Disinflation is a good thing

Deflation is characterized by sustained broad declines in both consumer and asset prices. Deflation sets up a vicious cycle in which consumers continually put off purchases because they believe they’ll be cheaper in another year. But this can happen only if there’s little or no growth in gross domestic product (GDP) because if there’s sustained growth, demand inevitably will push prices upward.

Japan has had deflation for the past 20 years. Consumer prices fell in 11 of the years between 1992 and 2013. Japanese house prices fell every year from 1992 to 2005 and are up only slightly since then. The Nikkei 225 stock index plunged to a low of 7,604 in April 2003 from 38,957 in December 1989. The index has not been higher than 18,300 since then. GDP growth averaged 0.8% from 1992 to 2013, and most of that growth came from exports – which now account for about 16% of GDP vs 10% in 1992 – rather than from domestic demand.

Disinflation is different. And it’s positive because it means demand is increasing enough to keep prices moving upward, albeit moderately. That means an economy can continue to grow for years. Normally, economies bounce back from recessions and, after five to six years of strong growth, they become overheated, with both wages and prices moving upward sharply. Central banks then have to raise interest rates to cool down the strong demand.

But there was no bounce-back after the global financial crisis and recession of 2007-09; just moderate growth. So, there are no signs of overheating and most global portfolio managers believe we are in a disinflationary period in most countries. The possible exception is Europe, where growth has been so weak that deflation is possible.

By last autumn, eurozone inflation had turned marginally negative, with consumer prices down by 0.1% in October and by 0.2% in November. That’s partly because of lower oil prices, and it certainly isn’t enough to cause consumers to put off purchases. But if Europe goes into recession, the downward price trend could continue.

Japan also is a concern. Inflation is running at 3% but only because of an increase in the sales tax of three percentage points last April. Otherwise, Japan’s inflation would be around zero. The country desperately needs consumers to increase their spending to get prices on an upward path. That requires more jobs and higher wages. The Bank of Japan and the government are doing all they can to achieve this. (See story on page B15.)

Many portfolio managers are hopeful that Japan can get on a sustainable growth path. But they admit the challenges are so great that Japan could slip back into virtually no growth and deflation.

Inflation also is low in the U.S., with the consumer price index up by only 1.3% in November from a year earlier. That’s not surprising, given downward price pressure from both oil and the decline in import prices resulting from the rising US$. However, if the economy grows at the expected 3% pace, deflation will not be a threat. The only risk is that the U.S. Federal Reserve Board makes a mistake by raising interest rates too soon or too quickly, causing the economy to grind to a halt.

There also isn’t much worry about China. Its economy is slowing, but a 6.5%-7% growth pace will keep it out of deflation.

However, Russia is in recession already because of Western sanctions, and the country is reeling from the plunge in oil prices and a drop in the ruble.

Brazil and Argentina also could face deflationary pressures.

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