The Psychology of Deflation

TODAY’S THOUGHT of the day starts with an idea posted by Kevin Depew at Minyanville.  It continues with my thoughts on the implications of the abrupt shift in consumer psychology. Those implications are massive. Read on and see why.

From Kevin:
The Psychology of Deflation

“It begins as a simple standoff. The bidders hold their bids. The sellers hold their offers. Activity lurches to a stop…until someone blinks. Of course, I’m talking about real estate, right? No. I’m talking about restaurants:

· In the face of a meltdown in same-store sales and falling customer counts, some of the biggest names in casual dining are cutting prices, according to USA TODAY

· “This is unprecedented,” Paul Avery, COO of OSI Restaurant Partners (OSI), which includes the Outback Steakhouse brand, told the newspaper

· Beginning in November, Outback plans to cut prices across its menu

· T.G.I. Friday’s has a new appetizer menu with limited-time discounts up to 50%

· And so the deflationary toothpaste tube gets a bigger squeeze

· This is the psychological aspect of deflation we think the market has yet to fully grasp

· Faced with widespread rising prices in the 1970s, consumers pushed purchases forward, virtually across the board

· Faced with rising prices in just a few segments of the economy today, the consumer cuts back. And they cut back fast

· Unprecedented, indeed.

“Deflation: How Entrenched Is It? Ask Japan.

“Japanese core CPI for July came in at 0.2%, less than half the 0.5% expected:

· The CPI data also followed major revisions to the CPI — the data now that core CPI actually fell in January and April, where before they were seen to have risen

· The new calculation method shaved around 0.5 percentage points off year-on-year changes in data for overall Japanese CPI from January, a government official said, while economists had expected a downward revision of 0.2-0.3%, according to Reuters

· Meanwhile, Reuters poll showed 8 out of 20 market players and analysts expect the BOJ to raise rates to 0.5% by the end of the year from the current 0.25%, while two now rule out the possibility of another hike before the end of the fiscal year in March

· The Japanese government bond market spiked higher on the news, with 10-year yields falling 9 basis points, to 1.695%, the lowest level since March 14

· The 10-year U.S. Treasury Note also saw a brief dip in yields below 4.8%, before giving back most of that gain in the early opening for equities

· OK, a rise is a rise. It’s not exactly deflationary. But it emphasizes the difficulty in shifting time preferences and changing consumption and spending behavior once a secular psychological trend is in place.”

Here is the article Kevin is referring to:

“Restaurants Shave Prices, Plump Menus

“Casual restaurants are no longer taking the national dining slump casually.

“In the face of a meltdown in same-store sales and falling customer counts, some of the biggest names in casual dining — from Outback Steakhouse to Applebee’s to T.G.I. Friday’s — are taking serious actions to try to salvage 2006. Some are even chopping prices.

“Excluding the weeks after Sept. 11, this is the toughest period the industry has faced in nearly a decade, says Richard Snead, CEO of Carlson Restaurants Worldwide, which owns Friday’s.

“‘This is unprecedented,’ concurs Paul Avery, COO of OSI Restaurant Partners (OSI), whose brands include Outback. Beginning in November, Outback plans to cut prices across its menu, he says.

“The $68 billion casual-dining sector posted a 1.8% decline in same-store sales in June, the most recent month reported by Knapp-Track, which monitors the restaurant industry…

“* Outback. The chain has carved $1 off the price of its popular sirloin steaks in about 40% of its markets, Avery says.

“By November, it will lower prices on ribs, side salads, appetizers, and drinks, Avery says. ‘We’ve lowered prices from time to time, but never this magnitude.’

“* Applebee’s. To lure price-sensitive diners, the chain has a three-course ‘Southwest Fiesta’ promotion (appetizer, entree, and dessert) for $9.99.

“Applebee’s today will announce it has hired Food Network chef Tyler Florence. He’s creating four ‘fresh’ entrees, which he calls quality cuisine at value prices.

“‘We’re adding a whole different category of food to Applebee’s,’ he says.

“* T.G.I. Friday’s. Known for appetizers, it has a new appetizer menu with limited-time discounts up to 50%, Snead says. Over the past six weeks, Friday’s has introduced 23 items, the most ever for the chain, he says.

“* Cheesecake Factory. For the price-conscious, the chain has created smaller, cheaper lunch entrees. The Shepherd’s Pie typically sold for $13.95 now has a lunch portion for $10.95.

“It also added 16 food items, eight drinks and five desserts. That’s the biggest menu change in a decade, says Howard Gordon, senior vice president.

“* Bennigan’s. Monte Cristos, usually $7.99, go for $5.99 on Mondays. On Wednesdays, half-pound burgers are $4.99 (usually $7.99). Next month, some markets will sell all burgers at $4.99, marketing chief Clay Dover says.

“* Ruby Tuesday. It recently added a Triple Prime Burger (tenderloin, sirloin and rib-eye) and will promote it with a $60 million TV budget, its biggest ever, says Rick Johnson, senior vice president.”

The Changing Psychology

Yes the psychology is changing. In Japan. Slowly.

The psychology is also changing in the U.S. Much more slowly. It started with housing, but that reality has not really set in yet. It is now shifting to restaurants.

Check out the “psychology on burgers.” Prices dropped from $7.99 to $4.99. Hmmm, is that a drop of $3 or 37.54%?

I am wondering: Is there a bear left on oil, other than perennial oil bears (POBs)? Or did POBs go extinct long ago?

Japanese Yen

In the August Survival Report, we wrote:

“People are excessively worried about a collapse in the U.S. dollar, in our view. We have our eyes on the yen. The market is likely to force Japan to hike. Refusal by the BOJ to do so may cause a currency blowup, and not the U.S. dollar, but rather the last place most people are looking, the yen…

“The yen is in a precarious position. A quick look at the yen futures shows the line in the sand for a new downtrend. A break below 86 will likely lead to a new decline that could last many months. From its December low, the yen has traced out a classic A-B-C correction to a high in May, and has since fallen back to its uptrend line (in blue). While this consolidation could have a few more swings left in it (see notes in black), a break below 86 could lead to a decline far below 82.”

At the time we wrote that section above, the yen was comfortably in the wedge. To us, it broke in the expected direction. Judging from talk on stock market boards I run, it seems most people are dollar bears and yen bulls. Unless and until Japan starts hiking aggressively, that sentiment is more likely to be wrong than right.

Discretionary Spending

No one (well, just a few of us deflationists) expected to see price drops. Well, here they are, first in housing and now in restaurants. What’s next? I expect we will see all kinds of drops in the prices of goods and services. Someone e-mailed me just a few days ago about a price drop at the nail salon from $10 to $9. Hmmm. Is that a 10% drop? Why yes, it is. Discretionary spending in all kinds of things is likely to go out the window. Prices will drop with falling demand, and it will not matter one iota what input costs are doing. Ask yourself if Bennigan’s is paying 37.54% less for ground beef than it was last week. Did it matter? Think this through one step further. What will that mean for home prices, the values of businesses unable to pass on cost increases, the stock market, jobs, etc.? It will be interesting to see just how much we overbuilt retail stores, nail salons, Home Depots, and restaurants of all kinds.

Watch what happens as the psychology shifts from consumption to saving in the U.S. and from saving to spending in Japan. What we are really talking about is a SECULAR change in “time preference.” There is likely to be a lot of pain associated with that change, especially in the U.S. Bernanke’s worst nightmare took another big step forward today with these price cuts. If those price cuts do not attract consumers, job cuts will follow.

Mike Shedlock ~ “Mish”
August 28, 2006