The following delves into why the United States may have more downside potential in terms of the general price level than most other major industrialized nations − say in Europe, for example. This relates to the question of how serious a problem “deflation” may become.

Deflation is bad because it promotes a downward spiral in prices and jobs that becomes hard to reverse. Who’s going to buy something when it is likely to become cheaper in a month or two? In turn, delayed purchases mean lower production, more job cuts, less spending and another cycle of price cuts.

The other really negative feature about deflation is that it makes outstanding debt bigger. It is, by definition, the opposite of inflation. Consumer Price Index (CPI) increases reduce a nominal or fixed dollar amount of debt over time. There is a good reason that governments and corporations and even indebted individuals like a little inflation. Also, the rising incomes that usually go along with inflation make the carrying costs of debt lighter, as a percentage.

Much of the more serious “deflationary” prospects in the U.S. relates to the use of cars and gasoline. The U.S. economy is more sensitive to gasoline prices than is the case in Europe. There are several reasons for this. While we complain about fuel taxes in North American, the level in Europe has been set a lot higher, in a bid to reduce consumption. Europe’s car driving history did not begin with abundant domestic reserves of oil, as was the case in North America.

Therefore, a cut in the world price of oil has a more elastic impact on gasoline prices in the U.S. than overseas. Plus the use of gasoline is a bigger part of the economy in the United States. Europe is more densely populated, with a lower volume of vehicular traffic. Also, Europeans are used to taking mass transit to a more intensive degree than in the U.S. Think about the sprawling suburbs in most American cities and the long hours of commuting by autos in cities such Los Angeles and Washington.

The Economist magazine (November 15th-21st 2008), in a special report on the car market in emerging nations, gives the following comparison of penetration figures in various countries. The United States has more than 900 cars for every 1,000 people of driving age. Western Europe and Japan have about 600 cars per thousand individuals. In Russia, the figure is below 200. In Brazil, it’s about 130; in China, it’s only 30; and in India, the figure is less than 10.

Lower world oil prices and lower gasoline prices will impact Americans to a more significant degree than elsewhere. Add to this effect, the fact that the U.S. dollar has been demonstrating remarkable strength. As the world’s reserve currency, there has been a flight to safety into the greenback that has raised its value vis-à-vis most other currencies. This is another factor lowering prices for Americans, through the mechanism of imports.

By the way, there is another aspect of the deflation question that economists will have to be aware of through the next 12 months. The impact of price drops on a year-over-year basis will be at its greatest next summer. That’s because the spike in commodity prices occurred this past summer. For example, the world price of oil peaked at $147 USD in mid-July, 2008.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News.

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