Why are lower prices bad?

A two-bedroom home in downtown Sparks that until recently commanded a four-figure rent is down to $850.

Grocery prices are dropping.

Gas prices are below $2 a gallon.

For the working poor, the Wall Street meltdown has so far been pretty good news. Prices of the basics of life like food, shelter and transportation are deflating. For those who earn their livings from work instead of from investments, the quality of life is improving. Some low-income workers are even managing to save. These are great days of low prices.

So why is it bad?

Economists say it is. Bankers say it is. Deflation is treated as a negative economic indicator.

In fact, it is taken so automatically as bad news that asking financial experts, “Why is deflation bad?” initially gets a halting, uncertain answer, as though that answer is so obvious that asking the question is silly.

Yet a lot of people are asking it. Google finds 1,200 instances of the question and the Associated Press on Nov. 18 ran an article trying to answer it. On one website, the question was expanded: “If inflation is bad, why is deflation bad?”

Frequently, the answer is usually framed in a way that satisfies only those invested in the system. The low-income working person who rents, takes the bus, and has no credit cards is not likely to understand some of the reasons offered for why lower prices are bad.

For instance, saying that it’s not good for things like homes to be worth less than a homeowner paid is not something to which someone who lives from paycheck to paycheck can relate. Both Nevada economist Glen Atkinson and Heritage Bank of Nevada president Stan Wilmoth started out interviews with that argument. But to the working poor, that’s a problem for the affluent.

“Owners don’t like deflation,” said Atkinson. “Right? If you own a house, you don’t like deflation. If you own some assets, you don’t like deflation. … If you had invested to produce gasoline at the high cost of production, and you have to sell the stuff now at this low price, you wouldn’t like it.”

But don’t most people live off their paychecks, not investments? That being so, wouldn’t most people in the economy be thriving now?

“They’re benefiting from low prices, as you say, but if prices fall far enough, the jobs won’t be there.”

Ah. Now that’s something a low-income worker understands. Price stability, Atkinson said, has a sort of built-in value.

“Moderate price rises or price falls are okay. But when it looks like it may be huge one way or the other, that’s when dislocation occurs.”

A banker’s view
Heritage Bank’s Wilmoth has an interesting view of how deflation can hurt. “Inflation causes people to spend money,” he said. “Deflation causes them to save, and this country is run on debt.”

Thus, deflation helps continue a slowdown. And he emphasizes that the isolated decline in prices is temporary—it will soon be joined by other economic factors that are much less favorable.

“Well, if deflation, if it goes on too long, then people don’t make new products because the next one they make won’t make them any more money. Therefore they’re going to lay off people at the low end, and they lose their jobs. … I mean, if it’s totally deflation, then nobody wants to buy a car, nobody wants to buy a house, nobody wants to buy any hard assets that are produced here in the United States, then eventually the worker gets laid off. If everybody sits on their money, out of fear … “

Wilmoth says, in fact, that the auto industry that Congress is considering bailing out has been concealing its own deflation for years, because deflation puts a brake on purchasing.

“Didn’t the car industry for years try to do everything but call it a decrease in price? Because the first minute that the consumer felt it was going to be cheaper next year, he would wait ’til next year to buy the car. Isn’t that the reality of it? What’d they do? They did incentive [programs], ‘Friends ‘n’ Family,’ ‘Cousins ‘n’ Uncles, they called it everything to make the consumer think it was a temporary price reduction. And they were very successful at switching a lot of purchasers into periods when they should have waited until next year to buy a car. … The fear of inflation caused the consumer to buy cars sooner than they should have.”

Rex Nutting, D.C. bureau chief for the financial news site MarketWatch, recently wrote about the decline in inflation: “But before we get out the champagne, maybe we should wonder if we’ve traded one worry for another. Should the risk of deflation be keeping us up at night? Probably not, at least not yet. the decline in consumer prices over the past three months was almost entirely driven by the historic drop in energy prices. Since the end of July, retail gasoline prices have fallen $1.88 per gallon. Clearly, we cannot depend on a 47 percent decline in gas prices every three months.”

But Nutting also wrote that the decline in prices seems to be broad-based—apparel, dairy, travel, hotel, used car and (heading into holiday buying) toy prices have all dropped.

Nevada economist Tom Cargill says part of the problem is that there is a time lag between the initial drop in prices that working people find attractive and the lower wages and job loss that will hit them after a while if deflation continues.

“The problem is that wages also go down with low prices,” he said. “That is, when you have deflation it affects not just the prices of goods and services you purchase, but it also affects the prices of labor, the prices of capital, and the prices of land. So when you have a general deflation, that’s a bad thing. In fact, it’s much worse than a general inflation.”

The italics were in his voice—he leaned hard on bad.

“Now, if workers keep their jobs and their wages don’t go down, sure—declining house prices, low interest rates, declining fuel prices—that’s great. But even that would be a very short-run perspective.”

Lower prices fuel job losses
So far, wages have not been reduced in most businesses. But the rate of increase of wages has been arrested as annual raises and such things are halted.

“Wages are not going up as much as they were,” Cargill said. “They’re starting to stagnate.”

He also says that some of the declining prices in basics—food, gas, housing—are deceptive.

“The only thing that probably is going to be permanent for a while are the lower prices of houses. But, you know, the world commodity prices falling, including the price of oil—that’s temporary because the world economy is in slowdown right now, so demand for those things has been reduced.”

During the Great Depression, Cargill said, employed workers did pretty well, since prices fell far more than wages. But job losses were so widespread that there weren’t enough employed workers.

“And even if your money wages went down a little bit, prices fell much, much further. You were actually doing OK. But only a small percentage of people found themselves in that situation,” he said. “The reason why, even if you found yourself in a situation like that, you should be concerned about the longer health of the economy, is why are these prices falling, and what’s causing it? And what that can do, of course, is down the line you can lose your job. Because businesses aren’t spending, there’s no real capital spending going on right now, people are pulling back. So even if you are, quote, in that comfortable position, you know, a low-income earner, maybe $25,000 a year, it is nice that you don’t have to pay as much for gas compared to a year or even six months ago. And that, if you did want to buy a house and you have some money saved, this could be an opportunity. But the trouble is, given what’s going on in the economy, you may not even have that job in six months.”

The consequences of tinkering with the economy has been shown before, the last time deflation was suspected.

In 2003, the Federal Reserve held down interest rates in order to combat what seemed to be a threat of deflation. It turned out that Fed officials were working from bad data, and the hold-down on rates helped cause the housing bubble that is did so much to cause this year’s meltdown.