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Deflation: Just a Figment of the Imagination


The fuss about alleged deflation is going to backfire

Editor's Note: This article was written by Nadeem Walayat, an editor for The Market Oracle.

What Is Deflation?

Deflation is the decrease of general prices in an economy. The most widely recognized measure of which is the Consumer Price Index (CPI), the composition of which aims to standardize the measure of prices of economies across the world to enable easier comparative analysis.

Unfortunately, many analysts mistakenly pick and choose alternative measures against which to support their own point of views at a particular point of time. This pick-and-mix attitude to analysis isn't just limited to deflationists, but inflationists also have been seen to seek propaganda over facts.

Inflation and deflation aren't measured by comparing one asset value against another, i.e. comparing gold prices to house prices. Whilst they may form part of a deflationary or inflationary scenario, they are not at the core of inflation or deflation, so such arguments are not analysis but rather propaganda.

Now, whilst my inflation mega-trend analysis is primarily focused on the UK economy because that's where I reside, the same could apply to the United States and most other Western developed economies.

UK Consumer Price Index (CPI)

The UK CPI clearly illustrates that all we saw from mid-2008 and into early 2009 was a minor deflationary corrective wave amid an ocean of year-on-year inflation. Subsequent inflation has far surpassed the inconsequential deflation seen during 2008 and into early 2009. Therefore the facts are completely contrary to the headline-grabbing mainstream press and blogosphere scaremongering of price deflation.

There has been no significant deflation, despite economic contraction of more than 5% GDP, unemployment soaring above 2.5 million, asset price destruction ranging from between 25% and 50% into the early 2009 lows. In fact, the deflation that we witnessed is probably mostly due to the sharp drop in commodity prices such as Crude Oil's collapse from mid-2008 into early 2009.

What Does This Suggest?

It suggests that severe economic contraction, debt deleveraging, and asset price destruction only succeeded in generating a minor corrective wave against the inflationary mega-trend, which therefore looks set to return with a vengeance over the coming years -- exactly what my inflation mega-trend scenario analysis continues to suggest as the government and the Bank of England (as with other central banks) mistakenly continue to be fixated with fighting deflation.

UK Retail Prices Index (RPI)

The CPI is the government's preferred measure of UK inflation because it's less volatile than its predecessor, the RPI index, which is the more recognized measure of UK inflation by the people of Britain as it pre-dates the CPI by many decades.

The above graph shows that the RPI has experienced stronger deflation than that seen in CPI.

However, this is because of government intervention, specifically in forcing UK interest rates down to an artificially low rate of 0.5%.

And this is coupled with funneling near-unlimited taxpayer cash to the bailed-out banks by means of quantitative easing, capital injections, and bad debt loan insurance -- which have created an artificial banking system that generates unprecedented profit margins for the banking industry to rebuild their balance sheets. Though, as we have seen with bank bonuses, this isn't what the bankers are doing, instead choosing to pay out artificial profits as bonuses.
No positions in stocks mentioned.

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