Deflation in US unlikely

Vast amounts of liquidity

By Vishal Teckchandani
Wed 17 Dec 2008

Deflation in the US is unlikely to persist given the ample amount of liquidity the government has pumped into banks.

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While there is little doubt the United States economy will experience falling consumer prices in 2009, the decline will likely be led by lower food and fuel prices and is unlikely to last, according to Perpetual.

The main reason deflation is unlikely to last is because of the vast amounts of liquidity being pumped into the American banking system by the US Government, Perpetual senior manager of investment markets research Matthew Sherwood said in a research note.

"These funds have been vast and has meant that only a few financial institutions have failed (unlike during the Great Depression when around 5000 banks failed)," Sherwood said.

"This suggests that while the US banking system has been severely wounded from the credit market woes, it will not be allowed to collapse as was the case in the 1930s and so any deflation in the US in 2009 is more likely to be cyclical than structural."

There have been two well known periods of structural deflation. US consumer prices tumbled 27 per cent amid the Great Depression and Japanese consumer prices dropped 4 per cent in the past 10 years.

Despite deflation being unlikely to persist in the US and global economy, Sherwood said 2009 is shaping up as the weakest year for global growth since 1982.

The downturn has been and will continue to be led by the US economy, which is already in recession along with Europe and Japan.

But the global economy is not expected to weaken further because the emerging economies, while at a five-year low, are still expected to record over 4 per cent growth next year.

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