Consumer prices

Just last summer consumers and economists were bemoaning high inflation, especially in energy, with crude oil touching its historic $147 per barrel level in July and soaring prices in other commodity markets as well.

Now, the situation has flipped 180 degrees toward deflation, with weak consumer demand forcing discounting at a variety of retailers. December 2008’s “headline” (overall) CPI number revealed a 0.7-percent decline, while the core rate, which excludes food and energy, was steady.

“We have extremely weak economic conditions, and if you have no demand for goods and services, you will have falling prices,” says Asha Bangalore, economist at the Northern Trust Co.

However, only four of 45 economists in the BusinessWeek survey predicted a negative 2009 consumer price index (CPI) number. The forecasts range on the high side from 3.3 percent from Richard Yamarone of Argus Research to a low side of -0.7 percent by Kurt Karl of global reinsurer Swiss Re.

Most economists are calling the current cycle disinflationary, not deflationary, which can be characterized as distinguishing between temporary and long-term price contraction.

“You have to distinguish between temporary discounting as retailers try to get things off their shelves, and lower prices because there is pressure on prices,” explains David Wyss, chief economist at Standard & Poor’s.

Ken Goldstein, economist at the Conference Board in New York, believes deflation in the U.S. simply “isn’t in the cards.” In regard to the current retail environment, he says, “Stores are discounting by 40 percent, 50 percent, 70 percent — that’s not deflation; it’s discounting. The difference is the store is doing it in order to move merchandise. They just want to be rid of it, knowing they aren’t going to make any money on it.”

Goldstein points to food, clothing, housing, and transportation, which comprise 70-75 percent of the CPI.

“You can find discounting on a large flat screen TV, but you and I cannot go to the bank or landlord and say we are going to pay you 20 percent less each month for rent or mortgage,” he says.

Similarly, medical costs have not declined.

According to Credit Suisse economist Jonathan Basile , most of the disinflation occurring now is coming from discretionary items, such as airfare, hotel rates, electronics, and home furnishings. December 2008’s 3-percent drop year-over-year in the durable goods category of CPI was the lowest reading in four years. That contrasts to August 2008’s -1.1 percent reading.

Retail sales readings have been negative for months. Basile defined three major ways a consumer can spend: past income (savings and stock holdings), which is lower; current income, which is down because of smaller paychecks and rising unemployment; future income or borrowing, which is also down because of tighter credit markets.

“There are headwinds for every possible way a consumer can spend,” he says.

Economists warn that headline CPI numbers in 2009 could be negative, while the core CPI rate, which excludes food and energy, will remain in positive territory. That will be in part because of the year-over-year comparisons in the data. For example, thirdquarter 2008 posted a positive 5.3-percent spike in the overall CPI in part because of surging gasoline prices, while Credit Suisse forecasts a negative 2.0 percent decline in CPI for the third quarter 2009. Because the rates are measured as a year-over-year rate, the plunge in gasoline prices will tug down the data.

“Gas price comparisons will generate negative signs on a year-over-year rate,” Basile says.

However, Credit Suisse forecasts an increase of 0.9 percent in the headline CPI reading for the fourth quarter on a year-over-year basis and an increase of 1.3 percent in the core rate, which excludes food and energy. By year-end, the readings should all be in positive territory, according to Credit Suisse.

Having reviewed the current situation in the U.S., let’s see how it compares to the Japanese collapse-and-contract scenario.