Those who hate anything big and global will hate this axis, too. Those who embrace free markets will celebrate the cutthroats, since they contributed mightily to a spectacular rise of productivity in the 1990s and helped smother inflation. Now, however, no big national economy is strong, all too many factories are underemployed, and one has to wonder whether price pressures are heightening the opposite risk: deflation. The United States, which has been haunted by the nightmare of deflation since its stock and Internet bubbles started popping in early 2000, is particularly vulnerable now that growth has slowed; core inflation is less than 2 percent. Cary Leahey, a Deutsche Bank economist in New York, gives deflation a 1-in-20 chance of striking the United States, up from 1-in-50 in 2001. “You could build a case for deflation as the dark side of the productivity miracle,” he warns.
The D-word is now a watchword. The U.S. Federal Reserve has been eyeing Japan, which has been subject to the wealth-destroying effect of deflation since its stock and real estate markets crashed in the early 1990s, and Fed governors have made clear their commitment to stave off a similar scenario in America. But competition in the global economy is now so intense that companies are rapidly losing the power to raise prices. Overall, prices in department and discount stores have been falling for six years, and the price of clothing in the States fell 3 percent in February from the previous year–thanks largely, analysts say, to the Wal-Mart effect. That’s changing consumer expectations. “We have to move to more global buying to get huge cost savings,” says the economist for a giant European multinational. “Consumers believe a price is just a starting point.”
The Fed has learned to control the boom-bust swings seen in the 1970s and 1980s, but that’s why inflation rates sail closer to zero. That leaves less of a margin for error in the case of a downturn, like the one we’re in now. The outlook for inflation is lower than when companies borrowed to expand in the 1990s, which means it will be more expensive to repay than they had expected. This is why Moody’s has been downgrading the credit of so many big companies, says John Lonski, chief economist at the credit-rating agency. “I don’t want to see inflation go any lower,” says Lonski. “The risk of price deflation in the U.S. economy is greater than at any time since at least 1950.”
There aren’t many people who remember the pain of deflation, since it last struck worldwide during the 1930s. In the roaring –’ 90s, everyone outside Japan forgot that prices can swing dangerously in either direction. At the same time, the Web was making price information available to shoppers everywhere, and now everyone from airlines to hotels and car companies are setting up their own discount Web sites to compete with the online middlemen. Car buyers can easily scan all available discounts from any or all manufacturers. Even home buyers cruise the Web for the best deals in mortgages and available properties. The lag between the introduction of a new gizmo and the collapse of its price is getting shorter and shorter. During the boom, rising volume made up for falling prices. But when the U.S. dipped into recession in 2001, the specter of “deflation” re-entered the global economic lexicon.
The pressure grows with every new offensive from Wal-Mart. The retailer has expanded from its home base in Arkansas to more than 4,400 stores in 10 countries, and from general merchandise to food and gasoline. It squeezes discounts out of its 30,000 suppliers, who squeeze their suppliers, and so on around the world. The discount ripple effect travels at light speed over Wal-Mart’s private satellite communication network, the largest system of its kind in the world, forcing rival stores to respond, too. With $247 billion in sales, Wal-Mart is already the world’s largest company by $60 billion, and it aims to double in size by 2008, even as the retail market is set to grow just 25 percent. It is now experimenting with car sales and financial services, and opening new stores in Europe, Japan and China. “Everybody’s going to be faced with Wal-Mart before long,” says Ira Kalish of Retail Forward consultants.
China is also putting relentless downward pressure on prices. In some cases, companies trying to stay ahead of competition from China wind up making up big investments that only add to a glut of factory capacity. Tatha Ghose of Dresdner Kleinwort Wasserstein figures cheap exports from China can lower the inflation rate of importing countries by half a point or so–a significant drop when inflation is only a few points.
The world may never fall below zero into the deflation red zone, but the threat will remain until growth picks up. “For the next two or three decades it may seem like all everyone talks about is deflation,” says Paul Donovan, global economist with UBS Warburg, who puts the probability of global deflation at 15 percent, and of inflation at 20 percent. “Now we have to guard against both.” Don’t be surprised, then, if the next “Coalition of the Willing” is made up of central bankers.
