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Two hypotheses have emerged: the world is heading for deflation, or it is heading for hyperinflation. So far, it has been low inflation, but not deflation, as real interest rates have remained very low. Financial markets expect a continuation of this equilibrium with low inflation but not deflation, as deflation is being averted by the money creation and the structural inflationary factors despite the massive savings glut, per Natixis.

US Dollar Index (DXY) fades recent bounces off 32-month low while receding to 89.60 during the early Thursday. 

Key quotes

“The deflation hypothesis results from the observation of an (ex-ante) global savings glut (ex-post, savings are equal to investment at the global level) and therefore abnormally weak demand. The savings glut is evidenced by the rise in the global savings rate and in the private sector savings rate, the decline in nominal and real long-term interest rates and the decline in global inflation.”

“It is true that if the savings glut gets worse after the COVID-19 crisis, depressed demand could give rise to true deflation. True deflation is a situation where inflation becomes so low that the real interest rate becomes excessive. This is not yet the case.”

“Traditional monetary theory explains that a large increase in the money supply leads to a large increase in prices in the medium term. But for this link between the money supply and inflation to appear today, the excess savings accumulated during the covid crisis must be at least partially consumed. If they are not consumed and are invested in financial or real estate markets, then asset prices but not goods and services prices will rise.”

“There are several possible structural causes of hyperinflation. Population ageing, as pensioners consume but do not produce; the energy transition, as renewable energy is much more expensive than fossil fuels due to the intermittency in the production of renewable energies and electricity storage costs; the need to lift low wages and achieve a fairer distribution of income in OECD countries and the return to regional value chains, which will reduce the use in OECD countries of lowcost products made in emerging countries.”