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We all want a deal -- that's what's scary

Despite signs of recovery, some see deflation looming

September 05, 2009|TOM PETRUNO

When a 20-something friend of mine recently told me she was looking for an apartment to rent in Los Angeles, I had only one bit of advice for her: Don't accept any advertised rent -- haggle with the landlord to get the price down, and demand concessions on anything and everything.

The housing crash and the recession have made this a renter's market. The cost of apartments and homes for rent can only decline. Just look at the number of "for lease" signs in every L.A. neighborhood.

This is deflation in action: falling prices that are, in effect, a transfer of wealth from landlords, goods producers and retailers to consumers.

If you're employed, price deflation can be a boon, of course. What's not to like about spending less?

Maybe this: The risk is that the new national frugality fueled by the recession could portend a true deflation -- a broad and persistent drop in prices that would be debilitating for the economy, leading to falling wages, an even weaker job market and another steep slide in the value of homes, stocks and other assets.

Commercial real estate is expected to be the next bomb to go off in the portfolios of banks already reeling from defaults on single-family home loans. Many of those same apartment landlords who are feeling the squeeze from potential tenants like my friend have debt they must service. If rents collapse, banks will be getting more keys in the mail.

Deflation fears deepened last winter as the economy worsened and the stock market crumbled. Since March, however, those worries have seemed to abate as the housing market has stabilized, stocks have rebounded and more signs have emerged that the recession was ending.

But in recent weeks I've heard more chatter on Wall Street about deflation, including from some unlikely sources.

This week, Federal Reserve Bank of Dallas President Richard Fisher -- long one of the Fed's loudest voices on the threat of inflation -- had a much different message in a speech at UC Santa Barbara.

"For the immediate future," Fisher said, "the risk to price stability is a deflationary risk, not an inflationary one."

The Fed's benchmark measure of inflation is the so-called personal consumption expenditures price index, which for various reasons the central bank has come to favor over the consumer price index.

In July, Fisher said, nearly 50% of the items in the PCE basket of goods and services were falling in price, even as the gloom over the economy was supposed to be lifting.

Many businesses, he said, "are operating in the shadow of the absence of pricing power."

The government's report Friday on August employment shows why that's still so, despite other improving economic data: The U.S. suffered a net loss of 216,000 jobs last month. Although that was the smallest decline since August 2008, the unemployment rate rose to a 26-year high of 9.7%, from 9.4% in July, as more people looked for work while jobs remained scarce.

For some Americans, frugality has always been a necessity. Now it has been forced on millions more who've lost their jobs, taken pay cuts or fear being laid off.

Southern California has become a laboratory of deflation causes and effects. The first cause was the plunge in home prices that has wiped out massive amounts of wealth since 2006 and sent mortgage defaults soaring.

Then came severe job losses that have pushed Southland jobless rates well above the national average, to 11.9% in Los Angeles County and 14.3% in the Inland Empire.

Little wonder, then, that Ralphs and Vons, two of the region's biggest grocery chains, this week launched a new round of price cuts to try to lure penny-pinching shoppers. As my colleague Jerry Hirsch noted in his story on the grocers, they're reacting in part to the threat from discounters including Wal-Mart.

For consumers, discounting wars obviously are welcome at a time like this. What the Fed worries about is a deflationary mind-set taking hold that could rival the one that crippled Japan's economy in the late-1990s, after its real estate and stock bubbles burst.

If Americans begin to believe that prices will only get cheaper, they can make that self-fulfilling by holding back on consumption, even if they're able to spend. That may lead to lower prices -- but at the cost of more jobs and lower wages as firms respond in kind to price pressures.

That's the deflationary spiral Fed policymakers are desperate to avoid, because once it starts it's so difficult to halt, as Japan showed.

Most economists still believe the U.S. will escape a sustained deflation. "With even a modest recovery you will lessen the risk of deepening deflation," said Gary Schlossberg, a senior economist at Wells Capital Management in San Francisco.

The consumer price index was down 2.1% in the 12 months through July, suggesting deflation already is underway. But excluding energy and food prices, the "core" price index was up 1.5%.

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