More and more we are being told deflation is the big worry now. And, in this vein, the latest economic news from the US really is quite spectacular. It all adds more grist to the deflation mill, too. But, on this occasion, it is surely something to be celebrated.
US producer prices saw their biggest monthly fall in 60 years in October. In all, prices fell by 2.8 per cent – that is in just one month.
It seems there are two reasons to fear deflation. If prices are falling because demand is falling, then that is bad for business, and our wages may be the next to fall.
Also, if prices keep falling, we then start delaying our purchase, leading to even less demand.
Yet the real cause of falling producer prices in the US was cheaper commodities. Gasoline was down 24.9 per cent, natural gas by 5.9 per cent, and even food was down by 0.2 per cent.
The whole point about these products is that, in the short-term, they are fairly price inelastic, meaning as price changes, demand remains relatively flat. In the long-term, demand adjusts to price – that is why demand has been falling recently. But the argument that people delay their purchases because they expect prices to fall even further just does not apply to essential items such as food and energy.
Cheaper food and energy mean producers will be able to reduce costs without damaging margins – and, contrary to what some are saying, demand will rise in the long-term as a result of these cheaper prices.
It does not mean there is no danger in deflation. The danger is that falling prices will spread beyond these non-discretionary items.
Then again, we have been seeing deflation in sofas, LCD TVs, computers and mobile phones for years. People don’t put off expenditure indefinitely. If anything, people upgrade their TVs, computers, mobile phones more often. As for sofas, these days they are fast becoming disposable items, just like razors.
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