Dear CIGAs,

As you can see from the article below, Merrill Lynch shares our view about central banks sowing the seeds of inflation with their money printing. They are not concerned about deflation. They see it as only a very short term phenomena, and nothing be concerned about.

Timothy Bond who wrote this is one of the great economists on China and Asia. I have followed his work for years, and he has been correct. He says inflation is the problem not deflation. Deep interest rate cuts will continue in Asia and they will cause “deflation to be swept away by a flood of policy stimulus.” He goes on to say “In fact, we share the concern that central banks could over do it, sowing the seeds of future inflation.”

Warm regards,
Monty Guild

Hot topic: The two extremes of inflation

Asia has swapped an inflation scare for a deflation scare in the space of just a few months.

Price levels are falling almost everywhere. Four countries (China, Hong Kong, Taiwan, and Thailand) could see year-on-year deflation by early 2009.

What’s our view? We think deflation will temporarily raise its head, then be swept away by a flood of policy stimulus. In fact, we share the concern that central banks could overdo it, sowing the seeds of future inflation.

Still, deflation is the clear and present threat right now. Heading it off requires more “deep” rate cuts by Asian central banks, in our view. For this reason, we think the rally in domestic bond markets could continue through early 2009.
—TJ Bond

Asian snapshot: China—Cut 2009E GDP growth forecast to 8.0%

The global economy, especially international trade, has been hitting a wall since mid-September and will have to take several months to bottom out from this severe demand shock. For China, the world’s second-largest exporter, the sudden contraction of external demand is beyond our original expectation, and we believe it’s warranted to lower our 2009E GDP growth forecast from 8.6% to 8.0% albeit our optimistic view on the effectiveness of China’s fiscal stimulus plan.

What to watch: Singapore and Taiwan

As investors work through the next few months of data, we think they should revisit our view on the “heart attack” and the cycle. We expected terrible data in 4Q08 (this is happening), followed by a bounce-back in early 2009…and then business as usual, meaning a bread-and-butter deterioration in Asian data through mid-2009 as the fundamental slowdown continues to unfold. The December data should remain in “heart attack” mode. We believe key activity data from Singapore and Taiwan next week should further validate this thesis.

As the downturn deepens, we expect Taiwan export orders—a key lead indicator of China’s trade—to contract 15.5% y-o-y in November, following a 5.6% decline in the previous month. Separately, we project Singapore’s November industrial production to contract 14% y-o-y (down 12.6% y-o-y in October) in view of the poor trade data. This suggests another negative GDP reading for Singapore.

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