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How Deflation Could Doom the Economy to a New Great Depression

Last Updated September 23, 2020 1:48 PM
W. E. Messamore
Last Updated September 23, 2020 1:48 PM
  • ING warns that deflation is going to strike the U.S. economy.
  • This could drive the economy into a vicious cycle.
  • It’s another eerie echo of last century’s Great Depression.

Chalk up another economic callback to the Great Depression. $1 trillion banking giant ING warned Friday that deflation is about to rock the U.S. economy:

The subsequent collapse in energy prices and surging unemployment means inflation pressures will evaporate with negative headline CPI soon set to arrive.

Intense deflation was a prominent characteristic of the Great Depression that followed the 1929 stock market crash. And ING Chief International Economist James Knightley points out that a deflation trend already started last month.

ING warns of deflation in U.S. economy
Economist James Knightley says deflation will soon rock the U.S. economy. | Source: ING 

Both headline inflation and core consumer price index inflation prints came in under expectations in March, as Knightley wrote:

The US consumer price inflation report showed prices fell 0.4% month on month in March, dragging the annual rate of inflation down to 1.5%. This was a touch weaker than the -0.3% MoM figure expected…

Energy and transportation costs declined sharply, leading the movement in consumer prices toward deflation. The energy sector’s month-on-month prices plummeted 5.8%. Apparel and transport costs also dipped toward deflation.

On top of drastically falling demand for gasoline, the oil price war flooded the market with crude. So on the supply side as well as demand, the energy sector faces a prolonged period of price deflation pressures.

Why Deflation Is a Major Threat

If the trend deepens and encompasses a broader swath of sectors, it will set off another contractionary spiral in both consumer and capital markets.

Businesses will face lower profitability and hire fewer workers while investing in less expansion of productive capital. Runaway deflation was a major factor in making the Great Depression so intractable.

ING Group’s economist isn’t the only major strategist to forecast deflation ahead. On Bloomberg TV Thursday, David Rosenberg said :

Well I don’t think there’s any inflation coming in the foreseeable future. This is an absolute global economic detonation. And the implications for aggregate demand around the world… what this does to the output gap is going to cause deflationary pressure to dominate. I’d say for at least the next year.

Rosenberg is the chief economist and strategist for Rosenberg Research and Associates. In addition to a long bout of deflation, he sees no end in sight to the stock market downtrend. We’re in for a long economic winter in his view.

Another Great Depression Indicator

Last weekend, an economics columnist at the Washington Post wrote a good summary of how deflation made the Great Depression worse :

Agricultural prices collapsed, making it harder for farmers to pay their debts. Mortgages went into default by the thousands. Prices fell more than wages, raising labor costs and frustrating firms’ efforts to resume production. Idle workers and idle machines pushed prices down, delaying the recovery.

In March, five leading economists compared this recession to the Great Depression. More than one of them argued convincingly that it would be much worse.

As lower prices make it harder for businesses to pay back a record corporate debt bubble, deflation will trap the economy in a vicious cycle. The deflationary outlook is unnervingly bearish.

Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com.