It isn't pretty, it's hard to talk about, it's misunderstood

The Economy

December 08, 1997|By JAY HANCOCK

A COLLEAGUE of mine keeps thinking about buying a computer, but doesn't. She knows the price of whatever machine she's eyeing will be $500 lower six months after whatever time she's eyeing it.

So her money, instead of landing in Microsoft's, Intel's and Compaq's receivable accounts, stays in her bank.

It's this kind of behavior that unsettles a growing number of financial analysts.

Prices are falling around the planet, a scene unimagined until recently by millions of consumers conditioned to fret only about inflation.

The worry is that price plunges will snowball, become epidemic and prompt procrastinated purchases everywhere -- not just in computers, where falling prices are a hallmark, but in homes, cars, sound systems and vacations.

It's called deflation, and it's not attractive.

Except among paranoid survivalists, a few intelligent Internet correspondents and some theoretically minded economists, deflation is not a word that has tripped easily from the lips in this half of the century.

Since World War II ended the Depression and deflation of the 1930s, Americans have become accustomed to an upward ratcheting of prices. Strong economies, loose monetary policy, the rise of labor contracts and tax policies that encouraged borrowing and spending all ensured that costs went only one way: skyward.

Now, like your HMO doctor warning about bubonic plague, economic diagnosticians are talking about an antique ailment called deflation.

It's a commonly misunderstood bug.

Deflation is a persistent fall in prices across the economy, not just among a few goods. In recent years the United States has experienced disinflation, which is different. With disinflation, some prices rise and some fall, but the cost of living overall continues to go up, although at a slower pace.

Deflation is when there is so little demand for products that companies keep cutting prices to move the goods. Deflation is when even interest rates close to zero can't prompt people to borrow and spend.

With acute deflation, the price of labor -- wages and salaries -- falls along with everything else. Deflation is when even huge increases in the money supply by central banks might not be enough to stimulate moribund demand.

Few respected analysts are predicting such a scene for the United States. But more and more are concerned deflationary trends in the rest of the world will at least wing the economy here, and maybe do worse.

In the past 15 years, East Asia has borrowed, spent and built itself into an economic titan, grabbing a huge chunk of the world economy. Asian banks financed the explosion, and, as we are now finding out, the banks conducted their business less in accordance with the wishes of their underwriting departments than of their governments.

The result was that they made billions in dumb loans, which were hidden for years by obfuscatory bookkeeping.

We now know that Asian debt was hugely overvalued. The factories, buildings and fleets that it financed are not capable of servicing it. There are too many of them, too much productive capacity and not enough customers. And as debt prices plunge back to earth in Asia, they are dragging many other kinds of prices with them.

Almost all Asian currencies have fallen in value against the dollar in recent years. Most of the plummet has come in the past few months, and in some places as much as 40 percent.

Japan is in a classic deflationary situation. You can take out a five-year loan there at 1 percent. As Johns Hopkins economist Steve Hanke points out, the "M1" cash money supply in Japan is rising while other money measures shrink -- a classic deflationary symptom as consumers stash money in mattresses.

The price of Japanese imports into the United States has shrunk by 5 percent in the past year.

At the very least, cheaper Asian imports will cut into U.S. producers' market share, hurt their profits and cast a pall on the U.S. stock market, many analysts believe. But people like Lacy H. Hunt, an economist with Hoisington Investment Management, worry that the damage could go further.

They point to gold prices, which collapsed to a 12-year low last week. They cite record personal bankruptcies in the United States as evidence of overvalued debt here. They warn about lofty U.S. stock prices.

One virtue of inflation is that it lights a fire under the economy. Understanding that prices always rise with time, consumers buy today rather than wait.

Deflation, doing the opposite, is in some ways more poisonous. Once consumers are convinced that prices will fall, they horde cash. That, in fact, ensures that prices will indeed fall.

Computer prices, of course, have been falling for years, and that hasn't kept the industry from doing very nicely, thanks. But the low-odds danger now is that other prices will follow them down and that, like my colleague, consumers will freeze.

No wonder the U.S. Federal Reserve hinted last week that it won't try to dampen demand by raising interest rates this month.

Pub Date: 12/08/97

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