Deflation a real risk for the 2011 Budget period

El-Erian.pngThe blog is a great fan of Pimco, the world’s largest bond fund managers.
They were the first people to spot the housing bust developing in the USA, and to suggest the scale of the damage it might cause. More recently, they have pioneered the concept of the ‘new normal’.
Thus a new analysis by their CEO, Mohamed El-Erian, is worth taking very seriously. His key point is that increasing volatility in financial markets makes forecasting the future much more uncertain:
• Traditionally, likely outcomes have clustered together, in a bell-curve.
• But increasing volatility means that we are seeing “a much flatter distribution of outcomes
This has enormous implications for chemical companies. We have become used to a world where most reasonable people could agree on a consensus viewpoint, and they would normally be proved right. Now, however, El-Erian argues that ‘rules of thumb’ regarding the evaluation of risk are becoming “less useful, if not dangerous“.
Bullard.pngBy coincidence, an example of El-Erian’s argument has just appeared in the USA.
James Bullard, a Federal Reserve Governor, is warning that he may have been completely wrong to worry about future inflation. Instead, he has converted to the blog’s view that Japanese-style deflation is a real risk.
If this happened, it would turn upside-down a whole range of current assumptions. Demand, for example, might well reduce, as it would become sensible for companies and consumers to delay purchases for as long as possible, whilst prices fell.
El-Erian has been right before, when the consensus was over-optimistic. As we come into Budget season, CFOs might find it useful to circulate his article around their colleagues. Forewarned, as they say, is forearmed.

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