Every time there’s a whiff of good news, markets panic. Meanwhile, the really worrying trends are practically ignored. We are gradually forming the view that we are in for a lot more turbulence in the months, maybe years ahead and that the recent sell off in shares is justified; it’s just that the reason behind the sell off is wrong.

Yesterday the rate of interest went up in the Eurozone, as well as in South Korea, Denmark, India and South Africa. But in the UK, rates stayed on hold. This sent markets in to a tailspin again, with the FTSE 100, for example, shedding another 143 points. And yet, good news was behind it all. The economy is doing better than many had expected. The Eurozone has been flirting, and occasionally bedding recession for years. But at last there are signs it’s improving, and its consumers are spending again – precisely what the economic doctor ordered. And just because things are going the way we wanted, the markets panic.

In the UK, economic forecasting group, NIESR had good news. The UK economy, it said, grew by 0.6% in the thee months to May, while in the US, the White House upped its estimate for economic growth, saying it now expected the US to see growth of 3.6% this year, from the 3.4% originally predicted.

But, the two pieces of good news came with a sting. After revealing its information about the UK’s growth, NIESR said that given the level of growth, the Bank of England were mistaken yesterday – and should have upped the interest rate.

While, the White House report also predicted a rise in inflation to 3%, from the 2.4% previously expected.

So in a nut shell, the sell of is caused by economies doing better than expected. As a result markets fear the rate of interest will go up, forcing the economies to slow down. To us, the logic behind this panic does not make complete sense.

Sure commodity prices are in danger of pushing up inflation, but many believe the commodity market is a bubble, then should it burst in the manner they expect inflationary pressure will ease.

And yet, scratch beneath the surface, and it seems there are more serious problems lurking. In any other era, inflation would have been rampant by now. Consumer spending, artificially boosted by the rise in asset prices – should have led to a take off in prices. That it didn’t was down to two things:

Firstly, the Internet has been a massive catalyst for deflation. The high competition it promotes, and the information it supplies, has empowered shoppers to find the best deal in a way that was not possible before.

Secondly, cheap imports from China have helped facilitate the rock bottom prices we are seeing in many goods.

But maybe, these two factors, that’s China and the Internet, are one offs. The Internet, has perhaps had its effect now – no longer are prices higher than they should be – no longer can we rely on the net inexorably forcing down prices- because there is no longer any slack.

As for China, the danger is that the country will start to move up the value chain. That it will stop competing on price, and its highly educated work force will be employed to compete on quality. Yesterday, Money Week suggested that this is precisely what is happening. It focused on a report from Daiwa Research by Toshikatsu Kimura which said that real wages per employee rose by 13% a year for the six years up to and including 2005.

And, if the Internet and China do cease to be a reason for deflation, – then this really will lead to global inflation – and rates will go up further still – perhaps the markets were right to panic after all.

But forward wind the clock a little further – then actually, from the worrying trends, good news will emerge. The global economy, and the US and UK in particular with their respective balance of trade deficits, need to find more consumers across the globe. A wealthier China, with wealthier Chinese workers is likely to provide the medicine the US and UK need. And, while the Internet might lose its deflationary impact, it will ensure prices will never shoot up in the reckless way it once did. The consumers will have too much information to allow that.

Sources

Why China may soon ditch its biggest export – deflationMoney Week

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