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David Goldman: ‘Extreme Risk’ of Deflation Ahead

Wednesday, 30 May 2012 | 9:37 PM ET

Weak gold prices, softening oil prices and a lackluster stock market while the euro zone crisis could increase demand for U.S. dollars — but is deflation the next stop?

“It’s an extreme risk, though I don’t think it’s an inevitable outcome,” David Goldman of financial research firm Macrostrategy said Wednesday on CNBC’s “The Kudlow Report.”

Goldman, the former global head of fixed income research for Bank of America, pointed to substantial risk — and a possible domino effect across the Atlantic.

Deflationary Alarm Bells Ringing
John Ryding, RDQ Economics, and David Goldman, Macro-Strategy, discuss the 10-Year Treasury sliding to an all-time record low today and what it signals for the U.S. economy.

“We have the first major OECD economy, namely Spain, which is going to implode to the point that, for example, bank senior debt is likely to be wiped out,” he said. “That simply hasn’t happened in the postwar period to any major economy.”

Such a tumble could spell trouble for Italy, Portugal and France, in particular, “because the French banks own the Spanish bank debt,” Goldman added.

The source of risk? Europe.

“There’s virtually perfect, 100 percent correlation between stock market, oil prices, gold prices, all of these things, treasury bonds,” Goldman said. “It’s all moving together because people are moving out of risk.”

Calling the Spanish financial institutions Germany’s “black hole in their banking system,” Goldman said Berlin was right not to write a blank check in guarantees.

But the problem is that Germany has not made clear where it would write a check, he argued.

“They have to make clear where you draw the line, that the senior debt of, say, the French banks, will be defended at all costs,” he said.

John Ryding, chief economist and a founding partner of RDQ Economics, wasn’t betting on the euro crisis to drag down the U.S. economy.

“I don’t think it could turn into deflation, but it’s certainly a theme,” he said. “And it was a theme at the Atlanta Fed conference — not enough safe short-term dollar influence.”

Ryding also laid out a scenario under which zero inflation could occur.

“If we were to have a big commodity crack from here, that’s certainly possible,” he said. “We saw it in 2008 into 2009 when we had the big drop in oil prices from $140 a barrel down to about $40 a barrel.”

But, he added, 1-, 5- and 10-year charts show inflation rates around 2 percent to 2½ percent.

“So I’m saying we’re talking stable inflation,” he said.

What happens in Greece next month, however, could raise more issues.

“I would just say the problem with the European banks is one of the asset class problems, is the government debt itself,” Ryding said. “So there is an issue of what you recapitalize the banks with or guarantee the banks with. I think the ECB is going to have to respond again if we have a bad outcome on June 17 for the Greek elections. If we see that, we could see, say, a trillion-euro LTI.”

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  • Lawrence Kudlow is a CNBC senior contributor. Previously, Kudlow was anchor of CNBC's prime-time program "The Kudlow Report"