Deflation: When low prices buy high anxiety - Los Angeles Times

In a weak economy, prices may drop, but so do wages and job security.
By David Pierson

February 8, 2009

Wedding photographer Pogos Kuregyan has lowered his prices.

FedEx aircraft inspector Dan Wallace is dealing with a salary cut and a retirement fund that's lost half its value.

Though prices are down for food, housing, energy and clothing, they can't buy much, because they're living on less.

After years of worrying about inflation, some economists fear the opposite could soon happen: deflation, an extended period of falling prices that indicates the economy is in a backward spiral.

Millions of Americans have less money coming in than before the recession, and their net worth has also shrunk. That means less to spend on food, clothes, gasoline, cars and shelter. And despite discounts at the store and the car dealership, a lowering of rents and a near-historic drop in the price of houses, people just aren't buying much.

For Kuregyan, owner of Unique Digital Media, a photography studio in Glendale, the trouble started when he noticed rivals advertising online packages hundreds of dollars cheaper than his.

His business began to slow. At first, Kuregyan did what many business owners have done in this economy: He offered discounts and extra services instead of formally lowering his prices.

But that didn't work.

Then he realized that he would need to borrow money from friends to make his December rent payment. Desperate for customers, Kuregyan caved and reduced the cost of his packages by $200 to bring him more in line with his competitors.

"It's extremely dangerous," the 24-year-old proprietor said. "If I start dropping prices and they do it too, then I do it again, then it all becomes fruitless."

The pain of Kuregyan's diminishing income is spreading to other businesses in the community.

It hurts the neighboring restaurants on Brand Boulevard where he often took his girlfriend out to dinner but can no longer afford to.

It means a sale lost for the electronics store where Kuregyan was going to buy a flat-screen television to display his photographs in his storefront window.

And it results in shelved plans to spend thousands of dollars to advertise with local TV stations and in the Pacific Theatres at the nearby Americana mall.

Deflation debate

This is the kind of downward spiral that worries policymakers.

Trying to get credit flowing more freely, the Federal Reserve has dropped interest rates to historic lows. President Obama has been emphasizing the urgency of a massive stimulus package to get consumers and businesses spending again.

But economists and politicians alike are divided about what to do. Taken as a whole, prices in the U.S. economy increased last year, but only a tiny bit. Inflation registered only 0.1% in 2008, the smallest increase in prices since 1954.

Consumer spending declined in December for a record sixth straight month and rose 3.6% for the year, its lowest annual gain since 1961. The economy lost 3.6 million jobs since the recession started in December 2007.

Yet experts debate whether all this indicates that the economy will slide into full-blown deflation, defined as a prolonged period of falling prices.

Skeptics say the federal government will inject enough money into the economy to prevent it. They say deflation has largely been relegated to apparel and energy prices. Therefore it's not wides- pread enough to raise great concern.

"It's a serious situation but we're a long way from that," said Christopher Rupkey, an economist at Bank of Tokyo-Mitsubishi in New York. "Seeing reduction in wages is good anecdotal evidence, but everyone would have to experience reduction in wages before we're in deflation."

But others argue that today's declines could spread -- and stay with us.

"Deflation will become more pervasive as we make our way through the year," said Mark Zandi, chief economist at Moody's Economy.com. "The downturn is intensifying, and businesses are under increasing pressure to cut prices to maintain some sales."

The fear about this recession rests on the severity of the real estate crash and credit crunch, which translates into pain for any homeowner who sank savings into a house only to see property values plummet. Those people are facing a cash crunch of their own.

There may even be signs that -- as they did during and after the Great Depression of the 1930s -- consumers will change the way they manage money, saving more and spending considerably less. Although few would argue that this is not a more conservative and ultimately safer way for American families to live, it could push deflationary trends in the economy even further.

Similar conditions contributed to Japan's deflationary period in the 1990s, known as the Lost Decade.

Initially, lower prices might seem like a boon to consumers. But price reductions can lead to layoffs, leaving more people without money to spend.

Scared to spend

Newlyweds Evan and Beth Lewis were surprised recently to see so many sales at the Grove shopping center in the Fairfax District. The two headed into Sur la Table, where there were items up to 75% off, and picked out pots and pans for their new apartment.

But they're not going all out in furnishing the place, just the bare essentials until they can save enough to buy more.

The pair work at box offices in separate theaters -- jobs they worry could be eliminated as customers continue to reduce discretionary spending. In a roundabout way, they said, their security won't improve until they see prices rebound.

"It's bad to see so many sales after Christmas because it means the economy is very poor," Evan said. "You know it's not a long-term solution."

Dan Wallace has a job, but his pay was slashed as his employer cut costs.

"After 23 years of sweat on the job, I moved up and got to that point where I thought I could have a comfortable pension, and then it all turned south," said Wallace, an aircraft inspector for FedEx Corp. The company cut wages 5% for 36,000 salaried employees in December, Wallace among them.

Future's less bright

Wallace, 51, said the pay cut, coupled with the loss of yearly bonuses handed out when the company made sizable profits, took about $8,000 out of his annual income. His wife, an executive with Bank of America Corp., fears her job is in jeopardy. If she were laid off, Wallace said, the Santa Clarita couple could not make their mortgage payments.

They expect to have less to spend in retirement as well. Thanks to the stock market crash, the value of Wallace's 401(k) has decreased by half. His wife has seen hers drop 40%. Instead of retiring with a $1-million nest egg, the pair now expect their savings to be worth $400,000.

As the Wallaces learn to live with fewer resources, they, like so many others, will have to cut back. They'll be spending less on necessities such as food and home repairs, as well as discretionary items such as vacations and dinners out.

That means less money coming into the businesses they usually patronize, which will in turn have to rethink their budgets.

For Kuregyan, the photographer, even a coffee at Starbucks has become a luxury.

He treats himself to an espresso only about once a week. He'll often wait until he collects enough coins from customers paying with cash as a self-imposed saving method.

"I'm hoping to last as long as I can," Kuregyan said. "But it feels more like a hobby than a job because I'm not making enough money.

"The economy is just too tough."