Does the world have the courage to deal with its debts?

Sept 07--Deflation is spreading from the core of the global system to the most unexpected regions of the world. It has even reached Latin America. Prices are sliding in Peru, Chile, Colombia, Paraguay, Bolivia, Ecuador, Guatemala, and El Salvador, to the consternation of everybody.

Enough of the world has already fallen so far into pre-deflation conditions that any misjudgment by the big central banks from now risks setting off a chain-reaction that may prove very hard to stop.

CPI inflation has dropped to –2.2pc in Japan (a modern record), -2.1pc in the US, -1.8pc in China, -1.4pc in Spain, -0.7pc in France, and -0.6pc in Germany.

This was not anticipated by the authorities anywhere, so we should be wary of their assurances now that we face nothing more than a brief dip in prices before rising energy costs bring inflation back into familiar and safe territory. No doubt prices will rebound as the "base effect" of oil prices kicks in. But by how much; for how long?

The sum of economists in the world (outside Japan) familiar with the cultural and psychological dynamics of deflation can fit into one London bus, and most are historians of the 1930s.

If PIMCO guru Bill Gross and hedge fund manager Paul Tudor Jones are right in fearing that the US economy will tip back into a "W-shaped" recession as the sugar rush of fiscal stimulus fades, we may wake up to find that we have baked deep deflation into the pie for 2010 and 2011. The G20's talk of "exit strategies" and rate rises will seem surreal.
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