Sorting Winners, Losers as Deflation Hits Home

Price deflation in the world economy was supposed to be one of the long-term side effects of Asia’s economic slump. But the long-term apparently is already here:

* The overall price of U.S. imports from Asia’s newly industrial countries fell 1.2% in November, while the price of Japanese imports was down 0.3%, Deutsche Morgan Grenfell reports.

* The U.S. producer price index, which measures prices of domestically produced goods at the wholesale level, fell 0.2% in November, the government said Friday.

“The Asian crisis has unleashed tremendous deflationary pressures in the global economy,” said Edward Yardeni, economist at Deutsche Morgan Grenfell. He expects U.S. wholesale prices to decline between 1% and 2% in 1998. That may not seem like much, but as an average figure it would imply that prices of many goods and/or services will fall much more sharply.

Asia-fueled deflation has three potential sources: First, East Asian imports are much cheaper because the currencies of many of those nations have collapsed versus the dollar; second, as those imports arrive on U.S. shores they should put downward pressure on prices of goods made by U.S. competitors; and third, if the world economy overall slows because Asia is consuming less, that should mean lower prices for many commodities.

Many commodities, in fact, have already tumbled in price. One key index of industrial material prices has slid to a 40-month low.

For consumers, and many companies, there may be a bonanza here. Shoppers may find less-expensive foreign-made clothing at their favorite department store in 1998, for example; home builders will pay less for copper pipes in new homes; powerful personal computers may become even more affordable for average families.

But for Wall Street, which just a few months ago was worried that 1998 would bring rising inflation and higher interest rates, the specter of deflation implies severe pressure on some companies’ profits. If widespread enough, weak or declining earnings could pull the rug out from under the bull market. That said, it is still far too early to know whether the earnings concerns that are riling the stock market are in fact justified for most companies.

Deflation has at least one clear beneficiary: the bond market. Investors rushed to lock in yields last week, figuring that the absence of price inflation makes current yields on bonds super-attractive. The bellwether 30-year Treasury bond ended last week at 5.92%, the lowest in four years.