The issue of inflation now lies at the centre of the economic debate. The legendary investor Warren Buffett (pictured) is warning again of the dangers.
 

He helped put it firmly on the agenda back in March, when he warned of an 'onslaught of inflation' due to the 'unthinkable dosages' of financial medicine being dished out by the government. Up until that point, most economists were still more concerned with the threat of deflation.

 

In the UK, for example. consumer price inflation reached 5.2% in September. But with global financial markets seizing up, commodity prices plunging and recession looming, the greater threat might actually be deflation.
 

Could other countries be about to repeat Japan's 1990s experience of minimal growth, falling asset prices and deflation?

At the moment, many countries share similar characteristics prior to the initial downturn. Unemployment was low and inflation was under control, but just starting to rise.

With asset prices rising, driven by increased borrowing, there has been a belief that house prices would never fall, fuelling the credit boom. In contrast, the excess capacity created by Japan's overinvestment contributed to the slide into deflation.

Japan experienced a mild recession in the early 1990s, but the Bank of Japan didn't see the necessity to cut interest rates rapidly and remained concerned about inflation as the Yen was initially weak. The first rate cut came only after stock prices had almost halved.

With hindsight the Bank of Japan was far too slow to cut interest rates. Certainly Japan didn't face the seizing up of credit markets currently afflicting other economies, such as the UK and global economy.
 

The first major bank crisis didn't happen until December 1994 with the failure of two urban credit cooperatives.
 

Full-scale deflation didn't begin until the onset of the severe recession in 1997-98. This downturn was exacerbated by the Asia crisis and the decision to raise taxes in April 1997.

Banks were slow to shed their bad debts and recapitalize in earlier years, leaving them ill- equipped to cope with the recession. By the time interest rates were cut to zero in 1999, it did little to stimulate activity.

Events have unfolded much more abruptly elsewhere than in Japan. The economy and the financial sector are adjusting rapidly. Unemployment is rising sharply and there have been several high-profile banking restructurings.

A combination of a different regulatory and political structure than Japan and intense market pressure is forcing rapid change of the global financial system. Japan's deflation compounded its economic problems and global policy-makers are determined not to repeat the same mistakes.

It's harder to pay off debt when wages are declining. As inflation falls, we think interest rates will be cut even faster. If this fails to stabilise the economy, then rates could fall further, perhaps to 1%. Even if rates drop to zero, there are several unorthodox measures a central bank can use.
 

The most extreme involves printing money, but as Japan discovered after the Second World War, this could undermine the currency and risks an uncontrolled surge in inflation.   Various government's plans to inject capital into banks is sensible and there is some scope for additional fiscal stimulus. 
 

 But global economies need to be careful not to raise concerns about their ability to pay off debt. A rise in government bond yields would undermine the recovery. This means monetary policy will need to work alongside fiscal policy to avoid a Japanese-style outcome.

While deflation should be avoided, a period of weak global economic growth now seems inevitable. Household wealth has suffered a significant decline following the collapse in house prices and stock markets. This is likely to trigger a rise in saving.

 

Lower interest rates will help homeowners on variable rate mortgages and those refinancing fixed-rate deals, but with unemployment rising, consumption growth is likely to be sluggish for some time.

Deflation should be the threat given the banking collapse that has caused the deepest recession since the 1930s. A similar consumer boom and bust which led to banking meltdown in Japan in the Eighties was followed by a 'lost decade' of falling shop prices, falling house prices and falling share prices.

Most of the Western world now faces the same problems as Japan. Recognising that, the response has been colossal. The US has a $300bn asset-buying programme while the UK's quantitative easing initiative is proportionally far bigger, at £175bn. It emerged yesterday that Bank of England governor Mervyn King was out-voted in his attempts to extend the programme to £200bn.

Printing money has a cost - it creates inflation, which is not only damaging to the efficiency of the economy, it makes it more unfair. Those on fixed incomes, such as pensioners, see their spending power eroded.  

But the impact of quantative easing on inflation is unknown. Japan gives the only comparable modern example when, during the post-dotcom bust, the country finally tried a little QE. Experts are divided on the success. Moderate economic growth followed - but then those were the years, 2003 to 2007, when the global economy was flourishing. Japan, as a leading exporter, was a big beneficiary.

Warren Buffett has praised the unprecedented attempts at stimulating the economy, so far. In fact last month he said more may be needed.
 

In his New York Times column, Buffett cited the iconic 20th Century economist John Maynard Keynes, whose borrow and spend theories were used to tackle the Great Depression of the 1930s and the current crisis. Keynes also noted the problem of unbridled use of his plan:

 

'By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.... The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.'

 

Chris Regan of Holborn Assets works closely with ExpatWoman to provide financial planning services for expats of all nationalities.