Ah yes, I remember deflation.
It was a scant five months ago (though, were he alive today,
would point out that five months is eons in Wall Street time) that deflation was the buzzword in the markets. With the Far Eastern conflagration, economists and strategists worried that U.S. companies would take a double hit. First, they would see sales fall apart in Asia. Second, cheaper Asian goods would put heavy pricing pressures on U.S. companies' goods. Companies would pay dearly for the extra capacity that they had built over the years -- extra capacity that assumed a world economy running full bore.
But the deflationary spiral hasn't come. True, prices in some commodities (notably energy) have dropped due to weakened Asian demand, but that, if anything, has helped U.S. companies, which now can get raw materials cheaper. Nor has the dreaded glut of cheap Asian goods arrived. What gives?
"The idea of deflation was just a silly notion," says Mickey Levy, chief economist at
NationsBanc Montgomery Securities
. "It was just another passing fad by people that don't understand the deflation process. The only way you can get deflation is if there is unstable demand for all goods and services. That's just not the case and it's not in the cards."
Silly notion though it may be, a lot of big fish rose to take the deflation bait. A complex idea, but not so complex an idea that journalists couldn't understand it and feel smug about it (sort of like the science in
ran features on it. (
, nibbled on the bait a few times as well.)
Deutsche Morgan Grenfell
chief economist Ed Yardeni, and
chief investment strategist Charles Clough and his cadre, who had been harping on a deflation threat to the U.S. for months, found a lot of new tents popping up in their camp. On New Year's Eve
wrote in the
that "the abandonment of fixed exchange rate regimes in Southeast Asia touched off an unraveling process that has exceeded everyone's worst fears, including my own," and warned: "We are on the verge of worldwide deflation."
But such dire predictions don't look like they're going to come to pass, according to Levy.
"Only a very small portion of U.S. imports come from Southeast Asia," he says. "The terms of trade vis-a-vis the U.S. didn't fall commensurate with the currencies. Instead, in response to the currency fall,
Asian wages and inflation rose. Furthermore, a lot of the commodity-based and manufactured goods are transacted in dollars. That whole notion that there would be a flood of cheap imports -- that was a silly notion and that never materialized." Levy points out that nonpetroleum import prices fell by only 0.2% in March -- less than the 0.4% and 0.6% declines in February and January. This, he says, shows that the bulk of the Asian crisis' effect on the U.S. economy has passed.
The deflationary headwinds that everyone was so worried about may also be running into heavy crosscurrents from a resurgent Europe. David Jones, chief economist at
Aubrey G. Lanston
, who, in the heat of the Asian free-fall, said that the economic crisis would take as much as 1% out of U.S.
gross domestic product
growth, doesn't see the same deflation threat that he saw back then.
"My sense is that, globally at least, we're not in quite the dangerous situation that we were," he says. With Asian growth down and European growth up, "it leaves the U.S. sort of in the middle." Jones also points out that inflation data suggests that the U.S. is in the sweet spot. "If you take the U.S. in general, the prices of producer goods have, in fact, fallen, but the prices of services are still going up. That averages out to something like stability."
Indeed, given this type of stability, there is very little talk of deflation in the Treasury market these days.
"At the peak of the financial crisis, when no one was sure how far the contagion would spread, there was concern that markets around the world would crumble; that that would lead to real wealth destruction," says Mike Cloherty, senior market economist at
Credit Suisse First Boston
. "A lot of the deflation talk was that sort of world financial crisis talk rather than a negative CPI. Now that we've had all the loan restructurings and the IMF money going in there, the risks of the real doomsday scenarios have receded."
And with that, the market is back wooing one of its old loves from before the crisis.
"Deflation has really dropped off the screen," says Cloherty. "Now the Goldilocks thing is coming back."
And the old deflation prophets? Back to being voices crying in the wilderness.
"Our story hasn't changed," says Lisa Cullen, market strategist at
. "The scenario seems to be continuing to unfold. If you look at the trade data, imports were flat. All the signs are there for us that corporations are having problems pushing through price increases. So nothing is different."
NationsBanc's Levy has very little sympathy for the people who piled on the deflation bandwagon.
"Unfortunately, commentators feel compelled to make bold statements rather than thinking logically about what actually might happen," he contends, framing what might be called the Non-Accelerating Incompetence Rate of Unemployment among economists. "There's just an oversupply of economic commentators. That generates lousy information."
And what of the rest of us, who, lousy information or not, became so enamored with the idea of deflation? It's easy to be engaged by a theory that sounds a bit like one of those
inventions where the lady upstairs throws flower pot (A) through awning (B), and the resulting hole (C) in the awning allows sun to come through and melt cake of ice (D), etc. When
Professor L.G. Butts
starts talking about the economy, though, it might be a good time to draw the shades and close the door.