Deflation Watch, Day 2: Consumer Prices

Yesterday it was producer prices; today it's consumer prices. The collective message is all the clearer: the risk of deflation is rising.

Consumer prices dropped 1% last month--a huge decline for a single month and the biggest on record, based on historical data on the Labor Department's web site going back to 1947.

Core inflation, which excludes food and energy, dipped by 0.1% in October, suggesting that the falling prices depicted in headline inflation is more than just a function of slumping commodity prices. And since the Fed focuses on core readings of inflation, last month's dip in core CPI reminds that the central bank is losing control of the pricing environment. Indeed, the last time core CPI dropped on a monthly seasonally adjusted basis was in July 1980, which proved to be a one-time event.

It's not clear that the negative signs in CPI this time are set for a quick fade. The perfect storm of recession, rising unemployment, a consumer population burdened with historically high levels of debt, the implosion of Wall Street, a housing crisis and a weakening global economy threaten to inject the poison of deflation into the U.S. economy.

It's true that the rapid price decline in commodities is the primary force behind the red ink in prices. That fact provides a bit of hope that deflation may yet be avoided. If falling prices is contained to raw materials, the trend could be dismissed as simply a correction in a formerly high-flying market. Indeed, at some point commodity prices will bottom and prices overall will stop falling. But with the other ills noted above, and the embedded deflationary risk they harbor, the extraordinary news of sharp price tumbles in wholesale and consumer prices can't be ignored just yet.

Another problem is that the Federal Reserve is nearly out of conventional monetary ammunition, and perhaps by more than is generally recognized. The widely quoted target Fed funds rate is at 1%, implying that another 100 basis points of cutting is still possible. But that rate overstates the case. The effective Fed funds rate, which is a better measure of actual transactions between banks and the central bank, is far lower at 0.37%. As such, lowering the 1% target Fed funds, which is likely, will be less of a rate cut than simply facing up to reality as it now stands in the credit market.

Fiscal stimulus engineered by Congress and the White House, along with nontraditional efforts at injecting liquidity by the Fed, are the only levers left. For a number of reasons, including the limited experience of dealing with deflation in the modern era, it's unclear how effective those efforts would be for combating a general price decline.

The good news is that it's still possible to say that deflation hasn't arrived in earnest, at least not yet. On a year-over-year basis, CPI still rose 3.7% through last month. The deflationary warnings have only just arrived, and so we're in the early stages of deciding the broad trend for prices. Hopefully, October's price trends are exceptions, but we'll just have to wait for additional data to be sure. The problem is that if deflation is in fact a real and present danger, acting in a timely manner is essential. Once a deflationary mentality takes hold, there's almost no solution.

Pre-emptive action, in other words, offers the only path for sidestepping the disease. For that reason, erring on the side of stimulus -- a lot more -- looks like a reasonable course. The risk is that it triggers inflation, in which case it'll be time to reverse course. But at least the world knows how to fight inflation. Deflation, by contrast, is an entirely different monster.

Comments

[trader1138:]

sorry to divert, but i'm currently enraptured by the bold-faced stupidity of the Auto Bailout Hearings Redux...I'm reminded of the line from 'Saving Private Ryan' when the Rangers finally take the German pillboxes and torch the occupants with flamethrowers. As the repulsive Huns leap aflame from their perches, one attentive G.I. yells to his buddies, "Don't shoot, let 'em burn!"....UAW, listen up

2008 Nov 19 12:11 PM

[cpi watcher:]

Almost the whole of the All Items monthly drop is accounted for by motor fuel and household energy. Everything else continued to go up, including food, housing ex-energy, medical costs, recreation ...

cpiwatch.com/component...

Transportation costs have dropped precipitously for the past three months but food prices continue to climb:

cpiwatch.com/trends?sa...

2008 Nov 19 12:31 PM

[DVW:]

Deflation has an easy cure since we're not on the gold standard anymore. Just print money. Remember we were on the gold standard during the Great Depression and it tied the hands of the government to fight deflation.

Seems to me that the government needs to print money but be quick on the draw once the inflation shows up. I think that's what they're trying to do.

2008 Nov 19 12:38 PM

[fatcat:]

Makes me want to go out and buy a overpriced,gas guzzler SUV...to help the home team...not..

2008 Nov 19 01:33 PM

[Pent up demand:]

Completely expected. The Fed never had control of the pricing environment. Their tools are extremely crude.

Expect to see continued deflation in financial assets with ever-increasing spillover effects in necessities.


On Nov 19 12:31 PM cpi watcher wrote:

> Almost the whole of the All Items monthly drop is accounted for by
> motor fuel and household energy. Everything else continued to go
> up, including food, housing ex-energy, medical costs, recreation
> ...
>
> cpiwatch.com/component...
>
>
> Transportation costs have dropped precipitously for the past three
> months but food prices continue to climb:
>
> cpiwatch.com/trends?sa...

2008 Nov 19 01:46 PM

[Chris B:]

Agreed DVW,

I also agree with the author's assertion that the current plan is for Helicopter Ben to intentionally overshoot in his attempts to flood the economy with money. The result may be 6-7% inflation in 2010, but they say so be it.

Key risks include producing more debt than we can ever dig out of, requiring a devaluation and long-term lowered standards of living.

More importantly, we should be asking what we will have for our money once all these trillions in stimulus money is spent? Will we have attained energy independence? Will we have an improved healthcare system? Will a college education be free to qualified students? Will we have all new infrastructure?

As it seems now, our massive investment will yield the following:
-temporarily propped up house prices
-millions of surplus GM, Ford, and Chrysler vehicles sold at a loss, depreciating daily.
-hundreds of billions of dollars in interest payments, owable each year from now on.

China, on the other hand, is using its stimulus to invest in things with a long-term payoff, like education and infrastructure. That's why they will be a superpower in 10 years and we will not.

2008 Nov 19 01:49 PM

[JonHolland:]

I am sure this is mostly attributed to an increase in unemployment (small) and a giant decreased in oil prices. Much like we l earned in the 1970s when oil prices are the major driving force for inflation, there is no central bank formula that can stop it. Not at our current consumption.

2008 Nov 19 01:55 PM

[Timmothy Posey:]

To quote a famous patriot, a little deflation now and then is a good thing. Right now consumers are getting crushed from all sides, and we are finally getting a break from extreme end-user prices (gasoline, homes, food, etc.) from this summer. Our purchasing power is increasing (assuming we all can keep jobs).

Deflation is a simple fix. Print the heck out of money and drop it from the trees. Give away cash through some national lottery system, give it to banks, give a loan to anybody with a pulse (or not). Give a green card to any foreigner who's wiling to buy a house here in the U.S. Helicopter Ben just needs to live up to his reputation of dropping money from helicopters. But it will lead to the mother of all inflationary scenarios 3-5 years from now.

2008 Nov 19 02:45 PM

[dshort:]

The Department of Labor website may only publish data since 1947, but the Bureau of Labor Statistics began tracking the CPI in 1913.

The October CPI marked the largest monthly decline since January 1938, during the Great Depression. Since that time, only 33 months have registered a month-on-month decline of 1% or more. Thirteen occurred during the decade of the 1930s, 15 during the 1920s, and 4 between 1913 and 1919. The declines during the '20s and '30s coincided with periods of deflation, as this chart illustrates:

dshort.com/inflation/i...

This one-month reversal is dramatic, but only time will tell if it's an outlier or part of a trend. Here are complete sets CPI and inflation stats since 1913:

dshort.com/inflation/c...
dshort.com/inflation/i...

Cheers,
Doug

2008 Nov 19 03:17 PM

[sickofthehype:]

Some great comments on here by the way.

I keep hearing about this deflationary spiral and the doom we are facing. Sure, the CPI increased 1%. Big deal. It's an easy explanation - oil dropped like a rock. But tell me what other bills everyone gets that are dropping. I see none.

I keep hearing about this being another Great Depression. Many elderly people I've spoken to personally, laugh at that statement. What we had back then was policy error, as the Fed REDUCED the money supply by a third. Plus Hoover raised taxes at the time. Dumb move. The government enacted tariffs keeping out foreign goods too. Then the world did the same. No imports/exports going on didn't help that period of time. We have the tools now to combat the various problems we are and will be facing, and it's only a matter of time before the new stimulus money, and the ones being prepared right now, will create a gigantic sum of inflation in this country. What's going on now is homes are dropping (as they should), and oil is dropping (as it was speculated up). Those things needed to happen.

What's also happening is a massive flight back to the yen for Japanese investors. The carry trade is creating a sell-now situation for markets all over the world. Add to that the fact that THOUSANDS of U.S. hedge funds are on the brink of failure - and in turn, liquidating EVERYTHING, and you end up with fundamentals being thrown out the window.

And another tidbit is the pronounced 'cash on the sidelines'. There's more cash parked in money markets than at any time in our history, ever. And you better believe that when the forced liquidations are over, and when the carry trade calms down, and when the stimulus packages 'hit the streets', that all of that cash will be at major risk to be devalued like no other due to the inflationary measures being undertaken currently. All of that cash will be used to buy hard assets, stocks, you name it, as it will be at risk of becoming worth-less.

2008 Nov 19 03:26 PM

[dw57:]

wouldn;t to do that just from the home team. almost every car company has one of those

On Nov 19 01:33 PM fatcat wrote:

> Makes me want to go out and buy a overpriced,gas guzzler SUV...to
> help the home team...not..

2008 Nov 19 03:57 PM

[dw57:]

and what tool will make it so consumers will buy a product when they get used to it will be cheaper later? that was the big driver in the great depression. no amount of fake playing around with interest rates will solve that


On Nov 19 03:26 PM sickofthehype wrote:

> Some great comments on here by the way.
>
> I keep hearing about this deflationary spiral and the doom we are
> facing. Sure, the CPI increased 1%. Big deal. It's an easy explanation
> - oil dropped like a rock. But tell me what other bills everyone
> gets that are dropping. I see none.
>
> I keep hearing about this being another Great Depression. Many elderly
> people I've spoken to personally, laugh at that statement. What
> we had back then was policy error, as the Fed REDUCED the money supply
> by a third. Plus Hoover raised taxes at the time. Dumb move. The
> government enacted tariffs keeping out foreign goods too. Then the
> world did the same. No imports/exports going on didn't help that
> period of time. We have the tools now to combat the various problems
> we are and will be facing, and it's only a matter of time before
> the new stimulus money, and the ones being prepared right now, will
> create a gigantic sum of inflation in this country. What's going
> on now is homes are dropping (as they should), and oil is dropping
> (as it was speculated up). Those things needed to happen.
>
> What's also happening is a massive flight back to the yen for Japanese
> investors. The carry trade is creating a sell-now situation for
> markets all over the world. Add to that the fact that THOUSANDS
> of U.S. hedge funds are on the brink of failure - and in turn, liquidating
> EVERYTHING, and you end up with fundamentals being thrown out the
> window.
>
> And another tidbit is the pronounced 'cash on the sidelines'. There's
> more cash parked in money markets than at any time in our history,
> ever. And you better believe that when the forced liquidations are
> over, and when the carry trade calms down, and when the stimulus
> packages 'hit the streets', that all of that cash will be at major
> risk to be devalued like no other due to the inflationary measures
> being undertaken currently. All of that cash will be used to buy
> hard assets, stocks, you name it, as it will be at risk of becoming
> worth-less.

2008 Nov 19 04:01 PM

[dw57:]

I also suspect it has to do with the collapse of wages. since credit is tight, consumers are living on wages, which have not kept up with inflation. or it could be that great equalization of world wide living standards the one where the US has the same as everyone ese?


On Nov 19 03:26 PM sickofthehype wrote:

> Some great comments on here by the way.
>
> I keep hearing about this deflationary spiral and the doom we are
> facing. Sure, the CPI increased 1%. Big deal. It's an easy explanation
> - oil dropped like a rock. But tell me what other bills everyone
> gets that are dropping. I see none.
>
> I keep hearing about this being another Great Depression. Many elderly
> people I've spoken to personally, laugh at that statement. What
> we had back then was policy error, as the Fed REDUCED the money supply
> by a third. Plus Hoover raised taxes at the time. Dumb move. The
> government enacted tariffs keeping out foreign goods too. Then the
> world did the same. No imports/exports going on didn't help that
> period of time. We have the tools now to combat the various problems
> we are and will be facing, and it's only a matter of time before
> the new stimulus money, and the ones being prepared right now, will
> create a gigantic sum of inflation in this country. What's going
> on now is homes are dropping (as they should), and oil is dropping
> (as it was speculated up). Those things needed to happen.
>
> What's also happening is a massive flight back to the yen for Japanese
> investors. The carry trade is creating a sell-now situation for
> markets all over the world. Add to that the fact that THOUSANDS
> of U.S. hedge funds are on the brink of failure - and in turn, liquidating
> EVERYTHING, and you end up with fundamentals being thrown out the
> window.
>
> And another tidbit is the pronounced 'cash on the sidelines'. There's
> more cash parked in money markets than at any time in our history,
> ever. And you better believe that when the forced liquidations are
> over, and when the carry trade calms down, and when the stimulus
> packages 'hit the streets', that all of that cash will be at major
> risk to be devalued like no other due to the inflationary measures
> being undertaken currently. All of that cash will be used to buy
> hard assets, stocks, you name it, as it will be at risk of becoming
> worth-less.

2008 Nov 19 04:04 PM

[User 265729:]

I've never seen a larger group of IDIOTS in my life.

Like DUH! Do you go into stores? Do you actually go to Safeway for food? Do you shop at Wal-Mart or Target? Home Depot or Lowe's?

Prices are through the ROOF! Things I purchased last year are 30 to 40 percent HIGHER!

Don't listen to the government for your statistics... DO THIS...

Take out your credit or debit card receipts for the past year or two and look at the difference in prices. Get the picture?

This says nothing for the MINIATURIZATION of everything. Proctor and Gamble should hand out microscopes with their products so you can see what you’re purchasing. CRAZY!

Then the government comes out with a bunch of pure BS to make it look like prices are going down -- sure cars, homes, etc are going down, but they didn't have that worth to begin with.

They changed the way the CPI was calculated in the 1980's so they can sham this data too.

We are up the creek and the paddle costs too much!

2008 Nov 19 04:07 PM

[User 265729:]

sickofthehype:

Excellent points, but our economy was not tangled in a web of trade agreements the likes of which the world has never seen. We are really screwed.

Our economy is based on something like 78 percent consumer spending. That is NOT a whole economy. We have allowed our manufacturing sectors and agricultural sectors to drift to other countries -- where we have NO CONTROL.

In turn, we have agreements that would really screw us. For example, if we try to save GM and Ford, by agreement BMW, DB, and all the others would have access too.

I don't know if my views could be considered "protectionist," but unless this country brings our economy under our control we are in a situation hopeless. Even the "stimulus" packages, end up my round two or three in Asia. During the depression, the money, by in large, stayed here. Not now. It ends up with the producer nations -- we end up with debt.

2008 Nov 19 04:18 PM

[sickofthehype:]

Very true - the only saving grace is that THEY are screwed as well since they're in this mess with us. Down with the ship they say.

Let's only hope that we're less-screwed than they are. Time will tell.

2008 Nov 19 04:48 PM

[DVW:]

Hey Curbs-in... yes, I shop, yes I see prices are higher. No I'm not an idiot... Have you filled your gas tank recently? Fuel is dropping like a rock. Commodity prices are dropping the same. Grains dropping hard. Banks have failed. That's all deflationary... eventually those price drops show up in the stores... or the companys get a mondo-fat profit margin for it.

I'm not denying that the govt jacks with the numbers, but all you have to do is look at the price trend of oil and grains to determine if you are in a deflation cycle... and we are.

Like everyone else, you got used to decades of price stability. Get un-used to it. Price stability of everything is going to be gone for a while.

2008 Nov 19 04:49 PM

[Steven Hansen:]

most of the commenters above at one time or another (including me) have stated that the cpi does not represent the purchasing mix of the average citizen. nothing has changed - it still doesn't.

the cpi is an over manipulated baseline of consumer costs - but it is a baseline none the less. what it is telling us is that the cost structure of living in america is declining. and the cpi excludes is real estate prices. it does not take a rocket scientist at this point to think there is some price contraction going on right now even if it is not universal.

the scariest part of this cpi drop is that the fed's monetary policy is in a crisis mode. to keep stable a fiat currency based economy performing well they need to keep moderate inflation. they have failed. the economy is out of control, and their monetary policy is not working. they are more likely to make things worse than better at this point.

happy thanksgiving

2008 Nov 20 12:43 AM

[Chris B:]

Let's see, if a currency crisis or a long, painful slide in the dollar hits the US, we would see massive inflation here and producer nations would see their foreign reserves decimated.

Situation in US:
Joblessness, prices through the roof in dollar terms, savings gone, no manufacuring capacity, infrastructure crumbles, no economical exports, = empire declines.

Situation in China:
Joblessness, possible currency destabilization but quickly restablilized, savings reduced but still valuable, factories and manufacturing know-how still in existence, infrastructure all freshly upgraded, = empire rises.

It would appear the nation that has put its currency in control of China and its economy in control of OPEC is the worse off one!


On Nov 19 04:48 PM sickofthehype wrote:

> Very true - the only saving grace is that THEY are screwed as well
> since they're in this mess with us. Down with the ship they say.
>
>
> Let's only hope that we're less-screwed than they are. Time will
> tell.

2008 Nov 20 08:49 AM