Is inflation or deflation the biggest threat to the global economy?

I really wouldn't like to be the man in charge of sorting out the UK economy today.

Almost every piece of economic data so far this week has been as bad as it could be. House prices are falling and retail sales are down. In the normal way of things, that spells deflation. But raw materials prices are soaring, and that spells inflation.

So what are we facing? Well, let's look at that data in a bit more detail

First things first. The latest survey from the Royal Institution of Chartered Surveyors found that 19 in every 20 surveyors reported falling prices in April. That's the worst reading in the survey's 30-year history. I probably don't need to point out that this includes the 1990s crash. Meanwhile, inquiries by new buyers are falling at the fastest rate since Rics began recording the data 10 years ago.

Unsurprisingly, this is all having an effect on consumer spending. The British Retail Consortium reported that the total value of retail sales was up 1.9% year-on-year in the three months to April. That doesn't sound too bad but in the quarter to March it was 3.5%.

The "horrific" rise in the price of manufactured goods

But at the same time, inflation is rocketing. The price of manufactured goods rose 7.5% in the year to April, the fastest since 1986. The rise was far greater than City forecasts, and was described as "horrific" by Ben Broadbent of Goldman Sachs, and "nothing short of terrible" by Paul Dales at Capital Economics. Even if you cut out food, alcohol and petrol costs, core' inflation was still higher than at any time since 1995 (for more on this story, see: UK inflation soars past City forecasts).

And the breaking news this morning is that consumer price inflation has hit an annual rate of 3%, way higher than the City had expected, and just a tenth of a percentage point away from triggering another letter to the Chancellor. Bank of England governor Mervyn King had better get his pencil sharpener out. We'll be following up this story on the website later today.

Meanwhile, import prices are climbing too, as the pound weakens. Import prices in the first quarter were up 10.1% year-on-year, reports the FT. "There is a wall of costs waiting out there to dump on the UK consumer," said Geoffrey Dicks of the Royal Bank of Scotland.

But consumers are spending less, and house prices are falling. That points to falling sales, which makes price hikes a hard sell. And even if prices do rise, rising employment insecurity will mean workers have a tough time demanding higher wages.

Good argument. But as John Plender pointed out in the FT a couple of weeks ago, there is a problem with it. The whole wage-price spiral might not be happening in the developed world. But the developing world the erstwhile workshop of the world - is another matter.

The end of cheap labour

The global share of the pie taken by labour (the workers) has fallen to a historic low. But now, "emerging market workers are battling for their income share." When we're talking about the end of cheap shoes, and the end of cheap vests, what we're really talking about is the end of cheap labour. That means "the developed world will have to pay more for its imports."

The other problem, Plender notes, is that even though emerging economies are experiencing rapid inflation (which would usually be bad for the currency no one wants to be in a currency which is losing value), many are pegged to the dollar. So even though there's more money around, in dollar terms, it can still buy the same quantity of goods. That puts more pressure on commodity prices as emerging markets gain more purchasing power over "globally traded commodities."

So developing economies have stopped exporting deflation, and are now fuelling inflation both in raw materials (as they have always done), which is now feeding through to their exported goods too.

Why our government has good reason to seek inflation

And the truth is that here in the developed world, our policy makers have a very strong incentive to pursue inflationary policies. Why? Because our big problem is debt. And inflation decreases the value of debt. Good news if you're in debt bad news if you're a creditor or a saver.

Of course, the flipside is that if the developed world can't afford to buy all those exports from the developing world anymore, then China and other export-dependent economies could also face rising unemployment and slowing growth. That might take some of the pressure off prices, but would lead to more social unrest with potentially explosive consequences.

So what's it going to be? Inflation or deflation? In the short term, Mervyn King will have to write another letter or two to the Treasury, that's for sure. In the longer term, it's hard to say, and it's a subject we'll be returning to regularly in the months ahead but whichever we end up with, it's going to be nasty.