ON DEALING WITH THE "D" WORD

NO, NOT THAT

The markets got a bit of a respite late this week, closing up on Friday after one of the worst performance in history for the month of October, with Barron's noting that global equities were down $9.5 trillion in October. 
It was nice to get a small break on Friday, but we're nowhere out of the woods.  This weekend New York Times piece goes into the next big thing for all of us to worry about (image source):

"As dozens of countries slip deeper into financial distress, a new threat may be gathering force within the American economy — the prospect that goods will pile up waiting for buyers and prices will fall, suffocating fresh investment and worsening joblessness for months or even years.

The word for this is deflation, or declining prices, a term that gives economists chills.

Deflation accompanied the Depression of the 1930s. Persistently falling prices also were at the heart of Japan’s so-called lost decade after the catastrophic collapse of its real estate bubble at the end of the 1980s — a period in which some experts now find parallels to the American predicament."

The article is a good refresher on what a Depression entails, and how much more difficult it is for policy makers to fix than it's alter ego, inflation:

"Only a few months ago, American policy makers were worried about the reverse problem — rising prices, or inflation — as then-soaring costs for oil and food filtered through the economy. In July, average prices were 5.6 percent higher than a year earlier — the fastest pace of inflation since 1991. But by the end of September, annual inflation had dipped to 4.9 percent and was widely expected to go lower.

The new worry is that in the worst case, the end of inflation may be the beginning of something malevolent: a long, slow retrenchment in which consumers and businesses worldwide lose the wherewithal to buy, sending prices down for many goods. Though still considered unlikely, that would prompt businesses to slow production and accelerate layoffs, taking more paychecks out of the economy and further weakening demand.

The danger of this is the difficulty of a cure. Policy makers can generally choke off inflation by raising interest rates, dampening economic activity and reducing demand for goods. But as Japan discovered, an economy may remain ensnared by deflation for many years, even when interest rates are dropped to zero: falling prices make companies reluctant to invest even when credit is free...
"...American policy makers have tools to avert the sort of deflationary black hole that captured Japan. Deflation fears last broke out in the United States in 2003, but the Federal Reserve defeated the menace with low interest rates that kept the economy growing. This time, the Fed is again being aggressive, dropping its target rate to 1 percent this week. And the government’s various bailout plans have also pumped money into the economy."

Deflation is something we haven't seen in the U.S. in any serious way since 1954.  Here's hoping it can be nipped in the bud globally, in the early part of the 21st Century.

Comments

[BearofNH]

You can lower rates all you want, but you cannot make people spend. Some consumers are worried, some are frightened and others are scared stiff. Until consumer confidence is restored you will continue to see retrenchment. How long will it take? Look at Japan...

[Alex Tolley]

Paul Krugman's advice to Japan was to print money to create some inflation and to directly counteract deflation. If the value of money can be made to fall, people will buy things to preserve value. The problem with the Fed's interest rate policy is that it is a monetary tool only. Perhaps it is time to rediscover Keynes?