Despite Friday’s report showing that producer prices rose last month at their fastest pace in nearly two years, it is still the threat of deflation — not inflation — that gives economists the heebie-jeebies. A double-dip recession next year, although still considered unlikely by most analysts, could be accompanied by a deflationary spiral that would raise disturbing parallels with Japan.
Wholesale prices rose 1.1 percent in October, according to the government’s Producer Price Index, but most analysts consider the result a one-time event caused largely by a surge in the cost of motor vehicles and the fuel to run them.
Automakers took advantage of the new model year to push through a 2-percent wholesale price increase last month, according to the government data, but clearly such a rate is not sustainable. Some analysts speculate the West Coast port shutdown, which President Bush ended Oct. 8, also might have had an impact on producer prices last month.
Excluding energy, motor vehicles and the volatile food categories, producer prices would have edged up only 0.1 percent last month, the Labor Department said.
“It’s very hard to find a person in business who claims to have any real ability to raise prices,” said Don Straszheim of Straszheim Global Advisors. “So I would write this morning’s PPI off as a statistical fluke. We don’t have an inflation problem in this economy — we’ve got a slow growth problem.”
That view was underscored by the surprisingly large 0.8-percent drop in industrial output last month, also reported Friday. The nation’s factories, after a brief increase in production over the summer, have lost steam again and are running at only about 75 percent capacity, compared with well over 80 percent for most of the 1990s. That means any upturn in demand easily can be met by raising production, making it hard for manufacturers to raise prices.
That leaves cost-cutting as the main way for businesses to boost profits, “and you cannot do cost-cutting indefinitely,” said Srinivas Thiruvadanthai, research director for the Levy Forecasting Center in Mount Kisco, N.Y. Without sustained growth in profit, businesses will be reluctant to invest in new equipment and hire new workers, and consumers, increasingly nervous about their job prospects, are unlikely to be an engine for continued growth.
Thiruvadanthai figures it all adds up to a 50-50 chance the economy tips back into recession within the next 12 months, and based on historical patterns that would lead to at least a brief period of deflation.
The danger is that deflation feeds on itself as businesses and consumers hold back on spending in the expectation that prices will be lower still in the future. In Japan, which has been mired in a decade-long economic downturn, prices have been falling for four years, and the central bank, having lowered short-term interest rates to near zero, has been unable to come up with a plan to revive growth.
Greenspan's arsenal
It will never happen here, Fed Chairman Alan Greenspan vowed this week, saying U.S. central bankers have more tools available to stimulate the economy even if they have to lower the benchmark overnight rate all the way to zero from its current 1.25 percent. Beyond rate cuts the Fed could boost the money supply in other ways, such as buying up long-term Treasury securities, analysts said.
Under questioning from a joint congressional committee, Greenspan acknowledged that deflation would be harder to fight than inflation, which the Fed can control by raising rates. But in any case, he said, Fed analysts see no signs of deflation thus far.
“We are not close to a deflationary cliff,” Greenspan said. But he added that the central bank would keep a close watch for falling prices. “We cannot allow that to creep up on us unseen.”
Greenspan said the most likely outcome is for the economy to emerge with stronger growth next year after what he called the current “soft patch,” and most analysts agree the economy is likely to muddle through another period of slow growth without falling into renewed recession.
But Straszheim cautioned that investors need to rein in expectations after the stock market’s 15 percent run-up since the recent Oct. 9 low.
“I think it is the case that we are going to have really disappointing growth at least through the first half of next year,” he said. “I would be very surprised to see the markets march on without hesitation from here.”
With the labor market weakening, consumer sentiment is fragile going into the crucial final weeks of the holiday retail season. But the rising stock market apparently helped boost sentiment in early November, according to a University of Michigan survey. And the latest wave of refinancing could offset weakness in the rest of the economy, Straszheim said.
“It’s a puzzle,” he said. “There is a lot of money sitting there just waiting to be spent. That is the only thing that is going to salvage the holiday selling season. But I think this is going to be a very weak holiday selling season.”