Disinflation strikes, but why now?

After a pause of a few days, the price of West Texas Intermediate crude oil is falling again this Monday morning, and the price of Brent crude oil is falling even faster, brining the spread between the two to less than $3 dollars, a level unseen since the two prices began to diverge in early 2011. Paradoxically, the abundance of West Texas Intermediate caused both the widening, and the narrowing of the spread, as it first eroded the scarcity of West Texas Intermediate, but has now caused world energy markets to settle on the highly abundant fuel as the normative fuel cost.

Put another way, for the first time in the living memory of most Americans, the country has seized control of its energy destiny, and in the process, disrupted global energy markets. This one shift is so fundamental that it is now transforming the US economy, though the transformation is in its early stages. If you want to see the turmoil the shift is causing, look no further than one-month performance of big oil companies, such as Exxon Mobil (XOM), which is down 6%, or Petroleo Brasileiro (PBR), which is down 13%.

The first and most noticeable effect for investors is the sudden rise in market volatility, which has more to do with energy markets in turmoil than it does with the Ebola panic. Sometimes, and this is one of them, traders are more rational than they appear.

The greatest impact, however, is yet to come, and that will be an across the board drop in consumer prices, or at least a decline of inflation to near zero. The cheap oil will take the usual few weeks to make its way through the refining process and become cheap gas at the pumps, but it surely will. The most recent dip in gas prices is likely just the beginning of a long trend. This will lower other prices as well. Why? Well, everything requires energy and/or petroleum based chemicals to manufacture, and everything requires transportation to get to market.

All of this creates a problem in that it is all anti-inflationary, and inflation is already low. Most economists fear it will soon become too low – that's disinflation. Disinflation has the same inhibitory economic effects as deflation, though not to the same degree. Americans are unlikely to cut back on spending – spending what you have is part of what it means to be an American – but disinflation could harm the economy in other ways, particularly as individuals and businesses large and small come to see this as a bad time to take on new debt.

This disinflationary trap may be the last major hurdle our economy must clear before we are really free of the lingering effects of the 2008 financial crisis. With luck, it won't prove high enough to make us stumble. 

Julian Close has been a business writer since the first day of the twenty-first century, having written for PRA International and the United Nations Department of Peacekeeping. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. He became a stockbroker in 1993, but now works for Fresh Brewed Media and uses his powers only for good. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.

Julian Close

Julian Close

Julian Close became a stockbroker in 1995. In his 20 years of market experience, he has seen all market conditions and written about every aspect of investing. Julian has also written extensively on corporate best practices and even written reports for the United Nations. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.

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