http://www.yardeni.com Excerpt From Latest GLOBAL PORTFOLIO STRATEGY: POCKETS OF DEFLATION. With oil prices soaring and labor markets so tight, no one seems to be concerned about deflation anymore. This was a concern during the summer and fall of 1998, when the global financial crisis pushed Asia into a severe recession and the price of oil fell close to $10 a barrel. However, the forces of deflation have not been defeated completely. They are still out there and may be quietly regrouping and gaining strength. We may see them launch another assault on the global economy as soon as next year. Clearly, Asia's amazing recovery last year and the global economic boom so far this year averted deflation. This is most obvious in the performance of the bond market, where 30-year Treasury yields fell to a low of 4.7% during October 5, 1998, but then rebounded to6.8% earlier this year, during January 18. The bond yield is back down to 5.8% currently, but this is hardly a solid indication that investors see a deflation risk again. But aren't soaring oil prices inflationary? Won't the latest oil price shock trigger reflation? In my opinion, the answer is no. Higher oil prices have both an inflationary impact and a deflationary one. If globally competitive markets make it difficult to pass through cost increases, then higher oil prices act like a tax hike on consumer incomes and business earnings. US consumers are currently paying $60 billion more, at an annual rate, for their gasoline than at the start of last year. It's worse in Europe, where government taxes on gasoline are already extremely high, and the euro price of crude oil has quadrupled thanks to a tripling in the dollar price of oil and 25% depreciation in the dollar value of the euro. No wonder the natives are restless in Europe and gasoline tax revolts have spread spontaneously throughout the region. Yet, as I observed last week, despite the energy/euro shock in Euroland, domestic price inflation remains remarkably tame in Euroland. The latest data for August show the CPI inflation rates, on a year-over-year basis, rising only 1.8% in both France and Germany. In Germany, domestic prices as measured by the GDP price deflator were actually down 0.5% from a year ago during the second quarter. It is competition and deregulation that have unleashed the forces of deflation in Germany. I have often in the past identified China as the epicenter of global deflationary forces. A story in the September 11, 2000 issue of The Wall Street Journal supports my view. It is titled "Japan Fights Domestic Price Competition By Widely Expanding Trade With China." Product markets are becoming more competitive faster than labor markets in Japan. Japan's GDP price deflator is down1.8% from a year ago. So, Japanese businesses are scrambling to lower their labor costs by producing more in China, where labor costs are much lower. The US is also becoming increasingly hooked on China. Indeed, our trade deficit with the Chinese is up from zero in 1988 to $75 billion over the past 12 months through June. This nearly matches our $80 billion trade deficit with Japan. These two countries account for40% of our trade deficit. In Europe, competition and deregulation are keeping inflation subdued in the face of a weak euro and soaring energy prices. In the US, a strong dollar and soaring non-oil imports are keeping a lid on inflation. So are falling US unit labor costs, as productivity gains surpass compensation increases. What about the inflationary consequences of soaring oil prices? Is the worst over, or just ahead? I believe that market forces will work. Higher prices are likely to boost production. OPEC is close to capacity constraints, but could probably pump another3 million barrels a day. If they don't boost production, high crude oil prices are bound to stimulate more non-OPEC output, which even now exceeds OPEC's output by 10 million barrels a day. Contrary to popular myth, OPEC does not have a monopoly on the production of crude oil. _______________________________________________ Crashlist resources: http://website.lineone.net/~resource_base To change your options or unsubscribe go to: http://lists.wwpublish.com/mailman/listinfo/crashlist
