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The world could be staring at a long era of deflation

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There are three games of chicken currently in play in the US. The first concerns its ongoing trade-cum-currency war with China. For political reasons, this is likely to last for months, unless a solution is reached in the form of a trade deal this October. The second is associated with US President Donald Trump’s constant dissatisfaction with the US Federal Reserve on the need to cut real interest rates more aggressively, though a rate cut happened last quarter and another seems in sight. The third, which seems more perplexing, is the Fed’s internal conflict with firms within the US and its puzzlement over how measures of monetary policy, including rate cuts, are having minimal effect in increasing real productivity growth in that country.

On a closer look, it is critical to see the second issue as entwined with the third, to examine whether rate cuts on their own can actually help improve US productivity.

Moreover, one key aspect that has been bothering most analysts even at the Fed, and now most investors, is the inversion of the bond yield curve, which indicates that a US recession is on the horizon. Why is this marker critical? In normal circumstances, a 40-year mortgage would carry a higher rate than a 20-year mortgage, which is also true of investments in government bonds; the longer the term, the higher the yield (of interest as a percentage of its market price)........

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