Deflation on the way?

The conventional wisdom is that, with the recession, the US will experience some inflation. Flanders, the resident financial guru on this blog, thinks the opposite. Here is a potential scenario for deflation, via Flanders, with some input from myself:

a) Deleveraging (selling assets to raise cash) by financial institutions means that they need lots of cash now-now-now and so dollars (because investors want to be paid in dollars rather than Euros or pounds) are more valuable.
b) A global recession means that raw materials are going down in price. So if you are a business needing raw materials, why buy now? Hoard your money for a bit and raw materials will be cheaper in the future. This could create a cycle of reduced demand creating an even steeper slide in price for raw materials, increasing the incentives to hoard money and buy later, decreasing demand further, etc. etc.

So overall, demand (from financial institutions) for the dollar is going up, while supply is going down because of hoarding. When demand goes up and supply goes down, price goes up. Therefore dollars will increase in value.

Since I don't really understand this stuff, comments are welcome.


Pat said...

i'm gonna disagree, while stipulating that i also don't know anything about any of this stuff. there may be some deflation in the short term, but i dont see how it could last, while the US recession seems certain to. long-term demand for dollars globally decreases i think as the global markets lose their taste for the places that started this whole mess. that plus whatever further actions taken by the fed in an attempt to bail out the economy... obama sounds keen to bailout the failing auto makers.. sounds a lot like japan in the 80s to me. and i think they experienced some pretty bad inflation then.

cflanders said...

Japan was highly DE-flationary in the 90's, which is why they had interest rates at 0% for a decade. Sounds like the Fed is on its way of taking us there or near there.

cflanders said...

The biggest "tell" for the deflation argument is the price of gold. Gold peaked a little over $1000 an ounce and now sits at $730. In times of panic/crisis gold usually zooms. So why is gold going lower and lower as the dollar moves higher, even with the Fed printing more and more money.

cflanders said...

Also, remember that for the longest time, the dollar kept going lower and lower. A lot of companies that manufacture stuff overseas shorted the dollar at higher levels to lock in that price for the dollar. They then converted it to another countries currency (say a south east asian currency) to pay for goods manufactured there. Now the currency they converted it into is worth less and the dollar which they shorted is worth more. I'm sure a lot of these companies are now covering their dollar shorts and are probably buying dollars before the market gets away from them.

And, Im Out said...

Looks like flanders and the Fed are on the same page. way to understand cyclicality in the marketplace flanders!