Puff of Smoke

"It's Lao's time."
--Lee (Enter the Dragon)

As we open the door into 2010, I still sense a pretty good chance of another deflationary wave lower. Given US debt levels that have only increased over the past year, it seems straightforward to speculate about a domestically led deflationary mechanism.

Increasingly, however, I wonder whether the mechansim might be situated in China. China's planners have been stepping on the economic gas pedal and signs of overcapacity are growing. Moreover, urban Chinese real estate markets are sporting that familiar bubblicious feel.

Centrally planned systems inevitably misallocate capital in a big way. If China's planners have mistakenly allocated enormous sums of capital toward facilities, raw materials, and, yes, US debt that they 'shouldn't' have, then the bust that follows will almost certainly resonate globally in a deflationary fashion.