We are walking on deflationary quicksand

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.