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The tone of news and comment is now "hopes of an early recovery" and "interest rates must rise because there is too much borrowing". This is typical of the lack of understanding about the deflationary forces in the global economy. Consider these points:-
1. The price of oil has fallen by about a third in a year.
2. Manufacturing prices are under pressure globally.
3. Retail prices are now permanently "competitive" - as in cars, much retailing and financial services.
4. Global demand is weak and Japan is unable to make any stimulus succeed.
5. In Britain, residential property prices appear to be peaking; falling rental prices, particularly in London indicate that the buy to let boom has run out of steam.
The truth is that the vast credit binge has kept the wheels turning. This credit binge has resulted in overborrowed consumers who now have to service their debts, just as it has resulted in fancy financial structures exposed by Chapter 11. The cost of debt service will now determine our economic future. The cost of failures such as Enron is still to appear, probably as asset liquidation by insurers forced reluctantly to pay for credit derivatives or, alternatively, as asset liquidation by lenders to Enron whose insurers fail to pay up. Someone, somewhere, has to pay real money for such losses.
Suppose the Fed or the MPC put up interest rates sharply. What will happen? The whole pack of cards of both consumer and corporate borrowing will collapse. As an investor you have a choice of two planning assumptions. The first is that the authorities know this and will try to keep the credit flow going; such an assumption implies that any rise in interest rates will be little more than a token gesture for a short period of time, to maintain the illusion that there is no deflationary threat. The alternative assumption is that rates go up sharply; what will happen then? The pack of cards will surely tumble down, leading to an even bigger crash in interest rates.
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