Plus, Leo Zuckermann is publishing a series of interviews this week with Raúl Feliz, the CIDE economist who made the declaration about Mexico's (kind of) recession last week. Today, they talk about inflation, or more accurately, deflation.
LZ: Does the idea of deflation in the US worry you?
RF: Enormously, because it's something truly bad. We, in the emerging markets, particularly in Mexico, don't have experience with deflation. We have been accustomed to combating inflation. Deflation is when the prices drop for a prolonged period which generates expectations in the private sector that we're going to see a persistent drop in prices.LZ: And then people stop buying products because they know that in the future they will be cheaper...RF: In effect. But that has disastrous effects on the cash flow of businesses. To survive, they have to cut the prices of their products and they can get to a point where they sell them for less than the production costs, at which point they go bankrupt. But, aside from that, this has a perverse effect on finances. Imagine a healthy business with a level of debt that under normal circumstances they can pay without any problem but if they are cutting all their prices, just to sell, their cash flow drops in comparison to the size of the debt. And if the first falls more than the second, without wanting to, the business can go bankrupt. The banks then aren't going to lend it money. The only way out is if the business pays decreasing amounts to its employees, which signifies that with deflation not only prices but also wages fall. And also, of course, the level of unemployment rises.LZ: The United States already has three consecutive months with negative inflation. What probability do you give to the possibility of deflation in that country?RF: Let's see what the bond market says...Now I think that if we fell into a situation like that the recession could get a lot worse. I feel that it won't. But I should warn you that I am an optimist. The central bank and the Obama government are going to do even the impossible to generate inflation. It sounds extravagant. But the situation has changed. Before, they had to control inflation, now they have to generate it.