Cheap oil prices. Low inflation. Sound like a dream come true? In economics, dreams have a way of turning into nightmares.
A sudden bout of deflation is the latest threat to the recovery of rates on savings accounts and other deposits. Recent months have seen the Consumer Price Index reverse from a troubling rate of increase to a decline. The Producer Price Index also recently turned negative, for the first time in more than a year. Oil prices, meanwhile, have been routed. The spot price for a barrel of oil fell from more than $100 in late July to the $80s by mid-October.
Bringing price increases under control has long been the goal of central banks and governments. However, when prices turn negative, it can be a sign of fundamental economic problems.
What's causing the inflation slowdown
One contributor to the turn toward deflation, including sinking oil prices, is a strong dollar. It may be more accurate to say the dollar has not so much been strong as other currencies have been weak.
The economy of Germany — perhaps the most reliable European economy in recent years — may already be in a recession, and Japan's economy could be headed the same way. Even supposedly fast-growing developing economies are in trouble. Growth in Brazil has stalled, analysts are wondering how long China can keep up the illusion of steady high growth, and Russia's economy is bound to suffer from the decline in oil prices.
As for the U.S., the effect of all this can be seen from a recent Bureau of Labor Statistics report on import and export prices. Import prices have declined by more than 1 percent over the past two months, due to the strength of the dollar. That is helpful for American consumers, but it represents lost income to struggling foreign economies. Meanwhile, export prices have also dropped in four of the last six months, representing lost revenues to U.S. exporters.
Implications for savings accounts
In the short-term, there is a benefit to savings accounts from falling prices. Deflation means that a fixed dollar amount of savings instantly gains purchasing power. This might seem like a fitting turnabout for savings accounts, after they have steadily lost purchasing power in recent years as interest rates trailed inflation.
The problem is, all this comes in a context of deteriorating growth. Whereas just weeks ago the talk was about how soon the Federal Reserve would raise interest rates, the concern now is that a weak global economy and an overly strong dollar might force the Fed to keep rates low longer than expected.
Most savers need income. It is not enough for savings accounts to simply tread water over the long run; they need to be able to earn a decent rate of interest. Steady growth with moderate inflation was the ideal formula for restoring interest to that level. A destabilizing bout of deflation amid global economic weakness is a step in the wrong direction.
Richard Barrington is a personal finance expert for MoneyRates.com. He has earned the CFA designation and is a 20-year veteran of the financial industry.