The Real Threat to the Economy

U.S. retail sales are falling, the producer price index is crashing, housing prices are falling… and no one’s talking about deflation but me.

The U.S. Labor Department reported yesterday the Producer Price Index fell 1.6% in October, the biggest monthly drop on record (and following a 1.3% drop in the CPI in September)! The same report said retail sales in the U.S. dropped in October as well.

Investor focus on the Federal Reserve now seems to be “when will interest rates start to fall?” While most analysts expect the Fed to lower the rates before May of next year, they’re missing the fundamental problem. And that problem is the continuing threat of deflation.

Several months ago I predicted the U.S. Fed would soon start to lower rates. This is old news. The economy and consumer spending are both slowing fast, hence it’s a given the Fed will lower rates soon to stimulate spending.

The real problem, the one no analysts seem to be talking about, is deflation. Fed governors are still talking about inflation–they’ve got it wrong. Only precious metals and stocks are maintaining their price levels, everything else seems to be in price decline. There’s no need for me to get into the dangers of deflation as I’ve written about them before. Let’s just put it this way: Deflation is about the worst economic state a country will experience.

It’s no secret the money supply has been expanding quickly so the Fed ensures there is enough cash in the system to stimulate growth and spending. How will the Fed deal with deflation? Will it drop rates down to a 50-year low again? And if rates do fall aggressively, will consumers spend in an environment where prices are falling? It didn’t happen in Japan during their 10 year period of deflation.

The risks to the U.S. economy in 2007 are greater than I’ve seen in years. I hope my readers are reviewing and preparing their portfolios for the bumpy economic times ahead.

NEWSFLASH–Chinese billionaire Larry Yung has purchased a significant stake in miner Anglo American at a cost of $800 million. The Chinese are making major investments in natural resources and commodities. People like Larry Yung are smart investors–putting their money where they believe others will soon follow. Gold could be a very valuable commodity in the face of a weaker U.S. Dollar.