Why is deflation bad?

ElliotWave ^

[Chet 99]

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Why is deflation bad?

Great question! Sometimes our subscribers ask us "what's wrong with deflation?", and "why is deflation bad?" For those who are prepared, deflation can be a welcome development. The value of your money increases while the price of the things you want or need decreases. If everyone was prepared for deflation, many would welcome its coming and ask rhetorically why is deflation bad. For those who are prepared, deflation is a win-win.

Unfortunately, virtually everyone is unprepared for deflation, because virtually everyone has leveraged themselves to the hilt. Years of low- and no-interest financing schemes on houses, autos, furniture, electronics, etc. have created years of negative savings rates for Americans. Furthermore, many American households’ savings are tied up in investments that will go sour in deflation: i.e. stocks, bonds, commodities and real estate. As if a wipeout of life savings isn’t bad enough, declining prices (one of the effects of deflation), means lower profits for companies. In turn this means layoffs and increased unemployment. More on that when we discuss the price and economic effects of deflation and the deflationary spiral.

But just because you have a stable job and a cash reserve doesn’t mean deflation won’t rear its ugly head in your life. Say you not only keep your job but you get a promotion, and the promotion requires you to move. In order to acquire new residence, you must sell your house. In a deflationary environment, plummeting housing prices can make selling difficult, especially if you expect to make a profit. Many sellers are forced to sell at a loss, which further begets the effects of deflation in housing.

Thus the answer to "why is deflation bad" is that it’s not bad if you’re prepared for it.

[Kozak]

The value of your money increases while the price of the things you want or need decreases.

Also decreasing is the value of anything you own or produce, and the wages you make....

[Redbob]

"Also decreasing is the value of anything you own or produce, and the wages you make...."

You miss what the article says?

If you continue to make the same wage, and the price of goods goes down, well... you figure out.

I just asked this of my 6th-grader, and he got it right.

[happyathome]

I will readily admit I’m not an economist, but isn’t inflation - due to the extraordinary increase in the money supply caused by porkulous and the bailouts - a more likely scenario?

[Windcatcher]

In reality, though, that isn’t sustainable for employers. In a deflationary period they’ll be forced to cut wages and/or jobs.

[Rudder]

The Phrase, “virtually everyone has leveraged themselves to the hilt,” overlooks of those of us who have no debt because we practiced fiscal conservatism. For me, there’s no such thing as TOO much deflation.

[Chet 99]

Well, that seems to be the goal... but if a deflationary spiral takes hold, they can run the printing presses until the cows come home, and it won’t make a difference.

[muawiyah]

It's actually more complicated than that. As the price of of a product falls it eventually falls below its cost of replacement.

Once that happens the product no longer appears on the market as the former manufacturer keeps his money in his pocket where it becomes more valuable every day without any effort on his part.

Another problem with deflation is that interest falls to 0%. That's when you have to start paying the bank to keep your money safe, or, alternatively, when you pay the US government to issue you bonds!

You see the biggest problem with deflation is that it's not like inflation ~ it has a zero point.

[thefrankbaum]

Depends on the window you’re looking at - prices of everything from real estate to oil to cars are on the decline. Further, the overnight disappearance of many investments has a deflationary effect on the money supply, as a lot of those paper earnings are gone. However, you’re right - once prices stabilize and start to creep back up, further growth in the money supply must slow to get back to equilibrium due to the rampant creation of new money, or we’ll see real inflation.

[proxy_user]

Well, the problem with having cash in this environment is that it is difficult to put it to work in reliable assets. In normal times, you can just loan it out on the money market or buy stocks - but now, those options seem too risky.

[allmost]

This one is hard to predict. Too many greasy political fingers combined with the recent decades of technological dissemination make the current situation unprecedented in my mind. The more congress does, the more chaotic and long lasting it will be with no natural market balancing forces allowed.

[lakertaker]

What can a lowly regular American Joe like myself do to protect his finances? I have rolled over into some gold, my debts are few, and my wife and myself make a decent living. Anything else??

[Attention Surplus Disorder]

“... isn’t inflation - due to the extraordinary increase in the money supply caused by porkulous and the bailouts - a more likely scenario?”

It seems like it will be...at some indeterminate future point; but [assuming that scenario eventually comes true] the PRICE inflation experienced THEN will be likely measured against a PRICE deflation trough/bottom of that loose constellation of price points we generally carry around with us....milk, gas, movie ticket, typical house, etc;

But this is a very tricky call. File that one under “duh”.

[KC Burke]

Dave will give you a better answer than I.

[ExpatGator]

Bingo. Not one penny of interest bearing debt. House is 170+ years old and PAID FOR! Newest car is 7 years old and PAID FOR! Business, building, inventory, and equipment OURS!

Bring on the deflation. And I’m not worried when it turns into an inflation.

[Rudder]

Well, the problem with having cash in this environment is that it is difficult to put it to work in reliable assets.

Good point. Although "retired," I own and operate a residential and barn building const. business in Appalachia, my home. Labor (gofers, carpenters, operators, etc.) in this area is still a good investment...for now.

[eyedigress]

I’m eligible for the interest free 7500 dollar home “loan” but am unsure where to put it. I have gold but thats old money. Any ideas?

[allmost]

If I only knew. This garbage in congress is going to make it worse, that I know. Which way it goes as far as certain individual investments go is going to be determined in back rooms and dictated by bureaucrats. If they go for the fuel cell welfare platinum, palladium, etc. are good. If they start buying houses, the housing market might come back in some areas. Gold could pop as well because there is no fundamental holding it up. Lead’s always a good investment though. :)

[RC one]

Remarks by Governor Ben S. Bernanke Before the National Economists Club, Washington, D.C. November 21, 2002 Deflation: Making Sure "It" Doesn't Happen Here Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation...... If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation..... Ben Bernanke November 21, 2002

[CowboyJay]

Probably won’t have inflation any time soon. Most of this money they’re throwing away for us will be sucked up by existing debt.

It could make things worse by dragging out the period of time that it will take for the market to correctly revalue assets.