Pick your poison: inflation or deflation?

Duncan Hood on All Business

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Back in early August, before the market collapsed and the economy tumbled after it, I wrote a piece for Maclean’s called “There will be pain” that gravely forecast that Canada was in real danger of developing an inflation problem. Boy was I wrong. Now, of course, consumers have stopped buying and everyone is worried about the exact opposite, deflation, which would see prices spiralling down and taking corporate profits with them.

That raises a serious question: Am I an idiot?

I prefer to think not. And I’ll haul out that timeless punditry excuse in my defence: My prediction wasn’t wrong, I was just off on the timing.

I still think that the U.S. and Canada will develop an inflation problem, in fact I now think it will be much worse. It’s just that it’s going to take a year or so before we get there. And on Tuesday I got some backup from some heavy-duty artillery in the financial pundit world.

Martin Wolf, associate editor and chief economics commentator at the Financial Times of London, also thinks that today’s deflation problem could quickly turn into a huge inflation problem. As he points out in his latest column (registration may be required) the two are actually pretty closely related, as both are side effects of an unstable economy. I like to think of it this way: When everything is steady, you keep standing upright, but when you’re thrown off balance, you’re as likely to fall forward as backward.

Anyway, as he writes, deflation is easy to cure. You just keep the money presses rolling — which is exactly what the U.S. is doing now. The more there is of something, the less it’s worth, and that applies to the almighty American greenback too. The problem is, once you’re cured the deflation problem, “the central bank will need to sell assets into the market, to mop up the excess money it has created in fighting deflation…. Otherwise, deflationary expectations may swiftly turn into expectations of above-target inflation.”

That’s why I’m dead set against all of the huge bailouts we’re seeing. They’re just prompting us to print more and more money, and we will pay the price for that, eventually. We’re not curing the problem, we’re just replacing one crisis with another. As Wolf writes, “the result will ultimately not be deflation but unexpectedly high inflation, though probably many years hence.”

What do you think?