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Deflation: Why Are Central Banks Failing?
In the battle of inflation and deflation, deflation still has the upper hand.
Recent months brought some troubling news from Europe and Asia about deflation:
- UK cost of living falls most since 1948 -- The cost of living in Britain ... fell the most ... since records began more than half a century ago, as the recession drove down the cost of food and housing. (July 14, Telegraph)
- Deflation accelerates in eurozone and Japan -- The much-anticipated round of global deflation ... moved a few steps closer yesterday with the release of record low inflation figures for the eurozone and Japan... (Aug. 1, The Independent)
Most conventional economists vigorously dismissed the very idea of deflation just a couple of years ago, but now it' a global reality. Just like the Federal Reserve Bank here in the U.S., overseas central banks have used the "quantitative easing" policy to stop deflation. And just like in the U.S., something is not quite working. Here's how Brian Whitmer, editor of EWI's monthly European Financial Forecast, described the efforts of the Bank of England and their surprising results in the July issue:
The Bank of England buys assets in the form of government bonds, which supposedly causes bond prices to rise and yields to fall. Low yields supposedly reduce everyone’s cost of borrowing, and, because the Bank created the money to buy the bonds, money in the economy goes up. With more money in the system, bank lending should increase, spending and income should rise, and inflation should remain at the targeted level of 2%. In a nutshell, quantitative easing defeats deflation, recession and depression.
The logic seems sound, right? But instead of rising as the mechanism requires, bond prices in the U.K. are falling. A chart of long-dated gilts still shows higher yields than before the Bank announced the program. Also, the chart below shows that growth rates of M4, the broadest measure of money supply in the U.K., continue to plunge. From March 5, the day the Bank announced quantitative easing, M4 growth has fallen from more than 20%.
Elliott Wave International has stated many times that monetary growth in a credit-based system requires borrowers to borrow and lenders to lend. Neither is happening now, despite the Bank’s £125 billion Asset Purchase Program. So, even though a temporary rebound in social mood and stock prices has talk of imminent hyperinflation waxing, we remind our readers of what Bob Prechter's June 2009 Elliott Wave Theorist argued, “You can’t beat deflation in a credit-based system.”
“Make no mistake about it: [Deflation is] a global story,” warns Elliott Wave International's president Robert Prechter in Chapter 9 of his Conquer the Crash*. The book shows you the systemic deflationary risk associated with the world’s modern financial system -- the risk that has already turned out to be much harder to manage than most economists had ever expected.