If deflationary trends persist, they can trigger severe economic repercussions.
Once it is widely assumed that deflation will continue, purchases are postponed in expectation that prices will decline further.
The current deflationary sentiment is a remarkable development. That is replacing worries about inflation ever since the 1930s.
As an aftermath of the Great Depression, in the midst of soaring government spending and consequently large federal budget deficits, worries about inflation took centre stage, particularly after North America detached its currencies from the gold standard that had been the bulwark against currency depreciation and price instability.
Our economy seems beset by gloom despite the modest recovery in the economy. Strange twists are occurring. Common stocks have turned in a first-rate performance, reflecting many factors and with interest rates at notable lows, investors have turned to equities, hoping for a good return. Stock market valuations are on the high side, notably from an historic perspective, but relative to bonds, that appears to be the only alternative.
Commodity prices are widely falling, certainly a telltale sign of deflation, but what is unusual at this time is the strength of the government bond market. Yet many commentators have stated repeatedly that the one investment to shun is the bond market. Pending inflation it is assumed this would adversely affect bonds as interest rates, according to this view, are certain to rise.
Still, despite these forecasts about bonds, yields on bonds continue to decline to about two per cent, and in Europe interest rates have turned negative and bond prices climbed in response. That has taken place even though the United States Federal Reserve has bought massive amounts of bonds.
Worries about the weak economies of Japan and the Euro-zone have added to our concerns. The sluggish economies everywhere have hurt commodity prices. They have dropped more than 15% over the past year while industrial materials have fallen as well. As a consequence, banks have been reluctant to lend, as the stability of the borrowers is developing.
In view of these trends, moves to raise interest rates are being postponed. The principal hope for a reversal of the deflationary trends is that investors will remain buoyant, even with a desultory economic revival.
Companies in the United States and here are expecting a strong resurgence in the economy. Then the strengthening of the market for industrial commodities will dissipate the dis-inflationary tides.
Yet fears persist that the world is slipping back into a recession. All that can be said at the present time is that the deflationary trends are worrisome and bear watching.