“In recent years, monetary and fiscal stimuli across the world have led to the assumption that serious inflation, if not hyperinflation, is on its way. I believe chronic deflation is more likely.”
“The expectation of rising prices is reasonable,” Shilling concedes. “Most people have only experienced inflation. The last meaningful episode of deflation was in the 1930s. That’s also the last time the U.S. was truly at peace. Deflation is a peacetime phenomenon.”
Yet he argues that even though deflation has been forestalled in the past decade, disinflation—declining rates of inflation—has prevailed since the early 1980s. Indeed, the consumer price index fell in November and December and was unchanged in January, he writes. For February, the cost of living in the U.S. was up 0.7%, the first increase in four months and the biggest since June 2009. Nonetheless, expectations for inflation over the next 10 years are for a continued drop.
So what are some of the factors he says will contribute to deflation?
Deleveraging: “In a normal economy, chronic deflation would already be well established. Our global economy, however, is dominated by deleveraging in the private sector and financial institutions, and is highly deflationary. These actions are overpowering the effects of stimulus programs since 2007 …The liquidity created by central banks is tiny compared with the destruction wrought by deleveraging financial sectors. The decline in securitizations is just one aspect of this contraction. Banks are eliminating or writing down off-balance-sheet vehicles substantially. Governments are increasing capital requirements even as banks dump assets to raise capital ratios.”
Increased Saving: The U.S. household savings rate fell to 1% in 2005 from 12% in the early 1980s, he explains. This decline of about one-half a percentage point per year meant that consumer spending rose on average around a half percentage point faster than GDP, adding about the same growth to total economic activity once multiplier effects were included. U.S. imports drove growth in Asian and other export-led economies.
Savings Rate: “In the years ahead, I expect the half-percentage-point annual drop in the savings rate to be replaced by a one- percentage-point annual gain. This would slice 1.5 percentage points off consumer-spending gains as well as GDP growth, after multiplier effects are accounted for. That alone would drop aggregate growth to 2.2% from the 3.7% annual increases in the period from 1982 to 2000.”
Other Deflationary Forces: “Fertility rates are below the replacement level of 2.1 in most industrialized countries, and populations around the world are aging. As a result, the ratio of working-age people to total population will shrink, retarding economic growth. Substandard education systems, especially in the U.S., restrain productivity growth, employment gains and economic advances. Instead of investments in education, research and productivity-enhancing capital equipment, the emphasis has been on consumer spending, housing and financial assets, which do little to enhance productivity and can curtail growth.”