Deflation Risk?
Let’s not get too carried away with today’s consumer price report – the CPI fell 0.1% in April – but perhaps we should be more alert. Clearly the US economy is undergoing massive “disinflation”. The annual rate of inflation for the past twelve months was just 0.9%, the lowest since 1966. Prices fell across the board: autos, apparel, energy, and housing all declined and none show much likelihood of changing course any time soon. On the contrary the risk, and I mean risk, is that we could tip into deflation.
That would be bad. Very bad.
Deflation is something we have watched for and feared since the crisis began. It would confirm our decline into a Japanese style malaise, and would be very difficult to break out of.
The big problem deflationary economies have is that the steady drop in prices aggravates debt burdens. It means that debt is paid off in dollars whose purchasing power for goods is growing. Thus the foregone purchasing power needed to pay off the debt is also growing. In other words debtors get progressively worse off under deflation. Since we are knee deep in debt of various sorts that does not bode well for the economy as a whole. In fact the implication would be for a prolonged period of stagnation as debtors struggle to repay debts and have to forgo consumption in order to do so. Plus, of course, wages would be under downward pressure and thus add to the problem of debt repayment.
For an economy built around debt and consumption, as ours is, it is tough to imagine a more difficult prospect than prolonged deflation.
The good news in today’s report?
That any talk of inflation created by the burst of monetary expansion we saw in the emergency part of the crisis is obviously way premature. That talk was very popular earlier this year, especially amongst opponents of government spending. It was particularly an issue for the ‘born again’ fiscal conservatives within the Republican party as they sought to attack the stimulus and its after effects. I say ‘born again’ for the obvious reason that fiscal rectitude was not an issue for them back in 2001 and 2003 when the government’s revenues were slashed and the deficit problems that we now have were created.
So without an onset of inflation caused by the loose money and high government debt policies of the crisis management months, we can expect long term interest rates to remain static, or even float down as disinflation continues.
That all could be blown away by the backwash from the Euro crisis. But that’s another story.
For now we can say that fears of imminent inflation are misplaced. On the contrary we should be worried about deflation.