ECB proves the war on deflation is raging

The European Central Bank's unprecedented move of declaring a negative interest ratefor deposits (minus 0.10 percent) shows that the war on deflation rages around the world.

The single biggest threat to the global economy is the threat of deflation. While that appears less true in the United States, it's a decades-old problem in Japan, it's quite apparent in Europe, and it's becoming increasingly apparent in places like China, Russia, Brazil — and possibly even Australia and Canada.

In many ways, central banks are fighting the mirror image of the war that was fought on inflation around the globe from from 1971 to 1982.

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Nicholas Monu | Photodisc | Getty Images

Most people have scant memories of President Richard Nixon closing the gold window in August of 1971, letting the dollar float freely against foreign currencies, and the subsequent wave of inflation that those combustible events ignited. The problem was further compounded by the Arab Oil Embargo that sent oil and gasoline prices soaring, while food inflation also took off everywhere. Unions, a much bigger force in the labor markets then than they are today, demanded that wages be raised to keep pace with prices, increasing the upward pressure that caused the dreaded wage/price spiral of that era.

When I was growing up in Buffalo, NY, in the early 1970s, we would frequently cross the Peace Bridge into Canada, where sugar, meat and other necessities were noticeably cheaper. That was probably the result of a currency arbitrage but it is seared in my memory those grocery store trips we made to save money on food and fuel. And that was really just the beginning of a 10-year battle with inflation that gripped, not only the U.S., but most of the developed world.

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Exacerbating the problem along the way were a number of major policy errors made by the federal government and the Federal Reserve.

President Nixon imposed wage and price controls in a disastrous attempt to hold down the cost of living. When those controls were lifted, inflation accelerated even faster. President Ford introduced a "Whip Inflation Now" campaign, complete with "W.I.N." buttons, that did nothing to alleviate the problem. Then, during the Carter years, another oil shock and series of monetary-policy errors drove inflation and interest rates ever higher, as many began to assume the problem could never be tamed.

In 1979, Paul Volcker was named chairman of the Federal Reserve. He immediately took bold, dramatic, and extraordinary, steps to tame inflation by driving interest rates to over 20 percent, creating a crushing double-dip recession that wrung inflation out of the system.

Many of us fail to remember, or conveniently forget, that the war on inflation lasted over a decade.

I believe that lack of societal memory is one reason people have difficulty believing that the war on deflation is required to be AS dramatic — and as long — as the war that started 43 years ago this summer.

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While I think bonds are overbought, I also think too many people fail to understand that the Fed, first under Ben Bernanke, and now under Janet Yellen, is in no rush to raise interest rates, even with better-than-expected economic numbers, should they materialize in the days, weeks and months ahead.

Some members of the Fed are worried about "complacency" among investors who are apparently taking on more risk in stocks, corporate bonds, and junk bonds, showing no signs of worry that stocks, in absolute terms, are somewhat richly priced, while the spread between investment/non-investment-grade bonds and US Treasurys is as narrow as it was in the summer of 2007, just before the crisis unfolded.

I'm not certain this is a function of complacency, but a recognition of reality. The reality is that, despite occasional rallies in bond yields, like the one we've seen over the last week, and despite notable improvements in the U.S. economy since the crisis crested, the world is still vulnerable to shocks. The risk of shocks, more precisely, further bouts of deflation, will likely keep interest rates lower for longer than many currently anticipate. And the so-called terminal fed-funds rate, which many believe is 4 percent, the rate at which interest rates are normalized, may be much lower — say closer to 2 percent!

Investors know economies cannot handle, nor will likely tolerate, a rapid rise in interest rates, either at home or abroad.

Interest rates are falling in many parts of the world, reflecting the global risk of deflation. The yield on the 10-year German Bund is about 1.4 percent. Published reports have shown that German interest rates, and more broadly, the average of pan-European interest rates are the lowest they have been since the Napoleonic Wars, roughly 1815. In Japan, 10-year yields are roughly 60 basis points, after briefly flirting with 1 percent late last year.

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Bond markets are telling us something from all quarters that the deflation fight is not yet over and to declare victory would be premature. At many points in the fight against inflation, throughout the 1970s, it was thought the war was won. It took a great deal of patience, fortitude and the right mix of policies to win that war.

This Fed is on course to do just that while investors need to show more patience and a deeper understanding of the process.

Many battles are won in a long campaign, but the war is not won until the enemy surrenders. Deflation has yet to hold up the white flag and beat a hasty defeat and the Fed won't rest until the enemy surrenders.

Commentary by Ron Insana, a CNBC and MSNBC contributor and the author of four books on Wall Street. He also delivers a daily podcast, "Insana Insights," and a long-form weekly version, both available on iTunes and at Follow him on Twitter @rinsana.