Time to declare victory over deflation? January 22, 2011|Tom Petruno | Market Beat
The Federal Reserve's massive money-printing campaign of the last two years has had one central goal: Make sure the U.S. doesn't lead the global economy into the black hole of deflation.
It may be time to declare "mission accomplished."
Around the world, many countries aren't confronted with the debilitating forces of deflation, or falling prices and wages, but the opposite — inflation. Rising prices, particularly for food, have fueled credit- tightening moves by China, India, Brazil, Australia and other nations in recent months.
Even in Europe, where a government-debt crisis is a serious drag on overall economic growth, annualized inflation in the euro zone rose to 2.2% in December, topping the European Central Bank's 2% target rate for the first time in more than two years.
In the U.S., a surge in energy prices in December boosted the consumer price index 0.5% from November, the biggest monthly increase since June 2009.
Fed Chairman Ben S. Bernanke last week suggested that the tide had turned in the battle against deflation, saying the risk had "receded considerably."
Central banks are petrified of deflation because it raises the possibility of a downward economic spiral that can't easily be reversed. If falling prices result from lack of demand, that could feed on itself, with wages falling as businesses slash costs to survive.
So if Bernanke is right about deflation risks receding, that ought to make people feel more confident about the economic recovery.
"The Fed will be comforted if inflation is rising," said Dean Maki, chief U.S. economist at Barclays Capital in New York.
Investors, however, have another consideration: how much closer the Fed may be to ending its easy- money policy, and what that would mean for stocks, bonds and other assets.
In emerging markets including China and India, inflation already has become serious enough — running in the mid-to-high single digits — to force governments to act by raising short-term interest rates in an attempt to slow consumer demand.
That has been painful for many emerging-market stock investors. The Shanghai market has slumped 13% since early November; Indian shares have lost 9% in the same period.
Meanwhile, longer-term interest rates have risen worldwide since late summer with inflation concerns, devaluing many fixed-rate bonds. The yield on 30-year U.S. Treasury bonds reached 4.62% on Thursday, a nine-month high and up from 3.5% at the end of August.
