Deflation continued...
What makes economists think the economy is
deflating?
Many believe the end of the Cold War
unleashed a wave of competitive pressures.
Freer trade and access to new markets meant
economic capacity has risen much faster than
demand, Yardeni says.
''Competition has created production faster than
the global economy can consume it,'' Yardeni
said. ''Firms are now price takers, not price
setters. The only thing they can do to compete is
lower costs, and try to do it faster than their
competitors.''
Economists at the International Strategy and
Investment Group in New York survey retailers
each week about their pricing power. On a scale
of 1 (weakest) to 100 trongest), the ISI retail
pricing power survey now stands at 3.3. In the
past four years, it has risen to double digits only
briefly.
Even consumer products firms, which typically
have more pricing power than most, have been
unable to make increases stick, notes Jennifer
Moran, associate economist at Donaldson,
Lufkin & Jenrette in New York. General Mills
Inc., for example, recently raised cereal prices
3.5%, but other cereal makers haven't followed
as they usually do.
The number of S&P 500 companies with
negative sales growth has doubled over the past
two years, DLJ research shows. That suggests
price cuts are not big enough to spark higher
sales, and that more price cuts may be on the
way.
But why hasn't the end of the Cold War
increased demand as much as supply? Several
factors may be at work, ISI research suggests.
Global competition for capital has led many
big-spending governments to try to get spending
under control. Even the European Union is
calling for cuts in farm subsidies.
When governments downsize, more resources
go to the private sector. Because it's more
efficient, that helps cut inflation further.
Also, many of the fast-growing economies of the
Pacific Rim - even that of China - are slowing
sharply. Bad loans at banks and currency turmoil
don't make for a healthy consumer sector.
And Europe's big economies have not been able
to get their people back to work, cutting into
demand there.
Here at home, demographics may be playing a
role, Moran said. A key gauge DLJ uses to
measure new demand is the number of people
turning 25 - a period that marks the start of
young families' peak buying years.
Those turning 25 in the U.S. will drop nearly 8%
this year from last, a historically large decline.
That reduce demand. It also raises productivity
because there are fewer young workers with
little experience entering the work force. The
demographic picture adds up to more capacity
than consumption, leading to lower prices and a
sharp economic slowdown in the future, Moran
says.
Still, Salsman doesn't think what's going on in the
real economy is creating the deflation he sees.
''It's strictly monetary,'' he said. ''The central
banks are issuing less money than the market
demands.''
A tight monetary policy, he thinks, is what's
creating all the competitive pressures out there.
''Because the monetary standard is being
maintained, it forces more competition,'' he said.
All the same, many people can be forgiven if
they're not looking forward to a deflationary
economy. The last sustained bout of deflation in
America was during the Depression era of the
1930s. Overseas, Germany and Japan have
recently had to deal with deflation, with painful
effects on the rest of the economy.
But no one thinks the deflation that may be in
store for the U.S. will be nearly as severe as that
of the Depression, when farm prices, for one
example, dropped by half.
''For consumers, it's a happy story as long as
they have a job,'' said Yardeni. ''For businesses,
it's tough to keep profits growing unless you're
really good at cutting costs, raising productivity
and innovating.''
Nor does Salsman think deflation in America
would bring the same kind of pain it brought
Germany and Japan.
The reason: The U.S. has relatively free markets,
unlike Germany and Japan. That lets businesses
adjust costs as prices fall, leaving consumers free
to enjoy low-cost goods. He thinks the falling
gold price will keep interest rate hikes at bay,
letting the economy grow faster.
On the downside, DLJ is warning investors to
look for sharply slowing profits.
Best of all, though, would be stable prices. To
paraphrase an old quip, the economy does best
with neither inflation nor deflation, but plain old
flation.
(C) Copyright 1997 Investors Business Daily,
Inc.
Metadata: GIS I/2090 E/IBD E/SN1 E/FRT E/NISS |
