Deflation settles in
Last Monday, as on every 15th of the month that does not fall on a Sabbath or holiday, Israel’s Central Bureau of Statistics published the Consumer Price Index (CPI) for August. As usual, this datum surprised the majority of the professional forecasters whose job it is to try and predict this monthly measure of inflation. “As usual” — because this is what happens most months, that the result does not correspond to the consensus forecast. Why that happens, why it happens more frequently than it used to and why large financial institutions continue to employ highly-paid and highly-intelligent people on this thankless task — all of those question can wait for another day. For the moment, suffice it to say that the August CPI went down by 0.1%, instead of rising by a similar amount or, at least, remaining unchanged — as had been “forecast”.
On Wednesday, the US Bureau of Labor Statistics published its CPI for August. Different country, different day (the Americans are much less rigid than the Israelis on this; they don’t have a fixed day in the month for the CPI — there are reasons for that, too…), same result. The CPI fell, taking all the clever people by surprise and causing various financial instruments to react in this or that way. The details don’t concern us here, it’s the overall phenomenon that matters.
I have cited Israeli and American inflation merely as a matter of convenience — it’s what most readers know and/or are/ should be concerned about. But the general phenomenon of inflation readings being either negative — i.e. the CPI falls from month to month — or at least surprising to the downside — i.e. being lower than predicted — is far more widespread. Europe as a whole (the EU), as well as many specific countries within it, are teetering on the edge of negative inflation not for a month or two, but for a twelve-month period or more. Consistently falling prices is the opposite of inflation and is termed ‘deflation’– an economic malady considered by almost all mainstream economists to be worse than ‘inflation’, i.e. consistently rising prices.
Clearly, Israel and the US are sickening for this malady and Europe already has it. Japan, as is well known, suffered from it for many years, but the extreme measures adopted by the current Abe administration have broken the deflationary spiral — although the treatment may well kill the patient. Even some emerging markets are in danger of contracting it, although others are suffering from actual or potential inflation.
This column has discussed deflation, warned about it and analyzed potential consequences, numerous times over recent years. But now it’s a reality — the CPI keeps going down! Just to make the point clearer: had the shekel not fallen sharply in value during August, the fall in oil prices on the international markets would have knocked several percent off the price of petrol on the first of this month — and pushed the September CPI into deep negative territory. Of course, as consumers, we all want oil prices to go down and, for that matter, the prices of other good too. We think we want lower prices for everything — but maybe not, if that includes the price of labor, generally known as “wages”.
The previous paragraph is a trapdoor leading to a major debate about whether deflation is really so terrible. Maybe there is “good deflation” and “bad deflation”, as some economists posit. If so, falling oil prices are surely good, unless your name is Putin or you are a member of the Saudi royal family or its peers in the Gulf. But then, if the fall in oil prices, and in many prices of commodities and manufactured goods, is the result of weak demand — rather than excess supply — then the implications are much grimmer. In that case falling prices will lead to layoffs and / or bankruptcies, and a whole ‘deflationary spiral’.
In any event, the topic of deflation and its relative seriousness is now for real. What makes matters far worse is that this is happening in the face of huge efforts by central banks to prevent precisely this outcome. Interest rates at or near zero and massive buying of government bonds have been the norm for the last six years, yet all this has failed to halt or reverse the gradual decline in the rate of inflation — whichever method of measuring it is used.
Whether these central bank efforts will continue, or perhaps even be intensified — as the European Central Bank is intent on doing — is certain to be one of the key features of economics and finance in 5775, as it has been for the six years since the Lehman collapse. During that time, the consensus has consistently been wrong about the direction of prices, as it has about the level of growth and, by extension, about the level of yields in the bond markets. It is difficult to see why or how that will change in the coming year.