One-armed economists

By Buttonwood

HARRY Truman famously asked to be sent a one-armed economist, having tired of exponents of the dismal science proclaiming "On the one hand, this" and "On the other hand, that". Economists are more inclined to stock their neck out these days (being a celebrity pundit is a good living) but I am not sure that has reduced the confusion.

Last week, we launched our economics channel with a debate on whether inflation or deflation is the greater threat. Scroll through the contributions and you will discover either that "Tough deflationary times lie ahead" or that "Eventual inflation is inevitable". Since this is the central question of economic policy at the moment, such a discordance of views is rather disturbing; much is made of the debate on global warming but the scientific consensus is overwhelmingly on one side on that issue. On economics, governments are being forced to choose in matters of fiscal austerity, where the debate is almost 50-50.

Perhaps that is why the markets are presenting such a confusing picture. Investors face the choice of whether to buy government bonds on very low yields (the 10-year bond is offering 3.2%) or gold at over $1,200, close to a record nominal high. (When gold peaked in 1980, the 10-year bond was yielding 10.8%.) Some argue that equities must be cheap, given that profits are booming and that shares have gone nowhere for a decade. But if the template is Japan-style deflation, shares can go backwards for 20 years.

The debate is really between the "output-gappers" who argue that inflation simply cannot be created when the economy is running so far below potential and the "credit bubble" group who argue that central bank money creation will inevitably result in higher prices. This debate cannot be settled by analysis of past trends; it is so difficult to isolate one economic variable and say what its effect wiill be. (As mentioned before, Greece, which is combining fiscal currency with a fixed exchange rate, is an interesting case study.)

My take, for what it's worth, is that deflation is more likely in the short run, especially as the broad money supply numbers remain so weak. Inflation may come much later, but only as the authorities get more and more deseprate. Alas, that puts me in the two-handed camp that sent Truman into despair. But the purpose of the blog is not to pretend that one journalist has all the answers; it is, more humbly, to try and provoke thought and debate among the readers, to point them towards interesting outside observations and to "join the dots" in terms of finding different market and economic themes.