Like most individuals who follow markets, I have spent the previous 2 years unsure between concerns that inflation will take off again as a result of the quick cash being pumped into the economy and between the opposite anxiousness that we may actually slip into deflation due to the depth of the commercial slowdown.
Markets themselves have yet to reach agreement on this subject. Bond markets seem to be pricing in a lengthened period of deflation with yields on 10 year administration bonds at wafer-thin levels, yet when one examines the costs of inflation-linked bonds, it also becomes clear that a decent number of financiers are buying cover against inflation.
The strongest case I've read so far that we face a lengthened period of deflation comes from a speech by Adam Posen in his capacity as a member of the Bank of England's Monetary Policy Committee (MPC). Histalklays out an strong debate why we are not in danger of inflation now and why more aggressive action is needed from central banking institutions.
In short his main points are:
1) there's not much likelihood of inflation because so much productive capacity (labour and machinery) has been idled but it's not been destroyed. In The United Kingdom, for example, he cites research showing that without the crisis total output (ie the scale of the economy) would now be 10% bigger than it now is. The facility to produce products and services to that extent isn't totally gone. Workers are still ready to work and many factories have simply closed a single production line or gone to shorter hours. But they have not dumped many factories. So that the economy could grow at a cracking pace without putting pressure on salary and costs.
2) Central Banking Institutions have to do more, but cannot do much more with interest rates alone, so they need to start purchasing assets and keep doing so until they start to see the economy moving in the right path (ie target the end result, not the amount spent).
For more detail you really need to read Posen's talk completely. It runs to 38 pages so will take a little while, but makes for animating reading.
As for the investment conclusion - if you think as he does that we are facing prolonged deflation then the assets you wish to be holding are government bonds, maybe even really long term ones. If Central Banking Organizations push IRs down (ie yields) by even a quarter of a % point then there is big money to be made. Bonds may be in a bubble, especially if you are thinking of holding them for a very long period of time , but for now with economies slowing, deflation a threat and central banking institutions moving more assertively it appears that there may still be some legs left in yields.
Markets themselves have yet to reach agreement on this subject. Bond markets seem to be pricing in a lengthened period of deflation with yields on 10 year administration bonds at wafer-thin levels, yet when one examines the costs of inflation-linked bonds, it also becomes clear that a decent number of financiers are buying cover against inflation.
The strongest case I've read so far that we face a lengthened period of deflation comes from a speech by Adam Posen in his capacity as a member of the Bank of England's Monetary Policy Committee (MPC). Histalklays out an strong debate why we are not in danger of inflation now and why more aggressive action is needed from central banking institutions.
In short his main points are:
1) there's not much likelihood of inflation because so much productive capacity (labour and machinery) has been idled but it's not been destroyed. In The United Kingdom, for example, he cites research showing that without the crisis total output (ie the scale of the economy) would now be 10% bigger than it now is. The facility to produce products and services to that extent isn't totally gone. Workers are still ready to work and many factories have simply closed a single production line or gone to shorter hours. But they have not dumped many factories. So that the economy could grow at a cracking pace without putting pressure on salary and costs.
2) Central Banking Institutions have to do more, but cannot do much more with interest rates alone, so they need to start purchasing assets and keep doing so until they start to see the economy moving in the right path (ie target the end result, not the amount spent).
For more detail you really need to read Posen's talk completely. It runs to 38 pages so will take a little while, but makes for animating reading.
As for the investment conclusion - if you think as he does that we are facing prolonged deflation then the assets you wish to be holding are government bonds, maybe even really long term ones. If Central Banking Organizations push IRs down (ie yields) by even a quarter of a % point then there is big money to be made. Bonds may be in a bubble, especially if you are thinking of holding them for a very long period of time , but for now with economies slowing, deflation a threat and central banking institutions moving more assertively it appears that there may still be some legs left in yields.
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