Does Deflation Lead to Depression? Who Sold Us This Theory?

Tuesday, August 18th, 2009

In a well written article at Bloomberg.com, Matthew Lynn challenges the notion of price deflation risk, and the widely held belief that deflation leads to economic depression.

First, is there really a risk of deflation anymore?

U.K. Chancellor of the Exchequer Alistair Darling said in a speech earlier this year that the Bank of England must be “prepared to act” to prevent price deflation.

“We are very keen on avoiding deflationary risk,” said European Central Bank President Jean-Claude Trichet in an interview this month. Much the same message has been pumped out around the world by economic leaders.

Nor have they been slow to put their freshly minted money where their mouth is. The Bank of England has embarked on a program of “quantitative easing,” or creating new money, to stave off the threat.

The trouble is, the theory doesn’t stack up.

Deflation, after all, has already arrived.

Is deflation killing the Eurozone?

So the “deflating” euro area is disappearing over an economic precipice, right? Not quite. It is leading the world out of recession. Figures released last week showed Germany and France were hauling the region out of the global decline — both expanded 0.3 percent in the three months through June after four consecutive quarters of contraction.

Not much sign of the dangers of deflation there.

Deflation did not prevent some of the most expansionary periods in history, e.g. the Industrial Revolution:

In other words, there were plenty of deflationary years. Yet over that period, the U.K. became the greatest economic power in the world: Its relative decline only started once inflation took hold. Deflation didn’t stop the Industrial Revolution, one of the most sustained times of economic creativity ever seen.

Likewise, a 2004 study by the Federal Reserve Bank of Minneapolis looked at the data on deflation across 17 countries over 100 years. It found that although the Great Depression of the 1930s was linked with falling prices, that wasn’t true of any other historical period. There was, it said, “virtually no evidence” that deflation caused a depression.

Why should it? We are constantly told that deflation is bad because it makes consumers hold off from buying things, thinking they will be cheaper tomorrow. But that is just silly.

The Bottom Line: Matthew Lynn is arguing that there are numerous times in history when deflation and depression were mutually exclusive c0nditions and only one time, The Great Depression, when the two were linked. Therefore the consensus that deflation leads to depression may be flawed. Lynn is not saying that a depression is not possible, just that it is not necessarily preceded by deflation. In addition, another important point Lynn makes is that we should not fear deflation, when in fact, we are already in a deflationary economic period.

Read the complete article here.

Source: Deflation Theory is a Lemon We Have All Been Sold, Matthew Lynn, Bloomberg, August 17, 2oo9

Tags: Alistair Darling, Bank Of England, Bank President, Bloomberg, Chancellor Of The Exchequer, Consecutive Quarters, Economic Creativity, Economic Depression, Economic Leaders, Economic Power, ETF, Eurozone, Federal Reserve Bank, Federal Reserve Bank Of Minneapolis, Global Decline, Great Depression, Industrial Revolution, Jean Claude Trichet, Matthew Lynn, New Money, Relative Decline
Posted in Markets | No Comments »

Breakingviews: Sovereign Wealth Funds Risk Index

Friday, January 25th, 2008

Jan. 25, 2008 - Today, we received this piece about Breakingviews.com’s new SWF Risk Index:

Breakingviews sovereign wealth fund risk index

By Una Galani AND Simon Nixon

To see the full index with detailed rankings, click on the link below

Sovereign Wealth Fund Index: Sovereign wealth funds were hardly talked about twelve months ago. Now they are one of the hottest topics in global financial markets. Over the last year, these state-owned entities have spent over $75bn snapping up stakes in some of the world’s biggest banks, taken big positions in stock exchanges on both sides of the Atlantic and even attempted a takeover of one of Britain’s leading supermarkets.

Such funds have existed for decades, but the shift in global economic power and the current weakness in western markets has given SWFs – forecast to grow assets fivefold to $13.4tr by 2017 – new influence and raised new fears about their motives. Critics such as President Sarkozy of France and some US politicians worry that SWFs tend to be secretive, target political as well as financial returns, and operate at the whim of governments not always sympathetic to western economic and political interests…

Tags: Banks, Biggest Banks, Brazil, Breakingviews, BRICs, China, Economic Power, Emerging Markets, France, Fund Index, Fund Risk, Galani, Global Financial Markets, Markets, Miscellaneous, Motives, Nixon, Political Interests, risk, Risk Index, Russia, Sarkozy, Stock Exchanges, Supermarkets, Swf, SWFs, Takeover, Target, Twelve Months, Western Markets, Whim
Posted in Markets | No Comments »