Fear of Deflation Growing, but Some Key Ingredients Are Missing
If government statistics are to be believed, overall consumer prices are falling for the first time in at least 15 years. Guy Hubschman doesn’t believe government statistics.
The 41-year-old real-estate executive says he pays more for everything, from medical care to groceries to dry cleaning, compared with a year ago.
“Look at my cable bill,” Hubschman said. “Why does that keep going up?”
As the economy has continued to deteriorate, debate has erupted over whether the U.S. is beginning to experience the rare phenomenon of deflation, or price cutting across a broad array of products and services.
Some experts say deflation could become a defining force in the U.S economy because, they predict, a growing number of companies will resort to slashing prices to drum up business.
Far from being an economic blessing, that forecast implies financial peril for many firms, because falling sales prices would eat into already enfeebled corporate profits. That, in turn, could trigger new waves of layoffs or salary cuts that would further weaken consumer demand. A vicious circle could ensue.
But many economists contend that deflation jitters are overblown. Though a recession almost certainly is underway, and the pace of price increases is slowing, optimists see no reason to believe that the huge and largely services-based U.S. economy is on the verge of widespread, sustained price cuts.
They say it’s a mistake to view plummeting prices of commodities such as oil, copper and coffee as harbingers of a general deflation. For one thing, commodity prices almost always slide during economic slowdowns--then often rebound sharply in recoveries, analysts note.
Prices of most goods and services, however, tend to be far “stickier” on the downside than commodity prices, for a number of reasons.
“My barber isn’t charging me any less,” said David Wyss, chief economist at Standard & Poor’s Corp. in New York. “It still costs me $1.75 to do a shirt” at the dry cleaner.
Worry about deflation was fanned anew Friday when the Labor Department reported that consumer prices fell 0.3% last month, the second drop in four months.
A government report a week ago showed an index of wholesale prices sank 1.6% in October, the biggest-ever monthly decline. A separate study found that import prices tumbled a record 2.4% last month.
Some prices have fallen noticeably. Computers and cars are cheaper than they were a year ago, government data show. Perhaps most visible to consumers is the plunge in gasoline prices, which sagged 10.7% just last month, according to the Labor Department. The slide in energy costs, which had soared in 1999 and 2000, has been a major factor in depressing government inflation indexes in recent months.
For homeowners caught up in the mortgage-refinancing swirl, the cost of owning is going down. That’s because interest rates, or the price of money, have dropped dramatically in recent months.
But to many Americans, the threat of deflation rings hollow. While prices of some goods have fallen, the cost of many other products and services has continued to rise this year, even amid job losses and salary freezes.
Goods Cost Less, but Services Prices Rise
The price of television sets, for example, has been on a decade-long slide. Yet the monthly cable-TV bill is an endless source of aggravation for many people. The average consumer is paying 3.8% more today than 12 months ago for cable, and a glaring 38% more than in 1995, according to the Labor Department.
Likewise, the average car sticker price is down 0.6% in the last 12 months, Labor Department data show, and considerably more than that when today’s cut-rate financing is factored in. But the average car repair bill is 3.4% more expensive than a year ago. Auto body work costs 3.7% more.
“The [cost of] the occasional purchase is going down, but the monthly underlying staple of what it takes to live is not going down,” lamented Hubschman, a married father of three from Andover, Mass.
Some prices are rising at a brisk pace. Medical services costs have climbed 4.7% in the last 12 months, while college tuition is up 6% by the government’s measures.
In total, prices in the services sector, which comprises about 80% of the nation’s gross domestic product, are up 3.6% in the last 12 months. That is down from a 4.5% rate of increase earlier this year, but it still indicates that services prices in general are rising.
That has kept the overall consumer price index rising. Through October, the CPI was up at a 2.1% annual rate this year, compared with a 3.4% rise in 2000 and 2.7% in 1999.
Lower airfares and hotel rates brought on by the Sept. 11 terrorist attacks could help hold back the rise in services costs in the near term, experts say. But outright deflation for many goods and services still seems far-fetched to many observers.
Consider the price of a cup of coffee. The cost of coffee beans in world markets has tumbled by more than two-thirds since mid-1997, to record lows in recent weeks. Yet Starbucks Corp. hasn’t cut prices, and announced last week that it may pay more next year for beans in part to offset the damage that slumping prices have done to farmers.
“We have not lowered any of our prices,” said Chris Gimbl, a spokesman for the 4,700-store Seattle-based chain.
Disinflation of the 1990s a Bonus for Consumers
The inflation/deflation debate comes after a decade in which conditions for U.S. consumers were about as good as they could be. Even as employment was high and wages were rising, for much of the 1990s the U.S. experienced disinflation , or successively lower annual rates of inflation.
Consumers thrived as businesses feared raising prices significantly and battled for shoppers’ affections through ubiquitous sales.
A confluence of factors supported the U.S. disinflation trend, and allowed many companies to prosper even without pricing power:
* Worker productivity rose sharply, boosted by increased use of technology. Rising productivity is considered the key to a healthy, low-inflation economy because it means more output per hour of work.
* The dollar remained the strongman of global currencies in the wake of financial crises in Mexico in 1994, Asia in 1997 and Russia in 1998. A strong dollar meant prices of imported consumer goods declined or stayed level for U.S. consumers. Cheaper imports forced competing American companies to keep their prices low.
* Oil and natural gas prices slumped because of a global supply glut. That reduced a major expense for both corporate America and U.S. consumers, freeing money to spend elsewhere.
* With inflation falling, interest rates also declined, further cutting business costs.
* A soaring stock market bolstered consumers’ wealth and spending.
In the 1990s, as now, prices of some goods were falling while others were rising. But there was little talk of sustained deflation because overall consumer and business demand for products and services was robust.
The danger today, some analysts say, is that the economy could become so weak that disinflation tips into broad-based deflation--desperate price-cutting to spur demand.
If companies try to match or outdo rivals with price cuts, profits would collapse and cause businesses to continue paring staff. Out-of-work consumers would rein in their spending, further reducing demand.
“You like [falling prices] until you lose your job” because of them, said Jim Paulsen, chief investment officer of Wells Capital Management in Minneapolis.
About 30% of the world economy already is mired in a deflationary cycle, according to economist Stephen Roach at brokerage Morgan Stanley in New York. It has beset Japan, the world’s second-largest economy, for five of the last six years, and Hong Kong and Argentina for three years each, Roach said.
Analysts Worry Deflation Is Next
It’s a realistic possibility for the United States for two reasons, Roach said.
First, prices of many products normally decline during recessions. In the last 20 years, that has simply led to ever-lower inflation rates. But with inflation already at minimal levels, it’s logical that further pressure on prices could lead to outright deflation in major price indexes, he said.
Those kinds of headlines could encourage many consumers to defer purchases in the hope of getting a bargain in the future. “If you’re going to be able to buy something cheaper six months from now, why buy it today?” Roach said.
Second, Roach worries that any economic recovery next year will be tepid, held back by vast overcapacity in technology and many other industries as well as by the inability of debt-strapped consumers and businesses to spend aggressively even if they wanted to.
That might force companies to keep slashing prices well into the official start of an economic rebound, he said.
At the same time, as companies absorb increasing costs in some areas, especially rising outlays for security against terrorism, they could be forced to continue cutting staff to try to boost profits.
“You’ve got the worst of all worlds for corporate profitability,” Roach said. “No real pricing leverage but the possibility, and a distinct one, of increased cost pressures. So profit margins would be hit and that would force companies to cut costs, which means laying off workers even more.”
Other analysts, however, see the glass as half full.
Yes, they say, the economy is in recession. But “today’s recession sets up tomorrow’s recovery,” investment strategist Edward Kerschner at UBS Warburg in New York said in a report to clients last week.
Within the $10-trillion U.S. economy, “improvements and innovations will continue, populations will grow, and spending pressure will build up again,” he said. “In a deeper downturn, immediately conditions are worse, but pent up demand emerges more quickly.”
With the unprecedented interest rate cuts by the Federal Reserve this year, and the government boosting spending, the economy is getting exactly the kind of stimulus it needs, Kerschner said.
The stock market has seemed to agree over the last two months: Share prices have rebounded strongly after diving in the first few days of trading after the terrorist attacks. The Dow Jones industrial average rose 2.7% last week and closed Friday at 9,866.99. It has risen nearly 20% since Sept. 21.
In addition, analysts note that the most obvious examples of deflation this year--in energy prices and interest rates--can provide a buffer against deflation elsewhere by leaving consumers more money to spend on other things.
If oil prices, which fluctuated between $30 and $35 for much of last year, were to remain consistently below $20 for a year, the spending power of U.S. consumers and businesses would be boosted by more than $100 billion, said Sung Won Sohn, chief economist at Wells Fargo & Co. in Minneapolis.
“That is good deflation,” Sohn said.
But a broader, dangerous deflation “is highly unlikely,” he said, because deflation in the prices of services remains the exception rather than the rule.
Many consumers may search far and wide for bargains for basic goods, but they are less willing to skimp or surrender convenience or peace of mind when it comes to personal services--dry cleaning, hair cuts, medical care, auto care, etc.
That attitude helps keep many services providers from facing heavy pressure to discount what they provide, analysts say.
Barring a massive new wave of job losses that causes the nation’s purchasing power to crumble, “services prices [still] are going up, not down, so sustained deflation is not possible,” Sohn said.
