Even Goldman Sees Case For Deflation Stronger Than For High Inflation

Reflation strategists at Goldman Sachs should be wondering about their own economists, as economists in a report published last night conclude:

Should a regime shift in inflation occur in the next few years, the case for deflation looks stronger than for high inflation. Spare capacity could remain elevated well into the next decade if our baseline view of a muted recovery in demand is correct, let alone in the case of a "double-dip" recession. This could eventually pull core inflation and inflation expectations into negative territory, reinforcing a downward spiral.

The US outlook has worrying similarities with Japan's "lost decade" of stagnation and deflation, which also began with a bursting asset bubble and featured a full-blown banking crisis. However, the United States is fortunate - at least on a relative basis - to be dealing with a considerably smaller bubble and has mounted a far more aggressive policy response. Rapid stabilization of the economy and financial system, combined with low and stable inflation expectations (thus far) should help the economy avoid a regime shift in inflation.

In contrast, media and investor attention tends to focus on perceived parallels to past high-inflation or even hyperinflationary environments. For instance, the 1970s "stagflation" in the United States also featured volatile commodity prices, big federal deficits, and deep recessions. But the persistently high inflation that marked this era had its origins in the overheating boom economy of the late 1960s, in stark contrast to today's environment of high unemployment and idle production capacity. Hyperinflationary episodes share with the United States the common trait of huge government budget deficits, but it is the monetization of deficits that truly set hyperinflations apart. The Fed's recent balance sheet expansion notwithstanding, money growth in the United States is an order of magnitude lower than in a typical
hyperinflationary prelude.

FT Alphaville features more food for both inflationists and deflationists.

So the plants of "sweet spot" are seeded, as foolish bond investors will fund the reflation trades of capitalistic strategists?