After gyrating wildly for weeks, the stock market lurched lower Wednesday as concern spread that the economy might be beset by a chronic and debilitating decline in prices.
The Dow Jones industrial average closed below 8,000 for the first time since early 2003 after new reports painted a grim picture of the economy and raised the specter of deflation, which would put more strain on hard-pressed businesses and workers.
The Labor Department reported that prices of consumer goods and services fell by a record amount in October, while another report showed that a measure of home building fell for the fourth straight month, to its lowest level in the 49 years that the government has kept that data.
While most consumers might welcome the idea that things are getting cheaper, deflation is an economists' nightmare. It was a hallmark of the Depression. A big worry is that deflation would blunt the impact of interest rate cuts by the Federal Reserve, forcing policymakers to use other tools to try to revive the economy.
The Consumer Price Index, a measure of how much Americans pay for groceries, entertainment and other goods and services, fell by 1 percent in October, according to the Labor Department, the biggest drop in the 61-year history of the index. Much of the decline could be traced to a 14 percent drop in the price of gasoline, but the cost of other goods – including clothes, milk and vegetables – also fell sharply.
The drop illustrated once again how quickly the economic danger can shift in tumultuous times like these. The inflation fears that gripped the nation just a few months ago now seem like a distant memory.
“Consumer price inflation has suddenly screeched into reverse,” said Brian Bethune, economist at IHS Global Insight. “The inflation threat has disappeared from the radar screen.”
The vice chairman of the Fed, Donald Kohn, said the risk of deflation, which is defined as a “general decline in prices,” remained slight but had increased. “Whatever I thought that risk was, four or five months ago, I think it is bigger now even if it is still small,” he said in response to a question after a speech. The Fed, he added, would be aggressive, if necessary, to prevent a broad drop in prices.
Financial shares led the stock market down, with Citigroup falling by more than 23 percent and Bank of America closing down 14 percent. General Motors and Ford also tumbled as prospects for a federal aid package looked grim. “That spooked investors quite a bit,” said Sam Stovall, chief equity strategist at Standard & Poor's Equity Research. “GM and Citigroup, two venerable companies, are right now on the ropes.”
In the credit market, the price of corporate debt and bonds backed by commercial mortgages plummeted, while government bonds rallied as investors sought safe havens. The yield on the 10-year Treasury, which moves in the opposite direction from its price, fell to 3.32 percent, from 3.53 on Tuesday.
Analysts say a sustained decline in consumer prices would be terrible for the economy. Businesses that cut prices to attract buyers are likely to have to lay off workers as well. They may also have little left over to pay lenders or shareholders.
Prices are falling outside the U.S., too. Consumer prices declined in Britain, France, Germany and elsewhere in Europe in October, and prices were flat in September in Japan, which has fought deflation for nearly two decades.
The decline in consumer prices is all the more remarkable because this summer many economists were concerned about inflation and the prospect for stagflation, in which inflation and unemployment rise simultaneously, contrary to their usual relationship. “It's funny that just a few months ago everyone was wringing their hands over inflation,” said Nariman Behravesh, chief economist at Global Insight. “It's gone. It's over.”
But that concern has been dashed, in large part because of a steep drop in commodity prices. Crude oil prices, for instance, have fallen more than 63 percent from their July peak of $145.29 a barrel, to $53.62 on Wednesday. The national average price for unleaded gasoline is now $2.05 a gallon, down from $2.92 a month earlier, according to AAA, the auto club.
In fact, it now seems clear that the nation is entering a more frugal era after years of conspicuous consumption.
For instance, rates at luxury hotels fell 5.4 percent in the 28 days ending on Nov. 15 – in contrast to a 1.3 percent increase in rates at mid-scale hotels, estimated Smith Travel Research, a firm that studies the industry. Overall, hotel prices fell 1.6 percent in October, according to the Labor Department.
High-end retailers are resorting to drastic discounting to lure customers into stores. Executives at Nordstrom, the department store chain, said on a recent conference call with analysts that the company had lowered prices on more than 800 clothing styles by an average of 22 percent. Saks, another store, is promising customers who spend more than $2,000 12 months of interest-free credit.
Airfares, which were rising along with energy prices this summer, are now sliding as airlines struggle to fill seats on many popular routes. The average price of a one-way ticket is down about 20 percent from July, to $107 in mid-November, according to Harrell Associates, a firm that tracks the airline industry.
Still, the so-called core price index – which excludes energy and food – was down a more modest 0.1 percent. The prices of goods and services like meat, alcohol, medical care and education increased in October.
“It would take significant and persistent contraction in the economy to push core inflation into negative territory,” said Dean Maki, an economist at Barclays Capital in New York. “We do not think that is likely, especially given the aggressive policy response on the part of the Fed and Treasury.”