Don't Sweat Inflation: Deflation "In the Cards" for 2009 and Beyond, Shilling Says

Runaway inflation and a weaker dollar may well be in our future, but probably much further down the road than most people currently expect, says Gary Shilling, president of A. Gary Shilling & Co.

In fact, Shilling says deflation, the polar opposite of inflation, is "in the cards" for 2009 and possibly beyond, thanks to: the crash of commodity prices, excess inventories, widespread wage cuts for the first time since the 1930s, and excess capacity in many industries.

In addition, Shilling believes the preconditions for deflation are all in place:

• Subpar economic growth: A slowing consumer plus deleveraging in the financial sector means 2%-2.5% GDP growth will be the new normal once the recovery occurs, says Shilling, who doesn't see recovery anytime soon as detailed here.
• Tech-led Productivity: Workers fearful of losing their jobs and employers determined to cut costs means the productivity benefits of technology will be pushed to the extremes.
• Globalization: Lower labor costs in emerging markets has already driven down prices for consumers worldwide. The current economic downturn is going to put even more pressure on exporters to lower their prices to remain as competitive as possible in a "beggar thy neighbor" world.

Some caveats need to be noted. First, Shilling is the author of two books on deflation, so is clearly biased toward this outcome.

Second, and more controversially, he is "not terribly worried" about rising deficits or the government's spendthrift ways. He believes higher tax receipts will help fill the deficit hole once the economy recovers, and that the Fed will be quick to remove excess liquidity if/when inflation rears its ugly head.

Both views are controversial, at best. But Shilling's recent forecasts have been eerily prescient; thus, his deflation forecast should not be dismissed and clearly seems to be carrying the day right now.