The Struggle to Dodge Deflation

The digitization of information and near-free international telecommunication mean it's now commercially feasible to shift large amounts of service activity from high-cost countries to low-cost ones with their abundance of young, highly-educated, adaptable workers, hungry to advance themselves.

According to Fortune magazine, China will produce about 3.3 million university graduates this year and India 3.1 million (all of them English-speaking). In engineering alone, China will produce more than 600,000 graduates and India 350,000 but the US will only graduate about 70,000.

The relocation of jobs out of high-cost countries has already expanded beyond low-skill sectors such as call centres into high-skilled ones such as software and microchip development, banking, medical research, legal and tax planning. It's a flow that's going to become a flood. The McKinsey Global Institute predicts that in some industries of the mature economies a quarter to a half of all jobs are likely to migrate.

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One implication is that in many kinds of high-skilled jobs, remuneration packages are going to fall instead of rise, as they have for decades. It's already started. In the US last year average employee compensation (pay and benefits) actually fell for the first time in 14 years despite strong economic growth.

Another implication is that workers throughout the advanced economies, having already lost some bargaining power, and about to lose more through competition from abroad, will be unable to push up their incomes the main source of domestic inflation.

Other factors undermining the bargaining power of labour include fast-rising productivity growth from application of electronics-based technologies, and very low cost of capital, which has made it cost-effective for employers to invest in capital equipment rather than higher labour inputs.

Other anti-inflation forces include:

** The strong focus of corporate managements on improving profits and strengthening balance sheets through controlling costs rather than raising prices; and

** The continuing strong orientation of central banks towards policies of inflation containment.

Inflation a threat to our future? I don't think so. If we're lucky, we'll have a "no-flation" environment for the foreseeable future. If we're unlucky, we may be unable to avoid deflation. It's happened before when there's a supply/demand imbalance in the world economy with insufficient demand.

There must be many fund managers who agree with me and have deployed their assets accordingly it's one explanation for the low yields/high prices of the traditional fixed-rate government bonds of major nations.

"But don't high gold prices suggest fear of inflation?" you may ask. Actually, the opposite. Gold can prove to be a good investment in inflationary times but it can be an even better one in deflationary times, when there are few alternative ways to safeguard your personal wealth. It's the only investment that's an each-way bet.

By Martin Spring in On Target, a private newsletter on global strategy