Great news on inflation (if you have money), but ominous sign for the economy

Posted Nov 19th 2008 9:50AM by Peter Cohan
Filed under: Economic Data, Recession

I sure am tired of writing about bad news. That's why I was happy to read this morning that the consumer price index (CPI) tumbled by a record 1% in October. In the last 61 years, there has never been a bigger monthly decline in the CPI. The cause? You guessed it -- a huge drop in gasoline prices.

But wait, there's more. Core inflation -- the Fed's favorite measure, which excludes "volatile food and energy" prices -- also declined for the first time in 25 years. The core consumer inflation decline was 0.1%. The numbers are not a big surprise after yesterday's wholesale inflation report.

The drop in prices across the board is great news for people with money. After all, it means they can spend less of that money to buy what they need. But the reason for the drop in prices is very ominous for the future of the economy. That's because companies have overproduced and they now have excess supply gathering dust on their shelves and showrooms.

It costs them money to keep it sitting there so they cut prices until people come into the stores to clear the goods off the shelves. The bad news? Companies' next move is to cut demand forecasts, reduce production, and close plants. And that means more workers lose their jobs.

Unemployed workers have less money to spend and they are not going to get access to the credit that enabled them to buy more goods and services a few years ago. Unless companies factor in the drop in demand from the rising ranks of the unemployed, they will need to go back for another round of layoffs, sustaining the vicious downward cycle.

But if you can avoid being caught in this spiral, enjoy the lower prices -- they'll keep falling.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

Tags: consumer price index, ConsumerPriceIndex, cpi, economy, inthenews