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Is America ready to fight deflation?

While recent surprise growth figures from the Office of National Statistics may have warmed sentiment on this side of the Atlantic, worries on the other side are only growing.

Stubbornly high unemployment figures of 9.6 per cent coupled with worse than predicted growth figures of 2.4 per cent GDP have led more US experts to bang the drum of deflation.

Federal Reserve Bank of St. Louis chief executive James Bullard warned this week that: “the US is closer to a Japanese-style [deflationary] outcome today than at any time in recent history”.

Wells Fargo senior economist Mark Vitner agrees. He says: “We track a large number of inflation indicators and virtually all them are pointing to reduced inflationary pressures during the second half of this year.

“These inflation numbers leave little margin for error – if economic growth falters or there is some exogenous shock to the economy, persistent and troublesome deflation could become reality.”

This economic uncertainty is reflected in the US dollar, which rose to a six-month high against the pound of $1.5969 this week.

Currently the US government is following in the footsteps of the British Government in forcing through austerity measures as the majority of the 50 states’ budgets remain in significant deficit. The austerity measures are backed by the International Monetary Fund, which last week urged the US to continue with its attempts to curb spending.

Charles Schwab chief investment strategist Liz Ann Sonders says there aren’t enough recent figures to assume deflation is coming to the US. She says deflation is just a market fear as yet, inflation will be low and corporate America’s confidence will increase without further easing.

“The US is closer to a Japanese-style [deflationary] outcome today than at any time in recent history”.

James Bullard

She says: “For what it’s worth, I continue to have a more optimistic view on the economy than the consensus and if that translates to improving jobs numbers – especially if deflation risks subside and inflation concerns kick back in.”

But Bullard says the US needs to stimulate the sluggish economy so as to encourage both individuals and businesses to spend more instead of crossing its fingers: “Hope is not a strategy…policymakers have to commit to new policy and the private sector has to believe the policymaker.

“The US economy is susceptible to negative shocks that may dampen inaction expectations. This could possibly push the economy into an unintended, low nominal interest rate steady state. Escape from such an outcome is problematic.”

Nomura chief global economist Paul Sheard says the Federal Open Market Committee, the US version of the Monetary Policy Committee, will have to begin increasing rates “or at least to stop the passive contraction of its balance sheet”, which are two of the three tools it has at its disposal.

The third tool, like the MPC, is quantitative easing. Bullard says: “On balance, the US quantitative easing [sic] program is the best tool”. Ignis chief economist Stuart Thomson agrees, recently estimating that the US has to print as much as $2.5 trillion (£1.57 trillion) to get the US economy moving.

“If economic growth falters or there is some exogenous shock to the economy, persistent and troublesome deflation could become reality.”

Mark Vitner

In the Federal Reserve’s semi-annual report last month before a Senate committee, chairman Ben Bernanke admitted the outlook for the US economy was “unusually uncertain” and said interest rates will remain low for the medium term. But he said the FOMC was ready with “further policy actions” in an attempt to heal the US economy.

The US Fed releases its latest statement next week and may announce measures to fight deflation and stimulate the economy. This may come just at the right time for the UK, which is reliant on its trading partners on its left and its right to help it out of its own economic malaise.


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