That might happen, but betting on it happening any time soon is probably foolish.

Read the full article here.

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