Why You Should Expect “Price Deflation” Just Ahead

The annualized change in M2 Velocity has “collapsed”

by Bob Stokes
Updated: July 09, 2020

Many people, including a lot of financial journalists, believe that deflation is defined as simply falling prices. Even some economists will echo this notion.

However, Webster's gives this definition:

Deflation is a contraction in the volume of money and credit relative to available goods.

So, the dictionary does not define deflation as falling prices.

Having said that, falling prices are an effect of "a contraction in the volume of money and credit relative to available goods."

Indeed, a specific indicator is predicting falling prices.

Murray Gunn, EWI's Head of Global Research, showed this chart in the recently published July Global Market Perspective and said:

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The chart shows that the annualized change in M2 Velocity has collapsed, as not only has M2 Money Stock expanded, but the economy has contracted.

Now look at its relationship with the Core Consumer Price Index... Over the past 20 years there has been a distinct relationship, with the change in M2 Velocity leading Core CPI by around 7 quarters. Therefore, if this relationship holds, we must anticipate a huge drop in the year-on-year rate in Core CPI over the next 18 months or so.

Of course, as you probably know, the Fed has been trying to ward off deflation through its quantitative easing efforts. But, contrary to popular belief, all this "money printing" since at least late 2008 has not lead to price inflation. In fact, "in 7 of the last 12 years, the Fed has been unable" to meet its own inflation target of 2%. (Kitco NEWS, July 1, 2020)

And not just the Fed. Our new, July Global Market Perspective goes on to provide this summary of other economies:

A two-month uptick in Europe's PMI data simply cannot mask the wider economic destruction that will take place over the second half of 2020. At -11.5%, Britain will suffer the worst GDP hit out of the 15 largest economies that the Organization of Economic Cooperation and Development (OECD) just studied. Not far behind, the French, Italian and Spanish economies will each contract at more than 11%.

Yet, a June 24 Reuters article quotes the chief economist of a Munich-based economic think tank:

"We have passed the economic trough, the low point is behind us and things are looking up again."

However, EWI's global analysts disagree with this assessment.

Get more global insights, including analysis of 40-plus markets worldwide, with zero-obligation for 30 days.

Follow the link below for your instant-access, risk-free review of our new, July Global Market Perspective.

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