Deflation Not Inflation, Stupid!

25th August 09 – Deflation not inflation, stupid

Notwithstanding a plethora of favourable economic indicators (see a previous diary entry) and the recent news that both France and Germany have technically pulled out of their recession (just), it is the dreaded word “deflation” and not the widely anticipated inflation that predominates in the mind of serious commentators.

Gabriel Stein of Lombard Street Research said “Ultimately, US consumer prices will not rise on a sustained basis until the negative output gap has closed and a positive output gap opened up instead. At some stage, this will happen. But not for some time.” What triggered this observation was a figure showing that US consumer prices over the past year recorded the biggest drop since January 1950. The world’s greatest economy has been in deflation for the past eight months. America is not alone. Eurostat figures show that the eurozone’s consumer price index fell by 0.7% in the past year.

One would have thought that with prices falling, people would be happy. And of course those with funds are on the right side since what they have will buy more. But the overall message of the credit crisis has been of debt and debts get effectively bigger as prices fall since the quantum of debt does not decrease. That is probably why confidence continues to slide in tandem with worries on the jobs and wages front.

Chris Rupkey of Bank of Tokyo-Mitsubishi UFJ is quoted as saying “If consumers are lacking in confidence, then they will not be able to help us spend our way out of this long, dark recession. Households are still concerned about the jobs outlook, and certainly, Fed policy is also gearing off the labour markets as no Fed has lifted interest rates while the unemployment rate is rising.”

Still, there is always a reason to be cheerful. Pizzas and custard and Shepherd’s Pie are flying off the shelf, or off the delivery van, and “cash-for-clunkers” is working a treat as the old bangers feed the scrap yard men. Indeed that is largely why Germany is back in the black – can you believe it?