Friday, November 21, 2008

The ONE PERCENT's Significance

In August consumer prices dropped 0.1% from the previous month. In September it was unchanged. The just released figure for October saw a 1% drop from September. This one percent month on month decline is very significant. Firstly, forget about inflation, we now have to seriously talk about deflation. We are only starting to see consumer prices feeling the effects of months of real estate price plunge and stock price decimation. A trend once established is hard to reverse. You people know how difficult prices take to come down. When it goes up, it goes up quickly.

When trade slows, when inventory builds up, consumer prices are very sticky in coming down. The fact that it did not just ease down is highly critical. One percent month on month decline has never been registered in the US, except during the Great Depression. Take a few seconds to reflect on that one percent now.

Proper tracking of consumer prices only started in 1947, and this one percent was the largest ever since tracking started. Deflation has many implications - the one percent decline shows how serious every sector is facing the crisis, it is felt in every sector basically. Consumers are delaying purchases in a deflationary environment. That's no good. The Fed is now setting its interest rate target at 1%, and there is a very good chance we could see zero interest rates before things turn around.

When I studied economics, zero inflation is not a good thing. It indicates that things are not moving, things are dying, industries will constrict, there will be cost cutting, there will be layoffs, there will be a great incentive to hoard and save.

The positive would be the one percent will cause the Fed to speed up spending policies. The Fed would be moved to lower rates faster than it need to. The Fed will have to pump liquidity into the system with more urgency.

Usually even in a downturn the consumer prices would be easing down month on month, not by the one percent we just saw. That indicates that the trend has just started and will see at least a few months of negative consumer prices month on month. That one percent will be enough to cause all commodities producers to drive down inventory, sell at all cost, even at losses, stop plants functioning, even if it means lowering capacity utilisation and incurring losses. 7,300 here we come. CPO prices, Rm1,200 here we come.

p/s photo: Grace Park


easystar said...

I think the need to inflate forever did not really occured until early 1900. Throughout history of man, there are interchanging periods of inflation and deflation and the price level of the entire period (I think until about 1500), hardly change.
(then we had the great spanish caused inflation)

Falling electronics prices etc does not stop us from buying an ipod now. Falling food prices isn't going to stop us from having to eat now.

One can even argue that we can do away with the 20th pair of shoes in the cupboard and measure our economic welbeings against something more tangible and focus our energy on, say space exploration rather than making the next iPod.

Deflationary scared is purely psychological and as I am in the telecom business which suffered from pride deflation for the past 10 years, things are just fine. Falling prices were made up by much higher volumes.

easystar said...

And with Helicopter ben Quantitive easing now in full force, I can't see deflation to stay as the monetary based has exploded.

virtualmystic said...

Your arguement that deflation or zero inflation is bad is based from a pure economic point of view. With the world's resources in real danger of being depleted and the proof of man's contibution to the destruction of our planets ecosystems isn't it better that this "correction" be allowed to occur naturally? We as a human races will still be here. People will find a different niche to get an income. Remember the lesson of the business man and the fiherman who was resting the whole day after going out to sea in the morning?