When over $3 trillion of government stimulus are injected into the economy, combined with rumours of monetizing an enormous foreign debt, high inflation is a natural concern. But what you should be concerned about is quite the opposite (queue dramatic music): deflation! If the economic recovery had worked as Keynesian policy predicted, the U.S. economy should be growing between six and nine per cent annually. However, U.S. economic growth has been trudging along at around two per cent, according to the most recent reports on GDP growth. If, in fact, growth was as expected, inflation would perhaps be a very real problem. But since the economy is about to run out of the government-generated steam it has been running on, we are now about to face a $61-billion drop in consumer demand combined with already falling prices. Welcome to the world of the double dip.
Lower prices mean lower revenues and the numbers from the third quarter U.S. GDP report indicate that prices are already falling. Real personal disposable income is down to a pathetic 0.5 per cent annual rate. In addition, the producer price index is at 0.8 per cent this quarter, a year-on-year trend down from 1.3 per cent to 1.7 per cent in January. A deflationary indicator can also be seen in the fact that sales are still 11 per cent lower than they were in the spring of 2008. Lastly, and perhaps most disturbingly, core consumer prices (excluding the effect of energy and food) were down to 0.6 per cent in October. Any evidence of inflation is very hard to find.
Now combine falling prices with downward pressure on wages caused by a decline in spending and a significant employment gap. In other words, there are so many people that want jobs that employers can take the easy battle against sluggish revenues by adjusting wages down because they are sure to find people who will work for less than their current employees. In normal times, inflation and the cost of training the new employee outweighs this inclination. In a time of deflation and very high unemployment, employers will be paying their workers less.
The political scene only reinforces these concerns. November 2 changed the U.S. political climate from one of doubt to one of belligerent, partisan impasse and will bring about almost certain gridlock in Congress. This leaves us with a Democratic Senate that will allow the Bush-era tax cuts to expire and a Republican House that will not further extend unemployment benefits. The final result: less money in the consumer’s pocket and that estimated $61-billion drop in consumer spending we talked about earlier.
Combining these three factors should result in several quarters of negative GDP growth and the double-dip recession that everyone is having nightmares about. For the Americans going home for the break, do your holiday shopping and then maybe consider storing your tuition up high in Canada. It’s going to be a long one and you don’t want your investments getting stuck in the frost.
Frazer Anderson, U1 Economics, and Simon Hudson, U2 Economics, can be reached at email@example.com.