April 21, 2009
Spain's Falling Prices Fuel Deflation Fears in Europe
By NELSON D. SCHWARTZ
VALENCIA, Spain Faced with plunging orders, merchants across this
recession-wracked country are starting to do something that many of them have
never done: cut retail prices.
Prices dipped everywhere, from restaurants and fashion retailers to pharmacies
and supermarkets in March. Hoping to increase sales, Fernando Maestre reduced
prices by a third on the video intercoms his company makes for homes and
apartment buildings. But that has not helped, so, along with many other Spanish
employers, he is continuing to fire workers.
The nation's jobless rate, already a painful 15.5 percent, could soon reach 20
percent, a troubling number for a major industrialized country.
With the combination of rising unemployment and falling prices, economists fear
Spain may be in the early grip of deflation, a hallmark of both the Great
Depression and Japan's lost decade of the 1990s, and a major concern since the
financial crisis went global last year.
Deflation can result in a downward spiral that can be difficult to reverse. As
unemployment rises sharply and consumers cut spending, companies cut prices.
But if sales do not pick up, then revenue can decline further, forcing more
cuts in workers or wages. Mr. Maestre is already contemplating additional job
and wage cuts for his 250 employees.
Nowhere is this cycle more evident than in Spain. Last month, it became the
first of the 16 nations that use the euro to record a negative inflation rate.
The drop, though just 0.1 percent, had not happened since the government began
tracking inflation in 1961, and Spanish officials have said prices could keep
dropping through the summer.
Some of the decline came as volatile food prices sank; the cost of fish fell
6.2 percent, and sugar was down 5.7 percent. But even prices in normally stable
sectors like drugs and medical treatments fell 0.7 percent in March, and there
were slight declines in footwear, clothing and prices for household electronics.
"Alarm bells are going off," said Lorenzo Amor, president of the Association of
Autonomous Workers, which represents small businesses and self-employed people.
"Economies can recover from deceleration, but it's harder to recover from a
deflationary situation. This could be a catastrophe for the Spanish economy."
Deflation is not just a Spanish concern. Luxembourg, Portugal and Ireland have
reported price drops, too. While the declines have been slight and prices
rose modestly after factoring out food and energy prices, which can fluctuate
widely other figures released this month suggest the risk of deflation is
growing.
In Germany, wholesale prices dropped 8 percent in March from a year ago, the
steepest fall since 1987. In Japan, wholesale prices fell 2.2 percent on an
annual basis. In the United States, the Consumer Price Index fell 0.1 percent
in March, year over year, the first decline of its kind since 1955, though
prices rose 0.2 percent excluding food and energy.
"It doesn't mean it will spread here to the U.S., but we need to look closely
at Spain and other places to understand the dynamic," says Simon Johnson, a
professor at the Sloan School of Management at the Massachusetts Institute of
Technology and a former chief economist for the International Monetary Fund.
"It's like the front line of a new virus outbreak."
The trends have unnerved even well-established businesses. "There is such a
huge lack of confidence in the politicians, in the European Union and in the
banks," said Arturo Virosque, 79, president of Valencia's chamber of commerce
and the owner of a local logistics company. Ticking off crises going back to
the Spanish Civil War in his youth, he said, "this is different. It's like an
illness."
After price cuts by competitors, Mr. Virosque's company reduced charges for
storage and transportation, and slashed its work force to about 170, from 250.
"The worst thing is that we have to cut the young people," he said, because
higher severance makes it too expensive to fire older workers.
While unemployment traditionally is higher in Spain than in much of Europe, the
sharp increase has many here nervous. The jobless rate for those under 25 is at
a Depression-like level of 31.8 percent, the highest among the 27 nations of
the European Union.
Before cutting prices in early 2009, Mr. Maestre ordered several rounds of job
cuts at his company, Fermax, as sales of the intercoms collapsed with Spain's
housing bubble.
"It's a question of survival for everybody," he said. Still, the lower prices
have not translated into higher sales. Fermax's orders fell 25 percent in the
first quarter. Prices for some intercom parts that he buys, like video screens,
have also come down, but it is not enough to make up for the sales drought.
"Prices have to come down more and we will have to spend less," he said.
The effects of this downward s
