Last month saw the Dow Jones Industrials index surpass the 13,000 level, taking it back to the level of May 2008 before the financial crisis really bit. In this article, Robert Farago asks is it wishful thinking to expect the calm to persist and should investors fear both inflation and deflation?
Looking out to sea on a calm day in Yakutat, Alaska, you would not think that it was possible to single out traces of waves that originated in the Southern Ocean. Walter Munk at the Scripps Institution of Oceanography is probably the most respected and renowned oceanographer alive today1. In the 1960s, he set up a network of six measuring stations spaced thousands of miles apart spanning the Pacific Ocean. He was able to follow the progress of waves created in a storm off Antarctica as they rolled past New Zealand, Samoa, Hawaii and into the vast expanse of the Northern Pacific. The same waves showed up 7,000 miles away in Alaska two weeks later. They encountered endless cross swell along the way but they passed through each other, like ghosts, to emerge unaffected on the other side. By the time they arrived, they had a wavelength of a mile and were just one tenth of a millimetre high.
Inflation in America has barely moved outside the range of 1 - 4% for the last 20 years. This apparent stability is currently the result of two massive and opposing forces. The financial crisis of 2008 unleashed a deflationary storm, triggering an unwinding of the credit that had built up over the previous five decades. Central banks around the world conjured up their own tempest, printing money in vast quantities. Somewhat to everyone’s surprise, these two massive forces seem to have cancelled each other out. This has produced a period of calm in financial markets that has seen the Dow Jones Industrials index last month surpass the 13,000 level, taking it back to the level of May 2008 before the financial crisis really bit. We do not have the sensitive equipment to separate the various flows of money and prices around the world. But we do think it is wishful thinking to expect the calm to persist. Our key concern over the years ahead is price instability and there are reasons to fear both inflation and deflation.