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.
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. 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% 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% 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.
Most economists 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% 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.
From Asia to Latin America, exports are slowing and should continue to do so as the global appetite shrinks. This is spawning fears that major producers like China and India — which vastly expanded production capacity in recent years — will have to dump products on world markets to keep factories running and stave off unemployment, pressing prices lower.
China has long been at the center of claims that the world could keep growing regardless of American troubles. China has been importing cotton from India and the United States; electronics components from South Korea, Malaysia and Taiwan; timber from Russia and Africa; and oil from the Middle East.
But many of the finished goods China produces with these materials have ultimately landed in the United States, Europe and Japan. When consumers pull back in those countries, Chinese factories feel the impact, along with their suppliers around the globe.
Now, a glut of products may be building in the United States. Orders for trucks used by business have plummeted. Investments in industrial equipment are declining. Yet inventories have grown.
“I worry about an economy that looks like Japan,” said Barry P. Bosworth, a senior fellow at the Brookings Institution. “We’re going to be struggling with how to put this back together again for several more years.”
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The New York Times (abridged)
