Pick Your Poison: A Recession Might Trigger Price Deflation

Here is a term that the global economy has not heard in a long time: Price deflation. The red-hot 9.1% inflation rate has made everyone furrow their brows, shake their heads, and howl to the economic heavens, wondering when this inflationary nightmare would come to a halt. Although this environment of skyrocketing prices has become the norm, and it will likely remain sticky for quite some time, consumers can take some solace in the likelihood that a recession will trigger a bout of deflation. It seems likely the Federal Reserve will kill the economy to resolve a 40-year high consumer price index (CPI), giving the public two options: cyanide or strychnine.

Is Price Deflation on the Horizon?

Since the May CPI data, crude oil and gasoline prices have come down, falling about 20% and 8%, respectively. The broader commodities market has also hemorrhaged red ink following several months of a supercycle, with many of the hard and soft crops posting double-digit losses over the last month. Could this be the catalyst to finally trimming broad-based inflation that has been entrenched in the US and global economies for the last 18 months? This is what the White House and economists are betting.

Indeed, public policymakers will flex their muscles, thinking they have successfully fought four-decade-high inflation. They can perhaps take credit for the drop in prices, but not in a good way. In the energy markets, crude futures have cratered mainly on intensifying recession fears, driven by widespread concerns that higher interest rates and elevated inflation – both manufactured by the government and central bank – will weigh on consumer demand, leading to an economic downturn. Many market analysts and economists contend that the US is in the middle of a recession – the Fed Bank of Atlanta’s GDPNow model estimates the second-quarter growth rate was -1.5%.

Investors were ebullient over the June retail sales report that came in at a better-than-expected pace of 1%. But the key metric has been on a downward trend since February, even contracting 0.1% in May. In addition, real consumer spending in the second quarter edged up at a tepid 1.8%. Personal spending rose 0.2% in May, falling short of the market forecast of 0.4%.

These numbers have weighed on business sentiment, too, with the National Federation of Independent Business (NFIB) Optimism Index weakening to 89.5. If companies are more pessimistic, they will act accordingly, and this is showing up in various labor reports: the four-week initial jobless claims numbers have risen every week since early April, small firms are shedding tens of thousands of workers every month, position openings have eased, and jobs cuts have expanded. If the demand for employees diminishes, wages will come down, too.

The elephant in the room, of course, is the Federal Reserve. The money supply has tumbled after hitting a peak in March 2022, slipping about 0.5%. This means fewer dollars were printed and injected into the economy amid the Eccles Building's tightening endeavors. Since today’s rampant price inflation was caused by the astronomical creation of new units of currency injected into the international marketplace, a deflationary period is not out of the realm of possibility.

Thanks, Guys

Put simply, a recession, tumbling demand, and slowing monetary expansion could trigger a new era of deflation. Unfortunately, it will not happen overnight since elevated inflation is a sticky mistress. But just think how badly Republicans and Democrats in Washington fumbled the ball and created this horrific situation: motorists are paying $5 for gas and 15% more for meat, parents are struggling to locate baby formula, and shoppers are buying smaller products at the same cost (shrinkflation). Once the recession or a prolonged period of stagflation strikes, hopefully, this will put the nail in the coffins of Keynesianism and statism.