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Road to deflation Original Source Link: (May no longer be active)
http://www.azcentral.com/arizonarepublic/business/articles/0809Deflation09.htmlhttp://www.azcentral.com/arizonarepublic/business/articles/0809Deflation09.html
Are we on the road to deflation?
Russ Wiles
The Arizona Republic
Aug. 8, 2003 12:00 AM
Like guests who overstay their welcome, the specter of deflation just isn't going away.
Just this week, analysts predicted the Federal Reserve wouldn't raise interest rates anytime in the foreseeable future, even if the economy continues to improve gradually. The reason: Central bankers are concerned about deflationary pressures, which tend to build with interest-rate increases.
Deflation, the opposite of inflation, is a trend toward lower prices for goods and services. Most Americans have never experienced it on a broad scale; the last down year for the Consumer Price Index was 1954.
Inflation has been the norm for decades, but it has weakened in recent years. In the second quarter of 2003, the CPI shrunk, or deflated, at a 0.7 percent annual pace, the Bureau of Labor Statistics reports. In certain industries, deflation has been around longer:
??Arizona's copper industry has shrunk nearly in half since 1995, when copper sold for $1.35 a pound. Today, copper fetches 80 cents. Demand has risen but output has climbed faster. About 1.2 million metric tons of the metal sit in warehouses, reports Phoenix-based Phelps Dodge, which has lost $370 million since 1999.
??Phoenix-based America West and other airlines are striving to regain profitability amid soft demand and excess capacity. Passenger "yields," which track the prices customers pay, dropped from 12.9 cents a mile in 1992 to 12 cents a mile last year, reports the Air Transport Association. Adjusted for inflation, yields are half of what they were when airlines deregulated in 1978.
??Rapid product obsolescence, excess capacity, tepid tech spending and other woes have led to "significant pricing pressures" in the semiconductor field, ON Semiconductor said in its annual report. The Phoenix firm cut its workforce by a quarter last year.
"There are a fair number of goods-producing industries experiencing deflation," said economist Tracy Clark at the W.P. Carey School of Business at Arizona State University.
For consumers, modest inflation can be good. Just think how much cheaper televisions, computers and clothing have become. Productivity improvements have enabled companies to sell these goods for less money, stimulating demand and often creating jobs.
"Price declines due to productivity improvements aren't harmful," said Rose Papp, co-manager of the Papp mutual funds in Phoenix. "They're only harmful when consumers refuse to buy or can't buy."
When people stop spending because they lack cash or confidence, it's a sign of deep, debilitating deflation. When demand plunges, employers cut their payrolls, which in turn boosts unemployment and constricts spending further.
"A true deflationary environment is hard to get out of once you're in it," Clark said.
The last round of debilitating deflation occurred during the Depression, when shell-shocked consumers closed their wallets and hid their remaining cash under the mattresses. Broad price declines accompany economic misery.
Borrowers have an especially rough time since they must repay loans in more expensive dollars. Bankruptcies and defaults accelerate.
Investors don't have many good options either. Stock prices plunge, and corporations default on their bonds. But U.S. Treasury bonds are a good bet, protected by the government's bankruptcy-free status.
Several factors have pushed the economy near the precipice. Recessions, by nature, tend to be deflationary. So do stock market slumps, which make investors feel poorer.
Many corporations have too much productive capacity, a consequence of the 1990s boom in capital spending. Extra capacity enables firms to make goods more cheaply, fostering price-slashing rivalries.
Globalization has spawned intense competition from low-wage nations such as China, especially in manufacturing.
Critics blame the Federal Reserve for focusing too much on battling inflation. Fed policies help to cool demand but don't seem nearly as effective at reviving it when interest rates already are low.
Even the aging U.S. population may play a role because older Americans are less likely to buy furniture, clothes and the like.
Pessimists look to the deflationary vise that has gripped Japan for years and ask why it couldn't happen here.
Yet for all the risks, it's not a foregone conclusion that deflation will come home to roost.
Wages are still rising, and unemployment at 6.2 percent is a world removed from the 25 percent jobless rate during the Depression. Besides, many non-working people today receive cash in the form of Social Security, pensions and jobless benefits, income not available during the Depression.
"It's not like everyone's salary is going down," said Robert Grosse, an economist and business professor at Thunderbird, the American Graduate School of International Management in Glendale.
As for Japan, that nation faces problems that haven't shown up here, including a real estate bubble that burst, a debt-soaked banking sector and a government that has proved unwilling to tackle the worst problems. Also, Japan's economy is more closed.
"The U.S. is just not in the same situation as Japan," Grosse said.
In addition, deflation hasn't spread as much to America's service industries, which make up a larger share of the economy. Productivity gains are harder to realize in service businesses compared with manufacturing, and the localized nature of service industries insulates against global competition. "You can't outsource haircuts," Clark said.
There have been encouraging signals that point to a healthier economy. Profits have improved, consumer confidence has stabilized, the stock market has rallied, productivity keeps rising and economic output nudged up to 2.4 percent in the second quarter from 1.4 percent in the first.
This spring's tax-cutting legislation should provide a boost. And if there's one economic behavior Americans have mastered, it's the art of spending.
Reach the reporter at russ.wiles@arizonarepublic.com or (602) 444-8616.
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