Deflation Fear
David R. Kotok
August 26, 2014



A worldwide deflation fear is expanding and may actually be rampant. BCA Daily Insights (August 25, 2014) notes that, “out of 32 OEC countries, more than two-thirds have domestic inflation rates that fall short of 1%.” BCA analysts go on to argue that the worldwide inflation rate may converge to zero over the next couple of years.

Debt markets currently reflect this fear. Here are examples of yields on the benchmark 10-year interest rate for sovereign debt. This is not about credit risk. This is about the risk that the global price-level change will approach or reach zero.

1.      United States 10-Year Treasury Yield, 2.4%
2.      Germany 10-Yield Bund Yield, under 1%
3.      Japanese 10-Year JGB Yield, under 0.5%
4.      France 10-Year Government Bond Yield, 1.3%
5.      Canada 10-Year Government Bond Yield, 2%
6.      United Kingdom 10-Year Government Bond Yield, 2.5%
7.      Mexico 10-Year Government Bond Yield, 3.2%
8.      Italy 10-Year Government Bond Yield, 2.4%

These are unexpected and remarkably low yields.  They reflect the results of central bank policies and the results of growing fear of disinflation or even deflation.

Is it any wonder that central bank actions which expand quantitative easing produce little or nothing beyond growing balances of excess reserves as those created monies recycle back into the central banks? Is it any wonder that an alternative form of recycling monies in the US, the reverse repo, is currently functioning at an administered interest rate of 5 basis points (0.05 of 1%).  The answer is No!

Worldwide deflation risk is serious business, and it is rising in the eyes of market agents. It means that central bank policies are neutralized. The central banks of the world have tripled the amount of excess reserves since the financial crisis commenced. If they were to quadruple the amount of reserves in the next year, doing so would not make much difference. Does it make any difference if the Federal Reserve holds an extra half trillion dollars of Treasury securities that are reflected in a rising balance of a reverse repo or in additional excess reserves? The answer essentially is no.

For the last six years, central banks worldwide have collectively offset the failure of their governments’ fiscal policies. That is about all they could possibly do. They have enabled nearly all creditworthy corporate and institutional borrowers to successfully undertake refinance at very low interest rates. That is about all they could possibly do. They have enabled creditworthy individuals and households to refinance household debt in order to realign their debt service payments. That is about all they could possibly do.
The burden of turning global economies around now falls on governments and their fiscal policies – policies that encourage growth, policies that diminish taxation, policies that expand trade, policies that address rising geopolitical risks that interfere with the expansion of trading.
Government officials’ criticisms of companies that want to seek better tax policies are specious and harmful. US Treasury threats to investigate “unpatriotic” transactions and other government interferences lead to contraction of trade, reduction of economic activity, and suppression of growth.

Unfortunately, governing executive branches, including the Obama administration in the US, still do not get it. The legislative branches in the mature economies and governments of the world continue to appear to be broken. The culprits are not the central banks. They have done all that they can.
We remain in the camp that suggests the short-term interest rate will be near zero for a long time in the world and for, at least, another year in the US. After that we expect that the short-term rate will rise very slowly here. It may not rise at all in some places in the world for the rest of the decade. Our US Exchange-Traded Fund accounts are fully invested.


David R. Kotok, Chairman and Chief Investment Officer, Cumberland Advisors

Category: Inflation, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

22 Responses to “Deflation Fears”

  1. Frwip says:

    Central bank policies are one explanation. Lack of proper fiscal policies is another one.

    But that has been going on since the 80s. Those explanations are going a little stale.

    And asking for policies that “diminish taxation” is a bit rich when this is exactly the kind of policies we’ve been having for the past 30 years. The rare ‘job creators’ who haven’t found a way to fully avoid taxation are taxed at 15%, at most. How much lower than that do you want to go? Zero? Welcome back to the Roaring 1870′s?

    There is another way to address the distortions that tax optimization strategies create and Kotok bemoans : to tell those corporations that is they want to do business in the country, they have to pay their taxes in full on every bit of revenue originated in the country, no matter which kind of Double Irish With A Dutch Sandwich they’re having for breakfast.

  2. postpartisandepression says:

    Just another excuse for lowering the tax burden on those that can afford it – corporations. It is true that the burden falls on governments and has fllen on them practically since the beginning. The US should have used these low interest rates (and should still) to rebuild our woefully inadequate and crumbling infrastructure which woudl put people to work and probably create a boom but we have a political party that would rather destroy the United States rather than let the black guy win.

    • RW says:

      Got that right. The revanchist reactionaries of the Right blow lots of smoke but most have no real respect for empirical evidence (unless it comes from ‘their side’) never mind any capacity for dispassionate analysis so ultimately what it really boils down to for them is: ‘We’ just can’t let ‘those people’ win! (meaning ‘We’ need more privileges and advantage)

    • mlnberger says:

      Read a bit more carefully. Kotok is calling for both stimulus and tax cuts — reasonable policies if the goal is to increase demand. His final paragraph, however, does take a pot shot at the administration that is unwarranted — with this tight-fisted Congress, revenues are tight, and diminished taxes for most in Congress means small Federal budgets, a foolish policy where the US government can borrow at historically low interest rates and the economy needs a kick in the pants.

      • Petey Wheatstraw says:

        If we do more stimulus and tax cuts, we might as well do helicopter drops of cash, for real.

  3. johnl says:

    Every day low prices, aren’t people looking for deflation every day at Walmart’s??
    Deflation works for me, but I don’t carry much debt.
    If my dollars won’t grow with interest, go right ahead and deflate them bigger please. It worked in Japan for a decade or two……..wonder what the push for inflation will do to them???

  4. dvdpenn says:

    I agree with Kotok that central banks (at least the US Fed) have been acting in the absence of reasonable fiscal policy. The issue is, and remains, a lack of aggregate demand. And while greater government spending is the cure, “lower taxes” are a pretty poor delivery system, especially if the taxes to be lowered are corporate taxes

    Working and middle class people need more money. Give them – and the businesses that employ them – a payroll tax holiday, and you’ll get the growth you want, without the debt you don’t. A payroll tax holiday would put $600 a month on average back in the pockets of the average family. That’s real money for people in my neighborhood.

    • Iamthe50percent says:

      Another payroll tax holiday and another and another would destroy Social Security just as demands are peaking. The American working man doesn’t need his old age pension to go away. He needs CHINA to go away.

      • VennData says:

        Americans with anti – intellectual, anti-education bias who are and religious schools, home schools and refuse to learn math and science and critical thinking skills (I am talking to you Texas) are the problem, not China.

        China is here to stay, Mexico, Korea, South Africa, and the rest of the world is here to stay. Thank goodness, now learn to read, do math, and think. Start by not falling for the Fox News and WSJ opinion page spin.

      • DeDude says:

        A payroll tax holiday that is covered by a transfer from general revenue funds to the SS trust fund does not have any impact on the solvency of the program. The question is how effective it is as a stimulus compared to other things such as investment in our infrastructure.

  5. Petey Wheatstraw says:

    They haven’t done everything they can.

    I have never gotten a straight answer to this question/scenario:

    The Treasury (not the Fed), bails out out the indebted with a huge round of QE (2.5X the average debt of the bottom 95%, or so). The bail out money would be taxed at 50% (effectively flooding the treasury with enough money to offset or substantially offset the national debt).

    With the remainder of their bailout money, the indebted will be required to pay off all of their debts, or as much as their share of the bailout will cover. This money would make the banks whole.

    At the same time, the government takes half a page out of the Nixon wage/price controls, and fixes prices, but not wages, for two years.

    Any remaining funds could be used by the indebted to spend as they see fit (starting businesses, buying crap, and generally spending freely).

    Yes, the dollar will take a huge hit, but it’s fiat, anyway (didn’t seem to hurt much when the banks were bailed out to what would have been unthinkable 30 years before, when we passed our first $Trillion dollar budget, under the deified Saint Ronald, in 1983).

    The economy would be smoking hot for years afterward.

    Lots of folks say this wouldn’t work, but non have been able to say why (a reaction that has become standard when the average American is confronted with anything having to do with the status quo that they don’t understand).

    Of course, the squillionaires fortunes would not look so damned out of whack, and their huge advantage over the average person would be minimized), so there would be a political resistance to it, but the economics, within our current system, and in light of the damage caused by a credit-based economy, would work.

    It’s either that, or eventual social breakdown.

    Anyone here that could destroy this scenario, please do. I’d love to stop thinking about it.

  6. Futuredome says:

    and then Germany starts printing Euro’s……..bye bye deflation. All the “deflation fears” are coming from one area and one only. Central banks are irrelevant. Germany initially got a subsidy but that is long gone. They have to print euro’s to expand the money supply to demand or face a recession.

    Another option would be to abolish the Euro, but you still end up with the same problems that existed before the Euro. Thus, Euro printing here we come. The real question is what does this do to global markets. I see 5 things: One, the Euro will crash against the dollar, or I should say, “respect” will come to the dollar as it should have been since 2011. Second, a surge in debt writedowns will likely happen with the incoming cash, likely leaking into the US markets. 3rd, commodities will decline as the rise in petro-dollar value squeezes at the margins driving liquidity into equities. 4th, government bonds globally will sell off as wealth will offload to investment vehicles 5th, credit expansion………….now the central banks become meaningful and to see if they learned their lessons or not.

    Germany’s attempts to squeeze the petro-dollar is over imo. They lost. They can’t sit by and watch the US grow while they contract.

  7. Herman Frank says:

    Good points. Where I go along is that the Central Banks stepped in to the best of their ability (and charter) to go where politicians didn’t want to or dared to or decided not to go. High time for the politicians to start working on getting systemic fixes in place, “step up to plate and start making the points!”

    Where our solutions diverge is that taxes should be more in relation to expenditure and be made more equitable (Warren Buffet said it so succinctly “why do I pay less taxes than my assistant?”), cut out the local pork …. and “get the house repaired and modernized!” Airports, high-speed trains, highways, optical cable (4G / 5G reach), harbors, workforce education, education at large, innovation and R&D should all be brought into the modern era. Look what the rest of the world did “to catch up with the shining US example”! They focused and overtook the # 1 example!

    America, don’t look into your rear-view mirror of history and lost-glory. Look in front of you to see who’s ahead of you and catch up with THEM! If you continue to look in your rear-view mirror you will see more and more countries behind you, but in reality they’re about to lap you! These countries took a decision to catch up with you in 5 – 10 – 15 years. When was the last time anyone here thought in those terms?!

    Will it help to make a comment like this? Don’t think so, as it takes a lot more than a comment to change the course of a culture.
    Good luck and Good Night!

  8. VennData says:

    So much for the inaction in DC meme being good for America.

    It’s bad for America the way the GOP refuses to poass anything just to make Obama look bad and not give him a “legacy.”

    GOP needs to accept that their precious egos are not the most important thing in this world and pass legislation.

    You want things done? Leave the GOP, cut off support to them.

  9. spencer says:

    We live in an open economy with a large current account deficit.

    Under these conditions the equilibrium, or market clearing bond yield is the one that attracts sufficient foreign capital with a stable currency. If the exchange rate is rising domestic bond yields are higher than they need be. Conversely, if the currency is falling it means rates are too low.

    I’m amazed that we have an entire industry of economic forecasters that do not incorporate foreign interest rates into their bond models.

    If you experiment with some measure of foreign yields into your bond equation you will find that that has become more and more important as a major determinate of bond yields. I use the average of British, German and Japanese bond yields in my bond equation and it plays a much larger role than fed funds and its importance continues to grow.

    Remember how in December the entire Wall Street community was forecasting that because of tapering, US bond yields would rise sharply. Well, they were completely wrong and in the face of tapering, bond yields fell. Why is it not surprising the few in the Wall Street forecasting community
    try to explain this are change their approach to forecasting rates.

    My bond equation has indicated that bonds were cheap all year and a major reason for that was the drop in foreign yields. Before you pay attention to any forecaster you should require them to explain why bond prices rose in the face of tapering.

    • Petey Wheatstraw says:

      Money created out of thin air (with interest due, upon creation), traded for bonds created out of thin air (with guaranteed interest payable, upon issuance), and we still have a F’d up economy.

      Where does capital come from?

      The same place it always did: Labor.

  10. DeDude says:

    Surprising that the one thing that would help both the slack in demand and the lack of inflation is not mentioned. I guess the people buying Kotok’s services would not stand for him talking about the most effective of the Obama proposals – increased minimum wages.

  11. victor says:

    Eventually the debt owners, domestic and especially foreign will demand higher rents and, we’ll hear in unison:
    Quo usque tandem abutere, O Federal Reserve Bank patientia nostra? Quam diu etiam furor iste tuus nos eludet? Quem ad finem sese effrenata iactabit audacia? (Cicero)
    Will the curtain then fall and expose the nudity of the Emperor?

    • History Buff says:

      Thanks for the prediction.

      So far, your thesis has been wrong for a century, but lets check back in 5-10 years to see if you have become correct.

  12. […] Indeed, despite massive QE by the U.S., Japan and China, there is now a worldwide risk of deflation. […]