Letting Air Out of the Economy

"Deflation?" "Recession?" "Tightwad consumers?"

Don't bother asking Joe DeGiorgi whether such clouds darken his Ford dealership lot: He's too busy "moving the iron."

"Business is steady and strong," says Mr. DeGiorgi, general manager at Century Ford, here, in between selling a $30,000-plus sport-utility vehicle and roaring off for another test drive.

Markets from Bangkok to Brussels founder, but US consumers continue to power a seven-year expansion with healthy - albeit weakening - spending. Retail sales rose a brisk 0.3 percent in September, driven largely by auto sales, says the Commerce Department.

DeGiorgi's business can thrive as markets dive because the shock wave of world financial tumult - deflation - has stayed beyond US shores.

Until now, that is.

Deflation is the topsy-turvy flip side of inflation and brings a sustained fall in prices. East Asian countries suffer from deflation, triggered by a crash in their currency values. That collapse pulled the rug out from under prices for goods they export.

The Federal Reserve on Oct.15 announced a surprise interest-rate cut to beat back the deflation menace looming from East Asia. But more rate cuts, matched by other nations' central banks, are needed, say some analysts.

The Fed made the sneak attack after a crunch on Wall Street threatened lending on Main Street.

Banks, concerned about the economy, have tightened lending standards for large corporations. And scarce credit might soon squeeze consumers and small businesses.

Already, strong US corporations have trouble selling bonds, which means they cannot find the money needed to expand - to produce more products and hire more workers.

The threat is a credit crunch, a co-conspirator of deflation, and the Fed fears it could nudge the US economy into a recession.

"Growing caution among lenders and unsettled conditions in financial markets more generally are likely to be restraining" the economy, says the Fed.

Indeed, world markets - especially those in Asia - have so far acted out a turbulent three-stage cycle from the classic book "Manias, Panics, and Crashes," by Charles Kindleberger.

In Stage 1, an economy booms on easy credit, high asset prices, and investor euphoria.

Stage 2 brings overextended businesses. With too much capacity, they falter and fail.

Finally creditors and investors flee rising risk; markets crash.

Evaporating credit and a growing economic slowdown have a sunny side: Many prices fall. Already many basic commodities and raw goods - such as oil - have slumped to the lowest price levels in decades.

That's good for people like retirees with fixed incomes and little debt. But it eventually crushes an economy under the two boot heels of fear and mistrust.

"If you hold your job, fine, but I don't know of any working person who wouldn't be hurt by deflation," says Dimitri Papadimitriou, executive director of the Jerome Levy Economics Institute at Annandale-on-Hudson, N.Y.

Deflation becomes a downward spiral that feeds on itself.

Consumers put off purchases; businesses lose profits; and employees are laid off, prompting creditors to deny loans with even the faintest whiff of risk. Prices for homes, stocks, and most other assets decline.

Indeed, last week's report of a record trade deficit, $16.8 billion, shows that US exporters already feel the deflationary pinch.

The Fed's Alan Greenspan calls this the "scary psychology" behind deflation and evaporating credit. The Fed's recent interest rate cut, the second in 16 days, is an apparent effort to break it.

Mr. Greenspan recently won help in trying to jog both minds and markets. Canada, England, and Spain have cut rates, and Congress approved $18 billion for the International Monetary Fund, encouraging other countries to bankroll the beleaguered battler of global chaos.

And Japan now promises $500 billion to help its banks with an estimated $1 trillion in bad loans. The banks put a huge drag on the world's No. 2 economy and the rest of Asia.

But to reverse deflation and a spreading world recession, many analysts want coordinated, worldwide rate cuts.

"I am not satisfied with the Fed. I think they have been very timid," says Mr. Papadimitriou. He says the Fed should reduce interests rates at least by another three-quarters of a point.

Not all economists believe deflation has taken hold. "There is a lot of talk about deflationary forces accelerating, but you don't see it in the data," says M. Carey Leahey, chief US economist at High Frequency Economics in Valhalla, N.Y. He doubts deflation will jar the US economy unless financial chaos badly disrupts Latin America or central banks bungle their interest-rate moves.