Deflation’s demand surprise

Deflation is the villain that every major country’s central bank has in its sights. But deflation is not necessarily a bad thing. Deflation is actually boosting economic recovery and debt sustainability in the Eurozone (EZ) and in the US too. It only risks causing a debt-deflation spiral after a massive credit bubble. Even in that case, deflation probably saved Japan from collapse in the “lost decade” by increasing the real value of wages and household wealth. The ECB’s reaction to deflation — QE — will make investors richer through three channels: Asset substitution (benefiting higher-risk assets); a weaker euro (our major short currency position along with the yen short); and by boosting EZ economic recovery (which helps debt sustainability in the periphery as well as boosting disposable incomes).

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