The market is constantly talking about the economy and slowing, but there is very little discussion of the rising threat of deflation, which is seriou...
The market is constantly talking about the economy and slowing,
but there is very little discussion of the rising threat of deflation, which is serious and, in fact, is what drove the Great Depression.
In the U.S., consumer prices have been on the decline for the last two straight months after falling another 1.7% in November, which was the largest decline since February 1947. And given that consumer have continued to hold back on spending, we could see more price cuts by retailers. The fear is that, if this trend continues, it would result in a deflationary environment, which is not good. Deflation will make consumers refrain from spending and wait for lower prices. The concern is that reduced spending would drive down corporate activity and this could lead to more slowing and a potential depression, similar to the Great Depression, which was impacted by severe deflation. This could mean more hard times for investors going forward into 2009.
In order to prevent this, we have seen hundreds of billions of dollars flow into credit markets so that consumers and businesses will continue to spend. The Federal Reserve made a bold decision at its December 16 FOMC meeting via aggressively cutting the key fed funds rate to the range of zero to 0.25% in an attempt to pump up the faltering U.S. economy.
And while the cheap financing will help the economy, we believe that the government will have to do more in order to try to improve consumer confidence and drive up spending. Reduced interest rates will not be enough. We expect to see more financial incentives. The weak jobs market and declining housing wealth also make it difficult.
Let's also go back a few years to see if zero interest rates actually work in a deflationary climate. In the 80s and 90s, Japan struggled to turn its economy around. In 2001, faced with deflation, Japan maintained a zero interest rate policy. Yet, in spite of the free use of money, consumers continued to slow spending down and waited for prices to fall further. The end result was a deflationary climate in Japan that made it very difficult for the country to get out of.
The same can be said for the U.S. It is a worsening situation that is filled by many negative factors, including a weak jobs market, distressed housing prices, and losses from stocks. When you factor in all of these variables, it becomes evident why consumers may not want to spend more than what is necessary and instead wait for discounting before considering buying.
At the end of the day, the historically low record rates will be an incentive for consumers to spend. Yet we believe it will take some time for the low rates to translate into more spending and economic growth. The journey will be difficult for Obama despite his fresh enthusiasm.
The most important thing is to avoid a deflationary climate, as this could prolong the recession and potentially lead to a depression. World economies are struggling and slowing. Add in the major loss of capital in the stock markets and we have some of the key factors for the Great Depression.
Profit Confidential
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