Intersecting Minds: Education, Business and Technology at the North Carolina State Jenkins Graduate School of Management

Don’t Look Now… DEflation? | January 17, 2009

More grim economic news today.

  • Bank of America is pleading for up to $20 billion of additional bailout funds from the government to handle the $118 billion worth of bad assets that Merrill Lynch brought with it from the acquisition.
  • Citigroup annouced that it will be splitting in two following nearly $19 billion in losses over the last fiscal year.

But those aren’t the stories that grabbed my attention. Instead, a little followed economic indicator (at least in MBA world, which is dominated by talk of the markets and job numbers), the Producer Price Index, reported the first year over year drop in producer prices since 1950. This matches up with steep declines in the Consumer Price Index over the last five to six months. What does this mean in English? One word: Deflation.

You might be thinking, “Wouldn’t deflation help us right now? After all, steep drops in oil prices have brought gasoline prices way down, providing relief for people all over America.” Yes, deflation brings prices down, but that’s not the only effect it has. Deflation also brings cuts in wages, pay freezes and cuts in benefits because now companies are reaching a point where they’d rather cut salary than lay more people off. The LA Times reports:

FedEx Corp. cut wages for 36,000 salaried workers by 5% last month; at construction equipment maker Caterpillar, many employees will see their pay reduced by as much as 15%. Gymboree Corp., the San Francisco-based children’s clothing retailer, is cutting senior executives’ salaries by up to 15% and the pay of some other staffers by as much as 10%.

Union workers at YRC Worldwide Inc., the nation’s biggest trucking company, voted last week to accept an across-the-board 10% pay cut to help their employer weather the slump in freight traffic.

At the Newport Beach office of MBH Architects, salaries for partners and many professional staff were slashed 25% to 50% as clients canceled projects and billings fell off a cliff.

The trend is also hitting workers at nonprofit organizations and in state and local governments, and experts say it is a sign that some employers are resorting to exceptional measures to deal with the crumbling economy.

“Companies would rather cut jobs than cut pay,” said John Challenger, chief executive of consulting firm Challenger, Gray & Christmas. “If a company is cutting wages, that’s a sure sign of recession.”

Not only is deflation a sure sign of a recession, but it might be considered a delineation mark between a severe recession and a depression. After all, the last real deflationary wage spiral we saw was the Great Depression 75 years ago.

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