The Fed has often said that inflation is low and many analysts are puzzled. Why is inflation so low after a massive money printing program by the Fed? The Fed has been worried by deflation since the last financial crisis, the purpose of QE was to create inflation, to boost asset prices and to create wealth and spending. The world economy is in the midst of a depression, this depression has been hidden by the Fed. If prices are falling by 3% and you create 5% inflation, real inflation is 2% which is where we are now.
Now the Fed is no longer doing QE, one would expect inflation to fall sharply. Indeed the depression is still underway, but the Fed is no longer creating inflation, this is why we see a global slowdown. China has been badly affected, what happens in China will spread to other countries. Analysts are now concerned deflation is taking roots in China after producer price inflation slowed sharply in December. In a deflationary environment prices fall including asset prices. The Chinese stock market has already collapsed, house prices are going down and commodity prices are declining. The same scenario will soon happen in the US, this is why the dollar is going down.
Trump thinks the US can avoid a hard landing by doing a trade deal with China and the Fed thinks the economy is on track to perform well if they stop raising interest rates. But this won't change anything, the bear market and the depression were due long before Trump came to power, long before the trade war started and at a time when interest rates were at zero percent. A trade deal with China won't change anything, and lowering interest rates won't do much to the economy as they are already low. I remember in the 1990s when rates were near 10% and the economy was doing fine. If today the economy is struggling with low rates there is a problem.
We are in a global system where problems in a major economy spread to next major economy. Once the deflation process starts it is difficult to stop it. No wonder Trump is desperate to boost the stock market. Rising asset prices help inflation, this is the same story, we are told that if asset prices rise, not only inflation will go up but people will spend more as a result of increasing wealth. This has been tested with QE, I am afraid it has not worked. Deflation will come and the stock market will collapse. Trump and the Fed will do everything possible to boost the markets, but they will fail. There could be more upside in the short term, the re-opening of US government will help, but in the long term it's going down.
