Malaysia is not heading for deflation: Economists

Publish date: Mon, 25 May 2020 



KUALA LUMPUR: Malaysia is not heading for deflation despite Consumer Price Index (CPI) having deflated further 2.9 per cent to 117.6 points in April from 121.1 in the same month in 2019, the lowest level since 2010, economists said.

Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid said the core CPI, which removes the volatile items such as fresh food and administered prices, had been recording positive growth of 1.3 per cent for the past three months now.

"Therefore, it is not deflation since the primary driver for the decline in headline CPI was due to fuel prices and electricity charges whereby both sub indices have declined by 38.2 per cent and 33.3 per cent respectively during April.

"I do not think deflation is going to happen in a truer sense. We can see food prices are still at elevated levels. Some items have been reporting quite substantial increment," he told the New Straits Times.

Afzanizam said besides that, the country had been recording trade deficits in food items.

He expects food prices to stay high with the ringgit continuing to be weak.

He said in 2019, Malaysia had recorded a trade deficit in food items of RM17.4 billion. The deficit has remained since 1990.

He noted that the country's Self Sufficiency Ratio (SSR) for rice, beef and chilli had stood at 70 per cent, 25.5 per cent and 38.8 per cent respectively in 2017.

"This would mean Malaysia has been relying from import source in order to satisfy its local demand," he said.

Putra Business School associate professor Dr Ahmed Razman Abdul Latif said he did not foresee the country heading towards deflation as the lower CPI was caused mainly by the decrease of global crude oil price for the past few months.

He said this had in effect reduced the costs of transportation and fuels.

He said, however, prices of global crude benchmarks such as Brent had steadily increased for the past few weeks towards US$35 per barrel which will stabilise the CPI movement.

"In addition, the price of food and beverages has increased steadily and this will also ensure that the CPI will not go towards negative number," he said.

RAM Ratings expects a deflationary trend in the second and third quarters of this year.

The firm revised its headline inflation projection for 2020, from 0.7 per cent to 0.0 per cent.

This is mainly due to weak global oil prices, generous discounts for household electricity bills, and subdued demand.

"While inflation remained stable at 1.5 per cent in January-February, it is expected to ease to -0.2 per cent in March," it added.



https://www.nst.com.my/business/2020/05/595198/malaysia-not-heading-deflation-economists



Comments:

What makes deflation such a dreaded condition is that, once it takes hold, it motivates consumers to hold back on spending in the expectation that they will be able to buy things at a cheaper price later. This causes further drop in demand today, leading to more cutbacks in production and even slower economic activity, which feeds into more price declines -- a highly destabilizing dynamic.

The Singapore Deflation No One Is Talking About

Singapore experienced deflation for two straight months in November and December 2014, but worryingly, many Singaporeans seem unconcerned with this development. Here’s why you should keep a careful eye on Singapore deflation.

—

When the Department of Statistics released Singapore’s November consumer price index two months ago, there was a mixture of concerned murmurs and expectant nods from many local economists. For the uninitiated, the consumer price index (CPI) measures the collective price of a variety of consumer goods and services in a country and is used by governments as a tool to measure price and inflation pressures.

For the first time in five years, the Singapore CPI for November dipped into the red (-0.3 percent), dragged down by private transport costs, petrol pump prices, and a softer housing rental market. However, if you removed the costs of private transport and accommodation, core inflation was at 1.5 percent, a 0.2 percent decline from the previous month.

The bleeding in November was stemmed slightly in December with the CPI rising slightly to -0.2 percent, but the negative numbers signalled yet another deflationary month for Singapore. Analysts were expecting these numbers mainly because of the global drop in oil prices and the Monetary Authority of Singapore has acted quickly, reducing the slope of its policy band to slow down the appreciation of the currency i.e. weakening the Singapore dollar against other currencies. This makes Singapore exports more attractive although it means that your overseas holidays will become more expensive. Still, the spectre of sustained Singapore deflation hangs ever-present, especially with the negative 2015 global economic outlook.

READ: A Year Ago, Pope Francis Condemned Capitalism

Why is Deflation Bad

Theoretically, falling prices sound wonderful for consumers since everything is cheaper and your dollar stretches further. While that’s true, deflation is bad for a country if it continues for a prolonged period of time.

When people expect falling prices, they become less willing to spend, which in turn means that they’re less willing to borrow. Taking up a loan means that you’ll be effectively paying more than the amount you borrowed, even though it is the same amount on paper. When no one is borrowing any money, the economy stagnates since there is no financial activity. Most people would rather put their paper cash in a tin as it provides guaranteed returns!

Japan is the most oft-quoted example of a country that has been grappling with chronic deflation for the past decade. At the beginning of the 1990s, the Japanese experienced inflated real estate and stock prices due to easy credit – banks in Japan lent money to anyone who came knocking. Due to this, inflation rose rapidly. In an attempt to keep speculation in check, the Japanese central bank raised interest rates. Prices crashed and have never recovered since then. Corporations, unable to sell their products and services, made cutbacks to their workforce while wages fell. As falling wages chased falling prices, Japan became stuck in a deflationary spiral. Even though the Japanese government has been running a fiscal deficit since 1991 to stimulate borrowing, the country’s economy is still stumbling over the financial obstacles and remnants kicked up by its financially wayward past. Today, Japan has one of the highest debt to GDP ratio in the world – 240 percent.

Why Singapore Is Safe (For Now)

At the moment, in Singapore, the deflationary pressure is mainly affecting goods and services that we don’t regularly consume. Everyday items such as food and groceries are still experiencing manageable inflation. Couple this with the tight labour market (Singapore’s unemployment came in at an admirable 1.9 percent in the third quarter of 2014) and the quick steps taken by MAS to combat global economic pressure mean that Singapore is still relatively safe from the gaping jaws of deflation that’s already biting on the heels of the Eurozone.

For 2015, MAS has forecasted core inflation, a usually better gauge for household expenses, to come in at between 0.5 and 1.5 percent and, for the first time since 2009, expects headline inflation to be between -0.5 and 0.5 percent.

The last time Singapore experienced deflation for six consecutive months, which occurred at the height of the global financial crisis, the country went into a recession. The similarities to the events happening around the world today are eerily similar to that tumultuous period.

The Eurozone is experiencing deflation on a widespread scale, one that economists had been expecting for a long time and that the European Central Bank had been prepared for – the bankers recently launched a quantitative easing programme, essentially injecting close to a trillion Euros into the monetary system in an attempt to stimulate demand. Only time will tell whether this controversial, last-ditch move will work. However, if this move fails to resuscitate a tottering patient on his last legs, then his collapse will trigger a tsunami across the world.

For our country to survive this possible impending financial storm, the key is in making sure that the Singaporean employee remains employable, competitive, affordable, and something that is rarely mentioned, happy. It’s a complicated and difficult equation that, honestly, is almost impossible to solve. And in our relentless push for employability, competitiveness and affordability, our happiness has been sacrificed by many cutthroat companies.

In the past, Singapore’s welcoming business environment was the cornerstone of our success. Companies and investors poured their money and time into our country, creating a lot of jobs for the labour market. For a long time, Singaporeans were happy, which contributed to our meteoric rise. However, our progress has slowed down due to a wide variety of factors and, in the process, our neighbouring countries are catching up quickly.

This is the new world we’re living in, and it’s time we face up to the harsh, uncomfortable reality –that we’re losing our edge.

READ: Singaporeans Are Unhappy and Poor. Why?

Deflation Affecting Investors and Non-investors

With all these information, it’s quite clear how Singapore deflation negatively affects not just the stock markets but everyday life in our country. Companies, both listed and non-listed, will start experiencing problems, which will cause panic in the markets. From then on, it’s only a matter of time before your charts resemble the outline of the Himalayan mountain range.

Is there anything that you can do if the deflationary trap gets its claws on the stock market?

If the case of Japan is anything to go by, the only thing you can do is to, well, pray.

When it comes to jobs, Singapore’s labour market, which is already experiencing heated competition from competitive neighbouring economics, cannot possibly withstand the body blows of deflation. Once again, when Japan was sucked into the deflation vortex, wages stagnated. To put things into perspective, real salaries in Japan fell 13 percent and economic output descended to levels that were last seen in the 80s.

The upcoming Singapore Budget 2015 will apparently address the concerns of mid-career, middle-aged Singaporeans “who want good, fulfilling careers”. Behind the scenes, we’re certain the collective heads of the different agencies have already anticipated and planned for the different possibilities and it seems that they’re trying to solve the happiness portion of the productivity equation as well.

In the meantime, keep an eye on the quiet Singapore deflation. It was the precursor to the previous recession and it might be signalling the next one to come.

4 February 2015

https://www.drwealth.com/2015/02/04/singapore-deflation-no-one-talking/?utm_medium=DISPLAY&utm_source=OUTBRAIN&utm_campaign=4C

Economic Factors - Price Changes in the Economy

InflationInflation is the economic condition characterized by continuously rising prices for goods and services. As a result, the purchasing power of a country's currency deteriorates as its value decreases and interest rates rise. 

What exactly causes inflation and how does it affect your investments and standard of living? See the tutorial: All About Inflation for the answers

There are two generally recognized types of inflation: demand-pull inflation and cost-push inflation.

• Demand-Pull Inflation: The money supply is seen as the cause of this type of inflation. In this situation, the money supply is too large when compared with the supply of produced goods in the economy. Interest rates rise as a result, making it more expensive to borrow money. As a result, the money supply begins to shrink with the drop in lending activity.
  
• Cost-Push Inflation: The rising cost of raw materials used to produce goods is seen as the cause of this type of inflation. Since manufacturers now need to pay more for these materials, they raise the prices on their products to compensate. As a result, retailers must pay more for goods, so they increase prices to pass the difference on to the consumer.

DeflationConversely, deflation is a persistent decline in the prices of goods and services usually caused by slowing market demand with a level supply. Purchasing power increases as a result of stagnant demand, fixed-income securities become more appealing, and producers must lower their prices to compete for the limited demand. 

Inflation usually has a negative effect on security prices, especially those equities that are particularly interest-rate sensitive, such as financials, smaller companies that rely on debt financing to grow, and cyclical businesses such as durable goods like heavy machinery, automobile and steel manufacturers, and other capital goods industries.

Read more: http://www.investopedia.com/exam-guide/finra-series-6/economic-factors/price-changes-economy.asp#ixzz1yhPyxhMx

Should investors worry about the possibility that business value may decline? Absolutely.

The possibility of sustained decreases in business value is a dagger at the heart of value investing (and is not a barrel of laughs for other investment approaches either). Value investors place great faith in the principle of assessing value and then buying at a discount. If value is subject to considerable erosion, then how large a discount is sufficient?

Should investors worry about the possibility that business value may decline? Absolutely. Should they do anything about it? There are three responses that might be effective.

• First, since investors cannot predict when values will rise or fall, valuation should always be performed conservatively, giving considerable weight to worst-case liquidation value as well as to other methods. 
• Second, investors fearing deflation could demand a greater than usual discount between price and underlying value in order to make new investments or to hold current positions. This means that normally selective investors would probably let even more pitches than usual go by. 
• Finally, the prospect of asset deflation places a heightened importance on the time frame of investments and on the presence of a catalyst for the realization of underlying value. In a deflationary environment, if you cannot tell whether or when you will realize underlying value, you may not want to get involved at all. If underlying value is realized in the near-term directly for the benefit of shareholders, however, the longer-term forces that could cause value to diminish become moot.

Ref:  Margin of Safety by Seth Klarman

What Is Money?

China needs to raise rates to cope with QE2

China needs to raise rates to cope with QE2
(Agencies)
Updated: 2010-11-05 11:04

BEIJING - China needs to increase interest rates to curb capital inflows driven by US monetary easing, an official newspaper said in an editorial on Friday.

Although such a move would increase the rate differential between China and the United States, which might by itself attract further cash from abroad, the China Securities Journal argued that raising interest rates would provide a net benefit by cooling domestic asset prices.

"We must not forget the Japan lesson. We must tighten internal policies to deal with external easing so as to avoid the formation of asset bubbles," the leading financial newspaper said in a front-page editorial.

It said that Japan's interest rate cuts in the 1980s inflated asset prices and led to deflation when the bubbles burst.

China needs to be wary about asset bubbles because food-driven inflation pressure is on the rise and efforts to ward off hot-money inflows are less effective since other developing countries, including Brazil, South Korea and Thailand, are also trying to impose capital controls, it said.

"From this perspective, it's necessary for our country to enter a cycle of interest rate rises," it suggested. "The process of our capital account opening should also be controlled."

The editorial does not necessarily represent official policy, but it does reflect widespread worries in China about how to cope with a rise in international liquidity after the US Federal Reserve unveiled a fresh round of quantitative easing this week.

China raised interest rates last month for the first time in nearly three years, although the jury is out among economists about whether the next rate rise will come before the end of this year.

http://www.chinadaily.com.cn/business/2010-11/05/content_11507379.htm

The madness of doing more QE

Mervyn King must turn off the printing press
Quantitative easing will do little to secure the recovery, says Jeremy Warner.

By Jeremy Warner
Published: 8:03PM BST 28 Oct 2010

97 Comments

The Bank of England has been edging in the direction of more QE Photo: Christopher Pledger

With a bit of luck, this week’s relatively strong third-quarter growth figures might give the Bank of England pause for thought as it prepares to sanction another bout of quantitative easing (QE), popularly known as “printing new money”. As Hallowe’en approaches, opinion is turning against this much-deployed but little-understood form of monetary witchcraft, and with good reason.

The Bank’s Monetary Policy Committee has been edging in the direction of more QE for some months now; George Osborne, the Chancellor, has repeatedly suggested that it could provide a useful counterweight to the austerity of his fiscal consolidation plans.

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In the United States, more QE is already pretty much a done deal. The Federal Reserve’s Open Markets Committee is next week expected to give the go-ahead to a further $500 billion of asset purchases. That might seem small beer against the $1.7 trillion already spent, but to describe an extra half-trillion of the stuff as “QE-lite”, as some Fed insiders do, still seems something of an understatement.

All in all, policy-makers are becoming worryingly dependent on further QE for salvation. The argument goes that with mountainous public debt excluding the possibility of further stimulus packages or tax cuts to boost the economy, why shouldn’t we just print more money instead?

To understand why this is a policy blunder in the making, it’s best to start with the case for the defence. There is plenty of evidence to suggest that the initial, crisis-provoked burst of QE worked as intended. It’s always impossible to prove the counterfactual – what might have happened if no QE had been applied – but it seems likely that the economic contraction would have been a great deal worse.

By boosting the money supply, QE helped keep interest rates in the real economy low, supporting consumption and allowing many companies to refinance themselves in the face of contracting credit. An otherwise catastrophic collapse in confidence, investment and trade was partially offset.

But you can have too much of a good thing – and as things stand, it’s quite hard to see why more of this monetary hocus-pocus would help things any further. On the other hand, the risks of it are all too obvious.

The case for going further rests on the idea that the private sector is not yet ready to step into the breach left by a shrinking state, and may actually be about to contract even more. In such circumstances, it would become necessary to keep pushing down on interest rates, to encourage both consumers and businesses to spend more.

It’s a funny old therapy that prescribes another dose of the same poison that brought the economy to its knees – too much consumption and not enough saving – but let’s leave this wider paradox aside for the moment. The more immediate problem is that it’s not at all clear that the slight reduction in interest rates that more QE might bring about would cause consumers to save less. Indeed, it could have the opposite effect: those with a surplus of savings might become more conservative still if they saw the outlook for income worsening at a time when their long-term security is being eroded by heightened inflation.

And where is the deflation risk that might justify more QE? It’s hard enough to see it even in the US, where – to my mind – a long-incubating problem of structural unemployment, hidden for years by the credit boom, is being misdiagnosed as one of deflation. It’s harder still in the UK. With inflation still stuck well above target, expectations of future inflation rising, nominal GDP growth back at almost 6 per cent, and the velocity of money – that is, the number of transactions for any given unit of cash – recovering fast, more QE becomes a very hard sell indeed.

Of course, the economy will require plenty of policy support to compensate for a planned fiscal squeeze that amounts to roughly 2 per cent of GDP a year for the next four years. But it is not at all obvious that more QE is the right way of providing it.

The Bank of England has repeatedly told us that recessionary pressures will cause inflation to abate – yet it has remained stubbornly above target. No one will believe the Bank if it cites a deflationary bogeyman that doesn’t yet exist as justification for turning on the printing presses again.

If all that new money actually were to reach the parts of the economy that needed it, I might have some sympathy. But QE has failed either to expand bank credit to small- and medium-sized enterprises or to lower its cost to them. It has, however, provided spectacular money-making opportunities for the City and inflated new bubbles in bond, commodities and emerging markets.

Goodness knows how central banks will unwind the vast positions they already hold in the debt markets, but the fear that they’ll end up taking the easy option and monetising what the Government owes – permanently adding it to the money supply, as happened in the 1970s – will only add to concerns about inflation.

There are plenty of ways to help the recovery, from raising infrastructure spending (which is perfectly compatible with deficit reduction) to boosting business confidence by enhancing the environment for investment and job creation. But please, no more QE.

http://www.telegraph.co.uk/finance/economics/8094536/Mervyn-King-must-turn-off-the-printing-press.html

Fed spends big to fight deflation

Stuart Washington

November 4, 2010 - 9:43AM

Quantitative easing barely registered on world markets but the message from the US Federal Reserve was heard throughout the world: it would use every measure possible to ward off deflation.

The move to support US asset prices through printing money served to slightly bolster already-high equity markets and pushed the Australian dollar to trade above parity with the US dollar for most of the morning.

George Tharenou, an economist with investment bank UBS, said the Fed’s announcement overnight of $US600 billion ($600 billion) in treasury purchases was combined with a commitment to continue buying troubled mortgage securities, bringing the total value of the package close to $US1.1 trillion.

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The second round of quantitative easing, or QEII, adds to $US1.7 billion in unconventional measures it launched after the collapse of Lehman Brothers in September 2008.

Mr Tharenou said the Fed was continuing action in an environment in which it could not cut already low official interest rates.

‘‘Whether or not the Fed can actually stop deflation is a matter of debate (but) I think the Fed is taking the best possible action it can,’’ Mr Tharenou said.

Andrew Pease, the chief investment strategist for fund manager Russell Investments, said the Federal Reserve had highlighted its commitment to restoring inflation and warding off deflation, with early signs being positive.

‘‘It’s a big package,’’ he said. ‘‘The question is what impact is it going to have. Is it going to be pushing on a string or is it going to do something? My guess is its going to reinforce positive price expectations.’’

Mr Pease said of deflation, which occurred in Japan after its own debt crisis in 1990: ‘‘People don’t spend, businesses can’t make profits ... there’s a whole lot of problems when an economy falls into deflation.’’

Mark Reade, a director of credit strategy for investment bank Citi, said the lack of market reaction was due to the package being broadly in line with expectations.

‘‘The Fed reiterated its commitment to keep rates low for an extended period of time,’’ he said. ‘‘That commitment is going to support asset prices.’’

He said the willingness to support prices also supported people's willingness to continue to invest in riskier assets - including equity markets and the Australian dollar.

On the news, the US dollar fell slightly below parity with the Australian dollar and remained there around midday.

However, Mr Pease warned the Australian dollar was ‘‘overvalued by just about any metric’’.

swashington@smh.com.au

http://www.watoday.com.au/business/fed-spends-big-to-fight-deflation-20101104-17ey0.html

The Recovery: Why Deflation Remains a Threat

GLOBAL ECONOMICS May 27, 2010, 5:00PM EST
The Recovery: Why Deflation Remains a Threat
Economic growth isn't strong enough yet to keep deflation at bay—and turmoil in Europe and market jitters amplify the risk

By Peter Coy

Bargains are everywhere in America these days. Men's shirts and sweaters were 3.4 percent cheaper this April than a year earlier. Prices also fell for eggs, peanut butter, bananas, potatoes, hotel and motel rooms, cosmetics, curtains, rugs, tools, and lawn care. Excluding gasoline and other energy items, the consumer price index rose just 0.9 percent for the year. That's the smallest increase since January 1962, when John F. Kennedy was President.

Everybody likes to save money, but flat to falling prices are not entirely good. They're a symptom of continued weakness nearly a year after the U.S. economy supposedly hit bottom. The same softness of demand that keeps goods cheap is pressuring workers. Annual growth of average hourly earnings fell from 3.5 percent in April 2007 to 1.6 percent this April.

The economic recovery, while welcome, isn't yet strong enough to ensure against the risk of deflation, in which prices fall across the board for an extended period. Deflation caused by a shortfall in demand can be dangerous. People delay purchases, waiting for lower prices, which exacerbates the slowdown. Bankruptcies rise because even though pay falls, debt levels don't. To keep deflation at bay, the Federal Reserve's Open Market Committee voted in April to keep the federal funds rate at near zero. Even with an overhang of more than $1 trillion of excess reserves in the banking system, ready to be lent, committee members cut their inflation forecasts by 0.2 percentage point between the January and April meetings, to a range of 1.2 percent to 1.5 percent for this year.

Turmoil in Europe is amplifying the risk of deflation in the U.S. It's driving up the dollar's value, making American goods less competitive in world markets and retarding growth. Europe's problems also are pushing down the U.S. stock market, which makes consumers fearful and less likely to spend. The Standard & Poor's 500-stock index has fallen 12 percent from its April high. A sharp decline in oil prices since the end of April shows that growth worries are worldwide, since it's global demand that determines the price of oil. Crude hit $71 a barrel in late May, down from $86 at the end of April. Gold is moving the other way, rising to more than $1,200 an ounce by late May from a recent low of less than $900 in April 2009, as investors seek a refuge from chancy markets and banks. All the grim indicators have made their mark. "Call it a nightmare," says one of the most prominent bears, David A. Rosenberg, chief economist and strategist at the Toronto-based investment firm of Gluskin Sheff + Associates.

The decline of output during the 2007-09 recession was so steep that there's still a huge amount of excess productive capacity. According to Federal Reserve data, only 69percent of total industry capacity was used in April, vs. an average of 81percent in the previous 38 years. As for labor, the unemployment rate remains stubbornly high because every uptick in hiring encourages more people to start looking for work again—and thus boost the official jobless rate.

The optimistic take on the economy is that the threat of deflation is temporary and will diminish as excess capacity gets eaten up. Kurt Karl, chief U.S. economist of Swiss Re, says employment gains are producing income that will be spent, generating more jobs and more spending in a virtuous upward spiral. "I'm still bullish," says Karl, adding, "employment growth has turned a major corner." Deflation, he adds, "would be a permanent kind of problem only if you didn't have any employment momentum." He predicts a decrease in the unemployment rate from 9.9percent in April to about 9.5percent at the end of 2010 and about 8percent at the end of 2011.

Certainly there are some signs of progress. On May 25 the Conference Board announced that its May index of consumer confidence rose to the highest level since March 2008. MasterCard Advisors' SpendingPulse measure of consumer purchases has ticked up sharply since early 2009. Luxury retail chains including Barneys and Saks (SKS) are scaling back discounts and promotions they offered to attract shoppers during the recession. In February, Tiffany (TIF) raised prices across the store. Consultants Bain & Co. say U.S. sales of luxury goods may rise 4percent in 2010 after declining 17percent in 2009.

There are worrisome signs, though, that the recovery could stall. Employment has been boosted by the Census Bureau's temporary hiring for the decennial census, but as summer approaches that source of employment will fade. Job creation will slow as the year goes on and be "anemic" in 2011, predicts Rajeev Dhawan, director of the Economic Forecasting Center at Georgia State University's J. Mack Robinson College of Business. Says Sumit Chandra, a supply chain expert who is a partner at A.T. Kearney consultants: "The recovery is real. It's happening. But I think the magnitude of the recovery, the level of confidence we have in it, is fragile."

Kelly Services (KELYA), the temporary help firm, sees the tentativeness of the expansion at ground level. Demand for its services is strong because companies "want to maintain maximum flexibility" in case the recovery fades, says George S. Corona, Kelly's executive vice-president. Meanwhile, upward pressure on wages is nil in most segments, says Corona. "We have a lot of résumés coming in the door," he says. "We're not having to work hard to find people." Exactly. Cheap shirts and sweaters are cold comfort for unemployed people who are sitting at home in their pajamas.

With Cotten Timberlake

The bottom line: The recession created so much extra capacity that the economy is struggling to absorb it, even as the recovery takes hold.

Coy is Bloomberg Businessweek's Economics editor.

http://www.businessweek.com/print/magazine/content/10_23/b4181009637404.htm

Lost Decade Looming?

May 20, 2010
Lost Decade Looming?
By PAUL KRUGMAN

Despite a chorus of voices claiming otherwise, we aren’t Greece. We are, however, looking more and more like Japan.

For the past few months, much commentary on the economy — some of it posing as reporting — has had one central theme: policy makers are doing too much. Governments need to stop spending, we’re told. Greece is held up as a cautionary tale, and every uptick in the interest rate on U.S. government bonds is treated as an indication that markets are turning on America over its deficits. Meanwhile, there are continual warnings that inflation is just around the corner, and that the Fed needs to pull back from its efforts to support the economy and get started on its “exit strategy,” tightening credit by selling off assets and raising interest rates.

And what about near-record unemployment, with long-term unemployment worse than at any time since the 1930s? What about the fact that the employment gains of the past few months, although welcome, have, so far, brought back fewer than 500,000 of the more than 8 million jobs lost in the wake of the financial crisis? Hey, worrying about the unemployed is just so 2009.

But the truth is that policy makers aren’t doing too much; they’re doing too little. Recent data don’t suggest that America is heading for a Greece-style collapse of investor confidence. Instead, they suggest that we may be heading for a Japan-style lost decade, trapped in a prolonged era of high unemployment and slow growth.

Let’s talk first about those interest rates. On several occasions over the past year, we’ve been told, after some modest rise in rates, that the bond vigilantes had arrived, that America had better slash its deficit right away or else. Each time, rates soon slid back down. Most recently, in March, there was much ado about the interest rate on U.S. 10-year bonds, which had risen from 3.6 percent to almost 4 percent. “Debt fears send rates up” was the headline at The Wall Street Journal, although there wasn’t actually any evidence that debt fears were responsible.

Since then, however, rates have retraced that rise and then some. As of Thursday, the 10-year rate was below 3.3 percent. I wish I could say that falling interest rates reflect a surge of optimism about U.S. federal finances. What they actually reflect, however, is a surge of pessimism about the prospects for economic recovery, pessimism that has sent investors fleeing out of anything that looks risky — hence, the plunge in the stock market — into the perceived safety of U.S. government debt.

What’s behind this new pessimism? It partly reflects the troubles in Europe, which have less to do with government debt than you’ve heard; the real problem is that by creating the euro, Europe’s leaders imposed a single currency on economies that weren’t ready for such a move. But there are also warning signs at home, most recently Wednesday’s report on consumer prices, which showed a key measure of inflation falling below 1 percent, bringing it to a 44-year low.

This isn’t really surprising: you expect inflation to fall in the face of mass unemployment and excess capacity. But it is nonetheless really bad news. Low inflation, or worse yet deflation, tends to perpetuate an economic slump, because it encourages people to hoard cash rather than spend, which keeps the economy depressed, which leads to more deflation. That vicious circle isn’t hypothetical: just ask the Japanese, who entered a deflationary trap in the 1990s and, despite occasional episodes of growth, still can’t get out. And it could happen here.

So what we should really be asking right now isn’t whether we’re about to turn into Greece. We should, instead, be asking what we’re doing to avoid turning Japanese. And the answer is, nothing.

It’s not that nobody understands the risk. I strongly suspect that some officials at the Fed see the Japan parallels all too clearly and wish they could do more to support the economy. But in practice it’s all they can do to contain the tightening impulses of their colleagues, who (like central bankers in the 1930s) remain desperately afraid of inflation despite the absence of any evidence of rising prices. I also suspect that Obama administration economists would very much like to see another stimulus plan. But they know that such a plan would have no chance of getting through a Congress that has been spooked by the deficit hawks.

In short, fear of imaginary threats has prevented any effective response to the real danger facing our economy.

Will the worst happen? Not necessarily. Maybe the economic measures already taken will end up doing the trick, jump-starting a self-sustaining recovery. Certainly, that’s what we’re all hoping. But hope is not a plan.


http://www.nytimes.com/2010/05/21/opinion/21krugman.html?src=me&ref=general

Pick Your Poison: Inflation, Deflation, Stagflation

Active Investing: Managing Risk

Pick Your Poison: Inflation, Deflation, Stagflation

Lauren Young
Monday, April 27, 2009
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Analysts see possible scenarios for each of these to strike the U.S. economy. Stay alert and invest accordingly.

Will the real 'flation please stand up?

Experts are arguing about where the U.S. economy is heading as the global financial system tries to right itself. Is it on the path to inflation, deflation, or, worse, stagflation? Rising unemployment and excess production capacity are making it hard for the U.S. economy to climb out of recession. And that, in turn, is putting a strain on pricing power and wage growth—raising fears of deflation, which develops when a broad decline in prices amid falling demand feeds further price-cutting.

But what happens if the Federal Reserve's efforts to jump-start the economy take effect? Stimulus to the tune of $787 billion is supposed to rev up economic engines. Prices could climb too high as too much money chases after available goods and services—the classic formula for inflation.

"I describe [the potential dangers in] this economy in the form of a snowy Minnesota road," says Peter Rekstad, a financial adviser at TruNorth in Oakdale, Minn. "A car slid off the road into the deflation ditch. The way out of the ditch is to get a bunch of friends pushing while you rock the car back and forth. The big danger is that you get out of the deflation ditch and race across the road into the inflation ditch."

Or to take Rekstad's analogy further, say a car is straddling the road, with its wheels mired in both ditches at once—the worst of both worlds. That situation, where growth slows while inflation soars, is known as stagflation.

Here's an investor's guide to protecting your portfolio from these three forces.

Deflation

Deflation is the threat dominating headlines. "You've got a strong supply of goods and weak demand. That's a recipe for prolonged deflation," says A. Gary Shilling, economist and author of Deflation: How to Survive & Thrive in the Coming Wave of Deflation (McGraw-Hill). The problem is deflation's ripple effect: When banks stop lending, businesses stop expanding and wages fall. Consumers stop spending, which pushes prices lower. Why won't massive stimulus pull the economy out of the deflationary lane? Shilling fears that the U.S. government's economic tampering will have a "Big Brother effect," hurting innovation and permanently curbing growth.

The Signs. The surest sign of deflation is a decline in the consumer price index, which tracks the prices of consumer goods and services. But it's hard to ignore lower real estate values, which aren't in the CPI. Home prices fell more than 18% in 2008, according to the S&P/Case-Schiller U.S. National Home Price Index. Another deflation indicator: the higher savings rate, which we're seeing for the first time in 25 years. Shilling expects the savings rate to rise from 4.2% to 10% in the next decade.

Investment Strategy. "Quality is paramount in deflationary markets," Shilling says. He thinks most investors should be in short-term certificates of deposit or money-market funds. Those with a 10-year time horizon should also buy tech stocks, such as semiconductors, he says. Companies facing deflation can't cut prices and must boost productivity through technology.

Inflation

The Argument. Many of the economists and financial advisers polled by BusinessWeek for this story believe the huge amount of money being pumped into banks by the Federal Reserve (chart, right) makes inflation a real threat. Hans Olsen, chief investment officer for JPMorgan Chase (JPM)'s private wealth management business, says the stimulus plan ultimately will lead to higher inflation. However, total inflation is basically nonexistent at -0.4%. The trick is figuring out when it will be a problem. "The nasty thing about inflation is that it's insidious," Olsen says. Banishing inflation from the economy once it is "infected" is hard.

The Signs. The leading indicator used to measure inflation is the CPI.

Commodity prices, particularly those of oil and copper, are another bellwether. One indicator Olsen tracks is government debt as a percentage of gross domestic product, which he sees surging from 40% to 80% over the next few years.

Investment Strategy. Mild price inflation is considered healthy for stock investors because it is a sign that the economy is growing. But when inflation spikes, as it did when it hit 13% in the 1970s, interest rates rise and borrowing stops. For bondholders, soaring inflation eats away at asset values over extended periods.

The most direct way to fight this is to buy Treasury Inflation-Protected Securities (TIPS)—government-backed bonds pegged to inflation via the CPI. (TIPS belong in tax-deferred accounts because they are not tax-efficient.) A study by economic consultancy Peter L. Bernstein Inc. found that, for an aggressive investor who is worried about inflation, a 47%/53% proportion of TIPs to stocks (the study tracked broad stock market indexes) provided the best risk-adjusted real returns over a wide range of inflationary environments.

Among mutual funds, advisers favor the Vanguard Inflation-Protected Securities Fund (VIPSX), which had an annualized return of 5% for the past three years. Other plays include the iShares Barclays TIPS Bond exchange-traded fund (TIP) and Pimco Real Return Fund (PRTNX).

Commodities are another classic hedge. A well-diversified commodity play is the Pimco Commodity Real Return Fund (CRIX), which combines commodities with TIPS. Many advisers also like the SPDR Gold Trust ETF (GLD) and the First Eagle Gold Fund.

Stagflation

Stagflation is caused by the combination of slow growth and surging inflation. Slower growth will come from extreme caution by lenders, households, and businesses, while a shortage of production capacity will create inflationary bottlenecks, argues Mohamed El-Erian, chief executive officer at Pimco. "Stagflation will be part of the new normal," he says.

The Signs. The misery index, which combines the unemployment and inflation rates, is the best gauge of stagflation. In March it was at 8.1%. El-Erian predicts that unemployment will hit 10% by yearend, and 2% inflation could bring the misery index up to 12% by the end of 2010.

Investment Strategy. Insulating your portfolio from stagflation is tough. Equity investors need to take a very conservative stance, focusing on high-quality growth stocks such as Johnson & Johnson (JNJ) and PepsiCo (PEP), says John Boland, financial adviser at Maple Capital Management. Gold, as well as TIPS, will help mitigate some of the inflation risk. El-Erian considers TIPS a bargain because 10-year TIPS are pricing in inflation of less than 1.5% for the next decade, and he sees inflation jumping as high as 6% by 2011.

Young is a Personal Business editor for BusinessWeek

With Tara Kalwarski in New York

http://finance.yahoo.com/special-edition/active-investor/inflate-deflate-stagflate;_ylt=Apx_JUcYDM.BiqB1peaegXC7YWsA

Active Investing: Managing Risk
http://finance.yahoo.com/special-edition/active-investor;_ylt=Av0dbBsyTSeandibSloqvq67YWsA

Spain’s Falling Prices Fuel Deflation Fears in Europe

Spain’s Falling Prices Fuel Deflation Fears in Europe

The company Fermax has reduced prices by a third on the video intercoms it makes for homes and apartment buildings, hoping to increase sales.

By NELSON D. SCHWARTZ
Published: April 20, 2009
VALENCIA, Spain — Faced with plunging orders, merchants across this recession-wracked country are starting to do something that many of them have never done: cut retail prices.
Prices dipped everywhere, from restaurants and fashion retailers to pharmacies and supermarkets in March. Hoping to increase sales, Fernando Maestre reduced prices by a third on the video intercoms his company makes for homes and apartment buildings. But that has not helped, so, along with many other Spanish employers, he is continuing to fire workers.
The nation’s jobless rate, already a painful 15.5 percent, could soon reach 20 percent, a troubling number for a major industrialized country.
With the combination of rising unemployment and falling prices, economists fear Spain may be in the early grip of deflation, a hallmark of both the Great Depression and Japan’s lost decade of the 1990s, and a major concern since the financial crisis went global last year.
Deflation can result in a downward spiral that can be difficult to reverse. As unemployment rises sharply and consumers cut spending, companies cut prices. But if sales do not pick up, then revenue can decline further, forcing more cuts in workers or wages. Mr. Maestre is already contemplating additional job and wage cuts for his 250 employees.
Nowhere is this cycle more evident than in Spain. Last month, it became the first of the 16 nations that use the euro to record a negative inflation rate. The drop, though just 0.1 percent, had not happened since the government began tracking inflation in 1961, and Spanish officials have said prices could keep dropping through the summer.
Some of the decline came as volatile food prices sank; the cost of fish fell 6.2 percent, and sugar was down 5.7 percent. But even prices in normally stable sectors like drugs and medical treatments fell 0.7 percent in March, and there were slight declines in footwear, clothing and prices for household electronics.
“Alarm bells are going off,” said Lorenzo Amor, president of the Association of Autonomous Workers, which represents small businesses and self-employed people. “Economies can recover from deceleration, but it’s harder to recover from a deflationary situation. This could be a catastrophe for the Spanish economy.”
Deflation is not just a Spanish concern. Luxembourg, Portugal and Ireland have reported price drops, too. While the declines have been slight — and prices rose modestly after factoring out food and energy prices, which can fluctuate widely — other figures released this month suggest the risk of deflation is growing.
In Germany, wholesale prices dropped 8 percent in March from a year ago, the steepest fall since 1987. In Japan, wholesale prices fell 2.2 percent on an annual basis. In the United States, the Consumer Price Index fell 0.1 percent in March, year over year, the first decline of its kind since 1955, though prices rose 0.2 percent excluding food and energy.
“It doesn’t mean it will spread here to the U.S., but we need to look closely at Spain and other places to understand the dynamic,” says Simon Johnson, a professor at the Sloan School of Management at the Massachusetts Institute of Technology and a former chief economist for the International Monetary Fund. “It’s like the front line of a new virus outbreak.”
The trends have unnerved even well-established businesses. “There is such a huge lack of confidence in the politicians, in the European Union and in the banks,” said Arturo Virosque, 79, president of Valencia’s chamber of commerce and the owner of a local logistics company. Ticking off crises going back to the Spanish Civil War in his youth, he said, “this is different. It’s like an illness.”
After price cuts by competitors, Mr. Virosque’s company reduced charges for storage and transportation, and slashed its work force to about 170, from 250. “The worst thing is that we have to cut the young people,” he said, because higher severance makes it too expensive to fire older workers.
While unemployment traditionally is higher in Spain than in much of Europe, the sharp increase has many here nervous. The jobless rate for those under 25 is at a Depression-like level of 31.8 percent, the highest among the 27 nations of the European Union.
Before cutting prices in early 2009, Mr. Maestre ordered several rounds of job cuts at his company, Fermax, as sales of the intercoms collapsed with Spain’s housing bubble.
“It’s a question of survival for everybody,” he said. Still, the lower prices have not translated into higher sales. Fermax’s orders fell 25 percent in the first quarter. Prices for some intercom parts that he buys, like video screens, have also come down, but it is not enough to make up for the sales drought. “Prices have to come down more and we will have to spend less,” he said.
The effects of this downward spiral are evident at Valencia’s principal soup kitchen, in an imposing stone building constructed a century ago as an alms house. Each day, a line forms around the block by noon. The Casa de la Caridad, or House of Charity, is helping three times as many people as it did a year ago. More than 11,000 meals were served in March, and it expects to top 12,000 this month.
As the economic decline has broadened, so has the range of people seeking help. In the past, most were out-of-work immigrants or the homeless, said the center’s director, Guadalupe Ferrer. Today, “it’s more and more people like us who had a house, a respectable job, but are now unemployed.”
The employed worry that falling prices will endanger their jobs as well.
Yolanda Garcia has worked as a butcher under the arches of Valencia’s soaring Art Nouveau central market for a decade, but she’s troubled that a drop in the price of chicken, to 5.99 euros a kilo, from 6.99, has not attracted more customers to her stall.
“Of course, we’re worried the boss will have to reduce staff,” said Ms. Garcia, 38, whose husband, a construction worker, was laid off two months ago.
All this has made deflation, once a subject largely reserved for economists who studied the Great Depression, into front-page news here.
The American economy is less vulnerable to deflation, in part because of the Federal Reserve’s decision to cut interest rates to near zero and increase lending by $2 trillion. The European Central Bank has also cut rates, though more slowly, and it has resisted the lending measures adopted by the Fed and the Bank of England to prop up spending.
When Spain had its own currency, the peseta, the central bank could have simply devalued it, or cut interest rates to zero. But that is not an option in the era of the euro, when monetary policy is controlled from the European Central Bank’s headquarters in Frankfurt, said Santiago Carbó, a professor of economics at the University of Granada.
“If we enter into a deflationary period, we won’t have the monetary tools to sort it out,” Mr. Carbó said.

http://www.nytimes.com/2009/04/21/business/global/21deflate.html?em