I think most people will say I fell from the moon but I think this week spike in CPI/PPI is actually good news. Let see Y/Y CPI:

And PPI:

Compare with crude goods:

First, there is very clear sign of economic slowdown. While crude goods are trending around 20% Y/Y the finished goods are clearly below peaks established in the last few years. When producers can’t pass costs to consumers they have to cut costs and take all measures to improve productivity, which we are already observing.

I think there is a very little danger of financial system to fall into hyper-inflation – it’s just too late for that. Hyper-inflation had to happen back in 2005, now money supply is very constrained. So the good news #1 is that there is no hyper-inflation in sight.

Second, it seems that we will fall into recession well before we fall into deflation, that’s good news #2. It’s very positive to inflate a little big that popping housing bubble, that will make the nominal price declines less horrible. Inflation is bad for new borrowers, old borrowers feel better. While the credit crunch is restraining the issuance of new debt anyway the existing debt will be easier to pay off. When the recession finally comes (very soon) new debt won’t be an issue anyway.

Third, Federal reserve finally got a very good excuse to not lower interest rates. The recent very tight Fed policy hints me that Bernanke actually want the economy to fall into recession as soon as possible. The reason for that is that the spike of productivity that usually comes with recession will be one more bullet to fire into coming deflation. High productivity always give Federal reserve more space for rate cuts and it will need those rate cuts later on. That’s good news #3.

In short, the most optimistic scenario is that we will have the recession very soon, hopefully by February. That will help to finally start the necessary wave of corporate bankruptcies and increase productivity. The stock market and economy will be hit fast and bad, but without falling into deflationary depression. Then we’ll have a quick recovery, maybe a year or two and then we will finally fall into deflation, but the preceding recession will hopefully cut most of inefficiency away from the economy and the second, deflationary recession will not produce a depression. It will be bad, but not as bad as USA in 1930s or Japan in 1990s.

You see, I’m optimist, I’m not your typical “doom and gloom” bear 🙂