Friday, August 15, 1997
Blind-sided by deflation?
While Wall Street obsesses about inflation, some fear a
drop in prices
by Lloyd Chrein
With the economy cruising along at a steady clip, you may
have thought the only threat was inflation. Well, think
again. Following this week's announcements of lower
producer prices and stable consumer costs, some
economists now say we should be wary of inflation's polar
opposite: deflation, when prices, corporate profits and
wages plunge.
One of the first symptoms of deflation, say economists, is a
steady drop in the Producer Price Index -- a monthly survey
of prices that manufacturers place on their goods. And this
week, the Commerce Department reported that the PPI had
slipped for the seventh consecutive month.
"That's a loud and clear drumbeat that there's deflation in
the pipeline," says Philip Braverman, chief economist at
DKB Securities. "There's a decline in crude materials prices,
intermediate prices, finished goods prices -- everywhere
you look. That's downright deflation."
According to economists, the perpetually slipping PPI is the
result of various factors, including fierce competition
among manufacturers. For instance, Braverman notes that
the recent slip in car prices -- with some automakers
announcing this week that prices on some 1998 models may
actually go down from 1997 -- is an early sign of deflation
in the economy.
"Unless companies maintain costs now, they can't maintain
market share," he says. And cost-cutting has a fast trickle-
down effect. Ford, for instance, recently said it would
require its suppliers to reduce prices by 5% per year or risk
losing the automaker's business, says Braverman.
The deflation threat could become acute if the PPI drop
begins to infect other inflation indices, like the consumer
price index. That hasn't happened yet. On Thursday, the Labor
Department reported that CPI moved up 0.2% in July after
rising 0.1% in June. The "core" rate of inflation, which
leaves out food and energy measures, rose 0.2% in July.
While you may not like the prospect of inflation, which
would bring higher interest rates and higher prices,
deflation is no picnic, either. Yes, prices would decline, but
so would corporate earnings and wages. Meanwhile, you'd
have to continue to pay fixed costs like real estate taxes
and long-term loans. With most people and businesses
earning less, the government would collect less in taxes,
which could reignite the budget deficit.
Overall, the economy would likely slip into a recession --
which tends to be a self-perpetuating state. "If you do allow
total deflation to develop, there's this tendency for it to
feed back to the economy because consumers are reluctant
to purchase as they wait for prices to drop," says Peter
Kretzmer, senior economist at NationsBank Capital Markets.
"Then you get further deflation and you get a very weak
economy."
Yet, as is frequently the case on Wall Street, opinions rule.
And when it comes to the prospect of deflation, the
forecasts are all over the lot.
Kretzmer, for example, says deflation is about as imminent
as another Depression -- that is, everything is just fine,
thank you. "The economy's quite vigorous, monetary policy is
pretty appropriate -- on the neutral to firm side, with no
evidence that monetary policy is choking off the economy --
so I don't think we have to worry about deflation," he says.
The key to that argument is Fed policy. According to
Kretzmer, "deflation is a rare situation that usually occurs
when there are financial difficulties in the economy. We had
falling prices during the Great Depression, and that had a
lot to do with the Fed's policy being too tight, which
allowed the money supply to fall by a third, which led to
banking panics. Both the deposit insurance system and a
central bank with more experience make that less likely
now."
Braverman agrees that today's Fed is too savvy to let
deflation run rampant. "Thankfully, some Fed officials
recognize that low-inflation is not a one-way street that
only brings benefits. You carry it too far, you create risks,"
he says.
Others are seemingly playing on another field altogether.
According to Michael Metz, the famously bearish chief
investment strategist at Oppenheimer, prices are more
likely to inflate than deflate.
"This is the end of the great era of disinflation," he says.
"The very strong dollar has kept downward pressure on
prices of everything manufactured here. We're also seeing
the beginning of an acceleration in wages. Finally, the U.S.
economy will soon cease to be the only one growing very
vigorously. Europe is accelerating now, and Japan will do
better, so worldwide we're going to have something of a
boom. This will put upward pressure on industrial
commodity prices."
Braverman believes that all this disagreement, with the
market remaining focused on inflation rather than deflation,
makes for a potentially dangerous situation. "If you're
prepared for inflation, you can deal with it. If you're
prepared for deflation, you can deal with it," he says. "But
what you can't deal with is something you're not prepared
for. We're not geared for outright deflation in our economy
and it would come as a shock on a business and government
level."
Marketwatch for Thursday, August 14, 1997
Dow Jones Industrial Average: up 13.71 (0.17%) to 7942.03
The Money 30 Index: up 11.69 (0.69%) to 1690.77
New York Stock Exchange
Advances: 1514
Declines: 1267
Volume: 534 million shares
NASDAQ Composite: up 3.26 (0.2%) to 1586.66
S&P 500 Index: up 4.32 (0.46%) to 924.77
30-year Treasury bond yield: down 7 basis points to 6.55%
London gold (afternoon fix): down $0.05 to $326.15 |
