There are two schools of thought about inflation prospects, both quite extreme.

Either one believes in a huge resurgence in global inflation shortly, linked to financial excesses (directly due to huge money supply expansion and indirectly through currency demolition derbies), with a resurgent commodity price inflation also possible.

Or one is firmly convinced about the dormancy of inflation for quite some while, linked to global economic underperformance, huge resource slack and downward price pressures as a consequence.

And as of this weekend, an outbreak of swine flu globally is weighing in on the scales on inflation's downside, as a full global outbreak and human pandemic would reinforce the global growth downside, potentially severely so.

For South Africans this matters, for either way we will be importing this global condition into our own CPI and PPI inflation outlook, in addition to the impact of the rand exchange rate, our non-tradable services inflation (especially government) and our own recession condition.

So which way will the cookie crumble?

Could inflation it go below 5?

With our CPI inflation currently about eight percent, do we only have limited inflation downside before the global upside risk takes us into its firm grip, pushing us beyond 10 percent CPI inflation once again?

Or will our CPI inflation subside yet more, as generally expected, but could it go well below five percent to even (much) lower levels (as few care to project so far)?

The world does not have happy memories of governments overly using printing presses. Zim has only been the last country in a long line of experiencing hyperinflation.

The aggressive manner of especially central banks in the US, UK, Japan and Switzerland (strange bedfellows, by the way, spot the odd couple) has provided much food for thought worldwide.

Opting for effectively zero interest rates, hugely increasing their own balance sheets to provide alternative funding channels, augmented by quantitative easing (buying bonds in the open market), are something out of a hyperinflation primer.

As is the behaviour of at least some governments in priming the fiscal pump, with the US budget deficit this year alone coming in at $1.8-trillion or 12 percent of GDP. In many countries, the national debt will hugely increase relative to GDP as governments play spender of last resort to prevent their economies (and banking systems) incurring too much of a fall.

Too much money chasing too few assets

Many people around the world don't like the look of this, thinking it typically irresponsible of Anglo-Saxons. With too much money chasing too few assets and goods this is seen as only translating into higher inflation in time.

The central banks concerned strenuously deny such views. It is because so much privately-held funds have become demobilized, passively sitting in bank deposits, that central banks have become so hyperactive to make sure there is enough liquidity greasing financial markets.

Private money is specifically not chasing goods and assets at present. For that reason all this liquidity creation by central banks will not create additional inflation. It is only when private funds mobilize again, and re-enter the economy and markets, as buying power for goods and services and asset purchases, that a dangerous moment could occur.

Exactly, groan the Nervous Nellies, at that point the central banks won't withdraw fast enough, with dire consequences for all.

It certainly would be a pregnant moment full of meaning if it all goes wrong. And things can go wrong too easily where humans are concerned, indeed too often.

Bankers swear by their unborn children

In contrast, the central bankers are swearing by their mothers' reputation and their unborn children (so intense is the debate) that they will know to withdraw just in time when the moment comes.

Have we heard this line before and come to regret it?

Indeed, apparently liking to live dangerously, the idea is for the central banks to stay overly committed right up to the last moment before starting to note stirrings of life as private money recovers its confidence and re-enters the ring.

It is at that precise moment that the excess central bank liquidity provision should start to run down at roughly the speed that private money re-enters the economy and asset markets.

Can't be done, wail the Nervous Nellies, they will stay in too long. We will all be lost.

No, we won't, bellow the central bankers, we know what we are doing, have prepared the process of our Grand Exit well in advance. Trust us!

It is an old story, this trusting business, as they take us on a conducted tour of the printing presses to inspire some badly needed confidence.

Lightening speed of the central bank reflexes

We will only know whether we could really trust those central bank reflexes and all the preparations they said they would put in motion when the moment comes.

Ultimately it is the same for government fiscal actions, though only slightly less hair-raising because theirs is in slow motion compared to the lightening speed of the central bank reflexes.

Most governments are maintaining their spending momentum, indeed in some cases are hugely topping it up with emergency stimulus, even as their tax revenues fall away, thus opening up large budget deficits and aggressively expanding their national debts.

Will such governments know how to turn their boats when the crisis abates?

No they don't, wail the doubters.

But we do, cry the politicians. We will be ending emergency spending when the moment comes. Also, recovering economic growth will pump up the tax revenues, meaning eventually falling budget deficits and ultimately declining national debts.

These are important concerns. But so are the honourable undertakings of central bankers and even governments.

Short-term threat is deflation

For now, with the world in recession and asset markets struggling to get up off the floor, there is little doubt the short-term threat is deflation. Prices will fall this year in quite a few countries.

But when the ship turns, what will happen then?

The pragmatists point to the huge resource slack in the making, with many more people unemployed and factories idled. That is not a condition in which one would expect quick inflation resurgence.

With large economies likely underperforming their economic potential for some years, the presence of excess liquidity needs not necessarily give rise to shortages and inflation push.

Only in time, with the world booming again, will policy need to make sure that liquidity is only modestly being expanded rather than fully accommodating exuberance.

But could the excess liquidity and government actions still create doubt about certain countries, setting in motion outflows of capital fleeing such irresponsibility?

Currencies acted as shock absorbers

That risk is difficult to quantify, especially in a world refusing to act in a uniform way. Some countries may champion actions that find followers in markets, as opposed to the actions of other countries.

So far this hasn't happened on any large scale yet, though currencies have acted as effective shock absorbers in some instances. But could there still be turbulence setting in motion currency demolition derbies?

It remains a risk and it then depends on which currencies get devastated as to who will experience rising inflation (as their exchange rate depreciate) and who finds its inflation suppressed (as its currency firms).

Probably closely connected to this currency prospect is the behaviour of commodity prices.

Will demand for commodities recover early, especially in China? Will supply be curtailed, as seen of late? Could commodity prices suddenly revive, more virulent as last time, possibly reinforced by currency movements?

Myriad of possible inflation outcomes

There certainly are believers in an early commodity price revival for all these reasons.

For South Africa, this mix of prospects leaves a confusing myriad of possible inflation outcomes.

Central bank and government policy aggression abroad is not at present creating undue inflation or currency pressure. Indeed, it is meant to prevent a repeat of the Great Depression. Thus these actions are probably also saving South Africa from a huge deflation (even if its eventuality would probably be tempered by an equally huge or bigger Rand weakening).

As things stand, however, such global policy action cannot prevent the Greatest Recession since the Depression, thus globally suppressing inflation to the point of turning into deflation this year (but not everywhere and not beyond this year).

This suppressed inflation condition is being imported by us, and is assisting in putting downward pressure on our inflation.

If central banks and governments can execute perfect Grand Exists once the world is embarked on recovery, this picture needn't change much, but do allow for some minor slippage. A bit of inflation grease at the time of the Great Turning could assist the whole recovery process, provided it doesn't get excessive. So don't get unduly nervous just as yet.

Demand and supply dynamics worrisome

As to commodities, their demand and supply dynamics globally could again be worrisome ere long. Warnings on this front should not be ignored. On a one-to-three year horizon we presumably could see quite a new upturn in at least certain commodity prices, potentially boosting our price inflation anew.

Even so, we may on balance still encounter renewed support for peripheral high-yielding currencies.

No you won't, shout the doubters, who fear global credit weakness and capital reversals. And now reinforced by the appearance of swine flu on the global scene.

But the global safety nets have been strengthened (central bank swap lines, IMF resources) and a global market turn could favour high yielders as carry trade and risk appetite return.

This seems to already have been happening of late, and could end up neutralizing any early commodity price revival pressures, though watch the progress of the swine flu as it makes its journey around the world.

Forces appear remarkably matched

Still, also watch the SARB for not wanting any Rand recovery to go too far, given the economy's current weakness, thus inviting renewed foreign reserve additions and limiting any Rand gains to 8-10:$ territory.

That still leaves the two main local forces, non-tradable services costs on the one hand and an underperforming economy weighing on the labour force and idled businesses on the other.

Despite the huge risk exposures in every direction, especially globally, these various forces appear remarkably matched. So much so that our CPI inflation prospect seems to be in animated suspension in the five percent to seven percent range for the next two years at least.

That would be no bad thing, as it would allow our internal stability to be re-established again. We don't now need big new shocks taking us in either direction.

But we can't be sure that the animated suspension will hold and that the forces driving our inflation will remain roughly balanced as sketched here.

Something could give way, not least pork futures.

A two-handed forecast

Precisely, echo the Nervous Nellies, in which case only the worst can surely happen.

But that is to run ahead of the story, not least because next time the whole thing could still break our way, in fact giving us for a while lower inflation than now discounted.

This may sound remarkably like a two-handed forecast. But a Bell-Curve always has two extreme tails, one for truly positive risk and one for awfully bad risk. Only time can show how evenly these tails are matched in size of risk.

For myself, in a deleveraging, underperforming, deflating world in which we are getting severely pummeled as well, I would say our inflation risk is on the downside from where we sit, especially if central banks and governments were to disappoint the Nervous Nellies as they eventually execute successful Grand Exits, and not forgetting pork belly prices currently plummeting.

A sustained low inflation outcome is not a given, but it is possible.

Cees Bruggemans is Chief Economist of First National Bank.