in oil prices in the past several months so that the
price is roughly one-third of where it stood a few
brief months ago. Was the high price of oil too high?
Clearly it was, and speculative forces were at play in
various ways that have yet to be fully determined.
Nonetheless, while we may be thrilled with lower
prices at the gas pump, it comes at the much more
significant cost of an economic recession and lowered stock prices. Several of my friends and clients
now refer to their “201(k)s” rather than 401(k)s.
The U.S. Treasury recently sold $27 billion in
three-month bills at the lowest rate since it started
auctioning securities in 1929. The discount rate
offered was 0.005 percent and $27 million in six-month bills were sold at a discount rate of 0.30
percent. We also saw bills being sold with negative
interest rates as of December 9 as investors are
flocking to safety like never before.
John Canavan, a fixed-income analyst in Princeton, New Jersey, summed it up as follows: “There
are also deflationary concerns … although we are
at a near-zero yield, if you are expecting a deflationary environment over the next few months, then the
real return is a little bit better.”
2
Internationally, we are seeing almost all central
banks such as Canada’s cut their lending rates between banks to 50-year lows to free up liquidity and
promote economic growth.
The United States Present Versus
the Japanese Past
If deflation were to oc-
cur, let us first look
at a recent example
and compare and
contrast some of
the events, demo-
graphics, and eco-
nomic actions that
took place to gain
insight into our own
situation.
Consumer debt in
the United States is deep
while in Japan, people save
money rather than take on debt.
Furthermore, according to figures from the U.S.
Bureau of Economic Analysis, since 2005 the personal savings rate average in the United States has
been less than 1 percent. Most significantly, in 2005
the U.S. savings rate hit negative figures for the first
time since 1933. Nonetheless, in October 2008, the
rate spiked upward to 2. 7 percent, so it did appear
that consumers were saving instead of spending, but
one can assume this was due largely to fear and economic uncertainty.
The Japanese personal savings rate is much
higher than the U.S rate. Part of the reason for this
is that minimum down payments on large-ticket
items such as homes have been around 25 percent
or higher in Japan while in the United States, as we
know, many consumers purchased homes with no
down payment.
High consumer debt poses a number of significant risks for the U. S. economy. Not all consumer
debt will be repaid; rising unemployment will lead
to record mortgage- and credit-related problems in
the next year or so. The question is to what degree
consumers would have to default on debt to precipitate a downward spiral in prices. Late in 2008, most
analysts would say that we are not there yet.
According to Shawn M. Narancich, CFA and
vice president of research at Ferguson Wellman Capital Management in Portland, Oregon,
We still have inflation in the economy, so what
we’re going through now is disinflation, or a decrease in the inflation rate. That said, clearly our
central bank is fighting the possibility of a pro-longed/deep recession which, if it occurs, could
result in deflation. The difference between us
and Japan in the 1990s is the quicker and more
dramatic policy response from our central bank,
coupled with the expectation for meaningful
fiscal stimulus. In my opinion, this combination
will preclude the kind of deflationary spiral that
engulfed Japan for much of the past 15 years.
Mr. Narancich is correct. As of October 2008,
the annual rate of inflation was still 3.66 percent.
Nonetheless, the rate of inflation appears to be declining and the Federal Reserve Board has continued
to reduce the federal funds rate. Chairman Bernanke
has not ruled out further Fed fund rate cuts.
From 1999 until July 2006, the Japanese Central
Bank kept its key interest rate at zero percent. This is
known as a quantitative easing policy.
Consumption in Japan continued in a time of
slow economic growth because consumers had significant disposable savings; Americans, who do not have
such deep savings pockets, will be forced to cut back
significantly on spending and focus on paying off debt.
