Monday, February 14, 2011

Inflation or deflation, that is the question

Will the future be inflationary or deflationary?
Whatever it turns out to be will have great consequences for the financial markets. Inflation and deflation are like day and night. As a rule of thumb: inflation means higher long-term interest rates, deflation lower. Inflation is not unfavorable for asset prices such as stocks, while deflation means profits drop and a rapid decrease in demand, leading for example to lower stock prices. Real estate loves inflation, but hates deflation. The picture for exchange rates is even blurrier, as there also the relative performance of various countries and regions is very important. Not all currencies can become weaker at the same time. Therefore, higher inflation in the US than in the euro area, for example, would send the EUR/USD exchange rate to new heights, everything else remaining equal.So, what will it be?