Given Chinese demand for commodities and a falling real exchange rate in the developed world, the result is that the west will face a bigger import bill in the form of higher raw materials prices. This will require services prices to fall sharply in the west to keep inflation low. In turn, this will be bad news for service sector profits. But it is better for the services sector, which invests little in new plant and equipment, to suffer than for the manufacturing sector, which invests much more, to do so.
But Smithers warns that “Real asset prices, including both shares and real estate, are likely to fall in these circumstances”.
Personally, I would have thought that falling asset prices combined with deflation would make the debt crisis much worse. But I think Smithers is attacking the key issue; faced with fiscal austerity at home, the developed world would like to expand its exports. That is harder to do in the face of Chinese competition, and the managed level of the renminbi. So the west must slash its costs, rather as Germany did in the decade after monetary union. The process will be slow and painful, but might be better than all the alternatives