October 31, 2008


CVS slashes generic drug costs, escalates price war: Using the products as loss leaders, the drugstore giant will sell 90-day supplies of more than 400 medications for $9.99 and offer discounts for cash-paying patients at its in-store medical clinics. (Lisa Girion and Andrea Chang, 10/31/08, LA Times)

One of the nation's largest drugstore chains ratcheted up a price war Thursday, offering deep discounts on generic prescriptions amid national concern about the spiraling cost of healthcare.

Drugstore giant CVS Caremark Corp. announced it would sell 90-day supplies of more than 400 medications for $9.99 and offer discounts for cash-paying patients at its in-store medical clinics.

The price war was unleashed by Wal-Mart Stores Inc., the country's largest retailer, a few years ago. Since then, many grocery stores have followed suit.

The price competition makes generic drugs just about the only healthcare bill that isn't escalating. The lower prices provide a measure of relief to consumers who are struggling with rising health insurance premiums and other out-of-pocket expenses or have lost coverage altogether.

Now savvy shoppers can buy many prescriptions for less than laundry detergent, face cream or a pound of deli meat.

The U.S. Economy at Risk for Deflation: The U.S. economy has all the ingredients—slowing job and wage growth, slack consumer demand—for a deflationary cycle, without strong financial markets to cushion the blow (James Cooper, 10/31/08, Business Week)
When policymakers at the Federal Reserve voted to slash interest rates at their Oct. 28-29 meeting, it's a good bet the threat of deflation played a role in the decision. That concern is bound to get more attention in coming months as inflation begins to fall amid a progressively weaker economy and the financial crisis. Deflation is an economic disease caused by a sustained drop in overall demand and falling prices that forces businesses to cut prices ever deeper. It was last seen in the U.S. in the 1930s and in Japan in the 1990s, when the inflation rate fell to zero and then turned negative for several years.

Deflation is a nasty situation that can give central bankers palpitations. It's especially onerous for borrowers. Because prices are falling, people who already owe money have to pay back loans in dollars that will buy more goods than the dollars they borrowed. For new loans, it raises the real, or inflation-adjusted, cost of credit, the opposite of what monetary policy needs to do to combat falling demand. Plus, in the effort to boost spending, policymakers cannot cut the target rate below zero. At that point, negative inflation can keep the real rate high enough to restrict economic growth.

Actually, his BW colleague, Chris Farrell, has explained why this is and has been a deflationary epoch. The Roots of Deflation (Chris Farrell, MAY 14, 2004, Business Week):
"The world is shifting from an era of structural inflation to one of deflation, in which prices for most manufactured goods and tradable services fall rather than rise," observed Eisuke Sakakibara, Japan's former vice-finance minister. Chief Executive Jack Welch got it right several years ago when he ran General Electric: "Inflation has yielded to deflation as the shaping economic force."

Of course in the current environment you can almost hear the sound of Wall Street veterans scoffing. They are fond of quoting the legendary investor John Templeton, "The four most expensive words in the English language are 'this time is different.'" They've been burned by too many new eras, new economies, and revolutionary transformations. Inflation is the economic condition we know.

Many baby boomers and Wall Street traders remember when inflation reached double-digit levels in the 1970s, peaking at over 14% in 1980. Inflation was eventually contained through a combination of factors, including a tough anti-inflation battle waged by the Fed under the leadership of Paul Volcker and his successor Alan Greenspan. The consumer price index averaged 7% in the '70s, 5.5% in the '80s, 3% in the '90s, and 2.5% in the early 2000s. The odds of another bout of double-digit 1970s-style inflation are remote. Still, now that the economy is picking up steam and the job market is getting better, the widespread expectation is for resurgence in inflation. Rising prices are such an embedded part of our society that we all assume inflation is the economy's natural state.

Yet every once in a great while the established economic order is overthrown. Within a span of decades, technological changes, organizational upheavals, and new ways of thinking transform economies. From the 1760s to 1830s, steam engines, textile mills, and the Enlightenment produced the Industrial Revolution. The years 1880 to 1930 were shaped by the spread of electric power, mass production, and mass democracy.

This time is different. Or maybe I should say, it's back to the future. From 1776 to 1965, America's overall price level was essentially flat. Inflationary flare-ups were mostly associated with major wars until the post World War II era. These inflationary conflagrations were quickly extinguished in the aftermath of war. The rest of the time stable to falling prices dominated, especially in the latter part of the 19th century, the last time there was a tightly integrated global economy.

It's sometimes obvious when a historic divide is crossed. The 1929 stock market crash. The 1973 oil shock. Far more often, "change creeps upon us incrementally, punctuated by upheavals that, often as not, are rationalized as part of business as usual," said the late, legendary financier Leon Levy. "Only later do we realize that the world has been turned on its head." Levy called these events "a tap on the shoulder." Deflation may have taken a lot of people by surprise in 2003, but the price trend didn't emerge overnight. It had been building for years, a secular undertow to all the cyclical twists and turns in the economy. There were many deflation taps on the shoulder.

Among the most important were the chairmanship of two inflation hawks at the Federal Board: Volcker and Greenspan; the rise of retailing giant Wal-Mart and its low everyday price strategy; the commercial embrace of the Internet, an inherently deflationary technology; a falling price level in Japan in the late 1990s; the vicious global price cutting wars that erupted following the financial collapse of Asia's emerging markets; China transforming itself into the developing world's leading economic juggernaut; and Corporate America's outsourcing high-pay, high-skill white-collar and skilled jobs to low-pay, well-educated workers in developing nations like India, China, and Malaysia.

The emergence of deflation as the dominant price trend will dramatically impact businesses, workers, investors, the government, and the economy over the next several decades. "Of all the recording devices that can reveal to an historian the fundamental movements of an economy, monetary phenomena are without doubt the most sensitive," wrote the French historian Marc Bloch. "But to recognize their importance as symptoms would do them less than full justice. They have been and are, in their turn, causes. They are something like a seismograph, which not only measures the movements of the earth but sometimes provokes them."

Deflation, like inflation before it, is taking on a momentum of its own. The promise of a fast growing deflationary economy is enormous. But so are the pit falls for everyone from the worker on the factory floor to the CEO of a major multinational corporation to the head of the Federal Reserve Board.

Deflation in America reflects fundamental changes on the economy's supply side. At the same time, a new international monetary system has evolved that contains a bias toward lower prices. Deflation is built on three fundamental changes dating back to the late 1970s and early 1980s: (1) the embrace of market capitalism at home and abroad; (2) the spread of information technologies; and, most importantly for understanding the economy of the next half-century, (3) the triumph of the financier. None of these factors is new, but what is surprising is how powerfully each change has informed and reinforced the other.

So, when central bankers reacted to the aberrational spike in oil prices as if it were indicative of systemic inflation they "raise[d] the real, or inflation-adjusted, cost of credit." This was particularly unfortunate because it cranked up the cost of adjustable rate loans far beyond what the money being borrowed was worth.

Posted by Orrin Judd at October 31, 2008 7:11 AM
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