Deflation, Unknown Since Thirties, A Possibility In 1970s, Few Imagined Inflation Would Shrink To Level Near Zero

One of the scariest things in life can be getting what you want. When former President Gerald Ford promoted the cause of “whip inflation now” in the 1970s, few people thought it would happen and even fewer contemplated the consequences.

We may be close to that point today. Indeed, Japan is already experiencing deflation.

And the inflation index published monthly by the U.S. Department of Labor shows consumer price inflation here running at less than 3 percent for most of the year. Some economists believe the CPI overstates inflation by as much as a full percentage point. Others say that when the increased quality of consumer goods is factored in, consumer prices in the United States are falling.

A week ago, the National Association of Purchasing Management said its index of prices paid by corporate purchasing managers fell 46 percent between November 1994 and November 1995. The broader inflation index compiled by the Center for International Business Cycle Research at Columbia University - a data series said to be closely watched by Federal Reserve Board Chairman Alan Greenspan - was down 9.8 percent in October on a year-over-year basis.

What do disinflation and deflation imply?

“Certainly we the baby boomers would find it hard to come to grips with the notion of deflation,” said David Resler, economist for Nomura Securities International in New York. Yet Resler notes that the respected University of Michigan monthly survey of households shows that Americans see lower inflation than the consensus of professional economists.

In many cases, the consumer’s income has stagnated or shrunk, and he or she is determined to hunt for bargains. The consumer “doesn’t have the wherewithal to pay higher prices,” Resler said.

The last time the United States experienced sustained deflation was in the Depression of the 1930s. Deflation in Japan in part reflects the bust portion of a boom/bust cycle in fixed asset prices, especially real estate prices.

Neither a depression nor a bust in fixed asset prices is on the horizon in the United States. However, just as a surprising spurt in inflation penalizes savers and investors, a surprising slide in inflation or - worse yet - an unexpected shift to deflation penalizes borrowers, Resler said.

With the high debt levels of American household these days, the ability of consumers to handle their debts in a disinflationary or deflationary environment is a serious question. Employers don’t mind handing out raises when inflation is boosting the prices of their products, but they don’t do it when prices are falling.

Disinflation and deflation would be a godsend to bond holders, but not for most of us who are net borrowers or investors in common stocks.

“The threat of deflation in the United States is not likely,” Resler said. “What is more likely is a significant enough reduction in demand to reduce production and employment.”