Inflation-Deflation Seesaw

[A piece for the Austrian paper Borsen-Kurier]
The big news from America is President Obama: a truly great man has been elected president, and he did it in spite of his race and unusual name. It is a great moment for America. President-elect Obama faces a global economy that is more tightly interlinked than ever before, and so trends that emerge in the US (and elsewhere) have global ramifications.
The US Producer Price Index has been falling for 3 straight months: down 2.8% in October, 0.4% in September, and 0.9% in August. The PPI doesn’t reflect the plummeting asset prices in financial markets (the Dow is down 40%) and real estate (down 20% nationwide, according to the Case Shiller index). There is considerable downward pressure on nearly every asset class worldwide, and it seems likely that commodity deflation will continue for at least several more months.
Of course, the central banks of the world are working overtime to combat deflation; the Federal Reserve and the Treasury have borrowed or created nearly $3 trillion out of thin air this year alone. As that new money is absorbed and digested by markets, it will eventually cause inflation. Certainly the announcements of the G-20 meeting, with its statement that the world should work together to re-inflate sagging markets, is also inflationary.
By the current rules of the game, no country that relies on exports to fuel its growth can afford an appreciating currency against the dollar, for the strengthening of the currency would hurt sales in the US and every other country that maintains a dollar peg, which includes some pretty big markets, as well as some high growth markets, such as China. This means that when the US creates dollars, other countries rush to weaken their currencies. With a worldwide crash in equities, countries are not exactly reluctant to create money and funnel it into financial markets, but at some point, this will catch up with commodities again, and we’ll see a resumption of global commodity inflation, which is likely to accelerate.
The US bond market is currently pricing in low inflation over the long term. Indeed, for a time the inflation protected Treasury bonds (TIPS) had a higher yield than the nominal 10-year Treasury bond, meaning that the bond market predicts deflation. But what will happen when the money creation returns to markets in the form of inflation? Bond yields will have to rise, to compensate for inflation, leading to broad-based increases in interest rates across the economy; even though the Federal funds rate is likely to be low, I bet we’ll see high interbank lending rates, with the consequence of rising rates for consumer credit, and rising rates for corporate bonds as well.
There is no easy way out of this, but President-elect Obama has already done one good thing: reminded America that there will be sacrifices ahead. I think we can make sacrifices, if there is an understanding that it’s for a good reason, and it will help to eventually restore solid economic growth.