Central bankers are busy perusing their inflationary policies. Worldwide money supplies are increasing at about 20 percent a year. But deflation seems to be winning the battle against inflation. Gold is down to $818 an ounce. Oil is in the doldrums. It’s at just under $114 a barrel. Why are prices dropping? Because the global economy is contracting, says Bill Bonner…

Well, it appears that the feds are losing the battle. We have the ’stag’…but no ‘flation.’ All over the world, in almost every sector of the economy, prices are falling. Inflation is on the run – or so it appears today.

Housing prices are on the decline in America, Britain, Australia, Ireland, and Spain. We don’t know about other markets. They are said to be still rising in Brazil and other emerging markets. But we wouldn’t bet on it.

Commodity prices have been going down for about two months. After hitting a high of $147, oil has slipped all the way down to $114.

Stock markets are down all over the world. Most indices are off 15% to 20% for the year, except for China, which has been cut in half.

Even the dollar is showing signs of deflation – it’s going up! Not only are the things it buys becoming cheaper, it is also gaining ground against its archenemy, the euro. Yesterday, the euro fell below $1.50.

“The inflation rate is going to come down,” said an economist at Lehman Bros. (NYSE:LEH) Most economists agree. And so do investors. TIPS are U.S. Treasury notes that are adjusted to inflation. Investors pay a premium for them in order to get the protection of the feds’ inflation adjustment. Thus, the yield spread between these notes and regular 10-year Treasuries is a good measure of how much inflation investors expect. And currently, the yield has dropped to its lowest point in nearly five years.

What is the reason for this stunning defeat of inflation? How come the central banks and financial authorities aren’t better at what they do best? The latest numbers we have show them trying hard. Money supplies worldwide are increasing at about 20% per year – five times faster than the rate of economic growth. According to theory, if the supply of money increases faster than supplies of goods and services inflation will result. Is the theory wrong? Or is something else is going on?

Yes, something else is going on. The world economy is cooling off. After running so hot for so long, a chill wind is blowing. It began almost exactly a year ago – on August 9, 2007 – when the subprime story broke. First, the homeowners got in trouble. And then, the builders. And then the lenders. And then the investors who lent to the lenders. The problem mounted up the financial ladder like a crusader scaling the walls of Constantinople.

For a long time, it looked as though the go-go economies of the Far East…and the commodity producers…would be able to hold them off. The world economy had “decoupled,” it was said – with the emerging economies continuing to grow while the old economies of Europe and North America were in a slump. With this huge new demand in front of them, commodities markets continued to move higher…even as stock markets and housing sank.

But now, it looks as though nothing will be spared. Everything is going down. Gold, stocks, property, copper, inflation, GDP growth rates, consumer spending, car sales, student financing, employment, house sales, housing prices – everything.

And against all this… the dollar is going up.

But what does it mean? Well, no one knows… (still, we offer a “what if” below…)

Expansions are typically inflationary. Contractions are typically deflationary. But we knew that. What we didn’t know was whether there would be enough juice in the emerging markets to keep the world economy growing…

…and whether the feds could effectively re-inflate – with their bailouts, handouts, and monetary cop-outs. The answer to those questions seems to be ‘no.’ But the matter is far from settled. No economist has ever seen a world money system such as the one we have now. No one knows how it will react to the stress of a major contraction. So, we’ll hold onto our gold a bit longer… and wait to see what happens next.

Source: Inflation on the Run