Posted November. 21, 2008 18:42,
With asset values plummeting and prices sliding in the United States and Europe, the specter of deflation is rearing its ugly head.
When an economy slides into deflation, or a decline in prices amid a recession, the impact is far greater than inflation, which can be curbed with interest rate hikes. Japan suffered through its lost decade due to deflation.
The growing deflation threat took a heavy toll on the New York stock market Wednesday. The Dow Jones average plunged below the 8,000 mark for the first since March 2003.
○ Deflation fear looming
The U.S. Labor Department said consumer prices fell 1.0 percent in October from a month ago, the largest drop since the department began compiling the statistic in 1947.
Declining energy prices were largely blamed for the steep fall. The price of gasoline dropped 14.2 percent and producer prices fell 2.8 percent from a month ago, the biggest in history.
Adding to fears was the 1.0-percent drop in core inflation, which excluded food and energy costs due to their volatile price fluctuations. The decline in core inflation indicated an overall drop in prices, including those of manufactured goods.
When asset prices fall, individual households tighten their purse strings to prepare for further drops, which in turn leads to a cut in production. This cycle is typical of deflation.
U.S. Federal Reserve Vice Chairman Donald Kohn said the risk of deflation, while slight, is larger than it was four months ago.
The same threat is also looming in the United Kingdom. Consumer prices there plummeted 4.5 percent in October, the biggest drop in 16 years.
British Prime Minister Gordon Brown even told lawmakers that the country faces the prospect of deflation next year.
European Central Bank President Jean-Claude Trichet said the threat of deflation has yet to appear in the euro zone, but experts said his comments show he is worried about it.
○ No end in sight to Wall Street crisis
As the fates of the top three U.S. automakers grow increasingly dim and deflation fears mount, Wall Street shares plunged to their lowest level Wednesday.
The Dow Jones average tumbled 427.47 points (5.07 percent) to close at 7997.68, its lowest finish since March 31, 2003.
The NASDAQ slumped 96.85 points (6.5 percent) to 1,386.42 and the S&P 500 slipped 52.54 points (6.12 percent) to 806.58, the lowest in five and a half years.
The Dow has fallen 14.2 percent this month, more than last month (14.1 percent). The NASDAQ has dropped 19.4 percent this month, much larger than last months drop of 17.7 percent.
○ EU presents stimulus package
The European Union will reportedly inject 130 billion euros (164.1 billion U.S. dollars) to stimulate its flagging economy.
German media said last week that 27 EU member countries are pushing for a massive stimulus plan requiring each country to contribute one percent of GDP over two years. The EU Commission will confirm the plan by Nov. 26 and submit it Dec. 10, reports said.
Its early to say the size of the stimulus package because the decision is yet to be made, commission spokesman Johannes Leitenberg said.
German Economy Minister Michael Glos, however, said the value of the package will reach 130 billion euros.
Germany opposes the package because of the hefty 32 billion euros it will have to pay, but will find it difficult to reject the stimulus plan altogether, experts say.
The EU has gone into recession for the first time since the emergence of the euro currency, with its combined growth dropping 0.2 percent in the third quarter.