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Yes, still deflation

Posted by: Michael Mandel on July 16

Maybe I’m crazy, but this morning’s CPI number actually improves the odds of deflation sometime in the next year. According to the BLS, consumer prices went up 1.1% in June—just for that month. And CPI is up an astounding 5% over the past year, the highest since 1991.

However, that gain is due only to food and energy—commodities whose prices are very sensitive to demand. The rest of consumer prices only went up 2.4%. In particular, medical care was only up 4% over the past year.

As the economy slows, the demand for commodities is going to fall. The price increases for energy and food could very easily reverse themselves over the next year. And with a weakening labor market, there’s little chance of starting a wage price spiral.

When the price of energy and food starts to drop, it will pull down the CPI just as quickly as it pulled it up.

Like I said, I could be crazy.

Added: I figured that I might as well put in a plug for Chris Farrell’s book “Deflation : What Happens When Prices Fall.” (Chris is a contributing editor at BW)

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Reader Comments

Justin Coffey

July 16, 2008 11:14 AM

A naive question:

Would this (deflation) be a bad thing?

All I ever read or hear is that deflation is worse than inflation, however this is so counterintuitive I have a tough time full grasping why it would /always/ be bad, especially after a situation such as the current one in which we've had such a painful loss of purchasing power in the middle class due to nearly a decades worth of wages not keeping pace with inflation.

Thanks for any clarification :).


July 16, 2008 01:07 PM

Justin,deflation is bad,because it causes consumers to postpone purchases,waiting for cheaper prices ahead.That causes demand to fall further,thus more people are laid of causing less purchasing power,a downward spiral can take hold and be hard to crack.I agree with Mike Mandel that inflation will come down quickly,as soon as commodity prices fall and once that happen there will be room to lower interest rates further,but not before.

Justin Coffey

July 16, 2008 06:16 PM

That makes sense, but then I suppose the implication is that inflation, or seen another way as devaluing of the dollar, is a one way street.

Of course, the dollar could always strengthen relative to other currencies, making imports cheaper. I suppose one could make the argument that as we get into a more globalized economy the eventuality is that any change in the valuation of a local currency can have a huge impact on inflation or deflation of prices. In fact, one could make the argument that we're already there as relates to commodity pricing.

At this point is deflation really /still/ always a bad thing? Take a scenario in which over the next 5 years the dollar somehow miraculously strengthens and commodity prices decline accordingly. Isn't deflation difficult, if not impossible to avoid?

I have this feeling that no one really fully understands what's going on right now and that many of our economic rules are starting to look rather pliable.



July 16, 2008 06:45 PM

But won't renewed growth just raise them again?

Mike Reardon

July 17, 2008 01:27 AM

I think this deflation draws more than a lot from asset revaluation and a de-leveraging of debt connected to that now revaluing housing debt. There should not be an extended systemic deflation but a clear limited bottom that will be clearly qualified. Rebuilding from that should not be inflationary because of lack of wage demand.


July 18, 2008 12:41 PM

You've got that right - I expect deflation in 2009.

But it isn't simply a function of energy/food-related CPI - it's a function of credit destruction far & wide. Credit-sensitive assets were bolstered for a generation - since 1982 when Volcker broke inflation's back - by consistent incremental declines in nominal borrowing rates. As those rates came down over that period, the price of associated assets escalated, but only on the back of ever-greater volumes of debt whose financing costs declined. The creation of new debt financially substantiated the previously-created debt, and the only thing that came to matter was monthly cash flow, since such assets values only rose. The blow-off in housing was the pinnacle: wealth-effect spending spilled over into domestic over-consumption (see U.S. balance of payments) from Greenspan's irresponsible negative rates. What we witness in today's CPI & PPI is the inflationary inertia from that period, but it will swiftly recede. Take note of how quickly crude fell back this week, as an example of the potential for such reversal.

Now, the virtuous cycle runs in reverse, as declining levered asset values impair balance sheets, causing diminished capacity to provide and secure credit. Case-Shiller foresees plenty more downside for residential real estate, and next year "Option ARMs" will be last year's "Subprime."

We're in middle innings to this mess.

Inflation/Deflation is fundamentally about the supply of money & credit. We're about half-way through the credit collapse, with more write-offs to come. The only question remains: will we suffer or escape a Japanese-style liquidity trap?

Last comment: Fed Funds futures recent pricing of a rate hike by the end of the year is deluded. The next Fed move is a rate cut, probably in 1Q09.


July 18, 2008 01:45 PM

Deptpocalypse,you said it very well and I agree with you 100%.

Evan Rowe

July 22, 2008 12:07 AM

I would see Deflation coming next. But I also see a massive great depression, steming from huge growing social inequities, no unions to back people (in the United States anyways, the EU I expect the opposite) up when and if the economy goes really far south.

I think the standard business school textbooks worked fine as theoretical arguments from the 50s, through their implementation in the 70s until now. But I would expect a serious re-writing of economics in the next 20 years.

I see very few real monetizable opportunities in the future in the digital economy that is slowly closing in on the old economy by virtue of its increased streamlined nature. This alone is highly deflationary. Producing music is much cheaper. Distributing it is much cheaper. The same will be true in Film. The same will be true in news. The same will be true in advertising, etc.. you name the business, there is either a growing ubiquity on the producer end (i.e. 4 million bands, or 4 million future filmmakers with a home animation system) or extreme competition which allows consumers with much greater ease, to choose the lower price (consider price sorting for online purchases) Once again, highly deflationary.

Furthermore, the economic integration generally called "globalization" has created huge integrated computer networks the likes of which have never been seen before.

Most of what you guys are looking at is in the world of finance...which at best, is a shell game that undergirds the real economy. But in the end, at times like this, the real economy is going to eventually dictate terms to the financial realm.

If you have a situation like this, my guess and i'm not exactly sure i'm an advocate of this yet, but my guess is you'll see the U.S. jack rates up to 10% or so, intentionally driving up the value of the dollar to maintain U.S. national dominance over competitor nations. Taxes will probably go up to New Deal levels, forcing, in essence a massive investment in the State. Other countries will follow suit..and governments will be providing the main social roles for people during the depression because the private sector simply cannot find monetizable opportunities to invest in..and will withold capital. This obviously will not fly for very long.

Unemployment is already much higher than policy makers care to admit. And the jobs that do exist are non full time jobs. They pay little, and provide no benefits. The only group of people doing really well are elites and top level coordinators who are in close proximity to capital. The situation at the bottom has only grown worse, and psychologically marketing the problem away with Jesus and abortion and terrorism will only work for awhile.

We'll see. Bold prediction perhaps.


July 31, 2008 11:39 PM

Inflation often arises from two things: energy costs (an enormous part of the cost of making and transporting goods and labor) and the amount of money flowing around in the system (the more of it there is from various sources, including debt, the more inflation results). Of course, other sources can arise (such as labor scarcity, or disasters, or market fads), but oftentimes energy and capital are the root causes.

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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