Sit Down Before They Start to Talking

Sean O'Grady writes in the Independent

"So what shoud we be worried about next? It may sound odd, in a week in which inflation rose to a16-year peak and gas prices were 49.9 per cent higher than a year ago, but the answer may be "deflation", or falling prices. Deflation is usually seen in an economic slump, which some of the most pessimistic analysts believe is heading to Britain. Although the possibility is remote, it could happen. In any event, inflation should come down sharply next year. Oil prices are already 40 per cent below the levels they peaked at in July. What would it mean? Well, it would be a looking-glass sort of world. We could no longer rely on inflation, for example, to erode the real value of our debts. A big mortgage now will remain a big mortgage. An endowment mortgage that leaves the principal unpaid will be an even bigger debt at the end of a deflationary time."

"The current psychology in the housing market – of buyers sitting on the sidelines in the hope that prices will drop even further – may become more ingrained and may even spread to other items, thus reinforcing the downward pressure on the economy. Keeping money under the mattress is not a stupid thing to do if, when you take it out, it buys you more than it did when you put it in. Soon, interest rates may well be close to zero. In those circumstances, not all prices would fall, just as not all prices are going up now; but many, possibly including property and shares, may decline or stagnate for a long time."

"The problem with deflation is that it is born of, and breeds, nervousness. Only economies where confidence has been drained away suffer from it, and it feeds on itself. The authorities can do little. Let's face it: there is no interest rate low enough – even zero – that would persuade you to invest in a property if you expected its value to fall. And there is no tax cut big enough to make you spend if you are scared that you will lose your job. Nor is deflation such an unusual phenomenon. Historians can point to many periods when general prices fell, at times dramatically. In fact, some economists were fretting about what we might describe as "nice deflation" at the start of this decade, when the prices of consumer goods, especially electronics and toys, were slashed as China joined the global economy and began exporting vast quantities of these goods. Tesco's £10 DVD player – cheaper than most discs played on it – was perhaps the apotheosis of that benign but slightly odd era. But there are more disturbing precedents. Between the two world wars, for example, prices in Britain fell more often than not, and continuously between 1926 and 1933, when they dropped by a cumulative 15 per cent."

From Armondo Duke in Access News

"Spot gold traded down below $800 and ounce in London Thursday while in New York, December gold contracts closed down over $34 per ounce at $804.50 as economic deflation took place in a global commodity sell-off."

"Silver futures were brutalized with December contracts losing 85 cents an ounce to reach a session low of $9.30 before closing up at $9.64 per ounce, which was still down 55 cents per ounce on the day. Platinum futures crossed the $900 per ounce barrier with January contracts finishing the day's trading session down 83.90 at $891.30 per ounce."

"Precious metals weren't the only commodity to get scraped on the trading room floor as December copper futures lost 13 cents to close at $2.09 per pound. Just a few months ago, copper contracts looked like they would pass the $4.00 per pound barrier when the global economy was still in a boom cycle of growth. But with the economies of the major countries of the world deflating, demand has deflated right along with it."

"Crude oil futures fell sharply as well with November contracts on the NYMEX losing $4.69 per barrel to finish Thursday's session at $69.85. Oil, like gold, is traded in dollars and while the greenback looked like it would show an upward push against major foreign currencies, it was really a deflation of those same currencies that made the buck look like a better bet."

"The EIA reported this morning that crude oil stocks in the U.S. grew by 5 million barrels last week, nearly three times the increase energy pundits were expecting. The global economic deflation worried oil ministers who are holding an emergency OPEC meeting next week to consider cutting back on production by as much as 1 million barrels per day due to the drop in demand. Critics argue the Cartel is looking to artificially boost the price of oil by cutting production back, but the global deflation of economies has also slowing demand."

Constantine von Hoffman comments on InMoneyToday.com

"Like everyone else I’m relieved that gas prices are dropping. As gas prices drop so do those of a lot of other things, like food and shipping and clothes. That’s all good, right? Yeah, unless they don’t stop dropping. When that happens you have deflation and it is very bad."

"Deflation always means hoarding because investors and buyers hold on to their money because they don’t want to invest in even the most solid of securities. Or commodities. Like oil. Or corn, whose price dropped 6 percent Monday. Gold is up for the moment, but I think that is more a sign of desperation and clinging to an old idea and won’t last."

"Very few folks around today know what a deflation is really like. My parents lived through the last great deflation in US history, but it was 1934 and they were too young to remember it. So if you have grandparents or great-grandparents around ask them about it. But do yourself a favor. Sit down before they start to talking.”

"Today’s economies are at far greater risk from deflation than they were in the 1930s. Financing is now much more integral to building than it was then so capital reserves are much lower. In a deflation, companies and people stop investing and spending because prices and profits are always going down. The less they spend, the more demand dries up and the more deflation. At least we think the economies are at far greater risk. The Fed is printing money like crazy as it did not do in the 1929-1935 period and we do not know this amount of money creation can/will/may reverse the deflation."

"How do you stop a rampaging deflation? Great question. In the 1930s, the government tried to increase demand via tax cuts and increases in government spending. In an attempt to stop the deflation and reflate the government went off the gold standard and devalued the dollar by 40%, a measure not really available to the Government today. There’s still a lot of argument over how much good, if any, that did. What is definitely true is that it took the hyper-demand generated by World War II to truly erase that deflation."

"Current theory argues for lowering interest rates. We are now the test case for that theory. BTW, did you know that during the Great Depression there were negative interest rates? And that we are near negative interest rates on government paper now and for the same reasons it occurred in the early 1930s? Sweet dreams."