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Attention, shoppers: Don't be too psyched about those 50%-off bargains you got last weekend.
Truth is, those sweet deals may actually be a harbinger of some seriously bad economic news: a nasty phenomenon known as a deflationary spiral.
Deflation destroys economic growth, jobs and income when it gets out of control. So it could wind up costing you much more in the long run than what you just saved on Christmas presents.
If you think falling prices won't be a serious problem because the talking heads on TV are dismissing it, don't kid yourself.
Virtually all economists and pundits offered the same benign forecasts for Japan right before it slipped into a nasty deflationary spiral that killed growth, dreams and hopes during the 1990s, according to a Federal Reserve Board examination of predictions that preceded that mess.
Why is the Fed so keen on examining the days leading up to the deflationary crisis in Japan? Because the Fed's leaders, including Chairman Ben Bernanke, are among those who are nervous about deflation right now.
A trend that's not your friend
We already see signs of this trend. After months of sharp inflation, consumer prices dropped a record 1% in October. That was the biggest one-month decline since the Labor Department started keeping statistics on consumer prices in 1947.Sure, a lot of that was the falling price of energy. We're paying $2 a gallon for gas instead of $4.
But the prices of products less directly linked to the cost of gasoline and fuel fell, too:
- Women's apparel was off 2.2%.
- Lodging was down 1.6%, even though you might think it should go up as gasoline prices go down and more people take to the roads.
- New- and used-car prices fell 0.7%.
"I don't think (deflation) is a possibility. I think it's here and now," says Ed Yardeni of Yardeni Research. "The shock waves of deflation have been spreading ever since mid-September, when the credit crisis turned into a global credit crunch."
The big problem with deflation is that once it starts, it is hard to get rid of, because it feeds on itself. That's why, generally, policymakers like to see a little inflation and gently rising wages, as a cushion against deflation.
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Companies that would suffer the most in a deflationary spiral are those that sell expensive items or rely on a lot of debt to survive. That would include General Motors (GM, news, msgs), Ford Motor (F, news, msgs) and Harley-Davidson (HOG, news, msgs), cruise companies such as Carnival (CCL, news, msgs) and Royal Caribbean Cruises (RCL, news, msgs), and appliance makers like Whirlpool (WHR, news, msgs). The fallout could be hard for their investors and for their workers.
In contrast, winners might be companies that are good at cutting costs, such as Wal-Mart Stores (WMT, news, msgs), or that assist in cost cutting, like temp agencies Manpower (MAN, news, msgs) and Kelly Services (KELYA, news, msgs).
Foster Wheeler (FWLT, news, msgs), Fluor (FLR, news, msgs) and other infrastructure companies may also benefit as the government ramps up spending to try to end the deflationary spiral.
The dean of deflation
To get the lowdown on the risk, I turned to the dean of deflation, a longtime market commentator named Gary Shilling. Shilling is worth listening to because he predicted much of the current economic malaise in his monthly newsletter, Insight.He also literally wrote the book on deflation, "Deflation: Why It's Coming, Whether It's Good or Bad, and How It Will Affect Your Investments, Business, and Personal Affairs." (Doing his part for deflation, Shilling offers the book at his Web site for 60% less than the price at Amazon.com, before shipping.)
Based on his studies of nasty bouts of deflation in Japan and during the Great Depression in the U.S., Shilling points out that what looks like welcome holiday price cutting may build on itself and wreak economic havoc in two ways:
Consumers wait, forcing prices even lower. Suppose you want to buy a flat-screen TV. You track the price on your favorite for a few weeks and notice it keeps going down. You hold off for a better price. A lot of other people do the same thing, so inventories build, and retailers have to cut prices to move the goods.
"You force an increase in inventory, so it is a self-fulfilling prophecy," Shilling says. "And it becomes a vicious circle. This is the one the Fed worries about the most."
It doesn't take much to persuade consumers to hold off on purchases these days, because they have lots of other problems. Unemployment is rising, declining home values have shut off the home-equity-loan spigot, and credit card companies are tightening charge limits. To Shilling, this means our debt-fueled consumer-buying binge has ended. It will be replaced by a period of saving that could last for several years. This contributes to deflation, too.
Debtors suffer; credit dries up. Conditions are bad in the credit markets; deflation makes them worse.
Here's why: As prices fall, the value of each dollar goes up. This makes it more expensive to pay off debts. At the same time, borrowers -- companies or individuals -- are earning less because the economy is weak, Shilling says.