Beware of falling prices

NEW YORK (CNNMoney.com) -- Lumber prices are sinking. And while that might make a trip to Home Depot cheaper, it's also a sign that the global economic recovery and the U.S. housing rebound are in danger of stalling.

Only a few months ago, inflation was the main worry of many economists. But falling prices for the raw materials of many industries, including lumber, have set off deflation warning bells for some economists, who worry that they could signal another global economic downturn.

Prices for framing lumber have tumbled 21% from their peak only five weeks ago, according to figures from the National Association of Home Builders. Prices are also falling for a wide variety of other industrial materials in recent weeks.

While consumers love falling prices, deflation can cause far more damage to growth than inflation can. Lower prices cause businesses to cut back production, which can lead to layoffs, which can then cause further declines in demand due to falling incomes and consumer spending, creating a downward spiral.

If prices continue to fall, it could cause some producers to cut back production or go out of business because they can no longer cover their manufacturing costs, according to Eric Schooler, CEO of The Collins Companies, a Portland, Ore.,-based lumber producer.

That's exactly what happened in 2008, when the bust in home building devastated the lumber industry, causing widespread closings at saw mills across North America.

In the first four months of 2010, however, lumber prices recovered as the homebuyer tax credit and other demand forces spurred homebuilding again. But the market got a little too hot.

"We suddenly had prices we haven't seen since spring 2006, and we certainly aren't building houses at the pace of 2006," said Bernard Markstein, senior economists for National Association of Home Builders, an industry trade group.

After the homebuyer tax credit expired in April, prices began to tumble again.

That will likely mean more lost jobs and income in a sector that lost more than a quarter of its jobs since the housing bubble burst.

"The manufacturers still aren't sure the home building rebound is for real," said Craig Adair, chief economist for the Engineered Wood Association. "They're beat down so badly, they're very cautious."

Lumber is still primarily a North American rather than global market, although exports to China and Europe have been growing in recent years.

But many other commodities are traded in global markets. And the concerns about the debt crisis in Europe, the slowing of rapid growth in China and the increasing value of the dollar are driving down prices of many of those goods as well, raising the same problems that cheaper lumber poses in the United States.

The global industrial prices index, compiled by the Journal of Commerce and the Economic Cycle Research Institute, has declined almost 10% from its peak level at the end of April.

Lakshman Achuthan, managing director of ECRI, said that the downward pressure on prices of industrial commodities, such as steel, lumber, oil and other raw materials, is another warning sign of weakening economic growth, although it is not yet enough to point to a double-dip recession.

"The way to read this is that a slowing of global industrial activity is starting right now," he said. "We don't want to jump the gun. We're not yet able to say the slowing is going to continue so much that we're going to get a decline in actual activity. We might, but we're not there yet."