Oversupply has industries cutting prices

U.S. deflationary spiral could lead to deeper recession, experts say


Attention, shoppers: America is now on sale.

Airlines and hotels are offering deep discounts. Carmakers are advertising interest-free loans. Department stores have marked down many items. Computer prices continue to drop.

Commercial rents are falling for the first time in a decade. Businesses are paying less for textiles, lumber, metals and many other basic materials than they were a few months ago.

In industry after industry, companies find themselves with too many products in warehouses and too much machinery on factory floors, even after a year of economic weakness and corporate cost-cutting. One result is a lingering glut of goods and price cuts.

For all the benefits that sales have brought to consumers, the United States could suffer an extended period of declining prices, or deflation, which could deepen its first recession in 10 years.

Overall, even though the cost of services is rising, consumer prices have remained flat over the past six months, the first time in 15 years they have failed to rise over a sustained period. The prices that businesses pay for crude materials have fallen for six consecutive months, dropping last month by 9.1 percent. Since the government began keeping such statistics in 1947, the only larger monthly decline came in February this year.

For now, the absence of inflation is one of the few bright spots for consumers, whose holiday spending will go a long way toward determining how quickly the economy emerges from its downturn.

The fall in energy prices alone has given households an additional average $100 apiece over the last five months - $10 billion in spending money - according to Economy.com, a consulting firm in West Chester, Pa. The average price for a gallon of gas - $1.20 - is back where it was in 1985.

Should the price declines spread further, many businesses would be forced to begin yet another round of job cuts. In a deflationary economy, wages drop as well, and people and businesses struggle to pay off debts, which effectively become larger as the value of money declines.

Most economists consider that unlikely, saying aggressive steps by the Federal Reserve have pumped billions of dollars into the economy, helping to stabilize prices and lift demand next year.

Still, the extent of the price decreases, and the oversupply of products causing them, suggest that the economic recovery is unlikely to be a robust one, many analysts say. In October, companies used only 74.8 percent of their industrial capacity, the lowest level since 1983, as many continued to suffer a hangover from their overly optimistic purchasing of new equipment in the late '90s.

Even if demand for their products begins to rise soon, businesses will not increase their investments again until they are using more of their existing capacity, economists say. "Inventories are still excessive, and companies are suffering a squeeze on profit margins," said John Lonski, chief economist at Moody's Investors Service. "That tells me that at best the recovery is going to be modest."

The price declines follow years of mild inflation that, according to many economic models, should have gradually picked up steam as the economy boomed in the second half of the 1990s. Instead, a strong dollar and a flood of imports helped keep inflation low, forcing businesses to increase profits primarily by becoming more efficient rather than by raising prices.

Between 1992 and 2000, inflation on consumer goods never exceeded 3.5 percent over a 12-month period. In previous booms, it reached 6 percent or more.

When the U.S. economy seemed to fall into recession this year, inflation all but disappeared. The exception was oil prices, because producers lacked enough supply to meet the surge of demand as Asian countries recovered from financial crises of the '90s. But by summer, the worldwide economic slowdown depressed energy prices, too.

After energy, the biggest recent price declines have come in industries operating far below capacity.

The starkest case is technology. Prices for computers and semiconductors have been falling for years as advances have cut costs and manufacturers have become far more efficient. Throughout the '90s, though, profits continued to rise as consumers and businesses quickly replaced old equipment with the latest innovations.

But businesses sharply reduced their technology budgets at the end of last year. Computer manufacturers were forced to curtail production; their output fell last month to 61.3 percent of capacity - a record low - down from 80 percent a year ago. Price cuts have accelerated, and computers are about 30 percent less expensive than a year ago, according to the Bureau of Labor Statistics.

Price declines "are a double-edged sword for U.S. companies," said Edward McKelvey, a senior economist at Goldman, Sachs & Co. "One company's cost is another company's output price."

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