[Marxism] NYT: "Specter of Deflation Lurks as Global Demand Drops "

[Fred Feldman]

http://www.nytimes.com/2008/11/01/business/economy/01deflation.html
November 1, 2008
Specter of Deflation Lurks as Global Demand Drops 
By PETER S. GOODMAN
As dozens of countries slip deeper into financial distress, a new threat may
be gathering force within the American economy - the prospect that goods
will pile up waiting for buyers and prices will fall, suffocating fresh
investment and worsening joblessness for months or even years. 

The word for this is deflation, or declining prices, a term that gives
economists chills. 

Deflation accompanied the Depression of the 1930s. Persistently falling
prices also were at the heart of Japan's so-called lost decade after the
catastrophic collapse of its real estate bubble at the end of the 1980s - a
period in which some experts now find parallels to the American predicament.

"That certainly is the snapshot of the risk I see," said Robert J. Barbera,
chief economist at the research and trading firm ITG. "It is the crisis we
face."

With economies around the globe weakening, demand for oil, copper, grains
and other commodities has diminished, bringing down prices of these raw
materials. But prices have yet to decline noticeably for most goods and
services, with one conspicuous exception - houses. Still, reduced demand is
beginning to soften prices for a few products, like furniture and bedding,
which are down slightly since the beginning of 2007, according to government
data. Prices are also falling for some appliances, tools and hardware.

Only a few months ago, American policy makers were worried about the reverse
problem - rising prices, or inflation - as then-soaring costs for oil and
food filtered through the economy. In July, average prices were 5.6 percent
higher than a year earlier - the fastest pace of inflation since 1991. But
by the end of September, annual inflation had dipped to 4.9 percent and was
widely expected to go lower. 

The new worry is that in the worst case, the end of inflation may be the
beginning of something malevolent: a long, slow retrenchment in which
consumers and businesses worldwide lose the wherewithal to buy, sending
prices down for many goods. Though still considered unlikely, that would
prompt businesses to slow production and accelerate layoffs, taking more
paychecks out of the economy and further weakening demand. 

The danger of this is the difficulty of a cure. Policy makers can generally
choke off inflation by raising interest rates, dampening economic activity
and reducing demand for goods. But as Japan discovered, an economy may
remain ensnared by deflation for many years, even when interest rates are
dropped to zero: falling prices make companies reluctant to invest even when
credit is free. 

Through much of the 1990s, prices for property and many goods kept falling
in Japan. As layoffs increased and purchasing power declined, prices fell
lower still, in a downward spiral of diminishing fortunes. Some fear the
American economy could be sinking toward a similar fate, if a recession is
deep and prolonged, as consumers lose spending power just as much of Europe,
Asia and Latin America succumb to a slowdown. 

"That's a meaningful risk at this point," said Nouriel Roubini, an economist
at New York University's Stern School of Business, who forecast the
financial crisis well in advance and has been warning of deflation for
months. "We could get into a vicious circle of deepening malaise." 

Most economists - Mr. Roubini and Mr. Barbera included - say American policy
makers have tools to avert the sort of deflationary black hole that captured
Japan. Deflation fears last broke out in the United States in 2003, but the
Federal Reserve defeated the menace with low interest rates that kept the
economy growing. This time, the Fed is again being aggressive, dropping its
target rate to 1 percent this week. And the government's various bailout
plans have also pumped money into the economy. 

"If you print enough money, you can create inflation," said Kenneth S.
Rogoff, a former chief economist at the International Monetary Fund and now
a professor at Harvard. 

But even as American authorities unleash credit, the threat has intensified.
Not since the Depression have so many countries faced so much trouble at
once. The financial crisis has gone global, like a virus mutating in the
face of every experimental cure. From South Korea to Iceland to Brazil, the
pandemic has spread, bringing with it a tightening of credit that has
starved even healthy companies of finance. 

"We're entering a really fierce global recession," Mr. Rogoff said. "A
significant financial crisis has been allowed to morph into a full-fledged
global panic. It's a very dangerous situation. The danger is that instead of
having a few bad years, we'll have another lost decade."

Global economic growth has flourished in recent years, much of it fertilized
with borrowed investment. This raised kingdoms of houses in Florida and
California, steel mills in Ukraine, slaughterhouses in Brazil and shopping
malls in Turkey.

That tide is now moving in reverse. Banks and other financial institutions
are reckoning with hundreds of billions of dollars worth of disastrous
investments. As they struggle to rebuild their capital, they are halting
loans to many customers, demanding swift repayment from others and dumping
assets - homes sold out of foreclosure, investments linked to mortgages and
corporate loans. Selling is pushing prices down further, making the assets
left on balance sheets worth less, in some cases prompting another round of
sales. 

"You get this adverse feedback loop where assets keep falling in value," Mr.
Barbera said. "You're essentially putting big downward pressure on the
global economy."

In past crises, like those that devastated Mexico in 1994 and much of Asia
in 1997 and 1998, weak economies managed to recover by exporting
aggressively, not least to the United States. But American consumers are
battered this time. After years of borrowing against homes and tapping
credit cards, consumers are pulling back.