Deflation Is Now Major Concern

Popular Economics Weekly

We wrote recently about the Eurozone in danger of becoming Japan, which has suffered through some 2 decades of a deflationary spiral, before Prime Minister Abe opened the stimulus spigots. Why is deflation (or disinflation, which is lower inflation but not falling prices) such a bad thing?

Because it deflates everything, including profits, incomes and so job creation.   This starts a vicious circle of more job cuts and shrinking household incomes, which is what causes a recession, or depression. That danger is now slowly creeping into the U.S. economy, though the U.S.  is growing faster than almost all other developed countries at the moment.

Pundits, and even Fed Vice Chair Stanley Fischer are beginning to voice fears that the slowdown in the Eurozone in particular could slow U.S. growth. Why? Because it lowers the demand for U.S. goods and services.

Fischer said in a speech on Saturday that, “if foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to remove accommodation more slowly than otherwise.”

This means the Fed would have to keep interest rates at the so-called zero bound longer than it wants to. That’s because too much cheap money feeds asset bubbles, as happened with the housing bubble. So the European data added to a slew of fears that growth could be slowing across the world.

U.S. growth at present is doing very well with 4.6 percent growth in Q2 after the 2.1 percent shrinkage in Q1, and third quarter growth could exceed 3 percent based on recent inventory rebuilding numbers.


Graph: Trading Economics

But there are headwinds, as interest rates continue to plunge, which signals worries of slower worldwide growth that is hurting stock prices. The 10-year Treasury note yield dropped below 2 percent for the first time in 16 months. But the good news is it will stimulate more housing sales, as 30-yr conforming fixed mortgage rates have plunged to 3.75 percent with 0 origination points, and the Hi-Balance conforming fixe rate is just 3.875 percent with 0 points. So the worries of slower U.S. growth, at least, have no basis.


Graph: Econoday

In fact,U.S. industrial production is approaching its historical average. Industrial production jumped an outsized 1.0 percent in September after a decline of 0.2 percent in August. Forecasts were for 0.4 percent. Overall capacity utilization jumped to 79.3 percent from 78.7 percent in August, close to its 80.1 percent long term average.

Manufacturing was solid, rebounding 0.5 percent in September after a 0.5 percent decline the month before. Within manufacturing, the production of durable goods increased 0.4 percent in September, led by the aerospace and miscellaneous transportation equipment. The production of nondurable goods also moved up 0.5 percent in September. With the exception of petroleum and coal products, each of the major components of nondurables posted gains in September.

So the warnings are real, but somewhat exaggerated. Europeans cannot allow prolonged slow growth policies that emphasize deficit reduction over job creation programs for long. And Fed Vice Chairman Fischer just emphasized that job creation is more important for Fed policy makers, and why the Fed will keep interest rates low for as long as possible, given almost no inflation, to spur more job creation.

Harlan Green © 2014

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About populareconomicsblog

Harlan Green is editor/publisher of, and content provider of 3 weekly columns to various blogs--Popular Economics Weekly and The Huffington Post
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