Back in the good old days, when oil was racing from $50 to $150, the optimists would explain away inflation by saying energy costs should be ignored and we should focus on core. Now prices are falling fast — deflation — and once again the pollyannas might be tempted to explain it all away by the drop in food and energy costs. Today’s PPI data showed a jaw-clenching drop of 2.8%, but core was up .4%, so the optimists have that thread to hang on right?
Peter Cohan at BloggingStocks says no:
Today’s wholesale price report is a doozy. The Producer Price Index (PPI) fell 2.8% in October — much more than the 1.8% decline economists had anticipated. The PPI decline was fuelled (pun intended) by a 12.8% decline in energy prices in October. And as long as those energy prices keep falling, inflation will be in full downswing mode. (I am happy to report that I won my bet that gasoline would drop below $1.99 a gallon in Eastern Massachusetts by February — I went to a station Sunday that charged $1.97.) But there’s more to it than simply declining oil prices. The entire economy was producing goods and services based on an assumption about demand that depended on easy access to debt. By shutting off the debt flow, goods are simply too expensive for consumers and businesses to pay the price. This means businesses will cut back on production and slash prices to clear their shelves of inventory. Then they’ll shut down factories and lay off workers. And the lower demand from those poorer former workers will start the cycle anew.
This won’t be hard to settle. The logic sounds right, because it’s hard to imagine anyone having pricing power in this economy. But right now oil is still the big piece of the downturn. When that starts to abate, but prices continue to fall, the deflation question should be put to rest.
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