Notes on the Global Economy & World Financial Markets – November 2009
World Economy Slipping into Deflation
Territory
The world economy is now heading towards deflation and the latest data shows that the annual rate of inflation has not only slowed sharply over the past several months but it has started to tumble into negative territory in dozens of countries (see Table 1). This global multi-country fall in consumer-price inflation is quite unprecedented and attests to the severity of the ongoing global recession.
The inflation rate in the United States fell to –1.3% in September of this year, down from 4.9% a year earlier and prices in the US have now been in negative territory for seven consecutive months. Similarly, inflation was negative in the other G7 economies of Britain, Canada, France, and Germany. Unhappily, Japan, after finally managing to finally extricate itself from a decade-long bout of falling prices, finds itself mired yet again in deflation with prices now falling at an annual rate of –2.2%.
TABLE 1
DEFLATION TAKES HOLD IN THE GLOBAL ECONOMY
(Year-over-Year % Change in Consumer Prices)
Country
September
2008
September
2009
Country
September
2008
September
2009
United States
+4.9
-1.3
Cyprus
+5.0
-1.2
Japan
+2.1
-2.2
CzechRepublic
+6.4
-0.3
China
+4.6
-0.8
Estonia
+10.8
-1.7
Germany
+3.0
-0.5
Finland
+4.7
-1.0
France
+3.4
-0.4
Slovenia
+5.5
-0.1
Britain
+5.0
-1.4
Switzerland
+2.8
-1.1
Canada
+3.4
-0.9
Sweden
+4.4
-1.6
Spain
+4.6
-1.0
Chile
+9.2
-1.1
Belgium
+5.5
-1.0
Malaysia
+8.2
-2.0
Ireland
+3.2
-3.0
Singapore
+6.7
-0.4
Portugal
+3.2
-1.8
Taiwan
+3.1
-0.9
Luxembourg
+4.8
-0.4
Thailand
+5.1
-1.0
Sources: Eurostat, The Economist, National statistics offices
Inflation is also turning negative in many of the emerging economies. In China, the world’s third largest economy, inflation was –0.8% in September and the index has now been in negative territory for eight consecutive months. Similarly, prices are falling in the Asian economies of Malaysia, Singapore, Taiwan and Thailand and deflationary forces are also plaguing a number of the emerging Eastern European economies including Estonia, Slovenia and the Czech Republic. In Latin America, Chile’s annual inflation rate has nose-dived from 9.2% a year ago to –1.1% this September.
Stimulus Measures Being Thwarted
Since the onset of the global recession in late 2007 policy makers have tried their utmost to spur demand and stop the economy from being sucked into a deflationary spiral. On the monetary policy front, the world’s major central banks have slashed interest rates to record lows and a number, including the Federal Reserve and the Bank of England, have embarked on an aggressive campaign of printing money via ‘quantitative easing’.
Similarly, on the fiscal policy front, governments have jacked up spending and poured trillions of dollars into their respective economies in order to shore up demand. Taxes have also been cut.
Yet, despite these aggressive policy measures, the world economy remains in a deep funk and consumer prices at the aggregate level have continued to decline.
Deflation’s Destructiveness
While a mild, and temporary, bout of deflation is no cause for alarm, it is another story if deflationary forces were to become entrenched. The longer it lasts the more grievous damage it inflicts on the economy. Deflation has a pernicious effect on a number of key economic variables. It reduces consumer spending, it increases the real value of debt, it raises the cost of borrowing, and it renders monetary policy impotent.
Initially, consumers welcome cheaper prices, but once deflation takes hold and consumers expect prices to fall further, they delay making purchases. This delay leads to a fall in consumer spending which in turn leads to lower economic growth. To clear their shelves, businesses respond by further lowering prices and in order to bring costs into line with reduced demand, start laying-off workers.
Moreover, deflation increases the real value of debt. As prices fall and wages come under downward pressure, the burden of debt rises. The level of debt stays the same but servicing it becomes more onerous as incomes drop.
By raising the real cost of borrowing, deflation also discourages both borrowing and spending. For example, if interest rates are, say, at 4% but inflation is at –2%, the real cost of borrowing is 6%. Indeed, loans to households and companies are growing at their slowest pace in decades in most OECD economies. Not surprisingly, given the depth of the global downturn and the aftermath of the credit crunch, banks are focusing on repairing their balance sheets and are reluctant to lend.
On the other hand, faced with mounting job losses and growing economic uncertainty, households are retrenching and paying down debt. Given these circumstances, there is little appetite for taking on additional debt. Similarly, with capacity utilization rates hovering at record lows in all the major economies, the need for companies to borrow funds in order expand plant and equipment is simply not there.
A Self-Sustaining Recovery is Still a Long Way Off
While there are welcome signs that the worst of the global recession is now behind us – GDP growth has turned positive in a number of the major economies including the United States, Germany and France – the foundation of the economic recovery is neither stable nor solid. There remains a very real concern about the sustainability of the recovery which is largely being driven by the various government stimulus measures and other temporary factors. But in light of the fact that job losses continue to mount, consumer confidence levels remain shaky, credit conditions remain tight, and private sector loan demand is virtually non-existent, it would seem that a self-sustaining recovery is still a long way off.
The key question remains – are the flickering signs of improvement in the global economy a precursor to sustainable growth or does it merely reflect a pause before the economy starts to downshift again? Much will depend on the sources of growth and its trajectory over the next few quarters. Crucially, until the private sector, especially in western economies, starts to ramp up production and resumes hiring again, the recovery could well falter.
Moreover, the danger is that if growth fails to revive once the stimulus ends, the world may find itself back at square one once again. But, this time it will be saddled with a humongous amount of government debt.
Bottom Line:
In the concluding sentence of the June 2009 edition of the monthly commentary I cautioned that ‘….the battle against deflation has yet to be won and it will continue to dog policy makers for months to come’. With deflation now starting to take root in dozens of countries the matter is even more urgent.
Ranga Chand is recognized both domestically and internationally as one of Canada's leading economists and mutual fund analysts. Professionally, he held senior positions with Canada's Department of Finance, then served as a director of the Conference Board of Canada, before joining a major stock brokerage firm. He has also taught economics at the University of Waterloo, published extensively in the field of economics, and represented Canada at numerous economic forums, including the OECD in Paris, the United Nations, and the World Institute of Economics in Germany.
A media personality with a huge following, his popular television show "Talking Mutual Funds with Ranga Chand" aired weekly on Canada’s Report on Business Television (ROBTV) for three years from 2000 to 2003 and reached over 4.3 million viewers nationwide. Much in demand by organizations, industries, and associations throughout
North America, Ranga is well known for his down-to-earth, clear, and informative presentations on the subjects of the global economy and investing.
He is the author of a number of best-selling books including:
Ranga Chand's Top 50 Mutual Funds
Ranga Chand's Getting Started with Mutual Funds
Best of the Best Mutual Funds, Featuring America's top 50 Heavy Hitter funds
Is Your Retirement at Risk? Winning Strategies for a Financially Secure Future.
Highly respected in the investment community, Ranga Chand is founder and President of the research and consulting firm Chand Carmichael & Company Limited, located in Ottawa, Ontario.
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World Economy Slipping into Deflation Territory
Nov 16 2009
He is the author of a number of best-selling books including:
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