The global economy has been the setting for an epic tug-of-war in recent years, between the forces of inflation and deflation. Now with China devaluing the renminbi it looks as though deflation has won, says Tim Price. It's scary stuff, and I find it hard to disagree with Tim's take indeed, we've said for a long time that the most likely endgame for the post-financial crisis era would start with a deflationary scare.
However, "scare" is the important word here. Markets have a nasty habit of doing the one thing that you're least prepared for. So if we take a step back and look at what's going on, what do investors seem least prepared for right now?
It strikes me that, with bond yields at record lows (and so prices at record highs); commodities having crashed down to levels not seen since the 2008 financial crisis; and the US dollar leaving all other currencies flailing in its wake; markets are more prepared for deflation and tighter monetary policy than they are for inflation and looser monetary policy. Given that this is the exact opposite of what central bankers across the globe (including in China) want to see, do you really think we're going to get it?
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Markets are wobbling all over the place as they try to get to grips with what China's move means, and we're already seeing the likes of bond "guru" Jeffrey Gundlach probably the most respected bond investor in the world right now warning the Federal Reserve that it'll be opening Pandora's box if it hikes interest rates next month.
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We need only see a few trading sessions where the Dow Jones closes down in triple-digit figures for the Fed to start reconsidering a rate rise, or to dilute market fears by hiking rates by an eighth of a percentage point rather than a quarter (seriously, wealth manager Pictet suggested this might happen in the FT this week, and I think it might be right).
Yet even as central banks have their fingers poised above the print buttons, there are signs that inflationary pressures are at least holding their own in some key areas. Walmart, the world's largest retailer, is starting to feel the pinch from rising wages. Britain's core inflation rate surprised on the upside too (as usual). What does it all mean?
When the gloom gets too great, you can expect the central banks to step in again. And unlike most developed-world central banks, China still has a significant level of slack to fall back on, as well as an economy that is still in a position to benefit from major reforms. "One day China will pull the lever and nothing will happen. We are not there yet," says Ambrose Evans-Pritchard (not generally known for his optimism) in The Daily Telegraph.
That's one reason why, I reckon, Rupert Foster, who wrote this week's cover story on China, is right and that China is more likely to be near the start of a long bull market than a massive bear market.
