Deflation is the word that economists dread. Deflation keeps Central Bankers and politicians up at night. Deflation is the force behind the printing press. If you look at where deflation is mostly found, however, you might come to a different conclusion about how you should feel towards this force. You might even learn to embrace it… who knows.
What Is Deflation?
Deflation is basically falling prices due to falling demand. Isn’t that a good thing? If that was your response, clearly, you haven’t received an education in economics. Please let the following conversation educate you.
Peasant: Isn’t falling prices a good thing?
Economist: No, you idiot. That means that demand is down, and when demand is down, businesses lose money and jobs are lost!
Peasant: So, what should we do?
Economist: We must stimulate demand!
Economist: Who cares how? We can convince people to borrow more, or convince them that things will be better so they shouldn’t hoard their cash, or we can provide “incentives” to buy things that they just aren’t buying anymore (those morons).
Peasant: But, won’t that prop up businesses through artificial demand? What happens when you remove the stimuli?
Economist: We’ll figure that out later. Errr… stop asking questions.
Ok, back to the main point. Where can we find the deflationary forces in today’s economy? There’s lots of talk of inflation, so can we have both? I think, yes.
If you think logically about a strapped consumer, the most common area that he will cut back is the purely discretionary purchases such as toys, leisure activities, travel, etc. Allow me to present a few examples.
Purchase That Nobody Is Purchasing Anymore #1: The Motorcycle
Company In Focus: Harley-Davidson, Inc. (HOG)
Harley recently reported its first loss in 16 years. Clearly, when times get tough, motor cycles aren’t necessary. This pure discretionary item, along with the examples to follow, benefited greatly from the largest ATM machine in modern history: the home. With the housing bust, the ATM machine disappeared.
Purchase That Nobody Is Purchasing Anymore #2: The Boat
Company In Focus: Brunswick Corporation (BC)
Brunswick is one of the leading manufacturers of boats across a number of brands. Last week, they reported a larger loss than expected.
We can also see deflationary pressure in consumer electronics. For example, there are a number of specials and promotions with multiple retailers attempting to get sales of big screen TVs ahead of the Super Bowl next week. Prices have been slashed in an attempt to stimulate demand.
There are also plenty of discounts with regards to vacations. Tourism and travel is down big and prices are reflected in hotel room rates and more.
Lastly, we can’t ignore real estate. Home prices continue to be under pressure despite the many attempts to prop up the housing market through programs like the Home Buyer Tax Credit.
The Reality About Deflation
The problem with our deflation combat techniques is that we interfere with rebalancing and restructuring that needs to occur in the broad economy. For example, way too much capital was allocated toward consumer products that we really don’t need. Because of the misallocation of capital, more factories were built and more people were hired to build things like motor cycles and boats. With the naturally-occuring restructuring that is taking place, yes, factories might close down and people will likely lose their jobs. While this is painful, it is a necessary aspect of a market economy. Should we keep building boats that nobody wants or can pay for just because we don’t want people to lose their jobs? Of course not.
I understand the risk of the deflationary death spiral that many fear, where less demand causes job losses which cause more demand destruction, and so forth. It’s a real risk. But, eventually, that spiral will stop and real market based production will kick in. Then, we can resume real, natural growth.
So, what you need to understand is as follows:
- These deflationary forces are real and they are not yet going away
- You should be very wise and strict with your money – hold on to your cash – don’t be concerned with missing the latest promotion on a new TV, there will be more
- Be cautious investing in companies that are directly tied to the consumer, especially discretionary, leisure products
Just a quick not about inflation… I do believe we will see inflation caused by our loose monetary policy in certain areas such as commodities. But with regards to stuff we don’t need, we’re most likely to see continued deflation.