Fed says deflation unlikely, but jury still out

What's one thing the U.S. and global economies can do without? They can do without roughly $1.6 trillion in toxic assets.

O.k., that we know, but what's something else the U.S. and global economies can do without? Deflation. That's correct, deflation -- the other dreaded 'd' word. For typical investors who have just seen the American government pump more than $9 trillion into the financial system over the past 18 months via fiscal stimulus, emergency spending, liquidity measures, stock and bond purchases, and related stabilization measures, deflation might be the farthest thing from their minds.

But more experienced investors know that the aforementioned money-pumping is only half of the ledger. There's also the asset destruction side. Consider this fact: the value of global financial assets including stocks, bonds, and currencies most likely plunged by $50 trillion in 2008, according to research sponsored by the Asian Development Bank, Bloomberg News reports.

Deflation -- a protracted, systematic decline in prices and wages -- occurs in pronounced recessions when demand is non-existent or very low. It robs companies of the ability to increase revenue and hurts the economy's ability to grow.

2008: Enormous asset destruction

Claudio Loser, a former International Monetary Fund director and the ADB report's author, told Bloomberg News the $50 trillion total represents a once-in-a-generation type hole for the global economy.

"The loss of financial wealth is enormous, and the consequences for the economies of the world will unfortunately be commensurate," Loser said.

Further, although the U.S. economy is in a pronounced recession and the global economy in 2009 is likely to contract for the first time since 1945, U.S. Federal Reserve Chairman Ben Bernanke, in a speech Tuesday, said the Fed sees no signs of deflation.

"We're not anticipating deflation, we do expect inflation to be quite low," Bernanke said, Bloomberg News reported Tuesday, adding that the Fed would be at the ready to adjust monetary policy, should inflation resurface.

Economic Analysis: The above represents a case study concerning why investors should never evaluate a statistic in isolation. On its own, the statistic '$9 trillion' sounds like an enormous amount of liquidity -- like an oversupply. But when evaluated in context with the tremendous asset destruction that has taken place, $50 trillion according to the ADB estimate, one can see why inflation is unlikely to occur.

Investors can always follow the monthly producer price index and consumer price index to gauge inflation; if the Fed's and Congress' actions are inflationary, the consequences will show up there. So far, inflation is not a concern. The view from here argues that the jury is still out on deflation, however.
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