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<DIV class=timestamp>November 1, 2008</DIV>
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<H1><NYT_HEADLINE type=" " version="1.0">Fear of Deflation Lurks as Global
Demand Drops </NYT_HEADLINE></H1><NYT_BYLINE type=" " version="1.0">
<DIV class=byline>By <A title="More Articles by Peter S. Goodman"
href="http://topics.nytimes.com/top/reference/timestopics/people/g/peter_s_goodman/index.html?inline=nyt-per">PETER
S. GOODMAN</A></DIV></NYT_BYLINE><NYT_TEXT>
<DIV id=articleBody>
<P>As dozens of countries slip deeper into financial distress, a new threat may
be gathering force within the American economy — the prospect that goods will
pile up waiting for buyers and prices will fall, suffocating fresh investment
and worsening joblessness for months or even years. </P>
<P>The word for this is deflation, or declining prices, a term that gives
economists chills. </P>
<P>Deflation accompanied the Depression of the 1930s. Persistently falling
prices also were at the heart of Japan’s so-called lost decade after the
catastrophic collapse of its real estate bubble at the end of the 1980s — a
period in which some experts now find parallels to the American predicament.</P>
<P>“That certainly is the snapshot of the risk I see,” said Robert J. Barbera,
chief economist at the research and trading firm ITG. “It is the crisis we
face.”</P>
<P>With economies around the globe weakening, demand for oil, copper, grains and
other commodities has diminished, bringing down prices of these raw materials.
But prices have yet to decline noticeably for most goods and services, with one
conspicuous exception — houses. Still, reduced demand is beginning to soften
prices for a few products, like furniture and bedding, which are down slightly
since the beginning of 2007, according to government data. Prices are also
falling for some appliances, tools and hardware.</P>
<P>Only a few months ago, American policy makers were worried about the reverse
problem — rising prices, or inflation — as then-soaring costs for oil and food
filtered through the economy. In July, average prices were 5.6 percent higher
than a year earlier — the fastest pace of inflation since 1991. But by the end
of September, annual inflation had dipped to 4.9 percent and was widely expected
to go lower. </P>
<P>The new worry is that in the worst case, the end of inflation may be the
beginning of something malevolent: a long, slow retrenchment in which consumers
and businesses worldwide lose the wherewithal to buy, sending prices down for
many goods. Though still considered unlikely, that would prompt businesses to
slow production and accelerate layoffs, taking more paychecks out of the economy
and further weakening demand. </P>
<P>The danger of this is the difficulty of a cure. Policy makers can generally
choke off inflation by raising interest rates, dampening economic activity and
reducing demand for goods. But as Japan discovered, an economy may remain
ensnared by deflation for many years, even when interest rates are dropped to
zero: falling prices make companies reluctant to invest even when credit is
free. </P>
<P>Through much of the 1990s, prices for property and many goods kept falling in
Japan. As layoffs increased and purchasing power declined, prices fell lower
still, in a downward spiral of diminishing fortunes. Some fear the American
economy could be sinking toward a similar fate, if a recession is deep and
prolonged, as consumers lose spending power just as much of Europe, Asia and
Latin America succumb to a slowdown. </P>
<P>“That’s a meaningful risk at this point,” said Nouriel Roubini, an economist
at <A title="More articles about New York University."
href="http://topics.nytimes.com/top/reference/timestopics/organizations/n/new_york_university/index.html?inline=nyt-org">New
York University</A>’s Stern School of Business, who forecast the <A
title="More articles about the credit crisis."
href="http://topics.nytimes.com/top/reference/timestopics/subjects/c/credit_crisis/index.html?inline=nyt-classifier">financial
crisis</A> well in advance and has been warning of deflation for months. “We
could get into a vicious circle of deepening malaise.” </P>
<P>Most economists — Mr. Roubini and Mr. Barbera included — say American policy
makers have tools to avert the sort of deflationary black hole that captured
Japan. Deflation fears last broke out in the United States in 2003, but the <A
title="More articles about the Federal Reserve System."
href="http://topics.nytimes.com/top/reference/timestopics/organizations/f/federal_reserve_system/index.html?inline=nyt-org">Federal
Reserve</A> defeated the menace with low interest rates that kept the economy
growing. This time, the Fed is again being aggressive, dropping its target rate
to 1 percent this week. And the government’s various bailout plans have also
pumped money into the economy. </P>
<P>“If you print enough money, you can create inflation,” said Kenneth S.
Rogoff, a former chief economist at the <A
title="More articles about the International Monetary Fund."
href="http://topics.nytimes.com/top/reference/timestopics/organizations/i/international_monetary_fund/index.html?inline=nyt-org">International
Monetary Fund</A> and now a professor at Harvard. </P>
<P>But even as American authorities unleash credit, the threat has intensified.
Not since the Depression have so many countries faced so much trouble at once.
The financial crisis has gone global, like a virus mutating in the face of every
experimental cure. From South Korea to Iceland to Brazil, the pandemic has
spread, bringing with it a tightening of credit that has starved even healthy
companies of finance. </P>
<P>“We’re entering a really fierce global recession,” Mr. Rogoff said. “A
significant financial crisis has been allowed to morph into a full-fledged
global panic. It’s a very dangerous situation. The danger is that instead of
having a few bad years, we’ll have another lost decade.”</P>
<P>Global economic growth has flourished in recent years, much of it fertilized
with borrowed investment. This raised kingdoms of houses in Florida and
California, steel mills in Ukraine, slaughterhouses in Brazil and shopping malls
in Turkey.</P>
<P>That tide is now moving in reverse. Banks and other financial institutions
are reckoning with hundreds of billions of dollars worth of disastrous
investments. As they struggle to rebuild their capital, they are halting loans
to many customers, demanding swift repayment from others and dumping assets —
homes sold out of foreclosure, investments linked to mortgages and corporate
loans. Selling is pushing prices down further, making the assets left on balance
sheets worth less, in some cases prompting another round of sales. </P>
<P>“You get this adverse feedback loop where assets keep falling in value,” Mr.
Barbera said. “You’re essentially putting big downward pressure on the global
economy.”</P>
<P>In past crises, like those that devastated Mexico in 1994 and much of Asia in
1997 and 1998, weak economies managed to recover by exporting aggressively, not
least to the United States. But American consumers are battered this time. After
years of borrowing against homes and tapping credit cards, consumers are pulling
back. </P>
<P>From Asia to Latin America, exports are slowing and should continue to do so
as the global appetite shrinks. This is spawning fears that major producers like
China and India — which vastly expanded production capacity in recent years —
will have to dump products on world markets to keep factories running and stave
off unemployment, pressing prices lower.</P>
<P>Earlier this year, some analysts suggested that American businesses might
continue to prosper, even as consumers pulled back at home, by selling into
foreign markets. Caterpillar, the construction equipment manufacturer, might
suffer declining sales in the United States, the argument went, but huge
projects from Russia to Dubai required front-end loaders. Australia and Brazil
needed earth-movers to expand mining operations as they sent iron ore toward
smelters in Northeast Asia.</P>
<P>But as much of the planet now struggles, Caterpillar is worried. “Next year,
no doubt, will be a challenge,” Caterpillar’s chief executive, <A
title="More articles about James W. Owens."
href="http://topics.nytimes.com/top/reference/timestopics/people/o/james_w_owens/index.html?inline=nyt-per">James
W. Owens</A>, recently warned.</P>
<P>China has long been at the center of claims that the world could keep growing
regardless of American troubles. China has been importing cotton from India and
the United States; electronics components from South Korea, Malaysia and Taiwan;
timber from Russia and Africa; and oil from the Middle East. </P>
<P>But many of the finished goods China produces with these materials have
ultimately landed in the United States, Europe and Japan. When consumers pull
back in those countries, Chinese factories feel the impact, along with their
suppliers around the globe. </P>
<P>Fewer laptop computers shipped from China spells less demand for chips. Last
week, Toshiba — Japan’s largest chip maker — said it lost $275 million from July
to September, blaming its troubles on a world glut. </P>
<P>Lower demand for flat-screen televisions means less need for flat-panel glass
displays. This month, Samsung, the Korean electronics giant, said a global
oversupply in that item caused its biggest dip in quarterly profits in three
years. </P>
<P>Now, a glut of products may be building in the United States. Orders for
trucks used by business have plummeted. Investments in industrial equipment are
declining. Yet inventories have grown. </P>
<P>“I worry about an economy that looks like Japan,” said Barry P. Bosworth, a
senior fellow at the <A title="More articles about Brookings Institution"
href="http://topics.nytimes.com/top/reference/timestopics/organizations/b/brookings_institution/index.html?inline=nyt-org">Brookings
Institution</A>. “We’re going to be struggling with how to put this back
together again for several more
years.”</P><NYT_UPDATE_BOTTOM></NYT_UPDATE_BOTTOM></DIV></NYT_TEXT></FONT></DIV></BODY></HTML>