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A View on How the U.S. Can Prevent a “Japanese-Style Deflation"

The only way the U.S. can prevent a "Japanese-style deflation" is through fiscal stimulus, according to an opinion expressed in the South China Morning Post.

This fiscal stimulus means "direct spending," not just tax cuts.

Here's an excerpt from an Oct. 29 South China Morning Post article:

In 2000, I sat in a bland grey Prague conference room opposite officials from Japan's Ministry of Finance. We were attending a G7/International Monetary Fund meeting. I asked if they thought the US and Europe could avoid Japan's protracted deflation. None of them could suppress a smile. "Unlikely," said one.

So far, these officials have been wrong, but just barely. European inflation is around zero, and US inflation is a bit above 1 per cent. Could Japanese-style deflation hit the United States? It could, particularly if Congress struggles to implement meaningful, long-term fiscal stimulus.

For savers, deflation means the assets that are so popular right now -- tech stocks -- could underperform the assets no one wants to hold, like cash and long-maturity Treasuries, a lesson Japanese investors have had to learn.

Lower US inflation will occur if demand is weak and goods supply ample. To stimulate demand, typically the Federal Reserve lowers policy rates. In response, the private sector borrows and spends -- usually on houses and cars -- and the economy picks up. However, once policy rates are zero, the Fed can't lower interest rates further.

The Fed can buy assets. This forces money into the hands of asset holders, which drives stocks and bonds higher, but doesn't get money directly into the economy. The only way to do that is through effective fiscal policy (direct spending, not tax cuts), which means that the Fed, Treasury and Congress need to work together.

Yet, signs of a developing deflation are already showing up in the U.S., as well as elsewhere around the globe.

Here's a chart and commentary from the April 2020 Elliott Wave Financial Forecast, a monthly publication which provides analysis of major U.S. financial markets and the economy:

ProducerPrice

Changes in producer prices, a key deflationary indicator that tends to lead consumer prices, are already negative. The chart above shows the persistent long-term slowing of U.S. producer prices on what Conquer the Crash maintains has been a steadily waxing precursor to deflation and depression. Noting PPI's movement back and forth across the zero line, CTC observed that "economists have had difficulty explaining why producer prices have been so sluggish. The short answer is that deflationary psychology is creeping toward gaining the upper hand, no matter what the Fed does." In February, U.S. PPI appears to have crossed the line into deflation for what should be a long period of time. After rising slightly in January, the last full month of the bull market, year-over-year PPI for all commodities fell 1.4% in February. On a month-to-month basis, PPI for final demand fell 0.6%, the biggest decline in five years. The trend is clearly global in scope, as the drop was accompanied by falling producer prices in all of the world's largest economies. PPI measures from January-to-February declined in Germany, China, Japan, the U.K, South Korea, Canada, France and Italy.

Of course, that chart was published some months ago, yet it does depict the big-picture trend.