Debate Over Deflation

Markets fret over early signs of deflation in the US, but the government is expected to launch more programmes to stimulate consumer spending

SHOPPERS love nothing more than a sale when prices are marked down for a season. They will always welcome an extended season of sale.

So, why did Wall Street swoon on Wednesday after the US labour department said prices of consumer goods fell 1% last month?

It’s odd that in mixed economies, shoppers can’t have a prolonged period of sale. If there is a sustained decline in the prices of consumer goods, profits of manufacturers will also decline or even turn into losses.

The companies will not expand their plants and hire more workers. They may even close some of their plants.

This works in the same way as a prolonged period of decline in commodity prices when some mines will be closed or farms abandoned.

Just a few years ago, there was fear of deflation caused by excess manufacturing capacity and labour in China.

This time, just a few months ago, the world felt the impact of high inflation. Now, economists and investors are worried over the risk of deflation.

To some extent, this sudden turn of events is due to the volatile commodity prices.

As consumer prices surged just a few months ago, it’s not surprising that those prices have fallen back as commodity prices retreated. Hence, the 1% decline in US consumer prices last month comprised 0.9% from food and energy prices that fell back, and 0.1% from discretionary goods like clothes and cars.

Notwithstanding that, deflation is associated with contraction of credit and consumer spending, which are the conditions in the US now. It would aggravate recessionary conditions.

Hence, the government will continue to launch stimulus programmes to reverse that.

Deflated CPO price

Current crude palm oil (CPO) prices have fallen back to the 2006 level of around RM1,450 a tonne, having toppled from an average of RM3,500 between April and June.

This, together with the sharply lower crude oil prices, will be a drag on nominal gross domestic product (GDP) which measures the country’s output of finished goods and services at current prices.

There would be a sharply lower growth rate than real GDP which is the figure reported by the media. Real GDP in Malaysia measures output at constant 2000 prices.

In 1986, for instance, real GDP showed a marginal growth rate of 1.1% but nominal GDP was a severe contraction of minus 7.6% due to a collapse in commodity prices.

While crude oil is by far the country’s largest export commodity, lower CPO prices have a greater impact on income levels as far more people are engaged in the cultivation of oil palm.

Rural income is sharply lower now for both planters and those in small towns where the main economic activity in the neighbourhood is centred on oil palm.

Mid-sized public listed plantations could also be struggling to turn a profit for those that have high all-in costs, analysts wrote in their reports last week.

Deflated US values

There is rough justice that the market values of iconic American companies have been crushed, if not annihilated altogether in some cases. The greed of American bankers have, after all, greatly aggravated the effects of a cyclical housing downturn.

While the distressing effects of the US recession have reverberated around the world, the blow to the market values of American companies has been far greater than their better managed Asian competitors.

A comparison of the market values of American companies with their peers in Asia should be an embarrassment to the inept, but more highly paid, American CEOs.

The market capitalisation of Industrial & Commercial Bank of China, for instance, is three times that of Bank of America.

The market value of Citigroup has fallen so much that it is almost equalled by the combined market values of the Big Three banks of tiny Singapore.

In the automotive sector, the equally besieged General Motors (GM) is surpassed in market value by little known Dongfeng Motor that operates in China and is listed in Hong Kong, and which is not even among the top 10 Asian car companies.

South Korea has reason to be proud of its Hyundai Motor Company which has a market value larger than the combined market values of Ford Motor Company and GM.

China’s Shanghai Automotive Ind-ustry Corp (SAIC), listed in Shanghai, is also larger than the combined market values of Ford and GM.

This recession could mark a milestone in the long term position of the US, the world’s biggest economy, as it weakens relative to Asia.

sources: The Star Business