1. Archive

Heavy debt fosters fears of deflation

Published Oct. 29, 1990|Updated Oct. 18, 2005

This summer's big spike in oil prices is rippling through the economy, fueling fears of inflation. However, some financial market analysts are saying those fears are misdirected _ it's deflation, not inflation, that people ought to be worried about. There already are some signs of deflation _ prices of many commodities have been declining since spring, stocks are down, real-estate values have deteriorated in some areas, and foreclosures are rising.

However, prices of many other items _ from gasoline to medical services _ have continued to climb. The first nine months of this year, prices increased at an annual rate of 6.6 percent, according to the Labor Department's Consumer Price Index surveys.

On balance, economists and analysts in the inflation camp continue to outnumber those on the deflation bandwagon.

If those predicting deflation turn out to be right, however, we could be in for some serious economic difficulties.

Deflation _ a decline in prices _ doesn't sound like such a bad thing on the surface, but it only occurs during economic hard times, which would mean a severe recession or depression and high unemployment. Prices go down under those circumstances because people don't have the money to buy things.

The deflation forecasters say that is what's already beginning to happen in the United States.

"We're in a recession that has a chance to become an outright depression because of the massive debt build-up that is now beginning to unravel," said Craig Corcoran, editor of the Davis/Zweig Futures Hotline, an investment newsletter published with Ned Davis Research in Sarasota County.

Ordinarily debt is a stimulant to the economy because borrowing creates new spending. However, Corcoran says there is now so much debt and the cost of servicing it is so high that it has become a depressant in the economy. He said higher oil prices will make the situation even worse, and lower prices on many items will result.

"If you're interested in buying a car, a house or a TV, wait," he advised. "Discounts are coming. Our best guess is the middle of 1992 for the bottom of this deflationary cycle."

He also says to stay liquid _ keeping your money in Treasury bills and cash.

"When the sky is falling, you want to have your money as close to you as possible," he said.

Charles I. Clough Jr., chief investment strategist for Merrill Lynch, Pierce Fenner & Smith Inc. in New York, also is concerned about deflation, but his recommendation is to buy long-term government bonds and lock in high interest rates.

"The consumer is strapped," he said. "The probability says this recession is going to be fairly severe. . . . People can't buy things anymore."

Clough said credit-worthy borrowers are in scarce supply as many consumers and corporations that have borrowed money walk away from their debts. Banks will have to lower the interest rates they pay on deposits because they won't be able to find borrowers for the money in depositors' accounts, he predicts.

"What we might really be dealing with is a deflationary environment rather than an inflationary environment," he said.

Others find the idea of deflation quite improbable.

"I think inflation is a greater problem," said Robert P. Forrestal, president of the Federal Reserve Bank of Atlanta, who was in Tampa recently. "If we were to have a very deep recession, we probably would get some deflation, but I don't see that happening."

He says the United States already may be in a recession, but he expects the economy to pick up some steam next year.

Mark Vitner, an economist for Barnett Banks Inc. in Jacksonville, said his forecast is for disinflation, not deflation. Disinflation means that prices continue to go up, but the rate of increase slows.

"What we always see in a recession is that commodity prices come down quite a bit," he said. "They're highly cyclical. When the economy grows rapidly, the demand for all sorts of commodities increases. When demand slows, the price falls."

However, the price of labor is not as cyclical, he notes. Even when the cost of the raw materials used in making an item goes down, the price may not because of the labor costs, he said.

"What it would take to have actual, pure deflation is an enormous calamity in the financial markets _ widespread financial ruin, something that will never happen again in this country," Vitner said. "The deflation we had in the 1930s came after the money supply shrank by one-third. It's just inconceivable that would happen again."

He also expects short-term interest rates to fall but long-term rates to remain fairly high at least until the middle of next year, when the inflation will start diminishing.

While Vitner projects disinflation, some other analysts and economists are talking about reflation _ a rising rate of inflation. One view is that higher oil prices will spur higher inflation. Another is that, in an attempt to avert a deep recession, the Federal Reserve Board will lower interest rates and create a new burst of inflation in the process.

"We face the worst type of recession _ one where unemployment rises along with inflation," said David F. Scott Jr., executive director of the Dr. Phillips Institute, which studies U.S. business activity at the University of Central Florida in Orlando. "It does appear that we are in the early stages of a "reflationary recession.' "

He suggests investors go bargain-hunting for quality stocks that have taken a beating.

"The happy investor today is the investor with a substantial amount of accumulated liquidity," Scott said.

Not many people would quarrel with that statement.

Inflation terms

Here are some inflation-related terms and what financial analysts generally mean when they use them:

Inflation: Rising prices

Deflation: Falling prices

Disinflation: A slowdown in the rate of inflation

Reflation: An upward spurt in the rate of inflation

Economists rarely use this word, and many would not accept this definition


This site no longer supports your current browser. Please use a modern and up-to-date browser version for the best experience.

Chrome Firefox Safari Edge