News from The Globe and Mail
Deflation poses danger to business
Monday, October 20, 2003
Deflation is a fact of life in Japan. In the past 10 years, consumer prices have tumbled, real estate values have plummeted and banks -- unable to collect their loans -- have been driven to insolvency or into forced mergers with stronger partners.
Back in the spring, there was a lot of worry that deflation would lurk at Canada's shores as a sort of economic grim reaper. In the May 23 edition of ScotiaCapital's Market Trends weekly newsletter, economist Aron Gampel wrote, "The global economy has visibly lost momentum, increasing the threat of a deflationary undertow. Pestilence, plagues and natural disasters seem to be the order of the day. Industrial overcapacity remains a major stumbling block to improving business conditions." Reviewing the numbers, Gampel noted that, in Canada, industrial product prices had declined 0.6 per cent in March. The stage seemed set for deflation.
Distinguished economists argue that more deflation is on the way. Gary Shilling, head of an eminent New Jersey-based consulting company that bears his name, argued in his 1999 book, Deflation: How to Survive and Thrive in the Coming Wave of Deflation, that falling prices for technology and a decline in overvalued stocks, the crumbling of the Asian "tiger" economies after the 1998 collapse that wrecked the Thai baht and other currencies, and the inability of central banks to pump up deflating economies would make inflation a distant memory.
For now, however, businesses in Canada and the United States probably won't have to crush their profit margins and give away their goods and services, because inflation remains the order of the day. What has saved North America and much of the rest of the world from deflation is the Iraq war and the inflationary effects of U.S. President George W. Bush's record $600-billion deficit to cover combat, his tax cuts and the massive U.S. trade deficit. Borrowing to spend on the American scale inevitably pushes up prices. Iraqi oil has yet to flow in larger amounts to Europe and to the United States, so energy prices have held up. All that and an increase in prices of services in North America have kept the bear of deflation at bay.
Writing in the Sept. 12 issue of Market Trends, Gampel noted that "Americans' renewed love affair with motor vehicles and homes will benefit many of our key manufacturing and resource sectors." So much for deflationary gloom. Or is it?
Richard Duncan, a Hong Kong-based international trade theorist and a specialist in Asian economic affairs, disagrees. In a disturbing forecast in his 2003 book, The Dollar Crisis: Causes, Consequences, Cure, Duncan predicts that when the U.S. property bubble pops (and, one might add, the property bubbles in Europe, especially in Britain and Ireland), the U.S. dollar will collapse (it is currently falling) and world trade will contract. The declining value of the U.S. dollar means that those foreigners who have bought U.S. bonds are bleeding red ink on a currency-adjusted basis. "The global economic slowdown in 2001 was a foretaste of the much worse slump to come," Duncan predicts. The facts bear him out.
Low-cost exports of finished goods from China are leading to factories closing in the First World and even in many parts of the Third World. Demands by the United States and other nations that China revalue its currency, the yuan, upward have so far been met with inaction. And the monetarist cure for deflation, printing heaps of money and flooding it into the banking system -- precisely what Japan has done -- has yet to stop prices from falling in that country.
Deflation, once started, creates its own climate of "irrational precaution," to adapt a phrase from U.S. Federal Reserve Board chairman Alan Greenspan. As a nation's prices start to fall, its currency buys more. Thus the Japanese yen has been very strong. There seems, at present, no way for Japan to end its deflation. A suggestion by a senior Japanese finance official that savings accounts be taxed shows how desperate the government is. If savings accounts in Japan, which now pay no interest, were to pay negative interest after the tax, money would flood out of the banking system and into the futons of the nation. More banks would fall. Brighter minds have prevailed and the proposal to tax savings balances has been followed by brilliant inaction.
In this disagreement of economists, the world is at the edge of a cliff. U.S.-led spending can pull major trading nations out of their malaise and perhaps re-inflate Europe, aid Russia and maintain the growth of China. On the other hand, if foreigners catch on to the idea that U.S. bonds are a losing proposition or if foreign central banks decide to stop buying U.S. dollars from their own banks, then the greenback will crumble to the status of the pre-European Union Italian lira.
Nice country, of course, but Italy as a source of sound money? The U.S. dollar wouldn't become as insignificant as the Vietnamese dong or the Albanian lek, but over time oil deals would no longer be priced in greenbacks, the U.S. buck would cease to be an international store of value and refuge in time of crisis, and the United States would have to become efficient in trade -- like other countries -- or shrivel. And Canada, tied so closely to the United States, would follow.
Deflation has been pushed out of the limelight by the U.S. deficit. How long it stays there depends in part on the ability and willingness of Washington to reduce outstanding debt. For now, however, the United States is more interested in its military problems.
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