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Inflation Genie, Deflation Ogre

Do you see either in assets or consumer prices...?
IT REALLY can't get much clearer, writes Greg Canavan in The Daily Reckoning Australia.
Prices aren't going up quickly enough for the head of the IMF, Christine Lagarde. Falling prices (aka deflation) threaten to derail the economy, she reckons.
"With inflation running below many central banks' targets, we see rising risks of deflation, which could prove disastrous for the recovery. If inflation is the genie, then deflation is the ogre that must be fought decisively."
Our family wealth expert Vern Gowdie agrees that deflation is on the horizon. Though he's no fan of Lagarde's, having previously labelled her "a socialist politician with zero experience in banking," he thinks deflation will wipe out huge amounts of wealth in the years to come.
But it won't happen if our heroic central bankers can help it. Here's more from Lagarde:
"Central banks should return to more conventional monetary policies only when robust growth is firmly rooted."
We'd suggest that robust growth is already firmly rooted. But that might get lost in the translation. In the meantime, Lagarde has sent a clear message to the world's central banks not to tighten policy until inflation is firmly entrenched. Not that they need any encouragement.
But what type of inflation? This is a crucial question. The lack of any type of nuanced answer shows just why the global economy remains in a precarious state five years after Lehman blew up.
First, where is the deflation? It's certainly not in asset prices. Over the past few years, the good old boys in the central banking club have pulled off the most successful reflation in history.
It's been so successful, in fact, that if it falters now, we're apparently going to be in a world of ogre-filled pain.
So no deflation in asset markets. Just rampant inflation. But the world's financial overlords don't even consider asset price inflation to be inflation at all. According to them, it's 'wealth'.
Their one-dimensional approach to the inflation/deflation theme is goods and services inflation. But even according to the highly cooked official measures of goods and services inflation, you're not seeing outright deflation in any major economy.
We say highly cooked because there are all sorts of strategies to hide inflation these days. There's the official ones like 'hedonic adjustments' and market based ones like shrinking packaging and lower quality ingredients...even restaurants re-jigging their menus with lower quality meat cuts and cheaper ingredients to keep prices low.
That wouldn't be a necessary strategy if wages were keeping pace with 'real' inflation. But you can't really hide inflation when it comes to beer. They tried it in Sydney years ago with the emergence of the shameful 'schmiddy', a cross between a schooner and a middy, with a schooner price tag. And while everyone grumbled about it, it was apparently worth the price to drink at an 'upmarket' pub.
Now you can't get away with buying a pint in Melbourne for much under $10. It's a national tragedy.
So where exactly is this obsession with deflation coming from? It provides cover for central banks to stimulate for as long as they can. The whole purpose of easy money is to raise the price level and 'inflate' away the debts of the irresponsible.
This avoids the need to write down and restructure bad debts. To do so would hit banks' profitability. And we all know banks are off limits when it comes to taking responsibility for previously poor lending decisions. So the little man pays through the subtle inflation tax.
The irony of the whole thing though is that current central bank policies merely create vast amounts of speculation and asset price inflation. This raises the risk of a destabilizing asset price bust that will REALLY bring about the risk of a deflationary depression.
Only this time people will finally see that the central bankers were the primary cause of it. When this happens, confidence evaporates and the game is up. To avert a meltdown of historic proportions, markets will probably close for a few days while the rules of the game change. But that possibility is over the horizon at this point.
Still, when it arrives much wealth will be lost. Inflation and deflation are two sides of the same coin. One leads to another. And the more inflation you have, the greater the deflation that will come after.
With people like Lagarde calling the shots, it's no wonder the world has problems. And sorry to say, these problems aren't going away. They'll fester under the surface and then one day will explode, revealing these people as the frauds that they are.

Greg Canavan is editorial director of Fat Tail Investment Research and has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as and the Sydney Morning Herald.

See the full archive of Greg Canavan.

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