EconomicCrisis.US

Is the U.S. economy in the early stages of a rare illness that last hit 80 years ago?

Because most of us have lived in an era of ever-rising prices, a full-blown bout of deflation would be a shock.

The United States has fought off deflation three times: in the Panic of 1837, after the Civil War in what’s called the Great Deflation and during the Great Depression in the 1930s.

Generally, a reduction in the money supply sparks deflation. Governments cut — actually cut — spending. Or central banks raise interest rates and drain banking reserves.

A reduction in credit, which often follows an explosion of government or private debt and the bursting of asset bubbles, can also tighten the money supply. In short order, governments enact austerity measures, people turn their attention to paying off debts and the collapse in collateral dries up credit.

People have less money to spend. The demand for goods and services drops, driving down prices. Investors pull back, starving companies of capital needed to expand.

Companies cut costs, cut wages, cut workers and cut plans for growth.

In a modern economy, companies will also begin a relentless drive for efficiency. Even as productivity per worker and profits soar, more people find themselves out the door.

Sound familiar?

How people actually handle their money also changes. In inflationary periods, consumers are tempted to buy a product sooner, rather than later. In a deflation, the smart thing to do is delay buying something because it will get cheaper.

Debt also bites harder. During inflation, borrowers pay back lenders with cheaper money. During deflation, they pay back debt with ever-larger amounts of purchasing power.

If deflation runs at 8 percent a year, even a zero percent loan doesn’t make financial sense because it’s repaid with money worth 8 percent more each year.

Creditors, savers and those on fixed incomes get the upper hand.

If the U.S. enters a true deflationary spiral, it will bring on that double-dip recession.

Paul Ashworth, senior U.S. economist at Capital Economics, a consulting firm, told The Wall Street Journal: “Economies don’t just tumble into deflation. It’s a grinding process. The longer people have been unemployed, the more willing they’ll be to take lower wages. It’s just going to gradually build.”

You can find early signs of that grinding. (Like doctors looking for an illness, we’re focusing on negative symptoms. Sorry.)

The dismal job situation is obvious — more so when you absorb that a whopping 650,000 disheartened people left the work force in June.

Retail and auto sales, along with housing, have all hit rough patches this summer.

Manufacturers used just 71.4 percent of capacity last month, still well below a six-decade average of 80.8 percent. That makes it hard to raise prices.

So the 0.1 percent drop in consumer prices in June was the third straight monthly decline. Gold, an inflation hedge, has been falling. So have oil and other commodities.

And here’s an astonishing fact: America’s 500 largest non-financial companies have $1.8 trillion in cash on their balance sheets. This supposedly is the highest in almost half a century.

Consumer psychology is also flashing a warning sign.

The University of Michigan consumer confidence index plummeted 9.5 points in June to 66.5, the lowest since last August. Before the recession it stood above 100.

And Americans are becoming more frugal. In a recent Pew Research Study of nearly 3,000 Americans, 71 percent said they’re buying less expensive brands.

This should deflate you: 11 percent claimed to have postponed marriage or children.

Pew had other insights on who was hopeful about the economy: “Older adults (ages 65 and older) are much less likely than younger age groups to have cut back on spending, loaned or borrowed money, had trouble paying for medical bills or housing, or had to increase their credit card debt.”

The young were more confident than their parents. Blacks and Latinos more than whites.

The most pessimistic? Middle-aged, middle-class whites, having lost the most wealth in home values and savings.

Most economists and pundits aren’t walking down the deflation gangplank yet.

But some are indeed joining the pessimistic crowd. Nouriel Roubini, the “Dr. Doom” who called the housing bubble collapse, is warning of a “stag-deflation.”

Federal Reserve officials reportedly disagree on the risk of deflation but are worried. The Boston Federal Reserve Bank president, Eric Rosengren, told The Journal: “The risk of deflation has gone up and is more of a risk than I would like to see at this point.”

The Fed has already cut its baseline interest rates to near zero. The best it can do is to restart its purchase of U.S. government bonds or mortgage-backed securities. At the deepest part of the recession it bought $1.5 trillion in bonds, which lowered consumer interest rates half a percentage point.

But it is now unwinding those purchases, and reversing that course would signal a lack of confidence in the recovery.

Uncle Sam could come up with another fiscal stimulus package. But our lawmakers are embroiled in midterm political game-playing fed by fear of adding to the national debt and running up interest rates, which would kill the recovery anyway.

Keep in mind, however, that the health of the U.S. economy really rests in our hands, not with the Fed or Congress or the administration. As always, it’s a contest between optimists and pessimists.

Los Angeles Times political columnist Doyle McManus observes that “pessimists don’t stimulate the economy by buying new houses or big-ticket consumer goods. Pessimists don’t invest money in the stock market.”

If you’re concerned about deflation but are an optimist — maybe because you’re fortunate to have a job — the remedy is in your pocket or purse.

Get out and spend some money.
By Keith Chrostowski – The Kansas City Star