BY GARETH MORGAN
US deflation is supply-side deflation a.k.a. “good” deflation. Japanese and German deflation is demand-side deflation and is bad, bad, bad. What’s that mean for the world? In the US the supply of goods and services (GDP) continues to rise apace and at a faster rate than the rise in jobs. So this productivity-fuelled deflation means consumers get more products and at cheaper prices – they are better off.
In Japan and Germany however, consumers are so insecure in their jobs that they no longer rush out to spend their incomes, fearing they are only a few pay cheques away from their last. The crimping of demand cause firms to produce less and in the end, sack workers. Without a rejuvenation of demand we can expect prices to continue to fall as producers desperately try to move inventories from their shelves.
Can good turn bad? Absolutely – in the US that would occur as soon as production ended up in unsold inventories. The so-called job-less recovery in that economy would then turn out to be no recovery at all. What might turn off the demand from consumers? If goods are cheaper obviously that encourages rather than discourages people to buy them. The bugbear that lurks though is the same one that now has Germany and Japan households firmly in its grip, namely job insecurity.
To the extent that the cheaper products America is making, do not stimulate spending sufficiently to restore the profit lines of its businesses, then the world’s largest economy with a quarter of its production facilities lying idle already, will have little choice but to close capacity down. And that means greater job losses.
US consumer confidence is way down and the job market is weak. Yet spending in the stores is strong and the housing market buoyant. Reconciling all this tells us something.
The number of jobs in US manufacturing is now down to where it was in 1964. Yet manufacturing production is three times what it was back then, productivity – that harbinger of “good” deflation – being the cause. And productivity is still rising quickly in the US, freeing up more and more people for work elsewhere, namely in the services sector. A flexible labour market would see those people quickly re-deployed. The challenge of falling prices requiring falling wages in order for the less productive firms to remain competitive, is a challenge Germany for example cannot meet. In the face of cheap products coming in from elsewhere it has no choice but to sack people – similarly in Japan.
The US so far has avoided this dilemma, but ongoing productivity gains plus the influence of cheaper goods from abroad make for a toughening outlook for jobs. And as job security gets undermined, good deflation can quickly turn to bad.
Of course how it’s all supposed to work out well in the end, is that the incomes of those producing cheaply rise in line with their boom in sales, and they then spend that income on the products others make. So in the context of globalisation we would expect the Chinese consumer for instance, to be emerging as a major force in world markets. And it’s happening, although not to the extent it could. The reason is that China has adopted the Japanese formula for growth – it encourages exports through a cheap currency and then sterilises the impact of the greater income by enticing consumers to save. This is achieved by issuing Chinese government bonds to those repatriating US dollars. Its foreign reserves have soared, while its domestic economy has not seen the full impact from the foreign earnings scored. Absolutely the same Japanese miracle we saw last for 30 years in Japan.
How does the US consumer do it – keep spending at the shops when all around them there is retrenchment, not just abroad but within its own nation’s factories? The fillip of course has been tapping the increased wealth in their properties. As house prices have risen and interest rates dropped, taking out bigger mortgages at lower rates has enabled them to keep on spending. We all sit and hope the US consumer will keep world growth at least modestly bubbling. Certainly their counterparts in Germany, Japan and China aren’t playing their part, so this is why the consumer confidence and job prospects of Americans are so vital.
Now in the US, big tax cuts are nigh so even though fewer are in work, those who are will have more to spend. The hopes of the world are on this being the lightning rod for a rejuvenation of US business spending – but don’t hold your breath. As Federal Reserve Chairman Greenspan has said – we also need to take out insurance via keeping interest rates very low as well.
For the global economy in fact let’s hope sloppy fiscal and monetary policy in the US works. If not good deflation will turn bad all round.