An end to deflation can have a downside

PUBLISHED : Monday, 12 January, 2004, 12:00am
UPDATED : Monday, 12 January, 2004, 12:00am

I LIKE TO RUN the sorts of charts that have a single line going suddenly way up or way down to emphasise a point. Sometimes, however, it is not so easy to do and this is one of those times. My apologies if my charts today give you the impression of a knitting pattern gone wrong.

What we have here is evidence that the deflation from which we have suffered for more than five years is coming to an end. That evidence is the retail sales report for November, which shows no difference between the growth of sales by volume and by value. Calculate that difference as a year-over-year rate of deflation and you get the red line in the chart. We are back to zero.

I grant you it is a preliminary indicator. The retail sales indices are not the soundest prop for such a finding as they cover only about a quarter of total consumer spending in Hong Kong.

Other measures say we still have some way to go to recover from falling prices. The consumer price index, represented by the blue line, says prices were still falling in November by a year-over-year rate of 2.3 per cent. The green line, representing the gross domestic product deflator, a measure of all prices in our economy, suggests an even more pessimistic outlook. For September, it showed prices still dropping by 5.7 per cent.

But what matters to you is the trend in prices of your day-to-day necessities. The big pull-down on that GDP deflator is the cost of capital equipment and other investment goods. How many paving machines do you buy on a daily basis? Why should you place special emphasis on the GDP deflator?

Similarly, the biggest single factor keeping the CPI down is housing rent, represented by the green line in the second chart, which still shows a negative number of 7.5 per cent.

But remember here that the CPI does not reflect the residential property market well. It only measures rent plus renovation and maintenance costs and entirely ignores housing prices. Yet separate figures published by the government show clear evidence that flat prices are rising again, which is what you would expect with economic recovery after a multi-year slump.

In much the same way, when you look at durable goods prices, another CPI component dragging prices down, you find that this drag is exerted by prices of computers, watches and cameras. All other sub-components show prices either rising or falling by less than the overall rate of durable goods deflation.

But what you have with computers, watches and cameras is consumer goods that have become cheaper because of advances in technology. This has little to do with specific factors that keep Hong Kong prices down.

The only real count that I would put against the evidence presented by the retail sales indices that deflation is coming to an end is that these figures do not incorporate consumer services. We actually spend more now on consumer services than we do on consumer goods and the latest evidence says deflation in consumer services is still about 5.5 per cent.

But while you may take this latest indication of an imminent end to deflation as heartening news, it introduces another question. The reason that deflation hurts you is that it brings down the prices of financial assets as well as those of consumer goods, in other words property and stocks as well as trousers or furniture.

And when financial asset prices go down, people are reluctant to invest. This in turn leads to higher unemployment and lower wages.

Do you really, however, object to paying less for everyday household goods than you paid for them earlier? I, for one, certainly do not.

What I would like in the way of an end to deflation is rising prices for property, capital equipment and financial assets while still paying lower prices for everyday consumer goods. It is the other way that things are going at the moment, however.



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