It All Depends

We are perched on a knife-edge and it all depends upon whether interest rates rise, or not, as to whether we crash and burn (aka relapse), or continue to dig our way out of the hole.

A deflationista would argue that there is no inflation and deflation is the true bogey. As such, they are probably highly conflicted because their view would support a low level of interest rates, and large amounts of monetary and fiscal stimulus. And, we have already seen what that does to asset prices. But rising asset prices is unlikely to comport with their view that a deflationary environment reflects falling demand which should translate into falling asset prices. Conflicted or confused. I'm not sure what they are.

On the other hand, an inflationista would argue that inflation is the true bogey, lying in wait around the next corner. The hydrant of low rates, and large amounts of monetary and fiscal stimulus is creating fictional money that will morph into inflation. They would point to the rapid rise in assets and the quickly reflating economy as support for their contention. At this point, the inflationistas seem to be winning the war, although inflation has yet to show itself.

Irrespective of whether you are a deflationista or an inflationista, we are sitting on precarious gains both in asset prices and in economic recovery. Should interest rates rise for whatever reason (inflation scares, reversal in monetary policy, funding concerns, liquidity constraints, currency crisis), all bets are off. The consumer is up to their eye-balls in debt (and would be hammered by re-setting and re-casting mortgages), the govt is up to their eye-balls in IOUs (and would be hammered by higher funding costs impacting the deficit/debt), and financial institutions, who are already skating on thin ice, would have less cushion to work with and be hammered by falling asset values.

We better hope the deflationistas are right, so that the inflationistas can continue to take the day.