Inflation or Deflation Redux

I wrote on March 5 that those predicting inflation in the near term needed to revisit their macroeconomic 101 textbooks. Monetary easing doesnt cause inflation if it occurs at a time of weak demand, excess capacity,an excess of available labor and slow velocity of money...like now.

From today's WSJ

Deflation Fears Stir in Developed Economies

 

Worries about consumer price deflation are resurfacing in the world's developed economies after weeks of financial-market turmoil driven by Europe's fiscal crisis.
The fears are most pronounced in Europe, where policy makers are under pressure to reduce large budget deficits now, before durable recoveries emerge. A combination of spending cuts and tax increases could weigh on economic growth and feed into deflation, which is a broad decline in consumer prices.
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Officials fret about deflation because it is hard to stop. Interest rates are already near zero in the U.S. and elsewhere, so policy makers can't use the traditional tool of rate cuts to spur growth and stop deflation.
That's an acute worry today. In addition to government debt, U.S. households are still trying to work off large debt burdens built up in the last two decades. 

Mr. Market is speaking as well
In one sign of rising alertness to the threat, yields on 10-year Treasury bonds—which fall when inflation worries recede and rise when inflation worries increase—have dropped from nearly 4% in early April to about 3.3%.

...And the lack of lending = low velocity of money is present as well.

"There are clear warning signs of deflation," Anthony Sanders, a George Mason University professor, warned at a Federal Reserve conference about housing in Cleveland Thursday. "My friends at the [Federal Reserve] may not agree with me. If the banks don't lend, we will get deflation."

And Mr. Market is speaking in the market that offers the most certain inflation protection; TIPS. I'll leave it to others to explain the massive gold rally.I'm with Chairman Bernanke yesterday who observed the gold price is unhinged from any other inflation indicators in the market.:

Fed chief Bernanke noted Wednesday that even though gold prices have been soaring—a potential indicator of inflation fears—many other inflation indicators are going the other way, including yields on U.S. Treasury bonds and prices for commodities.

And here is what Mr. Market is saying in the TIPS market:

Financial markets suggest investors are torn about inflation risks too. Prices for gold—which some investors buy as an inflation hedge—have soared, suggestion inflation worries are mounting. But expectations as measured in the market for Treasury Inflation Protected Securities, or TIPS, have been mostly stable and softened a bit in recent weeks. Yields on these instruments imply investors expect 2.7% inflation five years from now. This is down from 3.1% seen in April.

more on the unusual combination of higher long term bond prices (lower yields) and higher gold prices here.