Stocks Are Hurt by Latest Fear: Declining Prices


Richard Moore

The New York Times

November 20, 2008

Stocks Are Hurt by Latest Fear: Declining Prices


After gyrating wildly for weeks, the stock market lurched lower on Wednesday, falling to its lowest point in nearly six years, as concern spread that the economy might be facing a chronic and debilitating decline in prices.

The Dow Jones industrial average closed below 8,000 for the first time since early 2003 after new reports painted a grim picture of the economy and raised the specter of deflation, which would put more strain on hard-pressed businesses and workers.

The Labor Department reported that prices of consumer goods and services fell by a record amount in October, while another report showed that a measure of home building fell for the fourth straight month, to its lowest level in the 49 years that the government has kept that data.

While most consumers might welcome the idea that things are getting cheaper, deflation is an economists’ nightmare. It was a hallmark of the Depression and Japan’s so-called lost decade in the 1990s. A big worry is that deflation would blunt the impact of interest rate cuts by the Federal Reserve, forcing policy makers to use other tools to try to revive the economy.

The Consumer Price Index, a measure of how much Americans pay for groceries, entertainment and other goods and services, fell by 1 percent in October, to an annualized rate of 3.7 percent, according to the Labor Department. It was the biggest one-month drop in the 61-year history of the index and the lowest annualized gain since October of last year.

Much of the decline could be traced to a 14 percent drop in the price of gasoline, but the cost of other goods — including clothes, milk and vegetables — also fell sharply.

The vice chairman of the Fed, Donald L. Kohn, said that the risk of deflation, defined as a “general decline in prices,” remained slight but had increased. “Whatever I thought that risk was, four or five months ago, I think it is bigger now even if it is still small,” Mr. Kohn said in response to a question after a speech. The Fed, he added, would be aggressive, if necessary, to prevent a broad drop in prices.

Stocks started falling shortly after 10 a.m. and ground their way down for much of the day before tumbling sharply in the last hour of trading. The broad Standard & Poor’s 500-stock index closed down 6.1 percent, to 806.58, falling below a low it set on Oct. 27. The index is now only 37 points above its October 2002 low. The Dow dropped 427.47, or 5.1 percent, to 7,997.28.

Financial shares led the market down, with Citigroup falling by more than 23 percent and Bank of America closing down 14 percent. General Motors and the Ford Motor Company also tumbled as prospects for a federal aid packaged looked grim. “That spooked investors quite a bit,” said Sam Stovall, chief equity strategist at Standard & Poor’s Equity Research. “G.M. and Citigroup, two venerable companies, are right now on the ropes.”

In the credit market, the price of corporate debt and bonds backed by commercial mortgages plummeted, while government bonds rallied as investors sought safe havens. The yield on the 10-year Treasury, which moves in the opposite direction from its price, fell to 3.32 percent, from 3.53 on Tuesday.

Analysts say a sustained decline in consumer prices would be terrible for the economy. Businesses that cut prices to attract buyers are likely to have to lay off workers as well. They may also have little left over to pay lenders or shareholders.

Prices are falling outside the United States too. Consumer prices declined in Britain, France, Germany and elsewhere in Europe in October, and prices were flat in September in Japan, which has fought deflation on and off for nearly two decades.

The decline in consumer prices is all the more remarkable because this summer many economists were concerned about inflation and the prospect for stagflation, in which inflation and unemployment rise simultaneously, contrary to their usual relationship. “It’s funny that just a few months ago everyone was wringing their hands over inflation,” said Nariman Behravesh, chief economist at Global Insight. “It’s gone. It’s over.”

But that concern has been quickly dashed, in large part because of a steep drop in commodity prices. Crude oil prices, for instance, have fallen more than 63 percent from their July peak of $145.29 a barrel, to $53.62 on Wednesday. The national average price for unleaded gasoline is now $2.05 a gallon, down from $2.92 a month earlier, according to AAA, the auto club.

In fact, it now seems clear that the nation is entering a more frugal era after several years of conspicuous consumption.

For instance, room rates at luxury hotels fell 5.4 percent in the 28 days ending on Nov. 15 — in contrast to a 1.3 percent increase in rates at midscale hotels that do not serve food, estimated Smith Travel Research, a firm that studies the industry. Over all, hotel prices fell 1.6 percent in October, according to the Labor Department.

High-end retailers are resorting to drastic discounting to lure customers into stores. Executives at Nordstrom, the department store chain, said on a recent conference call with analysts that the company had lowered prices on more than 800 clothing styles by an average of 22 percent.

Airfares, which were rising along with energy prices this summer, are now sliding as airlines struggle to fill seats on many popular routes. The average price of a one-way ticket is down about 20 percent from July, to $107 in mid-November, according to Harrell Associates, a firm that tracks the airline industry.

Still, the so-called core price index — which excludes energy and food — was down a more modest 0.1 percent. The prices of goods and services like meat, alcohol, medical care and education increased in October.

“It would take significant and persistent contraction in the economy to push core inflation into negative territory,” said Dean Maki, an economist at Barclays Capital in New York. “We do not think that is likely, especially given the aggressive policy response on the part of the Fed and Treasury.”

The Fed has already cut its benchmark interest rate to 1 percent from 5.25 percent last year, and it has been lending hundreds of billions of dollars to banks and corporations in recent months to revive credit markets. The Treasury has also pumped nearly $300 billion into banks and other financial firms.

The Fed is anticipating significant further slowing in the economy. A report released on Wednesday shows that the Fed now expects 2009 growth to be 1.8 percent to minus 1 percent, down from a previous forecast of growth of 1.9 percent to 3 percent.

Even though the Fed’s target interest rate is close to zero, economists say there is much more the central bank and the government can do to revive the economy. In a speech in 2002, before he was the chairman of the Fed, Ben S. Bernanke said central banks could combat deflation by buying longer-term Treasury and mortgage-backed securities to drive down interest rates.

“The Fed is going to ram liquidity into the financial system whether it is asking for it or not, just going out and buying assets and printing money in order to do it,” said Alan D. Levenson, chief economist at T. Rowe Price. “If you jam money into everyone’s pocket, they will spend it.”

Furthermore, lawmakers in Washington are also expected to pass a significant fiscal stimulus package in January after the new administration and Congress take power. Policy makers could head off deflation by spending hundreds of billions of dollars on tax breaks, infrastructure projects and other initiatives.

Jack Healy and Stephanie Rosenbloom contributed reporting.