Deflation Nightmares: Lower Prices Scare Off Consumers

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This 2002 satirical classic seems especially pertinent right now.

Washington, D.C. – There is compelling new evidence that the U.S. economy could be headed toward a severe deflationary period without more aggressive monetary policies from Federal Reserve Chairman Alan Greenspan.

Stephen Roach, Chief Economist at Morgan Stanley, has written that "America is on the brink of deflation, and it reeks of crisis. We can pin some of the blame on Japan and its financial warts. Essentially, Japan has its deflationary monetary missiles aimed at our cities. In a sense, we need a strategic defense initiative to protect our economy from measures that will benefit consumers in the long run."

Steve Friedman, Bush’s top economic advisor, noted that "a drop in prices will put a crimp on corporate profits and economic growth. In fact, it might even lead to consumers being in a position to have greater purchasing power. We dread the thought that consumers would actually be able to more easily afford things like food and housing, let alone the inessentials or luxury items."

Talk around the White House, however, appears to center around propping up inflationary measures instead of just focusing on combating deflation. As Friedman pointed out, "For one thing, we’re hoping to sustain the housing bubble, asset-price bubble, and any other bubbles that we can invoke through micromanagement of the economy. It’s going to take more vigorous monetary policy actions to kick in the kind of inflation we’re hoping for."

Just the looming threat of deflation has had enormous effects. Retailers are already reporting immense decreases in holiday season revenues for December 2002. In spite of rebates, special discounts, price-drops, and item clearances, consumers are scared off by the notion of "getting more bang for their buck."

Deflation not only endangers corporate profits, but shoppers have remarked they’d be wary of lower prices for groceries and other everyday items. After all, consumers don’t tend toward spending more as prices spiral downward.

One shopper, Jenny Carson of Apple Valley, Minnesota, has remarked, "The department stores and chain discount stores are overrun with 50%, 60%, and 70% off sales, and this is frightening. The grocery stores are even worse. I fear that paying lower prices for my groceries might find my family having to adjust to greater amounts of discretionary income every month. I’m not sure we’re ready for that, so hopefully, Alan Greenspan will do what he needs to do in order to insure spiraling inflation."

According to The Economist, the index of commodity prices is up 21.2 percent over the past year, gold is up 13.4 percent, and oil is up 28.9 percent. In light of that, economists all across the board are signaling that a monstrous deflation is on the horizon. Most analysts say that these rising commodity prices can be ignored in this case, otherwise it wouldn’t produce the conclusions they are looking for.

According to Friedman, "We’ve got to look to Japan and its economic problems, and realize that they waited far too long to drop interest rates. Had the Bank of Japan just adopted a zero interest rate policy immediately upon the first sign of trouble, they’d be out of their recession by now and experiencing immense growth."

Next week, Bush’s economic team meets to discuss what government incentives will be appropriate to stave off further price decreases offered from retailers as their unsold holiday inventories pile up.

Karen De Coster, CPA, [send her mail], has an MA in Economics and works in finance and accounting in the securities industry. This satire is from 2002 or thereabouts.

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