By John W. Schoen Senior Producer
msnbc.com

Deflation was in the headlines this week, and Liana in California wants to know: just what is deflation, anyway? Michael in Virginia thinks he’s figured out a way to take a home office tax deduction — twice. And Albert in Connecticut is dying to know the market share of the biggest U.S. casket makers. As always, if you’d like to write to us, please include your first name and hometown.

DEFLATION DEMONS

Would you explain the difference between deflation (and its long term effects on our economy) versus inflation?
Liana — Walnut, Calif. 

Much was made this week of what Fed chairman Alan Greenspan thinks about the threat of deflation. But the more important question, really, is: what do you think about deflation? Because no matter what the government number-crunchers tells us, much depends on the psychological impact on consumers, workers, businesses, government, etc. 

There are some fairly clear-cut, short-term effects of deflation — defined as a prolonged period of falling prices (not to be confused with disinflation, which means prices are rising, but more slowly than in the past.) 

If prices keep falling, for example, businesses have to look for ways to make a profit with less money coming in. One way they’ve found to do that is to increase productivity — which has been rising more quickly recently that it has in decades. There are a lot of ways managers can do that — everything from computerizing drudgery to simply piling on more work. (The dark side of productivity — one you don’t hear much about — is that it usually just means firing people and telling those left with jobs to produce more.) 

Another way to make a profit if prices keep falling is to cut wages, as anyone in the airline industry is discovering these days. Lower wages cut consumers’ spending power, which puts pressure on retailers to cut prices, which brings more wage cuts — and eventually a vicious cycle begins. When that “deflationary psychology” takes hold, it can become self-fulfilling. People expect prices to keep falling, so they behave accordingly.

Beyond slowing spending and hurting profits, deflation is bad news for anyone who owes money. That’s because the dollar you give up to pay off a loan this year has more buying power than the dollar you borrowed last year. The resulting reluctance to borrow means businesses don’t invest and expand, which means fewer new jobs are created. That’s another reason for concern: despite the lowest interest rates in decades, U.S. businesses are still not spending the way they need to for the economy to perk up again. 

What’s puzzling is that the changes in prices right now are so uneven: prices are falling for many manufactured products — like electronics and apparel, where job loss to cheaper, offshore labor markets has been heaviest. But if you’ve gotten a college tuition bill lately, you’ll see that price tag of higher education is going up twice as fast as the overall inflation rate. Cable TV and insurance rates are going up, too. So are home prices. 

The most important variable, the one that’s hardest to measure, is how we’re all responding to this. If we all keep spending (as consumers have been doing), we should be fine. But if we start hunkering down too much, it could be a long, slow economic recovery.
       
DOUBLE DEDUCTION?

I just bought a house. I am going to set up a home based company (sole proprietorship or LLC) as tax shelter in addition to my full time job. If the home business occupies one third of the house, I suppose to be able to depreciate/deduct that potion of the house/improvement cost. Meanwhile, as a new home owner, the majority of the mortgage is interest is tax deductible. So the office deduction (1/3 of the house cost) plus the interest deduction may exceed the actual mortgage amount. I can’t imagine IRS will let it happen. So what did I get wrong?
Michael — Vienna, Va.

The issue here is double deducting: the IRS will never let you deduct the same expense (in this case mortgage interest) twice.

Major Market Indices

But you probably won’t even get that far. The key phrase in your question is “in addition to my full-time job.” In order to deduct a home office, you have to jump a number of hurdles. One of them is that the home office has to be used for your “primary business.”

For details, check out the IRS Web site.     
       
A BIG UNDERTAKING

Which casket manufacturers have the largest market share in North America?
Albert G. — Farmington, Conn.
       
This answer took a little digging (sorry) since most of the dozens of U.S. companies that make caskets are private, and therefore don’t publish financial data.

The largest casket manufacturer in the United States is Batesville Casket Co., which is owned by Hillenbrand Industries of Batesville, Ind. Last year, the company (which is public) reported 2002 revenues of $621 million from casket making, which is a roughly $1.5 billion industry. The second biggest public company is Matthews International, of Pittsburgh, Penn., which last year reported revenues of $107 million from its York Casket Division. According to the Casket & Funeral Supply Association of America, other large casket manufacturers include: Aurora Casket Co., of Aurora, Ind.; Astral Industries, Inc., of Lynn, Ind.; Freeman Metal Products, of Ahoskie, N.C.; J. M. Hutton Co., of Richmond, Ind.; and Milso Industries, of Richmond, Ind. 

Which raises an even better question: Why is Indiana the casket capital of the U.S.? (Can any of you Hoosiers out there help us unearth the answer?)
       
CURRENCY CONFUSION

Can you please explain why the British pound sterling seems to be linked to the American dollar? Both currencies have been falling against the Euro in recent weeks/months. Are the currencies linked, or is it just a coincidence that they seem to rise and fall somewhat in sync? I live in suburb of Amsterdam. My husband works in the UK and is paid in British pounds, so we closely watch the currency fluctuation against the Euro.
Suzanne — Hoofddorp, Netherlands
       
Sorting out the forces behind the fluctuations of the dollar, Euro and British pound is a bit beyond the Answer Desk’s expertise. So we asked Greg Anderson, senior foreign exchange strategist at ABN AMRO. Here’s what he said:

“Since the launch of the Euro, the British pound has traded like it was on an island between the U.S. and European mainland, which in fact it is,” he said. “It’s not just geography — the U.K. is also somewhere between the U.S. and Europe in political ideology and in terms of its economic model.”

In 1999 and 2000, the dollar rose sharply because of the roaring U.S. stock market and heavy technology spending on the Internet bubble, according to Anderson. The U.K. has no Silicon Valley, but its real estate and technology markets did attract lots of European and Asian capital — just not as much as the U.S., he said. So the pound’s fall has been less dramatic than the dollar.

Anderson also says that since mid-2002, the Euro has been rising because central banks and some overseas investors have been shifting dollar-denominated assets into Euros. The same has been happening to the pound, but to a lesser extent, he says

"To me, this relationship between the dollar and the pound is fairly stable,” he said. “I don’t think the correlation patterns noted between those currencies and the Euro and Japanese yen will go away or change suddenly.”
       
       
EARLIER ANSWERS
              
TAX CUT CIRCUS
       
Is the tax bill proposed to take effect for the 2003 tax year?
Bud — Illinois 
       
It’s anybody’s guess just what Congress will do: The debate over the tax bill looks more and more like a Saturday Night Live sketch every day. The latest delay came when members of the Senate Finance Committee discovered Monday they were working on the wrong bill. It took several days to figure out how to unsnarl the parliamentary train wreck that ensued.

Late Thursday, the Senate approved a scaled-down package that, among other cuts, phases in the dividend tax cut over three years — and then magically re-instates it, in full, in the 2007. Cuts in income tax rates would be retroactive to Jan. 1. But whatever comes out of the Senate needs to be “reconciled” with the mess already made by the House, which approved a $550 billion package, retroactive to Jan. 1, 2003. You can read in on the latest here on MSNBC.COM.
        
CLASS INACTION SUIT

I received the necessary papers, and completed them, to be part of class actions suits. Since then, I have never heard any more about either of them. The one with State Farm collision parts stated on the forms not to contact the judge. But if you contact the law firm that sent me the forms, they never contact you back. The other one had to do with Compaq stock and I have never heard about the results of that one either. Where do you go when you want to be updated on these class actions suits? 
Sonja — Pinehurst, N.C.
       
One of the best ways to keep up on these class actions is to search the Web: Law firms that handle these cases use their sites to update their clients — and troll for new ones.
       
Apparently, the Illinois Supreme court has agreed to review the $1.2 billion judgment against State Farm for the use of substandard parts to repair collision damage, according to a law firm that is involved in the case. So that money can’t be paid out until that court’s review is complete. Check the firm’s Website for updates on the progress of the case.
       
In the Compaq case, Hewlett-Packard (which merged with Compaq last year) settled a lawsuit filed by shareholders who claimed that Compaq executives made overly optimistic statements about the stock while they were selling their shares. The settlement amounted to $28.6 million. Another law firm has more details on that case. Try contacting the firm. If you don’t get anywhere, call or email Hewlett Packard’s investor relations department and ask how them how claims are being handled.
       
       
THE HOW OF THE DOW
       
I understand there are 20 or 30 companies that make up the Dow [Jones Industrial Average]. What is the formula for computing the average? I have asked three stock brokers to no avail. Help, please!
Darren S. — Grover Beach, CA 
       
Better steer clear of those brokers. You’re supposed to learn how the Dow works on the first day of stock broker school.

The Dow Jones Industrial Average was invented May 26, 1896 by Charles Henry Dow, Edward Davis Jones, and Charles M. Bergstresser, partners in a fledgling financial information company that now publishes of the Wall Street Journal, among other influential financial news sources. (Though he bankrolled the start-up, Bergstresser’s name was left off the company name — to the great relief of news announcers around the world.)
       
Originally, Dow calculated his average by adding up the closing prices of the 30 stocks he picked to represent the overall market, and then just divided that total by 30. But when one of those stocks “split,” he had to adjust the formula to account for the sudden drop in the price of each share. (When a stock splits, say, two-for-one, you get two shares for every share you own. But each share is then worth half what was before the split.) This meant coming up with a new “divisor” (the number that started out as 30) to eliminate distortions caused by stock splits.
       
Over time, as companies on Dow’s list were acquired, went of business, or — in the opinion of future Dow Jones editors — no longer reflected a cross section of the economy, the list continued to change. Most of these changes made the divisor smaller, and as of August 17, 2001, it stood at 0.14452124. So, to figure it yourself, add the closing prices of the Dow 30 stocks and divide by 0.14452124. Give it a try. (And see if your broker can do the math.)
       
If you’re still curious about the index, click here for more than you’ll ever want to know about it.
         
BANKRUPTCY BONANZA?

I have noticed many people asked the questions about owning bankrupted companies’ stocks such as Kmart that are worth nothing eventually. My question is: if I shorted some company’s stocks at a high price, and I didn’t cover my position before those companies declared bankruptcy or the stocks got de-listed, do I still have to cover my positions (buy back stocks) or I will just enjoy all the proceeds automatically?
Michael — Vienna, VA

If you’re determined to make money from financial flameouts like Kmart and WorldCom, you need to be careful you don’t get burned — as investors who bought these stocks recently learned the hard way.

Since the stock of a company in bankruptcy court is almost certainly going to be worthless, selling short is really the only way to make money. “Shorting” a stock, as you point out, involves borrowing shares (that you don’t own) and then selling them — while promising to give them back later (in this case, when they’re worthless). Like all short sales, everything works in reverse: you sell first, and then buy. So you make money if the stock goes down, not up.

The problem you may find shorting stocks of companies in bankruptcy protection is that they aren’t technically worthless until the bankruptcy filing is complete. At that point, the “old” (worthless) shares are replaced by “new” shares, and “old” shares are then de-listed, which means they’re no longer publicly traded. So where can you buy that worthless paper to close out your short position?

You should check with your broker before your short the stock to find out just what’s needed to close out the trade. In some cases, a broker dealer that makes a market in these shares may be able to help. Or you may be able to get a letter from the reorganized company’s legal department, stating that the position is worthless, and use that to cover your short position. (The problem you may run into is that the “new” shares are usually accompanied by a new management team, so it may take some time to get an answer out of them.)

There’s a much simpler solution. Just buy the “old” shares before they de-list — and leave the last few pennies of profit for another trade.
       
       
GOT A QUESTION?

Ever wonder what a P/E ratio is and why it’s so important? Are you confused about the official definition of a recession? And just what the heck is a derivative? We’re here to give you the answers. MSNBC.com’s weekly feature “The Answer Desk” helps you make sense of business, the economy and investing. So send along your questions to answerdesk@msnbc.com and we’ll try to get you the answer. (Please include your home town with your question; we’ll only include your first name if we use your question.)

Any question is fair game, with one exception: no questions about specific investment recommendations, please — we’ll leave the stock picking to the “pros.”

Each week, we’ll take some of the most-frequently-asked questions and answer them here. We may not be able to answer every question, but over the weeks and months we will provide a comprehensive resource for you, explaining some more puzzling aspects of business and finance.

You can mail in questions at any time and then check this column every Friday for the answers.

(All information will remain confidential in accordance with MSNBC's privacy policy.)

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