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Strategies & Market Trends : Currencies and the Global Capital Markets -- Ignore unavailable to you. Want to Upgrade?

To: Peter Singleton who wrote (408)	8/14/1998 5:21:00 PM
From: Frodo Baxter	Read Replies (2) \| Respond to of 3536

It's actually a snoozer. Maybe Thurow's been wrong so much, he has stopped making predictions. Anyway, he begs the question, here. for personal use only- Deflation, and its painful consequences, may be on the horizon; Falling prices, failing economy; OPINION / LESTER C. THUROW; Lester C. Thurow is professor of management and economics at the MIT Sloan School of Management. By Lester C. Thurow While generalized price declines have not been seen since the 1930s, the smell of deflation is now strong enough to make it worth thinking about how standard economic operating procedures change when selling prices start to fall. Today measured inflation rates are slightly positive, but some of our major price indexes have had months or even sequences of months when they indicated that prices were falling. Energy prices have taken a particularly sharp drop. If health care - a large sector of the economy with sharply rising costs not subject to global competitive price pressures - is subtracted from these price indexes and the quality corrections endorsed by Federal Reserve Board Chairman Alan Greenspan are incorporated into the measurements, the standard inflation indexes would show modest price declines in the past few years. Selling prices are falling dramatically in some industries. Micro-electronics is the most notable. Parts manufacturing faces falling selling prices. Auto parts manufacturers, for example, have signed contracts with the major auto suppliers calling for 3 percent annual price reduction. The economic meltdown in Asia is going to increase these downward price pressures substantially. With Asian currencies down sharply in relation to the dollar, Asia producers can lower their prices dramatically and still make money. To get the exports they need to recover, they are going to have to lower prices. US firms will have to match these price declines or watch their market shares decline substantially. With lower competitive prices come lower profits, or even losses, and falling stock market values. Last Tuesday's sharp drop in the stock market values was an expression of the worries troubling most investors. Profit expectations are being revised downward. Since many families have been using their new stock market wealth to finance investments in larger houses, a sharp correct in the stock market would lead to equally sharp declines in real estate prices. Put falling industrial prices together with falling stock market and real estate values and one has deflation. Deflation is not inevitable - Japan may yet get its act together - but its probability is growing daily. In a deflationary world, debt is to be avoided at all costs. Debts have to be repaid in dollars of greater value than those that were originally borrowed. If prices fall 10 percent, a $ 100 debt effectively becomes a $ 110 debt. Since money interest rates cannot go below zero, real interest rates are also very high in deflationary periods. If prices are falling 10 percent, a 1 percent money rate of interest effectively becomes an 11 percent real rate of interest. Put the two together and the economically smart never borrow. Those who have debts want to repay them as quickly as possible since debt burdens automatically get larger and larger in real terms. Since the value of money is going up while the value of other assets is going down, holding cash becomes the smartest investment. A dollar held today buys more tomorrow. One does not rush out to buy, because whatever one wants will be cheaper next year. In a deflationary world, business firms cannot afford to hold inventory. Anything built and sold 30 days from now will have to be sold for less. The Dell built-to-order model of manufacturing a computer only after it has been ordered and paid for becomes the only profitable business model. The auto companies, for example, will have to get rid of their 120 selling days of inventories if they want to remain profitable. As with individuals, debt repayment becomes the smartest business investment. Since getting costs down is the name of the game in a deflationary world, firms have no choice but to find ways to lower the wages of their employees. If they don't, the real wages of their employees will effectively be rising and they will be pricing themselves out of the market. Families facing future wage reductions don't make good consumers. Governments find that tax revenue falls since incomes and profits are down. While their costs of buying goods and services are also down, other obligations, such as monthly Social Security checks or employee wages, are politically difficult to reduce. This leads governments to cut spending on the goods and services they buy from the private economy to avoid having to make those more painful cuts in other forms of spending. Governments also have the same incentive to cut spending to eliminate debt and to postpone purchases to wait for lower prices. With deflation, it is very difficult for countries to sustain positive growth rates. Individuals postpone their purchases and repay debts. Businesses cut their inventories and repay debts. State and local governments cut purchases and repay debts. In the Great Depression of the 1930s, a vicious cycle emerged as falling prices led to falling GDPs and falling GDPs led to falling prices. Put simply, in the end, a deflation rate of 10 percent is much more painful than an inflation rate of 10 percent.