Deflating prices have silver linings
Plus: New gold security, and a Calandra 'spec-buy'
By Thom Calandra, CBS.MarketWatch.com
Last Update: 10:31 AM ET May 7, 2003
SAN FRANCISCO (CBS.MW) - The notion of deflating prices for goods and services, mentioned yet again by the U.S. Federal Reserve, isn't spooking investors.
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The Fed governors, in their decision to keep interest rates at a 41-year low, didn't use the word deflation. Instead, they referred to the slight risk of an "unwelcome substantial fall in inflation."
Still, investors, in embracing stocks, especially those of small issues, and in continuing to fuel rallies in government, corporate and junk bonds, clearly see some of the benefits of deflating prices.
A deflating economy, in which consumers are afraid to spend money and jobs are scarce, would still bring with it low oil prices and strong demand for residential properties. Both can boost economic growth by a percentage point or more over the course of a year.
In addition, the declining dollar that likely comes with deflating prices would have a laxative effect on American exports. More products, in other words, would sell overseas at cheaper prices for non-American consumers.
Sung Won Sohn, chief economist at Wells Fargo in Minneapolis, has long been saying the Fed is prepared to reduce official interest rates to near-zero in a deflation battle. That may well happen.
The Fed, in addition to lowering interest rates, could boost the growth of money supply beyond an 8 percent or so yearly average, thus fueling consumer and investor spending on goods, services and in the stock market.
The central bank also could lower reserve lending requirements on commercial banks, thus freeing up capital for businesses and individuals that want to expand, even in a sickly economy. "This is how much the Fed makes banks hold as insurance for bank loans," says financial author and Dallas fund manager Joseph A. Duarte at Willow Creek Capital Management.
"When the Fed really wants to make its point, it lowers reserve requirements, sending a signal to banks that it is imperative for them to lower standards and start lending money in order to boost the economy," says Duarte. The last time the Federal Reserve lowered requirements was December 1990.
One other benefit of falling prices: interest rates on Treasury bonds of all maturities would likely stay depressed, and that would be a continued boon to the government's interest-rate costs on the federal debt. In 2002, the United States Treasury paid $332 billion of interest on the federal debt, which amounts to $6.4 trillion.
With the United States paying an average 5.6 percent rate, the burden of interest-rate payments to America's creditors amounted to less than 18 percent of total federal revenue. That's the lowest point in more than 30 years and has, says James Turk at Freemarket Gold & Money Report, "worked wonders for the government's finances."
Economist Michael Darda and his team at Polyconomics.com, a supply-side think tank, points to sectors that would benefit from falling crude oil prices and a weak dollar. They include railroads, some airlines, truckers, international food, some regional banks and commodity producers that could enjoy actual price gains in a deflationary environment.
One example on the commodity side Wednesday was Newmont Mining (NEM: news, chart, profile), world's largest gold miner. The company said gold prices that were 20 percent higher than a year ago boosted income and sales. Net income was $117.3 million vs. a year-ago loss of $6.8 million, and revenue rose 74 percent to $864.6 million.
The prices of gold and many other commodities have been on the rise for 18 months, leading some to believe we may be headed to a world in which raw goods such as aluminum, copper and agricultural goods enjoy price gains while finished goods and services suffer flat or falling prices.
Darda at Polyconomics.com this year correctly forecast an explosive rally in transportation stocks. He put his research on the line by calling for rallies in companies such as America West Airlines (AWA: news, chart, profile) long before Wall Street jumped on the airline rally.
Darda is also willing to say "the pernicious part of the deflation has come and gone." Still, if so-called statistical inflation (between 2 percent and 3 percent on the consumer level) were to continue to drop, "a move to push more liquidity into the market could follow," Darda says.
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