But a growing number of economists and money managers are starting to worry about the opposite of inflation: deflation, a period of falling prices and declining incomes.
Sure, the government's consumer price index has gained 3.5 percent the past 12 months. Even stripping out food and energy, the CPI is up 2.1 percent, the Bureau of Labor Statistics says. And anyone who lives in the real world knows you can't live without food and energy.
But other prices have been moving relentlessly downward, from refrigerators to stocks to houses and salaries. Economist A. Gary Shilling argues that many of the factors for deflation are already in place, and that people overlook falling prices because they are so focused on the items they use the most.
In the meantime, everyone's looking for lower prices, either from one of dozens of deal sites, such as LivingSocial and Groupon, to low-price specialists such as Walmart, Target and Costco. "We have become obsessive to chase the lowest low prices," says Marian Salzman, trend-spotter and CEO of Euro RSCG Worldwide.
That's a deflationary attitude - something policymakers fear. In deflationary periods, consumers put off purchases as long as possible, believing that prices will get lower. Fewer purchases mean lower economic activity - which, in turn, leads to lower salaries and higher unemployment. While deflation doesn't necessarily mean another Great Depression, climbing out from a deflationary pit is tough - arguably, tougher than whipping inflation.
Chain reaction of debt defaults
Debt - specifically, the inability to repay it - is one contributor to deflation. As a simple example, consider what happens when your neighbor can't pay his mortgage. Eventually, the bank forecloses on the house and sells it at a cut-rate price. When potential buyers look at other houses in the neighborhood, they base their bid on the last price - your neighbor's discounted foreclosure price - and home prices on the entire block fall.
When enough people and businesses default on their debt, they set off a chain reaction. Banks, hurt by loan defaults, have to raise capital to cushion against further losses. That means selling profitable divisions, because those are the only divisions they can sell. As profitable divisions get chopped off, bank stock prices fall, banks lend less, and the economy grinds to a halt.
Already, European banks such as Banco Santander and Deutsche Bank are peddling highly profitable ventures, such as Deutsche Bank's asset management business.
And your neighbor's foreclosure may be part of a larger trend. "Any surge in debt-repayment problems are a byproduct of a deflationary trend," says John Lonski, chief economist for Moody's Analytics. "The inability to pay off debt usually flows from two things: Either your cash flows are less than anticipated or the value of the collateral declines precipitously."
Most individuals have seen their income tumble. As unemployment has soared, businesses have discovered that they can get away with paying employees less or withholding raises. Median household income (half were higher, half lower) fell 2.3 percent in 2010, according to the Census Bureau. And many of those who have been laid off have to take a lower salary than the one they had before.
Companies have also found that bankruptcy filings can force employees and unions to accept lower wages. Towns and cities, struggling with labor costs, could also start looking at bankruptcy as a way to force wages and benefits downward, Lonski says.
Another source of falling wages: competition from overseas. Factories in China and the Far East can produce goods at much lower labor costs than the U.S. The result is a relentless downward push on U.S. wages, particularly among unskilled or semiskilled labor.
Asset prices, too, have been falling. Consider housing. The S&P/Case-Shiller Home Price index has fallen 31 percent from its high in July 2006. And, according to the National Association of Realtors, housing is close to all-time record affordability. (NAR measures affordability by looking at the median price of existing single-family homes, average income and mortgage rates.)
Not much home buying
But there's no rush to buy homes. "I think everyone realizes that home-buying conditions reflect the best affordability since the series started," says Lawrence Yun, an economist for NAR. "But people are wondering if it will be even more affordable a year from now."
The result, says Yun, are lots of house lookers but relatively few house buyers. "Brokers show many houses, but buyers just won't pull the trigger," he says.
Houses aren't the only big-ticket items that are down, and down big:
- Financial assets. Anyone with a retirement account can tell you that most financial assets have fallen. The Wilshire 5000 Total Market Index is down 16 percent from its October 2007 high - a loss of $3.2 trillion. Assets in stock mutual funds have fallen to $4.8 trillion from $6.5 trillion in 2007. Despite a generally rising market, investors have yanked an estimated $87 billion from stock funds since March 2009, when stock indexes bottomed. Wall Street has so little fear of inflation that investors are willing to lock in Treasury yields of 2 percent or so for a decade. And Treasury Inflation-Protected Securities, which rise in value to keep pace with inflation, actually have negative yields.
- Commodities. Prices of raw materials have plunged this year. The prices of copper, coffee, aluminum, cotton, nickel, natural gas, wheat and silver are all down more than 20% since the end of April, according to Bloomberg. Gold, widely viewed as a barometer of inflation, has fallen 11 percent since its September high of $1,900 an ounce. Inventories of commodities have gotten so high that metals dealers have had to buy extra warehouse space for them. In November, copper warehouses in New Orleans were 98 percent full, and aluminum inventories in the U.S. are at an all-time peak, according to FastMarkets.com.
- White goods. Prices for many big-ticket items, such as appliances, have fallen on an inflation-adjusted basis as well. In 1970, for example, a 14-cubic-foot refrigerator cost $288. In 2011 dollars, that's $1,681. Lowe's recently advertised a similar refrigerator for $469. And shopping for deals has become a national obsession. Groupon, one of the leading daily-deal sites, recently raised $700 million in an initial public stock offering, although its price has fallen below the IPO price of $20. Yipit, which tracks daily-deal offerings, counts 785 deal sites, ranging from Groupon and LivingSocial to ZinginDealz.com. Nearly a third of consumers surveyed in Deloitte's Annual Pantry survey said that at least seven in 10 items in their shopping cart were discounted. Another 66% said they shop when they know products will be on sale. And 55% said they were cutting back not because they had lost income, but because they simply felt they should be spending less.
The Fed and deflation
The classic cure for deflation is inflation, and the Federal Reserve may be trying that by targeting a specific level of inflation, rather than interest rates.
During the Great Depression, massive federal spending - both in the New Deal and during World War II - reflated the economy.
Few expect that in today's political climate: Budget-cutting and austerity are the watchwords. Cutting government employment, however, simply means a higher unemployment rate and more debt defaults. Instead, much of the deflation-fighting duties fall to the Fed.
"The Fed is right to be worried about deflation," says Michael Hanson, senior U.S. economist for Banc of America Securities-Merrill Lynch. "It's out there as a risk, but not an imminent risk. We think the Fed has the tools to make it a low-probability event."
If so, the Fed's tools are working very slowly. The key fed funds rate has been at zero for nearly three years now, and the economy remains stagnant. In the meantime, consumers continue to hold out for the lowest prices but expect inflation.
"Every time prices go down, it's because people think of themselves as good shoppers who have done something smart," Shilling says. "When prices go up, it's the devil incarnate."
In reality, rising prices could be the exception - and falling prices the rule.
(Copyright © 2012 USA TODAY)