Why Deflation–and Not Inflation–Is the Main Concern Right Now

Steven Ricchiuto, Chief US Economist for Mizuho Securities, argues that we are in a fundamentally different economic environment than the last 35-40 years where deflation—and not inflation—is now the main concern and raising rates may end up being a huge mistake. Here's a portion of his recent interview with Financial Sense Newshour on his big picture outlook...

Just when it looked like the US economy might gain momentum, there's now been a string of less than favorable numbers come in. What's your reading of the US economy and your general outlook?

"Well, I think what you're really seeing is an economy that's just stuck. We've been stuck in this 2 - 2.25% growth path for about 5 years and I don't see that changing...

The Fed is telling us that they think the economy will accelerate by the middle of this year. Keep in mind, the Fed has been saying the economy should accelerate in each of the last five years and they've been wrong...

The Fed is telling you that they think inflation is going to pick up and the latest PPI number comes out and there's clearly no evidence of a pickup of inflation in the PPI number. In fact, you might argue...that there's some deflationary signs showing up in there.

The third point the Fed is making, 'Well, if we get stronger growth and we get stronger inflation, we're going to have stronger wages,'...well, we don't have stronger growth, we don't have stronger inflation and we certainly don't have any evidence of an acceleration in wages. So, therefore, the three basic premises that the Fed is saying that they'd like to raise rates on are not coming to fruition, so why would you forecast that the Fed is going to raise rates?"

Do you think that the US economy is about to roll over into a recession?

"I don't...and this is the other side of the equation. Basically, we are no longer living in inflation cycles. Historically, in a world of excess supply, inflation determined business cycles: inflation heats up, the Federal Reserve creates a credit crunch, the economy slows down, inflation comes off a boil, the Fed takes its foot off the brake and puts it on the accelerator and everything goes back to its merry way.

Since 1990 we haven't really had an inflation cycle—we've had three credit cycles. And credit cycles behave very differently. Credit cycles have an improving phase and a deteriorating phase and they last much longer than inflation cycles do because we've now transitioned into a world of excess supply of tradable goods.

We can produce more goods and services than we can consume as a nation. And globally there's an excess supply of goods and services as well, which are weighing down on domestic pricing power. So we don't necessarily have to go into a recession to get the deflation. We could actually import the deflation which is another argument against raising rates because raising short-term rates will lead to a stronger dollar..."

What do you say to those who believe we need to be raising rates because the unemployment rate has gone down?

"My argument to them is I don't know what the unemployment rate is telling me because participation rates have not been at these levels for 40+ years. And I also don't know what is the appropriate level of short-term interest rates given that we now have a global economy where a number of large important economies now have negative interest rates...

This concept that just because nominal interest rates in the United States are near zero that is somehow or another abnormal, I think against the backdrop of where the global economy is, it may not be abnormal. And this is again where you have to begin to look beyond the models and look to the fact that this is a different world...when you look at the data that is facing you and you look at the global interest pattern that's facing you and you look at the deflationary pressures...you're faced with an environment where this time it is different...

This was exactly the same mistake [the Fed] made in the 1930s where they continued to believe the old patterns and flow-throughs would work and suddenly discovered after they raised rates that they blew it. And that again is a critical issue...we are in a new world order: we now have a world of excess supply, we now have credit cycles...and that is a fundamental difference between the US economy then and the last 35-40 years vs where we are now..."

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