In the Next 10 Years the US Will Go into Deflation

So far, inflation has been the norm in both the U.S. and global economies. Japan has experienced more than 16 years of deflation, which began in earnest in the late ‘90s. It’s safe to say that it is the first advanced country in the world to have undergone this protracted a deflation since the 1900s.

The Energy Revolution Puts an Increasing Deflationary Pressure Globally

However, we can expect an increasing deflationary pressure going forward in the U.S. and the world at large, as well as in Japan. Behind this is the energy revolution, with shale gas and oil at the core of it.

This revolution will make it possible for the U.S., which has been the world’s biggest importer of energy, to undertake domestic production, thereby satisfying domestic demand on its own. If that happens, we will have a global glut of energy, which will cause a steady slide in energy prices.

Over the past decade, the annual inflation rate based on the Consumer Price Index has been around 2 percent. What’s behind this number? This 2 percent increase reflects changes in prices of all types of products and services. The biggest performers among them have been gasoline, electricity and food. In other categories, the price of cars, for instance, has scarcely improved, if at all, while the prices of products such as electronic appliances and clothing have declined.

The Federal Reserve Board will move to gradually taper off quantitative easing sometime in 2014. I am unclear about the timeline, but continuing on the path of monetary easing is not a viable option, so they will probably turn off the faucet somewhere along the way. It means the Federal Reserve Board will start collecting all the money they have so far printed with abandon. If that happens, we want to pay attention to its impact on the exchange-traded fund market, which is essentially a basket of securities that tracks the prices of stocks, gold, etc.

A Huge Impact on the Exchange Traded Funds Market

So far, speculators such as hedge funds have engaged in leveraged investments in financial products, based on the projection that QE will continue, thinking the demand for them has bottomed out. For the uninitiated, leverage is an investment scheme whereby you expand your investment principal with borrowed money for high returns with higher investment efficiency. With the interest rate in the U.S. kept low, it was a propitious environment for leverage utilizing external debt.

However, with QE shrinking, in addition to the decreased demand for financial products, the interest rate for debt will rise and increased borrowing costs will put a huge burden on leverage. For that reason, investment positions will have nowhere to go but down.

This will have a huge impact on the ETF market as hedge funds, using leverage to maximum effect, are investing in ETFs tracking crude oil or natural gas, gold or silver, aluminum, corn, wheat, beans, etc. If investment positions have to be scaled back, the prices of such commodities as crude oil or natural gas, gold, silver, aluminum, corn, wheat and beans that have been blessed with an infusion of funds will experience a downswing — some of which might take a much more severe downfall than others.

In the future, thanks to the shale revolution, America will see prices go down dramatically for not only natural gas but also crude oil. Before even that happens, a tapering of QE will bring about a downfall in commodity prices through the ETF market, leading to a further decline of spot prices. Viewed in this light, a never-ending inflationary economy is simply a mirage and the global economy will most likely head gradually toward a deflationary one.

So, is a deflationary economy an evil? In Japan, which has experienced a recession due to a protracted deflation, opinion is, of course, fairly negative. In actuality, however, deflation is not necessarily such a bad thing.

’A Rise in Stock Prices Equals A Good Economy’: A Thing of the Past

In America today, it is said that one out of every six people is in poverty and one in three is in pre-poverty. If the shale revolution makes cheap energy possible, those in poverty or pre-poverty will enjoy some wiggle room in their household budget thanks to cheaper gasoline, electricity and food.

Especially in America, cars are a must, even for short distances. Gasoline is a basic necessity, so the ups and downs in crude oil prices directly affect people's living standards. Crude oil prices are high now, which is putting an unwelcome burden on Americans’ everyday living. So if the slide of crude oil prices progresses in the future, life would be less constrained. Of course, with the decline in energy prices, food prices among other items would fall as well, which would improve living standards.

On the other hand, stock prices won't go up as they have up to now. As I said, tapering is a negative factor for stock prices.

However, the equation of "a rise in stock prices equals a good economy" should be thought of as a thing of the past amid the ongoing energy revolution. Over the long term, even with reduced stock prices, a fall in energy prices will reduce prices of goods generally, underpinning people's living standards.

Mainstream thinking in America today is that inflation is good and deflation is evil. However, as the energy revolution gets into full swing, this kind of thinking will go the way of the dodo, when the new thinking that "deflation is not necessarily evil" will have gotten its foot in the door of American consciousness.

Thus, in viewing the U.S. economy, we should remember, somewhere in our heads, that a fall in prices is not necessarily a bad thing.