The price of a gallon of gas in July topped $4 on average nationally – today it’s about $2. (Source Fox News 11/21/2008)
At that same time, commodity prices were peaking, causing food costs to push to all time highs. As a result, the Federal Reserve quit cutting interest rates, fearing that further cuts would lead to even more inflation. (I define inflation as too much money chasing after a limited amount of goods and services causing prices to rise. When the Fed cuts interest rates, the money supply is ‘loosened’ which means there’s more of it out there, potentially leading to inflation)
Those mid-summer inflation fears have now been replaced with deflation worries. In October, the Consumer Price Index which is the indicator most commonly used to measure inflation dropped 1%, the biggest one month decline since the government started keeping records in 1947. (Source Fox News 11/21/2008)
Gus Faucher, director of macroeconomics at Moody’s Economy, defined deflation as “when prices are falling, and not just on a few items, but broadly across the economy’.
It appears that’s what is happening. Many analysts are predicting another drop for the month of November.
So why are lower prices bad?
For one thing, it can give consumers a reason not to buy now. If consumers see that prices are falling and perceive that prices may fall even further in the future, they may postpone purchases thinking that prices will fall even more at a later date. A perfect example currently is the US auto industry, in spite of the fact that car makers are slashing prices on vehicles, SUV’s and pickups in particular, sales are stagnant with consumers waiting for an even better deal later.
The chair of NADA, the National Automobile Dealers Association, Annette Sykora, recently noted (Source: NADA News, 11/19/2008) that automobile sales are currently at a 15 year low. Sykora noted that car sales account for 20 percent of all retail sales and due to the slowdown many dealerships are cutting business expenditures including employees with over 700 dealerships across the country already out of business.
But this spending deceleration by American consumers hasn’t been limited to only the automobile industry; retailers in general are feeling the pinch. A Los Angeles Times article published November 28, 2008 noted that online retail spending was down 4% during the first 23 days of November compared to the same period last year, the first ever decline on record.
Deflation seems to have arrived; consumers are holding on to their cash waiting for an even better deal.
If you want to determine how this might affect the US Economy and the markets moving ahead, it’s helpful to take a look at deflation historically. In an article published by “Business Week” in March of 2002, titled “Japan’s Deflation Disaster”, the economic problems that deflation can bring are clearly outlined.
In 2002, two years after the beginning of deflation in Japan, the article states that prices were continuing their drop due to cheap imports from China and other parts of Asia, overbuilt industries were pricing their products to move (see car industry comments above), and consumers didn’t want to spend. Deflation can be a slippery slope.
In 2001 in Japan, just one year after the deflation spiral began, 20,000 companies went under. The successful companies were the ones that moved production overseas, mainly to China, to reduce production costs.
Other factors contributing to deflation over the long term were government taxes and levies. It was difficult for Japanese companies to cut production and shipping costs in order to create products that consumers would buy due to road levies at least 5 times more than US companies paid during the same time frame and shipping costs that were twice the rest of the world due to the fact that the Unions controlled the docks. The end result, Japanese companies were forced to move production to China and other low cost production centers; companies like NEC Corp and Matsushita Electronics did exactly that resulting in the loss of jobs.
Is this where the US is headed?
While it’s too early to tell for sure, the first indication that we have deflation is here. The direction that the US economy ultimately goes in my opinion will depend on the policies that our leaders adopt.
The last thing that we want to do is create additional roadblocks to allowing businesses to be successful – additional taxes, increased credit costs, and other levies imposed on business must be lowered.
The Federal Funds rate, now at 1%, in my opinion should be reduced to 0%. The additional taxes proposed by President – Elect Obama during the campaign, must not be enacted.
Of course, these short term actions will need to be taken in conjunction with implementing a sound fiscal policy as a nation, something that our politicians have been reluctant to do for a long time. (See my blog posted November 6)
So how will all of this potentially affect your money and wealth?
In my view it’s pretty likely that economic conditions will continue to change rapidly over the next year or so and having a money management policy that’s flexible and adaptive will be critically important. For more details on these strategies visit www.usawealthmanagement.com.
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· Investing in market related securities involves a risk of principal loss. Prior to making any investment decision, the services of an appropriate professional should be sought as investment related recommendations are dependent upon the personal financial situation of each individual investor.
