|November 1, 2008 / New York TIMES
Fear of Deflation Lurks as Global Demand Drops
By PETER S. GOODMAN
AS DOZENS OF countries slip deeper into financial distress, a new
threat may be gathering force within the American economy — the
prospect that goods will pile up waiting for buyers and prices will
fall, suffocating fresh investment and worsening joblessness for
months or even years.
The word for this is deflation, or declining prices, a term that gives
Deflation accompanied the Depression of the 1930s. Persistently
falling prices also were at the heart of Japan's so-called lost decade
after the catastrophic collapse of its real estate bubble at the end
of the 1980s — a period in which some experts now find parallels to
the American predicament.
"That certainly is the snapshot of the risk I see," said Robert J.
Barbera, chief economist at the research and trading firm ITG. "It is
the crisis we face."
With economies around the globe weakening, demand for oil, copper,
grains and other commodities has diminished, bringing down prices of
these raw materials. But prices have yet to decline noticeably for
most goods and services, with one conspicuous exception — houses.
Still, reduced demand is beginning to soften prices for a few
products, like furniture and bedding, which are down slightly since
the beginning of 2007, according to government data. Prices are also
falling for some appliances, tools and hardware.
Only a few months ago, American policy makers were worried about the
reverse problem — rising prices, or inflation — as then-soaring costs
for oil and food filtered through the economy. In July, average prices
were 5.6 percent higher than a year earlier — the fastest pace of
inflation since 1991. But by the end of September, annual inflation
had dipped to 4.9 percent and was widely expected to go lower.
The new worry is that in the worst case, the end of inflation may be
the beginning of something malevolent: a long, slow retrenchment in
which consumers and businesses worldwide lose the wherewithal to buy,
sending prices down for many goods. Though still considered unlikely,
that would prompt businesses to slow production and accelerate
layoffs, taking more paychecks out of the economy and further
The danger of this is the difficulty of a cure. Policy makers can
generally choke off inflation by raising interest rates, dampening
economic activity and reducing demand for goods. But as Japan
discovered, an economy may remain ensnared by deflation for many
years, even when interest rates are dropped to zero: falling prices
make companies reluctant to invest even when credit is free.
Through much of the 1990s, prices for property and many goods kept
falling in Japan. As layoffs increased and purchasing power declined,
prices fell lower still, in a downward spiral of diminishing fortunes.
Some fear the American economy could be sinking toward a similar fate,
if a recession is deep and prolonged, as consumers lose spending power
just as much of Europe, Asia and Latin America succumb to a slowdown.
"That's a meaningful risk at this point," said Nouriel Roubini, an
economist at New York University's Stern School of Business, who
forecast the financial crisis well in advance and has been warning of
deflation for months. "We could get into a vicious circle of deepening
Most economists — Mr. Roubini and Mr. Barbera included — say American
policy makers have tools to avert the sort of deflationary black hole
that captured Japan. Deflation fears last broke out in the United
States in 2003, but the Federal Reserve defeated the menace with low
interest rates that kept the economy growing. This time, the Fed is
again being aggressive, dropping its target rate to 1 percent this
week. And the government's various bailout plans have also pumped
money into the economy.
"If you print enough money, you can create inflation," said Kenneth S.
Rogoff, a former chief economist at the International Monetary Fund
and now a professor at Harvard.
But even as American authorities unleash credit, the threat has
intensified. Not since the Depression have so many countries faced so
much trouble at once. The financial crisis has gone global, like a
virus mutating in the face of every experimental cure. From South
Korea to Iceland to Brazil, the pandemic has spread, bringing with it
a tightening of credit that has starved even healthy companies of
"We're entering a really fierce global recession," Mr. Rogoff said. "A
significant financial crisis has been allowed to morph into a
full-fledged global panic. It's a very dangerous situation. The danger
is that instead of having a few bad years, we'll have another lost
Global economic growth has flourished in recent years, much of it
fertilized with borrowed investment. This raised kingdoms of houses in
Florida and California, steel mills in Ukraine, slaughterhouses in
Brazil and shopping malls in Turkey.
That tide is now moving in reverse. Banks and other financial
institutions are reckoning with hundreds of billions of dollars worth
of disastrous investments. As they struggle to rebuild their capital,
they are halting loans to many customers, demanding swift repayment
from others and dumping assets — homes sold out of foreclosure,
investments linked to mortgages and corporate loans. Selling is
pushing prices down further, making the assets left on balance sheets
worth less, in some cases prompting another round of sales.
"You get this adverse feedback loop where assets keep falling in
value," Mr. Barbera said. "You're essentially putting big downward
pressure on the global economy."
In past crises, like those that devastated Mexico in 1994 and much of
Asia in 1997 and 1998, weak economies managed to recover by exporting
aggressively, not least to the United States. But American consumers
are battered this time. After years of borrowing against homes and
tapping credit cards, consumers are pulling back.
>From Asia to Latin America, exports are slowing and should continue to
do so as the global appetite shrinks. This is spawning fears that
major producers like China and India — which vastly expanded
production capacity in recent years — will have to dump products on
world markets to keep factories running and stave off unemployment,
pressing prices lower.
Earlier this year, some analysts suggested that American businesses
might continue to prosper, even as consumers pulled back at home, by
selling into foreign markets. Caterpillar, the construction equipment
manufacturer, might suffer declining sales in the United States, the
argument went, but huge projects from Russia to Dubai required
front-end loaders. Australia and Brazil needed earth-movers to expand
mining operations as they sent iron ore toward smelters in Northeast
But as much of the planet now struggles, Caterpillar is worried. "Next
year, no doubt, will be a challenge," Caterpillar's chief executive,
James W. Owens, recently warned.
China has long been at the center of claims that the world could keep
growing regardless of American troubles. China has been importing
cotton from India and the United States; electronics components from
South Korea, Malaysia and Taiwan; timber from Russia and Africa; and
oil from the Middle East.
But many of the finished goods China produces with these materials
have ultimately landed in the United States, Europe and Japan. When
consumers pull back in those countries, Chinese factories feel the
impact, along with their suppliers around the globe.
Fewer laptop computers shipped from China spells less demand for
chips. Last week, Toshiba — Japan's largest chip maker — said it lost
$275 million from July to September, blaming its troubles on a world
Lower demand for flat-screen televisions means less need for
flat-panel glass displays. This month, Samsung, the Korean electronics
giant, said a global oversupply in that item caused its biggest dip in
quarterly profits in three years.
Now, a glut of products may be building in the United States. Orders
for trucks used by business have plummeted. Investments in industrial
equipment are declining. Yet inventories have grown.
"I worry about an economy that looks like Japan," said Barry P.
Bosworth, a senior fellow at the Brookings Institution. "We're going
to be struggling with how to put this back together again for several