Is deflation the next economic disaster?

Posted Oct 19th 2008 11:40AM by Douglas McIntyre
Filed under: Housing, Federal Reserve, Recession

With the prices of oil and housing dropping, what companies charge for a number of key goods and services could begin to fall. Firms may have to drop the prices of what they charge for everything from clothing to cars to toothpaste.

Instead of inflation being the next great enemy of the economy, it could be deflation that actually causes a wave of trouble.

According to The Wall Street Journal (subscription required), "the financial shock and a faltering economy can set the stage for a deflationary environment." The paper goes on to say that the Fed thinks the chances of that are unlikely. This means the agency will probably not drop rates again. Better to keep them high and push the cost of money up a bit.

The Fed probably has it wrong. Leaving aside other factors, housing prices have come down over 20% from their peaks in most places. In hard hit geographic areas like California and Florida, the correction has been closer to 30%. To make matters worse, home prices are still falling.

As home prices collapse, so does the consumer's buying power. As buying power drops, getting people to buy anything is especially hard unless sellers drop prices. When very few people can afford a new washer at $500, the only way appliance companies can clear out inventory and keep their own factories operating is to take the price of that washer down to $450

Rising unemployment only makes matters worse. It means there are fewer people are in the market buying at all.

Deflation is almost certainly coming. The only issue is how bad it will be.

Douglas A. McIntyre is an editor at 247wallst.com.

Tags: consumer confidence, deflation, Fed, housing, inflation, inthenews, oil prices, unemployment

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Reader Comments (Page 1 of 1)

10-19-2008 @ 1:15PM

beachpaul said...

Well, if the Fed says it is unlikely, then we all know what that means. The only question I have now is,why? Why did we allow real estate to triple for no apparent reason? Especially, in light of Japans experience.

10-19-2008 @ 2:26PM

DS said...

Mr. Douglas McIntyre has little understanding of money and value.

Monetary expansion makes money less scarce and thus less valuable, therefore prices go up, which you call inflation. But inflation is ultimately caused only by the central banks of corrupt governments.

Zimbabwe is the best example, and the USA the second-best. No government has ever reduced the money supply over a significant period.

Mr. Douglas McIntyre is so fixated on short-term price gyrations. He forgets that the unit of measure, the US dollar, is rapidly losing scarcity and value because of the government.

The ubiquitous volatility of prices is a signal that people are not sure anymore what PAPER MONEY is worth anymore.

Meanwhile, the demand and supply of cheese, milk, oil, wheat etc do not vary so greatly over time. Their actual value is really quite constant.

Forget the stupid paper currencies. Buy gold to preserve the purchasing power of your paper money savings.

10-20-2008 @ 1:49PM

dsg said...

I guess I'm a bit naive and confused on this issue. Is Mr. McIntyre implying that it would be better to maintain a modicum of inflation within the US economy? I understand that with deflation, the paper value of assets decrease and that does not always correlate with the value depreciation in consumer goods, whether they be cars, houses, or groceries. However, just based on supply and demand, as well as the basic relationship between prices and costs of goods, would it not be somewhat desirable to experience a normalization of commodity prices to real wages? In other words, is it not a good thing for commodity prices to adjust accordingly (as much as possible, anyway) to real commodity value in relation to real wage rates? I would think that this would help the value of the US dollar to adjust up accordingly rather than further depreciate in value.

Based on that, wouldn't that imply that consumer's buying power, over a period of recover, would actually increase?