Good Deflation, Bad Deflation

dollars getting shorter indicating deflation

Photo composition by Thursday Review

Good Deflation, Bad Deflation
| published January 28, 2015 |

By Thursday Review staff


If we told you that prices are going down across the board—and never mind the fact that six months ago we warned you that all prices were going up, up, up, thanks to Polar Vortex and drought—you would almost automatically assume that falling prices are a good thing. It’s an intuitive reaction.

But the fact is, there’s good deflation and bad deflation. No, we are not referring to Tom Brady and the New England Patriots—the accusation that the Pats may have been somehow systematically deflating game balls to give them an offensive advantage. Besides, we’ll hear more about that as the hours and minutes tick off prior to the Super Bowl, when Seattle meets New England and the real inflation is the rate advertisers pay for 30- and 60- second ads during the game.

Football jokes aside, bad deflation is when no one wants to buy products—or no one can afford products—and manufacturers and retailers are forced to lower prices so far that they undercut profitability. The end result of too much of that kind of deflation: lost jobs, layoffs, factory shutdowns, retail closures, economic contraction. This kind of deflation can occur when there are lots of unemployed, or underemployed, or both. Many countries in Europe, still struggling to emerge from the Great Recession, are experiencing this kind of deflation.

Good deflation is defined as when production and demand come into such sweet harmony that it produces a self-generating cycle: prices drop, which means people have more disposable income; more disposable income means people will make more purchases; more purchasing means more retail demand and more factory orders, which means more people get hired; an increase in hiring will eventually put positive pressure on employers to raise wages and boost benefits, all of which puts more money into people’s pockets. So forth and so on.

Despite last year’s widespread and consistent prognostications that Americans would be paying a lot more for the everyday things—coffee, milk, food, energy—very little of that inflation has come to fruition. Why? The reason most often cited by economist: falling oil prices and a glut of oil and energy reserves.

Oil and gas prices, for those who have been asleep since last September, have been falling. The reasons are many, but the core causes include some—or all—of the following: robust overproduction by Saudi Arabia and a few of its partner nations; high levels of production from other OPEC countries such as Iraq and Iran, now caught in a kind of death match over how much oil they can produce; heavy energy output by Russia, which is seeking to offset serious economic problems wrought by U.S. and EU sanctions; and better-than-expected levels of output by U.S. and Canadian shale oil, which has given the U.S. markets much to celebrate.

And there are other reasons sometimes cited: increased output by Canada, coupled with better and faster distribution (thanks to the partially completed Keystone XL Pipeline); more efficient forms of extraction in the Gulf of Mexico; and even better computer and software technologies for the distribution of oil, whether crude or refined. In short technology is creating efficiencies never before available for distribution. Lastly, the future is arriving now: Americans are using measurably less gasoline thanks to stricter fuel efficiency standards and better emissions guidelines; and more vehicles on the road which use little, if any, fossil fuel. Hybrids and alternative energy cars are common, and sales of battery powered cars are beginning to reach the tipping point where demand will rise faster than supply. Tesla has nearly completed its network of charging stations across North America, and soon Tesla’s competitors may flood the market with even cheaper alt energy vehicles. A few technologists have even suggested that we can thank Google Earth and the wide variety of vehicular GPS systems for saving energy, as less time is spent driving aimlessly and pointlessly.

All fine and good, expect that what has all of that to do with the price of squash or the cost of a new Blu-ray player? Because when oil prices fall this dramatically, so to do the myriad of interlocking processes which get both squash and Blu-ray players to market. Transportation costs drop, shipping prices get competitive, and retailers spend less money lighting, heating, and cooling stores. The multiplier effect becomes obvious when one looks at how much money businesses and retailers spend on energy-related tasks and costs, and this applies even to online-only operations like Amazon. When oil prices drop as dramatically as what we’ve seen since last summer, the trickle-down effect can be a powerful engine.

Even with California’s sustained and unprecedented drought, consumers have not seen the staggering price increases so often predicted through most of last year. Oil prices have mitigated much of the marketplace damage by making it cheaper to transport those same products—milk, lettuce, strawberries, oranges, lemons, tomatoes, grapes—from other states or other countries. And despite all those grim warnings we saw last year (yes, we printed a few of them here), many other sectors did not experience the kind of inflation widely expected. In fact, the core measures of inflation did not change at all between late October and the end of December 2014. More importantly, some areas of the economy have seen prices fall slightly in an orderly way, including clothing and shoes, appliances, and—most shockingly of all—airline fees, an industry not prone to casual rate decreases even when aviation fuel costs drop.

Economists are in general agreement that as long as the current spate of deflation does not spawn setbacks in other areas—i.e., by triggering factory shutdowns or forcing producers to sell products at prices lower than the cost of production—American consumers will continue to benefit from the widespread effect of low oil and gas prices.

On the other hand, a few economists are wary of establishing any long-term view based on today’s falling energy prices. They point to a wave of speculation by investors and risk-takers (among them Royal Dutch Shell and the billionaire Koch Brothers) who are buying, renting or leasing massive tankers for the purposes of floating oil storage. What’s the angle? Simple: a hedge against what these investors see as the inevitable surge in oil prices, possibly late this year or no later than early 2016. Once crude prices start to climb—and in the wake of the passing of Saudi Arabia’s King Abdullah, who’s to say when that could start—these oil hoarders could easily double their investment.

In the meantime, the U.S. economy will continue to reap the benefits of low-cost energy, and its myriad examples of positive market spin.

Related Thursday Review articles:

Oil, Debt, & Venezuela on the Brink; R. Alan Clanton; Thursday Review; January 9, 2015.

U.S. Consumer Confidence Rising; Thursday Review staff; Thursday Review; December 30, 2014.