A Case for Deflation

As early as January, inflationary pressures in the US economy have been weak. This has caused deflationary concerns to arise, especially since spare manufacturing capacity is still high and job growth remains subdued. Although it may be true that the Fed’s quantitative easing measures and ultra-accommodative interest rates have held up expectations on inflations, the bias is still for a deflationary trap.

Let’s take a look at two of the best measures of inflation, the consumer price index and the producer price index, to back up this claim. (Don’t you just wish you paid attention to my article last week discussing the two indices? Hah!)

Looking at the figures, both the CPI and PPI figures have been printing some disappointing results as of late. This past month, the headline CPI report showed that consumer prices fell by another 0.1%, marking the third straight month of decline. Apparently, the fall was driven by drop in energy prices.

And while core CPI data showed an increase of 0.2% this past June, core prices have risen just 0.9% on a yearly basis. For those who haven’t been keeping count, this is way below the last decade’s average of 2%. Once you factor in how weak prices were from last year, I think it would be safe to say that inflationary pressures seem to be subdued.

Meanwhile, PPI data, which measures the price at which producers sell their goodies, showed a decline of 0.5%, which also marked the third consecutive month of falling prices.

If the US does sink into deflation, it could further drag economic growth down. Think about it: If consumers know that price levels will keep dropping, won’t they put off their purchases for a later date when goods are much cheaper? This would result to lower sales for companies and, with prices falling, their revenue and profits would drop too. What would happen to workers’ wages and consumer spending then? Oh the horrors!

I guess this possibility had the worrywarts up at the Fed biting their nails, troubled that the US economy would probably need additional stimulus. Are we talking an even longer “extended period” of low interest rates? If only negative interest rates were an option, the Fed would probably take that, hah! Well, that’s not looking too sunny for the Greenback…

For now, it might be better to sit tight and wait for more data confirming whether the US economy is on track towards deflation or not. Besides, we never know if the Fed could pull a few more strings here and there to keep the US from falling into a deflationary spiral.

  • Santacruz

    so, we will be watching some more US economic news and might prove this forecast.

  • personalme

    I’m wondering why there are very few comments when we talk about economic. I’ve found your insight very useful to me to see where the wind goes. Anyway, if the same circle goes to UE (which is very possible) then it sounds more like an economic malaise to me.

  • rjw256

    Good explanation of what I fear will happen. One of the few things governments can’t control is peoples spending habits. You can lead a horse to water, but you can’t make it drink. Apart from the “fear” factor, the “aware” factor is coming more into play. Throwing government funny money at the problem has limited effect, and the real problems still remain. Naturally, we all try to avoid pain in ours lifes, but I think we have alot more to come to rid ourselves of this economic sickness.

  • Santacruz

    so, we will be watching some more US economic news and might prove this forecast.

  • personalme

    I’m wondering why there are very few comments when we talk about economic. I’ve found your insight very useful to me to see where the wind goes. Anyway, if the same circle goes to UE (which is very possible) then it sounds more like an economic malaise to me.

  • rjw256

    Good explanation of what I fear will happen. One of the few things governments can’t control is peoples spending habits. You can lead a horse to water, but you can’t make it drink. Apart from the “fear” factor, the “aware” factor is coming more into play. Throwing government funny money at the problem has limited effect, and the real problems still remain. Naturally, we all try to avoid pain in ours lifes, but I think we have alot more to come to rid ourselves of this economic sickness.

  • sunglow

    I have frequently heard the argument that when prices are falling, consumers put off their purchases until tomorrow, when the cost will be less. That argument is logical, but it is not what consumers do. During my life, there has been deflation in the cost of personal computers. This has not stopped people buying computers, in fact, many households now have more than one computer and operate a home network. The thing about deflation is that it rewards savers and punishes borrowers. To those of us who have no borrowings and some savings, deflation is not a problem, in fact, I would welcome it. But given that the Government is the biggest borrower of them all, they will move heaven and earth to keep inflation going, hence the ridiculously low interest rates and the printing of money.

  • sunglow

    I have frequently heard the argument that when prices are falling, consumers put off their purchases until tomorrow, when the cost will be less. That argument is logical, but it is not what consumers do. During my life, there has been deflation in the cost of personal computers. This has not stopped people buying computers, in fact, many households now have more than one computer and operate a home network. The thing about deflation is that it rewards savers and punishes borrowers. To those of us who have no borrowings and some savings, deflation is not a problem, in fact, I would welcome it. But given that the Government is the biggest borrower of them all, they will move heaven and earth to keep inflation going, hence the ridiculously low interest rates and the printing of money.

  • ForexGump

    I agree that it does punish borrowers and rewards savers…in the short run. In the long run, however, a prolonged period of negative inflation could lead to a deflationary spiral. The overall decline in prices could lead to lower production, which in turn causes wages and demand to subside… which then leads to another round of price decreases…

  • ForexGump

    I agree that it does punish borrowers and rewards savers…in the short run. In the long run, however, a prolonged period of negative inflation could lead to a deflationary spiral. The overall decline in prices could lead to lower production, which in turn causes wages and demand to subside… which then leads to another round of price decreases…