Tag Archives: Deflation

Seeing the Positives from the European Debacle

What happened in the stock market two weeks ago was scary: the Dow dropped 1,000 points in a matter of minutes.  Greece was on the brink of defaulting on it’s debt; a country I might add, that has it’s currency denominated in Euros.   Investors were worried that if Greece went down, it might drag down the Euro with it.  Luckily, the EU finally pushed politics aside and realized that in order to keep the EU from causing a European Lehman chain reaction, they had to bail out Greece.  If Greece went, so the saying goes, the rest of Portugal, Italy and Spain would go with it.  As the bail out was announced, U.S. stocks surged.  But the damage was done.

Stocks are still up since a year ago, but a lot of that equity was lost.  Some say it was a much needed market correction.  In a way, I agree.  Investors started to feel that they were being left out of the party (considering that stocks rallied considerably since March 2009) and wanted to get into the action, driving up valuations.    The market correction has left some worried that the lost momentum from the stock market and the teetering European situation means that the U.S. is going to lose steam in it’s recovery.  But it won’t; it will only make our recovery stronger.  There are several positive indications that Europe’s struggle is in America’s benefit.

  1. A stronger dollar against the Euro should help bring in an influx of investment.  While a weaker dollar sent investors over seas, most wealth generated outside of the U.S. will start seeking to invest here.*
  2. The Fed funds rate is still around 0% to .25%.  Inflation hawks are going to have to start rethinking their position as deflationary pressures continue to rear its ugly head.  Mean trimmed CPI is on a downward trend, and with energy and commodity prices pointing lower, it will only continue to send overall prices downward.   This type of environment will keep the Fed from raising rates, making borrowing cheap.  With mortgage rates continuing to be low, buying a house is still attractive.
  3. The potential benefit for having low interest rates is that foreign investors looking for returns will look towards equity markets.  This means more potential growth for U.S. companies and the stock market.
  4. The stock market wasn’t the only thing that experienced slides.  So did commodity prices, especially oil.  Oil was moving up to around $90 a barrel until the market correction happened.  Now, oil prices are down to $75 a barrel.   Any increase in gas prices is taxing on consumers, but so far, gas prices have stagnated and won’t be increasing any longer.  The cost of inputs are now lower across the board thanks to declines in commodity prices, providing cushy margins for companies that lowers the pressure to raise prices, resulting in an absence of pain for the consumer.

As you can see, there is upside to the European situation.  I agree that it is still a gloomy situation for Europe in general.  Greece (and the like) face long-term structural issues that will make resolving their situation an incredibly hard task and I won’t be surprised if in 6 months Greece begins to default on its debt again.  But will it really drag down the EU? The rest of the countries such as Portugal, Spain and Italy should benefit from a lower Euro, helping wages that outpace productivity come to parity.  So should Germany and the rest of Europe, as a lower Euro will stimulate exports.  What needed to happen was a devaluation of the Euro  to a value more inline of what it is worth.  Yes, it is unfortunate that these irresponsible countries are essentially a drag on the EU, but that doesn’t mean the U.S. will have to suffer for it.

While the EU is a major trading partner to the U.S., I doubt there will be significant drops in demand for U.S. goods. There are more, higher growth areas for the U.S. to consider.  In terms of the U.S. recovery, if exports were the upside to the U.S. downturn, then U.S. exports to Europe is going to be the downside to the U.S. recovery.  But there is going to be a recovery nonetheless.

*And in minutes, this pops into my RSS reader: China boosts holdings of US Treasury debt by 2 pct

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Deflation Worries…Again?

Free exchange posted a piece on whether or not we should be worrying about deflation again.

Today, the BLS released September producer price data, which showed a surprising decline in headline inflation of 0.6%. Core producer prices dropped by 0.1%. And while the headline figure in August increased 1.7%, the broader trend is clearly downward:

That’s a chart of the three-month percent change in core producer prices. The last entry there is 0.0; prices have been flat since June, essentially, before which they were still increasing at a very slow pace.

Perhaps prices will not begin falling outright as the year draws to an end. Recent increases in capacity utilisation indicate that some upward pressure on prices may begin to appear. But housing cost categories will probably keep falling, and labour costs will probably keep falling. Preliminary surveys of consumers and retailers indicate that holiday spending will be depressed, and discount shopping will be quite common. The bigger threat at this point is clearly deflation, rather than inflation, and so it is somewhat disconcerting to see the Federal Reserve working to convince inflation hawks that it takes their concerns seriously.

It would make sense to hit another round of deflation.  The unemployment numbers have not gotten any better, putting a strain on consumer incomes and forcing buyers to demand lower prices.  It would be incredible if prices would dip below 0 once again considering that economic recovery (at least is believed to be) is underway.  Can an increase in GDP growth happen with receding price levels?  Maybe it is a symptom of our “jobless recovery.”

UPDATE:  Producer prices dropped 0.6% in September, while core producer prices fell 0.1%. (here) Most of the drop was from energy and food but also trucks and computers.  Weak demand is pushing prices lower.  Deflation definitely is starting to look like a reality.

UPDATE (10/21): Econbrowser has a great post showing that unemployment can have downward pressures on expected inflation.  More of the reason to assume we are in a period of deflation, no? But why has commodity prices relative to a sinking dollar not keep up?