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Where's The Inflation?
By Paul Amery | 22 May, 2009 10:02 (GMT)   

To me this is a contrarian indicator.  It seems that the themes of the day are the green shoots of recovery, buying emerging market equities, buying inflation-protected bonds and shorting long-term Treasuries.

But wherever I look I see evidence that prices are falling, not going up.

Yesterday I was talking to a Ukrainian friend who runs a team of building workers in London.  Since the housing market started to fall, he said, he's being undercut aggressively by other contractors who are desperate for work - to the point that he doesn't understand how they can cover their costs.  And this is at the cheaper end of the market.  The only people in London who still have money to spend on substantial renovation jobs, he said, are middle easterners, whose wealth is linked to oil.

Then last night I went to see a film with a friend who makes television documentaries.  Budgets at the channels commissioning such features have gone through the floor, he said, and independent producers are being forced to work for far less.

Residential property rents are falling in both the US and the UK and so prices could have plenty further to go down too.

The US economy is operating with a record output gap - the difference between actual GDP growth and the potential growth trend - which means more downward pressure on prices.

I read somewhere this week about plummeting resale prices at auction for some of Caterpillar's monster trucks - from a $4-5 million price tag new, to a few hundred thousand now, though I can't find the link.

This evidence says that deflation is accelerating, and yet everyone seems to want to talk about green shoots and rising prices.  Something doesn't add up, and I suspect it's another case of the financial markets indulging in wishful thinking, or the slope of hope, whatever you want to call it.

I conducted two interviews for the forthcoming June edition of ETFR, which will be out online in the next few days, one with an economist expecting inflation (Peter Warburton), the other with one expecting deflation (Steve Keen).  It was a fascinating assignment, and I've thought a lot about the two sides' cases.  But, on balance, I find Keen's argument hard to dispel.  He describes the multi-decade scale of the debt bubble, argues that it has to be unwound, and that central banks' attempts to counter the deleveraging wave will fail, as it's too big for them to fight against.

I can see why central banks, governments and bank bosses want to see, in fact are desperate to see the return of inflation.   But that doesn't mean we're going to get it. 

Even if deflation is not the consensus outcome, it must be prudent for everyone to take a long hard look at how they would manage with a prolonged period of falling prices, and to consider positioning their portfolios accordingly.

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