The "D" Word

Geez, the cat is finally out of the bag.

No sooner does Federal Reserve Bank of St. Louis President James Bullard utter the word "deflation," then the whole market gets all quivery and queasy. It's as though nobody wants lower prices or even a temporary restraint on runaway excess credit expansion.

Well, here's the news: We've been experiencing deflation - depending on how loosely you wish to interpret the definition - since about August of 2007.

Really? You ask, stunned by not being aware of current financial conditions. Yes, really, since August, 2007, like three years, when stocks began to deflate (or, go down). And real estate prices deflated. Remember when they called residential real estate prices a bubble? What happens when you prick a bubble? It deflates. If there's any indication of deflation, just ask homeowners in vast areas of California, Michigan, Florida or Nevada, where home prices have fallen by as much as 60% or more.

Technically speaking, there are two definitions of deflation, though since economics is more art than science, the two are often blended into one, such as this definition from Investopedia: "A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending."

Over on Wikipedia, deflation is described as. "a decrease in the general price level of goods and services." Pretty simple, and correct, though some economics adherents will insist that deflation is a decrease in the supply of money.

There are very good discussions on both of the above linked references, and each of them makes salient points which overlap and intersect in such a way as to make my argument - that we've been in deflation since August, 2007 - pretty darn accurate.

So, let's take a look at conditions since the summer of 2007, and see how we Americans are doing on the deflation scale. First, we know that houses aren't as expensive as they were back then, so the residential housing market is definitely deflated.

How about other assets, like stocks? Well, the Dow Jones Industrials were tickling the 14,000 mark back then, and are barely able to maintain a level over 10,000 today. Sounds like about a 30% deflation there.

Here's one nobody gets: wages, which haven't generally risen since 2002 and even before that were pretty stagnant. So, if you're an employer, you like deflation - or, at least stagnation - in the price of labor.

As for money supply, it may have been increasing, though according to these charts from Shadowstats.com, the rate of growth of the various popular money supply definitions (M1, M2, etc.) seems to have been slowing, so that would qualify, technically, as "disinflation," not deflation. Hey, I can't be 100% right all the time, no?

And, lest we forget, the Spring and Summer of 2008, when gasoline prices hit upwards of $3 and $4, so, since everything doesn't all go down at once, and some prices actually have gone up (like gold, or silver), I believe it's safe to say that deflation has been the dominant economic theme for the better part of past three years.

If you're unconvinced, just try raising prices on consumer goods and see how quickly your customers will become those of your competitors. Deflation, while it isn't an evil thing (in fact, it's probably preferable to inflation), is not regarded as generally good for businesses, especially the kind whose stocks are traded on Wall Street, who have to keep increasing their profits every quarter, which, when you think about it, is a pretty absurd concept. Most people who own small businesses are fairly happy just making the same profit over and over and never becoming billionaires, just "comfortable."

Deflation really scares the bejesus out of Wall Street types and with god reason. The companies they hype will die in a prolonged deflationary environment.

As for how the markets responded to the dreaded "D" word, the response was rather muted. Being fairly bright people, many traders already know that deflation has already been in effect for some time, and they also don't jump the shark and sell everything on the word of one Fed President, so the markets did a little dip, then rose, then sold off at the close, producing a chart probably more closely related to fears of what the second quarter GDP estimate will be tomorrow morning than anything else.

Dow 10,467.16, -30.72 (0.29%)
NASDAQ 2,251.69, -12.87 (0.57%)
S&P 500 1,101.53, -4.60 (0.42%)
NYSE Composite 6,994.57, -4.61 (0.07%)

Advancing issues barely beat decliners on the day, 3296-3093, and new highs continued to dominate new lows, 280-85. Volume was better than average.

NASDAQ Volume 2,332,617,500
NYSE Volume 5,247,904,500

The forces of deflation seemed to have little effect on commodities. Oil surged $1.37, to $78.36 per barrel. Gold was up $8.10, to $1,170.50 per ounce, with silver gaining 18 cents, to $17.62.

Initial unemployment claims came in slightly lower than the previous week, though still unacceptably high, at 457,000.

The first estimate of second quarter GDP will be announced at 8:30 am on Friday.