The worst nightmare for policy makers and economists alike, that of a fully synchronised global recession, appears to be happening before our very eyes. The economic news from the US, Europe, Asia and Latin America, made depressing reading, even before the September 11th attacks. Central banks, led heroically by the Fed's Uncle 'Al, have reacted with rapid and large cuts in interest rates', bringing them down to 40 year lows.

Part of the new paradigm myth of the late 1990's was that not only had the typical economic cycle been re-engineered due to technology led productivity gains but also that central bankers had tamed the curse of inflation ... the goldilocks economy of not too hot and not too cold.

Well here we are some eighteen months since the stock market bubble popped and despite the valiant efforts of the CB's in slashing interest rates, the consumer looks as if he or she is rebuilding low saving balances due to the uncertainty of job insecurity and very volatile financial markets. Red hot numbers off the wires this week suggest otherwise, as the US retail sales figure for October came in at 7.1% versus the September collapse of -2.4%. The optimists suggest that the September figure was a 'rogue number' due to the post 11th September trauma that kept consumers in front of their TV's and out of the shopping malls, and that the October figure proves that the consumer is alive and well ... And ready to do his duty in spending (read that as borrowing) more, to save the economy.

In some ways, October was a contradiction in that we saw the largest job losses since May 1980 (towards the end of the 1970's period of stagflation) yet auto sales enjoyed their strongest month of sales ever! Whilst interesting to note, that if auto sales are 'stripped out' of the aforementioned 7.1% figure, October retail sales remained positive ... but at a 1% figure and at the slowest rate for eight years! Of course, zero cost financing and other incentives played a prominent role for the auto industry, although even manufacturers who did not offer such deals reported strong sales.

Our contention has been that the major problem for the US economy (and global) is not a general lack of demand, but more to do with too much capacity. However, industry is starting to reduce the large inventories held within certain sectors. Low headline inflation figures globally have allowed Uncle 'Al and his foreign counterparts to slash interest rates in an effort to halt the slowdown and to hopefully stimulate growth. Whilst we have contended that due to the scale of credit excess it is unlikely that the aftermath of a bubble economy will be of short lived pain, of equal importance will be the shape of the economy going forward post bubble i.e. now looking forward.

Households have continued to borrow and spend, in fact to dangerous excess. We have commented extensively over the past few years on the dangers of an economy funded by sustained credit excesses. Excesses as witnessed in the late 1990's are problematic and destabilising for both the economy and the financial system.

Politicians around the world, regardless of party complexion, have for too long, fudged cheated and changed many times, to paint a better picture, the constituents of the measures of inflation. Just what is inflation anyway? Is it the cost of service goods (increased demand/reduced supply) rising? Wage prices? A result of a weak currency sucking in imports? Or caused by rising oil prices? In truth it can be due to any combination of these factors. However, Webster's definition of inflation is: -

"A persistent, substantial rise in the general level of prices related 
to an increase in the volume of money and resulting in the loss of
value of currency".

Of particular importance in this definition is THE INCREASE IN MONEY AVAILABLE. History is littered with examples of manias and the subsequent busts, more often than not supported by prolific credit creation by the banking community, who multiply the money created by central banks (out of thin air). The charts above show the US CPI (supposedly a basket of goods and service prices) that are measured each month in order to detect price increases, and the US money supply growth, a figure that some, including ourselves, believe to be the only honest measure of inflation. You can see the problem of interpretation!

The CPI chart is supposed to represent the long run measure of US inflation, with the red line showing the annualised percentage change over each previous year. After the calamitous 1970's, policy makers take credit for the taming of the inflation genie, particularly in the mid 1990's. So what you may say! It is important to understand the mechanisms of debt during either a deflationary or inflationary period ... This is important! Inflation is good for borrowers and poor for savers, whereas the reverse is true during deflation. As witnessed in the 1930's and more latterly in Japan 1990's, a deflationary environment kills debtors; the real carrying cost accelerates while the asset purchased with the debt falls in value. This is partially why Uncle 'Al and his colleagues are reducing interest rates like mad AND creating new money in case of deflation.

Of further importance is that the CPI number(s) are LAGGING indicators. Mainstream analysts not only continue to read and act on lagging indication but they also claim that there is too much supply in many commodities, hence the prices are deflationary. As you look at most commodities, both consumption and production have been rising, so there is a differing story at hand.

Either way, the judge is still out in respect of inflation or deflation looking forward. The money supply suggests the former whilst the current mind set the latter. As evidenced by prior examples, the legions or over borrowed consumers, had better pray for the 'dreaded' inflation!