Yes, Yes…Deflation has arrived, we will finally be able to afford that new TV, a new smartphone, and a new car. Do you think that we should also buy a house for the holidays? I hear that rates will be so low in the next two years. Our money will definitely be more valuable so we can afford it.
What is Deflation
Deflation is considered to be the hero against inflation (and for more information regarding inflation, check our other article here: Inflation). But is it really a hero? Or it is an anti-hero? I hope that until the end of the article we will have an exact characterization.
To have the dictionary definition: deflation is a general decline in the prices of goods or services. It can be caused or associated with a contraction in the supply of money and credit in an economy. To put it this way, during a deflation time your money has more power.
Causes of Deflation
Some of deflation causes are:
- Factories or goods producers, supply more products on the market than the available demand and money
- Prices fell because the consumer simply don’t have enough money to buy at the current prices
- The National Banks do not print so much money
- Banks do not give credits so easy anymore
- Consumers postpone investments or purchases in hopes of a better price
- MONETARY POLICY: rising interest rates may lead people to save their cash instead of spending it and discourage borrowing
How it’s calculated
Same as Inflation, the Deflation is calculated using indicators like the Consumer Price Index (CPI), which tracks a group
f commonly purchased goods and services. When the prices are lower in one period than the period before, we have deflation. But other types of indices, that we have explained in the Inflation article, can be used.
What types of deflation we can have
Even if it’s a bit strange, we can define types of deflation, based on the factor that produced it:
- Deflation Caused by Lower Costs – Good Deflation: This deflation is caused due to a lower in costs, due to a high number of available products. This usually can be associated with high productivity, thus keeping the economy working. Lower prices mean the consumers can buy more of the same product, so the producers may keep the same salaries or even higher for the personnel.
- Deflation caused by Falling Demand – Bad Deflation: This deflation is caused by a weak demand, caused by a higher price range for some products. Higher prices mean that the products will not sell that good, and producers will try to cut costs and wages to diminish the losses they have.
How are we losing because of deflation
Even if having lower prices seems good, it can be damaging to the economy. The economical power of the country is contracting, the economic agents and the government postpone investments to protect against an increased risk of lack of profit or even bankruptcy. Because of all of this, we have a higher risk of unemployment and even recession. The economical growth is not stimulated anymore ( the salaries won’t rise anymore).
But why did the unemployment rise? Because the producers will start selling their products with a loss, and as a normal action, they will try to cut the losses by resizing the manpower to the demand of products they have to ship.
Because of unemployment, there will start to be more and more persons that can’t pay their credit, so the bad credit will start piling and this is leading to a decrease in the supply of money. Because of this, more companies are in danger of losing their finances and going to bankruptcy.
Deflation is also a sign of economic recession because it discourages production and encourages “cutting loses”. This process is also explained as Spiraling Deflation.
How we can protect against inflation
As with inflation, there are some actions we can take to protect against a deflation period (of course depending on the length of the period).
- Reducing debt: If your salary is decreasing, it is almost certain that you can be in the position not to be able to pay your credit. This should be one of the first actions you take, diminish your spending and focus on paying the credits you have.
- Stop buying stocks: As companies are the first to feel the deflation period, their stocks can take a great fall. Investors don’t have that much money to invest. If the companies are unable to keep up the revenues the investors will be driven away. You will just buy a “dip” that continues to fall.
- High-Quality Bonds: because the prices of Bonds increases when the interest is falling.
- Keeping Cash available can be a good solution, as probably the bank will offer negative interest to your saving deposits ( The expression “Cash is King“)
- Stocks can be an option: but you have to invest in specific sectors like canned goods, toothpaste, beverages especially if they have a good brand.
Last few words
As a good to know information, the most typical example of deflation was the big drop in prices during the Great Depression of 1929-1930, caused by a suprapopulation of the stock market. Everything happened on a Tuesday – The Black Tuesday.
In my opinion, I prefer to consider deflation as an ANTI-HERO. Yes, it diminished the prices, which is desired when having a 10% inflation that will just skyrocket everything. But at the same time, it has so many side effects that can lead to the collapse of so many companies, rising unemployment, and encouraging migration to better countries.
In a proficient society, we need a good balance between deflation and inflation, so the economy is properly stimulated to grow, dragging everything after it and putting the respective country in a “better light” to compete against the other countries.
Thank you all for having the patience to read the post! See you next time with another financial term explained. If you have any suggestions and topics, please mail us at [email protected] with your proposal! And do not forget to subscribe!
Disclaimer: I am not a financial consultant! All the information you find here are my decision, I have taken at that moment, on my own analysis. I am open to any type of discussion about money. If you want to replicate my portfolio take into consideration that it is your money and you can have losses.