This is the week when deflation reared its ugly head and started reminding investors of the dangers it can pose to economic stability. At times it sounds esoteric, but as the experiences of the 1930’s and of Japan in the past 20 years show, deflation makes life tough for consumers, companies, governments by increasing the cost of debt and strangling economic activity.
So for heavily indebted consumers, companies and countries, deflation is a cruel hoax – falling prices actually means the value of existing debt rises. Inflation is not present to, over time, cut that value of the held debt. The cost of interest rates falls a touch (a small benefit), but in aggregate the impact is to stifle economic activity on all levels.
And there’s an even more insidious impact – because prices are falling, consumers and companies start holding back on spending plans because they come to realise that products and services will get cheaper – so economic activity slows, retail sales slow, company revenues and profits come under rising pressure (exacerbated by the rising cost of debt). Economic growth slows to a halt or starts dipping into the red.
This reduction in economic activity can cause years of weak growth, a shallow recession, or, as we found in the 1930’s a depression.
After the big falls on Wednesday night in Europe and the US, and in Europe overnight Thursday, investors are certainly aware of the problem. Wall Street finished on a mixed note – the one bright spot for markets was a rise in oil prices.
Adding to the concerns in the eurozone a continuing rise in 10 year bond yields in Greece to more than 8%, threatening to re-ignite the eurozone debt crisis once again.
Greek rates are rising because leftwing political parties are doing well in opinion polls and have resumed threatening to abandon the country’s bailout. Greek finances remain weak and the situation is being made worse by deep deflation.
This week we have seen disinflation (the slowing of the pace of price growth) and very low levels, or outright deflation emerge or confirmed in a host of countries, from China, the UK, perhaps the US and certainly parts of the financially – stricken eurozone.
Overnight Thursday the final report on inflation in the 18 countries in the eurozone, confirmed consumer prices rose by just 0.3% in the 12 months to September, the lowest annual rate of inflation since October 2009, and down from 0.4% in August. That confirmed a preliminary estimate released at the end of last month.
For the European Union area as a whole, prices by 0.4% in the year to September, slowing from a 0.5% rise in the previous 12-month period. It was the lowest annual rate of inflation recorded since September 2009.
The figures showed that eight of the EU’s members saw delation in consumer prices over the 12 months, with five of those being members of the eurozone: Greece, Spain, Italy, Slovenia and Slovakia. The three EU members that don’t use the euro and which suffered the same fate were Bulgaria, Hungary and Poland.
Deflation deepened in Spain and Sweden, French consumer prices fall last month from August, and Britain saw a surprise slowing in its CPI last month. Sweden saw a 0.4% fall in prices and its economy has now seen inflation in 16 of the past 24 months.
And the UK saw its annual inflation rate slow sharply to just 1.2% last month, from 1.5% in August and is now at its lowest level in five years.
Germany, Europe’s largest economy, saw its consumer prices rise an annual 0.8%, the same as in August and July. Prices were unchanged compared with August, meaning that disinflation is slowly squeezing the German economy.
The most immediate culprit in most cases is the 20% slide in oil prices since June, on top of falling real wages, low interest rates, sluggish economies and weak demand.
And China seems to be joining in as the consumer price index slowed to 1.6% in September from 2% in the year to August.
And while the month to month rate rose 0.5% last month from August, up from the 0.2% rise seen in August, the longer term trend is lower and slower.
The Chinese consumer price inflation rate is now less than half the government’s target of 3.5% a year.
And producer prices fell at a faster rate as well – down an annual 1.8% from the 1.2% rate seen in the year to August.
That was the 31st consecutive monthly fall in the producer price index and was pushed lower by falling oil and energy prices, plus weakening cost of steel.
Oil prices have fallen further since September, while the currency has risen with the higher US dollar.
Adding to the deflationary impact is the rising value of the yuan – up 5% this year, which makes the falling prices of oil and LNG, coal, copper, iron ore, soybeans and the thousands of other items imported, cheaper by the week.
The Chinese currency is moving higher as the US dollar has risen, and yet China reported a 15.3% jump in exports in September (which was much higher than expected) and an equally surprising 7% jump in the value of imports (despite the higher currency and lower prices), when another fall had been forecast.
The CPI grew 2.1% year on year in the first nine months, well below the 3.5% target set by the government.
Third quarter gross domestic product along with September retail sales, industrial output and investment data will be released on October 21.
