NYTimes.com Article: A Sinking Feeling at the Register

Daniel Grisinger daniel@netgods.net
Mon, 20 Jan 2003 02:08:45 -0700

Deflation is a very real possibility in the US, but it isn't
clear (at least at this point) that it will have the negative
effects normally associated with deflationary economies.  Labor
productivity growth has been through the ceiling for several years
and it is showing in the prices that firms have to charge to recoup
their costs.  It isn't clear, though, what effects deflation rooted in
non-monetary causes will on our society.  (Japan doesn't seem like
a good analog because we haven't seen the level of hyperinflation in
the value of real estate that they experienced.)

On the one hand, our deflationary tendencies, rooted in productivity
growth, are leading to a greatly enhanced standard of living for our
citizens. On the other hand, widespread deflation could spread beyond
industries with significant productivity improvements because of the lag
in changing of relative valuations (not all industries will experience
the same rate of productivity growth and it is going to take investors
some time to arrive at even remotely stable new relative valuations).

Anyway, notice the prices comparisons given in the first few paragraphs
of the story and remind yourself that they're reporting *nominal*, not
real, prices of the goods mentioned.  Actual price declines for the
specific categories they look at have been far greater than this
story shows.


A Sinking Feeling at the Register

January 19, 2003

ONE year ago, a 50-inch Hitachi television cost $1,400 at
Circuit City. It costs $1,000 today.

Five years ago, automakers charged $25,500 for the average
new vehicle. They charge about $24,500 today.

A decade ago, a round trip on Delta Air Lines between New
York and San Francisco cost $388 - and it was part of a
sale. Delta now sells the same advance-purchase ticket for

Most stunning is the price path of Burger King's Whopper
sandwich, which cost about $1.40 some 20 years ago, when
the Dow Jones industrial average hovered around 1,000 and
hourly wages were about one-half their current level. This
weekend, a Whopper sells for 99 cents.

Deflation, a sustained decline in prices across the
economy, remains merely a threat, with overall prices still
rising mildly. For some of the nation's largest industries,
though, falling prices are a reality. The costs of cars,
clothing, electronics, furniture, jewelry, kitchen
equipment and toys - indeed, of most manufactured goods -
have been dropping for more than a year, causing turmoil
for companies and their workers. Although airlines and fast
food are among the only industries in the service sector to
be suffering through declines, overall service prices are
rising more slowly than they were two years ago, according
to figures released last week.

"More goods are chasing less money," said Arthur J.
Rolnick, research director at the Federal Reserve Bank of
Minneapolis, "instead of more money chasing fewer goods."

Worried about falling prices, the Fed lowered its benchmark
interest rate again late last year. Officials say deflation
remains unlikely but, because it is so hard to stop once it
starts, they are taking preventive measures.

The lack of pricing power has been forcing executives to
cut costs even as they increase production, and it has
helped to make the current economic recovery a jobless one.
Almost 200,000 jobs were eliminated across the country in
November and December.

The squeeze has also cost some chief executives their jobs,
like Jack M. Greenberg of McDonald's, who resigned last
month, shortly before the company announced its first
quarterly loss since going public 38 years ago. Other
companies, including airlines, automotive suppliers and,
last week, FAO, the toy retailer, have filed for bankruptcy

The biggest culprit is the 1990's bubble that left many
industries with more goods than they could profitably sell
and more capacity than they could use. But the surge of
imports from low-cost countries like China, the rise in
American productivity and the continuing trend toward
deregulation and market-determined prices are all playing

FACED with stagnant revenue, many companies are aggravating
their industries' troubles by further reducing prices to
grab pieces of a shrinking pie.

The weak economic growth of the last year has caused
poultry prices, for example, to drop about 1 percent. Tyson
Foods, the world's biggest seller of chicken, has responded
by offering more promotions to supermarkets, said John
Tyson, the chief executive.

General Motors, the first automaker to offer zero percent
financing after Sept. 11, 2001, expanded its incentives
last month to match the deals offered by Ford Motor, after
G.M. had cut them back in November.

"We go to zero percent, 36 months, then the guys who were
griping about incentives go to 60 months," Rick Wagoner,
G.M.'s chief executive, said in an interview, referring to
competitors. "And guess what? They get big market share,
and we don't."

Now "they're going to have to fight toe to toe," Mr.
Wagoner said.

Even some products in great demand have become less
expensive, as retailers use them to woo customers. Although
Chicken Dance Elmo, a doll based on a "Sesame Street"
character, is dancing its way off shelves, Wal-Mart and
Target still cut its price to $15, from the list price of
$20, said Jim Silver, the publisher of The Toy Book, which
covers the industry. Other sellers followed quickly,
contributing to a 30 percent decline in overall toy prices
since 1996.

Across the economy, inflation is running at an annual rate
of about 1 percent or 2 percent, depending on the
government measure. With the economy still weak, however,
economists and policy makers worry that a deflationary trap
similar to Japan's is now possible, if unlikely.

"There are some well-founded reasons to presume that
deflation is more of a threat to economic growth than is
inflation," Alan Greenspan, the Federal Reserve chairman,
said recently. But, he added, "the United States is nowhere
close to sliding into a pernicious deflation."

So long as an economy's demand for goods remains much below
its capacity to produce them, inflation tends to decline,
and the continuing job cuts suggest that the American
economy is still operating well below capacity. If low
inflation turns into deflation, unemployment can spike,
debts can become unmanageable and, in the most extreme
cases, consumers may hold onto their money, waiting for
prices to fall further.

The Fed, by lowering interest rates and making dollars
effectively less valuable, can typically cause inflation to
rise - unless banks, consumers and businesses hoard their
cash. Even if Fed officials cut their benchmark rate to
zero, they can still print more money to keep prices stable
or rising at a slow clip, they say. "We can always prevent
deflation," Mr. Rolnick said. "There are enough people in
central banks around the world who think it's a bad thing
that they just aren't going to let it happen."

In recent weeks, a few economists have started wondering if
2003 will be the year inflation reasserts itself. Many of
the Fed's interest-rate cuts the last two years are still
washing over the economy, giving people reasons to spend,
while a war with Iraq could bring both a spike in
government spending and a climb in oil prices. The dollar
has also lost some of its value recently, and import prices
will probably rise as a result.

"I don't know if we've reached the inflection point," said
Peter L. Bernstein, an author and economic consultant, "but
my impression is that this phase is coming to an end."

There are still worrisome trends, however, that suggest the
1990's spending binge by consumers and executives has left
a bigger hangover than a typical expansion does. In most
recent downturns, prices in the service sector continued to
rise as fast as they had been, largely because demand for
services like education, medical care and haircuts does not
drop during recessions. Since late 2000, by contrast,
inflation in services has fallen to 1.8 percent annually,
from 3 percent - a sign of weak demand, said Stephen Roach,
the chief economist at Morgan Stanley and probably the most
vocal deflation worrier.

"The good news is that policy is responding," Mr. Roach
said. "The bad news is that there's no guarantee it will

In many industries, the issue is far more than academic.
The battle against runaway inflation in the late 1970's and
early 80's was won, but the victory has created its own

Encouraged by the stability and prosperity of the 90's,
American companies spent billions on new factories,
equipment and software, vastly increasing their ability to
make products. Some service companies helped inflate the
bubble, too.

Combined, McDonald's, Burger King and Wendy's opened 6,100
restaurants from 1994 to 2001, expanding by about a third,
according to Technomic, a research company in Chicago. Many
now compete with one another, as well as with thousands of
new outlets of Starbucks, Subway and other chains that have
lured customers more successfully than the burger chains.

In response, McDonald's and Burger King have waged price
wars, of which the current 99-cent Whopper sale is a part.
Wendy's rarely offers discounts, but its president, Thomas
J. Mueller, said, "We pride ourselves on not increasing our

Manufacturers also face new competition from overseas
because many foreign companies are attracted to the
American market, which they consider the world's
healthiest. Since 1995, in fact, the United States has
accounted for almost two-thirds of global economic growth,
Morgan Stanley says.

In the auto industry, Honda and Toyota began making
hundreds of thousands of sport utility vehicles every year.
Hyundai captured parts of the low end of the vehicle
market. Volkswagen increased its sales here.

To keep factories running and high fixed costs covered,
American companies fought back by offering incentives and
markdowns. Today, those discounts are equal to $3,100 a
vehicle, twice the level of two years ago, according to
Autodata, a research company. A family making the median
income now must use about 20 weeks of pay for a new
vehicle, compared with 29 weeks in 1996, according to
Comerica Bank.

"The competition has basically turned the industry into an
unprofitable one," said David E. Cole, president of the
Center for Automotive Research, a consulting firm in Ann
Arbor, Mich. "The business model is broken."

The shakeout is beginning. Fiat, the Italian car company,
is struggling to stay in business. Ford is planning to cut
billions of dollars in expenses this year.

"It's not a very pretty process," Mr. Cole said. "And it's
not over."

But globalization's contribution to price pressure can also
come wrapped in an American company's label. Since the
double-digit inflation of 25 years ago, Mexico, China and
other low-wage countries have greatly increased their
manufacturing bases. The strong dollar of recent years -
another reflection of the American economy's primacy, even
in a slowdown - has made imports even less expensive.

Imports have helped prices fall 12 percent for men's pants
since 1999 and 10 percent for women's suits, the Labor
Department calculates. Furniture prices are down 4 percent.

Ethan Allen, a chain of 315 furniture stores, made nearly
all its products in the United States in the early 1990's;
now the portion has fallen to 80 percent. Some of its most
expensive products, like a $3,000 bed, are made in
factories in China and the Philippines that have become
much more efficient in recent years, said M. Farooq
Kathwari, Ethan Allen's chief executive.

"That has put a tremendous amount of pressure on prices,"
said Mr. Kathwari, who announced some price cuts late last
year. "In the next year or couple of years, I don't see
much chance of increasing prices."

Since 2000, Ethan Allen, based in Danbury, Conn., has also
cut its work force about 5 percent, to 10,000, while its
sales have risen slightly. It operates 17 factories,
compared with 27 a decade ago.

Elsewhere, a slow unwinding of government regulation has
laid the groundwork for price declines. The federal
government stopped setting airline fares in 1978, for
instance, but low-fare airlines have only recently
established their presence in almost every region of the
country. Their success has kept fares flat since 1990, and
it played a crucial role in the bankruptcy filings last
year by United Airlines and US Airways.

The rise in productivity in the last decade has also helped
bring down inflation. With new technology, new management
techniques and an increasingly educated work force,
American companies can make more goods than they did in the
past while using the same amount of labor. G.M. made a
profit in its most recent quarter, despite its discounts,
partly by becoming more efficient.

In some previous eras of high productivity, like the late
1800's, deflation and economic growth coexisted as
companies and workers split the spoils of their efficiency.
The technology sector benefited from a similar virtuous
cycle in the 1990's.

Today's wave of price cutting - stemming mainly from
economic weakness - continues to bring benefits for
consumers, but there is little that is virtuous about it
for companies caught in its vise.  


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