The Economist magazine brought an interesting article titled with : “Betting big on bonds“ – an economist advises investors to expect deflation” http://www.economist.com/node/17853304,
A paragraph which provokes thinking: “Debt ratios, relative to GDP, are so high that it seems unlikely that most developed economies can grow their way out of the mess. That leaves the unappealing options of default, Japanese-style stagnation or rapid inflation to erode the real value of the debt burden.”
Debt of developed countries looks bad. If investors stop covering that debt, the country has an option to default. Usually better option is inflationary mechanism– printing money to cover debt. If the inflation rate is higher than interest rate of government bonds, it is not in favor of investors to buy government bonds. Some investors might still buy government bonds even if interest rate is below inflation since it is considered as low risk investment. They do so to diversify their portfolios.
At the other way, modern global economy is highly competitive which by itself deflatory process. If you can produce a good or make service cheaper, most likely you’ll sell much better than competitors. It was obvious in expansion of big supermarkets (so called hypermarkets). They provided goods cheaper than competitors. Modern economy is deflatory – market wants cheaper goods.
So the market does deflatory mechanism and government does inflatory mechanism.
So which is most likely future? Inflation? Deflation?
Possibilities:
Defaults of governments and financial institution – this will most likely happen unless government is printing money, since printing money is better for a country than default, countries will print money
Japanese style stagnation –real estate, stock and general market deflatory mechanism combined with no government default, slow money printing machine and investors preferring government bonds in spite of insane debt to GDP ratio
Rapid inflation - sounds like a real possibilities unless certain types of assets are over valuated.
If certain types of assets are over valuated as housing, it brings unprofitability to many financial and insurance institutions and in general brings stock value down. In the other way, price of commodities goes up due to money printing mechanism and overvaluation of other assets… isn’t it what is happening now? Isn’t the price of housing going down and the price of commodities going up? Isn’t the price of stocks bind to housing going down as well? Which trends do you predict in 2011?
