Inflation Is Plunging Globally – Is Deflation Next?

In my February 10 E-Letter, I focused on how deflation is spreading around the world, first in Japan since the 1990s and more recently in Europe, which saw inflation go negative in December of last year – for the first time in decades. This is a very serious issue and one I will be focusing on frequently in the months ahead.

Inflation is falling rapidly around the world. Take a look at the chart below. Inflation is now below 1% across the industrialized world. This is happening despite the unprecedented efforts of the US Federal Reserve and other central banks around the world to reverse this trend.


Some are now conceding, as does the Washington Post reporter who provided the chart above, that inflation is dead for the foreseeable future. While that is an interesting observation, those of us in the real world know that prices for things such as food, clothing, housing, etc. continue to go up month after month. But that is a different discussion for a different time.

Today, we want to focus on whether the current trend of falling inflation will lead to deflation – falling prices – in the months ahead. Let’s look at some historical examples of when inflation has declined.

Inflation has a long tendency to decline following financial crises, as was the case in the 1830s, the 1870s, the 1890s, the 1930s and more recently in 2008-2009. Throughout this almost two-century period, central bankers have fought vehemently to reverse falling inflation. The theory among such academics is that some level of mild inflation is preferable to falling prices.

As everyone reading this knows, the US Federal Reserve has been fighting an unprecedented battle to boost inflation since the financial crisis of late-2007 to early-2009. The Fed has printed apprx. $3.5 trillion in new money to buy US Treasury securities and mortgage backed securities in its effort to reduce long-term interest rates, while at the same time holding the Fed Funds rate near zero.

Despite its massive bond-buying program and ZIRP (zero-interest-rate-policy), inflation has continued to fall. Making matters worse, if you are a central banker, is the fact that oil prices collapsed by almost 60% since the middle of last year. Almost no one expected that.

Now this is good and bad news. The good part is that cheaper gasoline puts more money in people’s pockets for them to spend. But the bad part is why oil prices are so low. Sure, a lot of it’s about the new supply that’s come online from US fracking technology. But most economists agree that the huge decline is oil is because of decreased demand. The global economy, in other words, is slowing down again.


Source: Eurostat

As a result, the US Consumer Price Index dropped in December, down 0.4%, the most in over seven years. This raises the question:

Is The US Headed For Deflation?

The US has done better than almost every other post-financial crisis economy (which doesn’t mean it couldn’t be doing even better with better policy), but now its relative strength is at risk of becoming a weakness as the dollar has gone up significantly, making our exports more expensive around the world.

Put it all together, and you get falling demand that’s turning into falling inflation, which could spell trouble for our economy later this year. As I wrote in my February 10 E-Letter, I don’t believe that the US economy will fall prey to deflation anytime soon – meaning the next year or two. However, the growing deflationary trend around the world certainly increases the odds that it could happen here before too long.

The fact that the Fed has printed an unprecedented $3.5 trillion to buy US Treasury securities and mortgage backed securities to push interest rates to near historical lows, and yet inflation continues to fall, should be a warning to us all that we are in uncharted waters.

While the US stock markets are at or near all-time highs, and interest rates near all-time lows, these are not signs that all is well. In fact, just the opposite perhaps. As a result, I would advise investors to be taking steps to protect profits and reduce risks.

Now might be an opportune time to consider some of the professionally managed investment strategies I recommend, with the option to move out of the market when the risks are highest. You might want to attend our next webinar with Niemann Capital Management next Thursday, February 26 at 3:00 CST. To register for the free webinar, CLICK HERE.

Posted 02-24-2015 12:26 AM by Gary D. Halbert
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