Deflation can turn a bad situation into a full-scale crisis. Deflation means companies are earning less income—but outstanding debt is still the same, and consumer spending decreases. Deflation helped turned a recession in the early 1930s into the Great Depression.
Why have we avoided it? GDP reports have been positive, and by the technical definition of a recession as two quarters of negative GDP growth, the recession is over. While unemployment is still uncomfortably high, it could be that consumer spending has increased and industrial demand has ramped up.
The Dow dropped from resistance levels around 10,700 to support around 10,300 through this week. The energy component of CPI rose by 2.6 percent, which could be a sign of increased industrial demand. The retail sales report was slightly below consensus, but still within the consensus range.
What this means going forward
To reiterate: the positive CPI numbers are not a sign that the worst is over, but it is one less red flag that could have been severe. Things to monitor in the near term:
- Retail sales data when more back-to-school shopping data is available. On Tuesday, Abercrombie & Fitch releases earnings—and on Thursday, Aeropostale, Gap, The Buckle, and Zumiez release earnings.
- Data from Western Europe. Right now, the biggest deflationary pressure is contraction in the Eurozone from austerity and stagnation.
- Chinese statistics. Call it a hunch, but I’m starting to feel a possible credit bubble in China. Financial blogger Robert Eberenz at Diamond Slice has more details here, and they’re not pretty.
If back-to-school data turns out to be more robust than expected, things may be shaping up. If China ends up contracting, look out below.