Executive Summary

• The 3 reasons why deflation will continue to haunt the global economy
• The importance of cash flows in a deflationary environment
• Understanding the deflationary reasons behind the recent drop in oil prices and the material implications this will have going forward

If you have not yet read Part 1: Deflation Is Winning available free to all readers, please click here to read it first.

So a very important question remains despite the trillions in new currency printed around the world in the past few years: Why are deflationary pressures still present?

1. The debt overhang from the prior cycle has not vanished by a long shot. In fact today there is significantly more debt outstanding globally than was the case at the highs of 2007, primarily driven by global government borrowings.  The following chart is total US credit market debt relative to GDP.  You can see that very little has been reconciled since the peak. 

 Data Source:  US Federal Reserve       

Additional global debt assumption means additional interest cost burdens, even under an environment of interest rate suppression.  And that means higher taxes to service the debt.  Servicing debt crowds out capital availability to the private sector, which academically suppresses GDP growth.

2. Taxation globally has risen.  Increasing government size, borrowing and spending likewise crowd out private sector economic growth as taxation extracts what may otherwise be investment capital from the system.  Investment capital that otherwise would have gone into plant and equipment expansion, necessarily involving employment growth.  All the stimulus is great, but the offset is higher taxation and other assorted government revenue generation initiatives. 

3. The emerging markets (think China, Brazil, Indonesia, etc.) had been massive beneficiaries of the $13 trillion in central bank liquidity creation over the last six years.  We are seeing meaningful economic slowing, with a special spotlight on the 800 pound gorilla that is China.  Despite the Bank of Japan’s recent accelerated money printing shock, taking the US Fed out of the money printing game for now, reduces overall global liquidity potentially destined for real economies.  A reduction in the overall global liquidity tide is deflationary for emerging economies.  If they respond by trying to further debase their currencies, they send deflationary impulses into the global economy.