For the first time since 1955, the consumer price index fell on a year-over-year basis. Last month’s seasonally adjusted CPI slipped 0.1% for the 12 months through December, the Labor Department reports. On a monthly basis, the decline in CPI is more pronounced, falling by 0.7% last month–the third straight monthly decline.
Deflation, in short, is here. It’s been expected for some time, as we’ve been discussing in recent months, including here and here. The great question, of course: How long will it last?
Team Fed is working overtime trying to keep the visit relatively brief. By dropping the central bank’s key interest rate to virtually zero and otherwise buying up assets that no one else wants, Bernanke and company are pulling out all the stops to engineer inflation back into the system. So far, the policy has yet to show results. But such actions take time to work. Eventually, and perhaps quite soon, signs of progress will emerge for keeping consumer prices on an even keel. The Fed, in sum, will win, and then the real work will commence. But that’s a problem for another day.
Today, the central bank can’t afford to lose this battle. Lower prices are nice, of course. More importantly, falling prices give consumers some relief from the ill winds otherwise blowing in the economy, and that’s stimulative generally. But there’s a limit to stimulus delivered in this form. If continually lower prices endure, the trend becomes toxic for growth and business expansion. And the bottom line is that the only way out of this mess is through growth and expansion.
In some respects, the Fed’s raison d’etre is on the line here. If deflation persists, at some point one can imagine Congressional hearings and the like calling for a major reordering of the Federal Reserve. The institution, after all, is a creature given life by Congress and so the Fed ultimately exists and operates at the mercy of politicians. As such, the Fed’s war on deflation is also a fight for survival to keep the central bank as it now stands intact.
Changes in banking generally are now being discussed openly. The prospect of nationalization, or something close, regarding several large private banks is topical these days. “We are down a path that this country has not seen since Andrew Jackson shut down the Second National Bank of the United States,” Gerard Cassidy, a banking analyst at RBC Capital Markets, tells the New York Times today. “We are going to go back to a time when the government controlled the banking system.”
Maybe, although for the moment a true nationalizing of such institutions as Citigroup is still unlikely. Yes, one can argue that a quasi-nationalization is already taking place, given the rising influence that Washington has over the finance industry via all the bailout money being extended to private institutions. But outright control and management of the banking sector by the federal government still looks improbable. Then again, we don’t know what 2009 will look like and so one can never say never, especially these days. Perhaps we’re idealists, but the lessons of modern economics insure that policymakers won’t turn the clock back to the Age of Jackson in banking. More regulation and oversight is coming, but direct ownership and unfettered management of banks is doubtful.
As for the Fed, it’s not too difficult to imagine that if deflation runs on for an extended period, and inflicts havoc on the economy, the incoming Obama administration and Congress may feel pressed to take even bolder actions to stem the tide of financial implosion. The front line of this battle is winning the war against deflation. It’s not clear that if the Fed fails on this front the Congress can fare any better, but that wouldn’t stop politicians from trying.
But we’re fairly confident that the Fed won’t fail. Deflation, we believe, will be slain and inflation will return. Timing, of course, is unknown, and since timing is increasingly the politically and economically sensitive variable in 2009, there’s risk ahead—lots of risk, with predictions as well as with economics.
Still, there’s reason for hope. Keep in mind that the CPI needs only to flat line for a while to keep deflation at bay. Stability seems likely in the months ahead if you expect, as we do, that the bulk of the decline in energy prices—gasoline in particular—is now behind us.
The energy component of CPI has fallen now for five months straight. It’s too soon to say for sure, but it looks like November was the climax of the decline, with the CPI’s energy index tumbling a hefty 17% that month. In December, energy fell again, although the pace slowed considerably to an 8.3% decline. Since gasoline makes up most of the CPI’s energy index, we can look to the fuel for signs of what may be coming in future inflation reports.
On that note, the March ’09 gasoline futures contract appears to be stabilizing, suggesting that perhaps the great energy selloff has passed. No guarantees, of course. Yes, gasoline demand over the past 6 months has taken a hit and so have prices. But unless you really are expecting the apocalypse, energy prices generally are set to stabilize.
Demand for fuel won’t keep dropping by leaps and bounds month after month after month. Or so we believe. That’s not to say that energy prices won’t go lower still. But on a percentage basis, the big declines are behind us. That’ll go a long way in helping battle deflation, and letting the Fed keep its fancy offices on Constitution Ave.