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We are walking on deflationary quicksand

‘The clowns pulling the levers of fiscal and monetary policy will take us back into recession’, with outright deflation beckoning as we all turn Japanese according to SocGen’s perma-bear Albert Edwards

 

The UK is heading for a double dip recession and a Japanese style deflationary spiral that will send the deficit higher, according to SocGen’s perma-bear Albert Edwards.

He warns that the fiscal situation could become so bad that central banks will be forced to print money, which could even spark a return to the days of double digit inflation.

‘The clowns pulling the levers of fiscal and monetary policy will take us back into recession. But this time outright deflation beckons and we will all be turning Japanese,’ he says. ‘Our view is that governments are insolvent. Ultimately, central banks will be forced to print and print for fear of the alternative. And maybe 20%+ inflation will indeed prove to be the ‘best’ (or least bad) way out of this mess.’

Edwards points out that most forward-looking indicators are now signalling a second half slowdown with the only area of debate around its actual magnitude. Added to this, core inflation rates are below 1% in the eurozone and the US, meaning we are just one recession away from Japanese-style deflation.

‘Investors have yet to fully acknowledge that we are now walking on the deflationary quicksand that will inevitably suck us towards fiscal and financial ruin- you ain’t seen nothing yet,’ he says. ‘Recent fiscal tightening will hasten the speed of our descent into this quagmire. The market reaction to the acknowledgement of that fact is likely to be unprecedented in its savagery. The response to the coming deflationary maelstrom will be additional money printing that will make the recent QE seem insignificant.’

‘The super-inflationary end will result will become obvious to all.’

Edwards slams the years of lax monetary policy, saying that although the transferral of private debt to the public sector is not unusual, the sheer scale of the current situation is what makes the outlook so bleak. He even goes as far to accuse the likes of Alan Greenspan, Ben Bernanke and Mervyn King of being ‘criminally negligent’ for the current ‘stinking fiscal mess’.

Taking financials out of the equation, Edwards says that there has not yet been any deleveraging. On the consumer level the same rings true with US house prices having slid for six months in a row even before the housing incentives ended in April.

‘A renewal of house price deflation will of course add more volume to the already audible sucking noise of an economy sliding into recession,’ he adds,

Edwards is renowned for his bearish take on things and many will argue that he has surpassed himself with this note. That said, few investors are positive about the outlook for the second half of the year and to an extent, it is all a question of degrees with Edwards clearly at the ultra-bear end of the spectrum.

6 comments so far. Why not have your say?

William Bishop

Jun 28, 2010 at 16:45

I have a certain scepticism about dire predictions of deflation followed by high inflation (or, for that matter, the other way about). The chances of getting both swings of the pendulum right in advance in such a forecast seem to me to be quite low. Muddling through between these alternatives, though less dramatic, still should be possible.

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Ian

Jun 28, 2010 at 16:53

There is nothing wrong with some modest deflation. My concern is that the collection of jokers in charge, Mervyn King etc, will do no more than make the situation worse. If they left the economy alone it would probably recover rather more quickly than with the uncertainty caused by the tinkering and intefering.

Nearly all economic historians are in agreement that the Great Depression was prolonged by the efforts of governments and central banks to correct it and the lessons of history seem not to have been learned.

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Ralph Musgrave

Jun 28, 2010 at 16:57

Complete nonsense from SocGen’s Albert Edwards. Everyone who has got half way to GCSE Economics knows that governments are constantly caught between a rock and a hard place: excess unemployment and excess inflation. It is POSSIBLE that one or more governments get it seriously wrong in the next five years. But that is always a possibility and always has been.

I agree with Ian just above, buy the way.

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Ian

Jun 28, 2010 at 17:33

Thanks Ralph. I think that we may see house price deflation, or better put a correction, as the bubble deflates but I do not see widespread collapses in prices in the wider economy. I dread the thought of Mervyn King printing vast sums of money to "cure" deflation as the problems down the line will be horrendous.

I wish Mervyn King would quietly resign and disappear. This may seem a bit harsh but he even looks like a stupid man and I have trouble taking him seriously given his track record of doing nothing about a massive build up of debt based on cheap credit.

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Chris Robin

Jun 29, 2010 at 07:38

Just on the assumption that we do get a degree of deflation - what are the best routes for an investor.

The only one I can think of are in the absolute returns arena

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Anthony O' Grady

Jul 01, 2010 at 22:21

Chris, if we get outright deflation, and given that George Osborne is just about to suck 100 billion pounds out of the economy we will,

1) Cash

2) Government bonds and US treasuries

Over the last 15 years of Japanese deflation lite, yen bonds have returned circa 6% per annum with a guarantee of redemption at par on maturity.

The bear market in equities started just over 10 years ago and still has some time to run. Read what David Kauders has to say and pay attention. Contrary to many who think they know better, this man is not a crank, just very astute.

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