Investors brace for risk of deflation

Investors are constantly reminded to think about inflation when making decisions about their money.

Now there's a new wrinkle: the possibility of deflation.

We've already had severe deflation -- falling prices -- in housing, stocks and commodities this year.

The question is whether that could spill into prices of goods and services across the board, as well as into wages, as the economy worsens.

If you knew a serious deflation was coming, there are at least a few things you'd want to do with your portfolio and your finances.

On the assumption that interest rates would continue to fall, you'd want to lock in yields on high-quality bonds or bank savings certificates.

You'd also want to avoid borrowing, because debt becomes more onerous in a deflationary world.

And in the stock market, you'd want to stay away from shares of companies that have high debt loads or that have little or no pricing power with their products or services.

Hmm . . . all of that sounds like what a lot of investors already have been doing, doesn't it?

Most economists, however, don't buy the idea that the U.S. could fall into an extended period of actual deflation. That conjures images of the Great Depression, or Japan from 1995 to 2005.

Although the U.S. is surely headed for a painful recession, there still is a widely held view that we're not on the verge of economic calamity -- despite the dive in financial markets.

On Friday, the government reported that its employment cost index, which measures the growth of wages and benefits in the economy, was up 2.9% in the third quarter from a year earlier.

That's seeing the economy in the rear-view mirror, to be sure, but it shows that incomes were holding up.

If you use the consumer price index as a benchmark, it shows that inflation overall has been easing in recent months but remains at the highest level in many years.

The CPI in September was unchanged from August, after seasonal adjustment. And compared with a year ago the index was 4.9% higher -- mainly because of the surge in energy prices that began last fall.

But it's virtually certain that inflation will be coming down over the next six to 12 months, for two reasons.

First, we all know what has happened with oil prices. Crude has fallen by more than half from its July peak, to $67.81 a barrel now. Prices of other commodities also have slid.