What to make of this deflation

From the Inflation Data link we have the following CPI numbers for the last few months:

0.03%

0.24%

-0.38%

-0.74%

-1.28%

-1.43%

-2.10%

We are still seeing price reductions. In our simple queuing model, this price reduction represents increasing inventory build up in the retail sector. Store closings outrun goods production for a time.

We have gone through store closings 1100 for GM alone, as well as smaller outlets as luggage Maker, Samsonite, Closing About Half U.S. Retail Stores, Circuit City and Sears closed 28 underperforming stores and strip mall showing higher vacancies, such as NYC where some malls have 25 to 40% vacancies. The affect is excess inventory build up in remaining outlets.

Here are the CPI number for the first half of 2008:

4.28%

4.03%

3.98%

3.94%

4.18%

5.02%

5.60%

5.37%

The rising CPI prices represent scarcity of inventory. Too many stores for the amount of goods flow.

So, using this simple queuing model we do not need supply/demand and price equations and can simply go straight to goods flow. The retail supply chain has reduced the stages of production, going from an inflated state to a deflated state; from a longer to a shorter supply chain.

The retail sector has a yield curve that is a multi-stage flow of goods. It, like the monetary yield curve, has gone from flat to steeped. However, because of quantum choices, it always over corrects. Both the monetary yield curve and the goods flow yield curve are adjusting. The monetary yield curve is generally six months behind, but both should soon attempt to flatten.

Here is how the adjustment process occurs. Consumers hoard of money as continued price reductions incentivize consumers to wait on purchases ( the Keynesian speculative holding of money). Though nominal short term interest rates at low, the price reductions yield a real 2% gain from holding money.

The retail banks will also shorten their supply chain to match the shortened retail supply chain. The result is larger lot sizes, larger purchases by consumers with fewer transactions, and larger but fewer loans by banks. This is the economies of scale effect, larger lot sizes and fewer transactions. It means that the short end of the yield curve disappears. The short end sample rate is lower, the finance industry no longer measures shorter term activity.

So consumers really aren't hoarding money, they are simply buying less often but buying more quantity. The entire system is equilibriating by applying economies of scale. The resulting economy has settled on longer intervals between transactions. Everything seems to slow down. The interest rate yield curve still measures the growth of inventories but with fewer measuring points. It is a simpler supply chain and a simpler monetary yield curve with fewer term points.

What are the fiscal and monetary policy implications? Nothing is implied by this analysis except that government and the Fed have to deflate. Any policy recommendations would be concerned with what caused the original inflation and subsequent deflation. It is the constraint that is causing us to seek economies of scale, find that constraint and solve it.