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Falling Prices Raise a New Fear: Deflation

By Steven Mufson and Michael S. Rosenwald
Washington Post Staff Writers
Friday, November 21, 2008

With the stock market crumbling and the economy shrinking, a whiff of deflation is in the air.

Oil prices yesterday slid below $50 a barrel to the lowest level since May 2005; stores are advertising sales on the eve of what should be peak holiday shopping season; and worldwide demand for items as varied as steel, petrochemicals and clothing plunged in October.

This week's news of a drop in consumer prices may sound on the surface like a good deal for financially strapped U.S. households. But economists warn that sustained deflation -- a period of falling overall prices -- would deepen the nation's economic troubles. Such a period would make it harder for people to repay debts and would prompt consumers to delay purchases in anticipation of lower prices and harder times.

"Everyone is having these huge sales, and consumers know if they wait longer, the chances of them not having a good selection is fairly small and the chances are that the prices will be lower," said Charles McMillion, an economist who runs MBG Information Services. "So why buy today? This is exactly why economists are always scared to death of deflation."

Other economists cautioned that one month's swoon in prices -- concentrated in areas linked to plunging energy prices -- was not cause for alarm and that the Federal Reserve possessed the weapons needed to combat falling prices.

The mere specter of a prolonged deflationary period, which hasn't happened in the United States since the Great Depression, is likely to steer Fed policy toward lower interest rates in the coming weeks. Fed Chairman Ben S. Bernanke warned about the dangers of deflation in 2002 when he was a Fed member and Alan Greenspan was chairman.

Ed Yardeni, a financial strategist and head of Yardeni Research, predicted that the Fed will move soon to force interest rates down and make it cheaper to borrow money to buy homes and finance other purchases, thus jump-starting the economy. "How do I know all this?" Yardeni said in a report this week. "Ben told me. He told everyone. He said he would do this under certain dire circumstances, which are rapidly unfolding right at this time."

But deflation could make borrowing unattractive for companies even if lending rates hit zero. Executives would not want to take on debt while prices and profits are falling.

The Labor Department's consumer-price figures for October, released Wednesday, showed the steepest drop since publication of figures began in 1947 and added to the anxiety in markets this week. And retailers are feeling the pinch.

Apparel makers have been hit hard. The recent consumer price index report showed that apparel prices fell 1 percent last month, the latest in a long history of problems for the industry. McMillion said apparel prices have been under severe pressure for 15 years as lower-cost imports have entered the market.

"Now, in addition to facing very low-priced imports, they are also facing a sharp cutback in demand," he said.

Retail prices for apparel -- even without adjusting for inflation -- were lower last month than in 1989. Overall consumer prices are up 76 percent in the same time.

"A $20 shirt today, that same shirt in 1989 was $20," McMillion said. "That's fairly amazing."

Crude oil prices have also defied expectations. Only a few months ago, oil experts and oil ministers from the Organization of the Petroleum Exporting Countries asserted that prices had reached a new plateau and that high-cost exploration areas would prevent prices from dropping much below $65 a barrel, the approximate cost of extracting oil from Canada's tar sands, the most expensive oil being produced.

But oil prices slipped below that level as consumption around the world stalled or fell. Now companies have announced delays in Canadian tar-sands projects. Last week, Petro-Canada joined Suncor in postponing expansion plans, citing credit market conditions and oil prices.

OPEC plans to meet Nov. 29 to consider output cuts aimed at bolstering prices.

But propping up prices could prove difficult when industrial activity is sagging. Crude steel production for the 66 countries reporting to the World Steel Association was 100.5 million metric tons in October, 12.4 percent lower than in October last year and 6.9 percent below September 2008.The declines were particularly severe in China, down 17 percent from last October, and in Russia, down 27 percent.

"I think that the prognosis for November and December will be more of the same," said Nicholas Walters, spokesman for the association. "That's what we're hearing from the industry."

Used-car prices are also plunging -- down 2.4 percent in October after a 1.8 percent drop in September, according to the government's price report. While that could create bargain opportunities for shoppers, lower used-car prices mean that people hoping to trade in vehicles are also getting lower prices, said Mike Linn, chief executive of the National Independent Automobile Dealers Association. That could make it difficult to pay off loans on the cars and give people less money for a down payment on a shiny new car.

U.S. farmers have also been hit hard by deflationary trends. And it has all happened extremely fast.

This summer, the price of a bushel of corn climbed to about $8, boosted by the growing economy, soaring gas prices that fueled demand for corn-based ethanol and floods in Iowa. Higher corn prices rippled through the economy, nudging up prices on everything from Corn Flakes to steak at Morton's.

But with the economy in a tailspin, prices have crashed. A bushel of corn is now around $4. This week's consumer price index report showed that five of six grocery-store food-group prices fell last month. Fruits and vegetables fell 2.2 percent, on top of a 0.5 percent decrease in September. Dairy fell 1 percent, after a 0.6 percent decline in September.

"It's hard to see any prices that haven't fallen," said Iowa State University agricultural economist Chad Hart.

Some of farmers' costs haven't fallen as quickly, however. Fertilizer prices are still high. So are prices on seeds and insurance for crops. And for corn growers, prices offered by ethanol makers have fallen with gasoline prices.

"They are definitely now seeing that pinch," Hart said. "I would say things are more scary now than in the past."

Some economists argue that what's really causing consumers to hold back isn't the deflation mentality but broader fears about their economic security.

"The issue is less price cutting, it seems to me, than no sales," said Edwin M. Truman, a longtime Fed and Treasury official who is now a senior fellow at the Peterson Institute for International Economics. He said that people were holding back on buying goods today "not in order to spend tomorrow, but because they're worried about having a job tomorrow."

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