Why Is "Deflation" A Bad Thing??? How To Prepare/Profit?

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Why Is "Deflation" A Bad Thing??? How To Prepare/Profit?

Post by Swampy » Mon Jan 12, 2015 7:57 am

I've been reading articles and posts on "deflation" or "disinflation" being a "bad thing."

OK, why is it so bad to be paying less for items that cost more last year?

At the gas station, I can fill the tank for less than $40. Last year I regularly spent $70+ for the same privilege.

Educate me as to why "inflation" is a "good thing." Why is inflation, even at 2-3% a year, so great?
Inflation seems like a way the government can gradually debase the currency over time and a person slowly loses what they have earned and saved.

Personally, I view inflation like a slow growing cancer that is imperceptible to its victims - until it's too late.

The current "melt value" of an old silver quarter is about $3.00. Is that silver content really worth $3.00, or has the dollar been inflated to that point?

50 years ago practically everything cost a mere fraction of what it does today (with the exception of electronics).

Granted, my dad earned somewhere around $6000 a year, we were able to live on his income alone. Fast forward several decades, it took the two of us to earn and pay for our living expenses. Really, are we better off? When I grew up, my dad worked outside the home. Mom was a 'stay at home' parent. My wife was not. In retrospect, this was a terrible disservice to our kids.

The house I grew up in cost about $15,000. The house my kids grew up in cost a lot more than that.

A million bucks buys a fraction of the goods and lifestyle it once did. Apparently, you could buy a new Rolls-Royce 50 years ago for under $17,000. They start at around $300,000 now.
Try buying a decent new car for $17,000 now.

Reading a few tomes would go a long way to educate yourself about economics and deflation. I recommend Arthur Laffer's book, "The End Of Prosperity," and works by Ludwig Mises at mises.org.

That said, where does one position investments to safely capitalize on deflation?
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by awval999 » Mon Jan 12, 2015 8:01 am

Because the majority of US citizens are in debt. If they had to pay their debts off in deflating dollars it would be bad.

Secondly, if prices would consistently fall across all items (not just gasoline in your example) people would stop purchasing things. They would (smartly) wait out further price drops. This would further destroy the economy.

The old Fed chairman, Bernanke had a nickname of Helicopter Ben. From what I remember, the story goes, deflation is so terrible, that he stated if it would come to it, he would print and then drop $100 bills out of a helicopter until deflation had ended.

Deflation is terrible. It is why the Fed prints money. It is why Japan had not grown in 30 years.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by richard » Mon Jan 12, 2015 8:06 am

Swampy wrote:I've been reading articles and posts on "deflation" or "disinflation" being a "bad thing."

OK, why is it so bad to be paying less for items that cost more last year?<>
On an economy wide level, spending equals income. If someone is spending more, someone has more income. There are distributional issues (a small number may benefit while many are paying more), but that's true of inflation, deflation or just about anything else.

Put another way, deflation means prices go down, but it also means the wages we use to pay those prices goes down.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by adamthesmythe » Mon Jan 12, 2015 8:06 am

If I understand correctly, the most recent deflationary period in the US was the Great Depression. I wasn't around then but I hear it wasn't great.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by RNJ » Mon Jan 12, 2015 8:35 am

On my highway drive home I pass a number of gas stations. Yesterday, I found myself passing station after station, looking for for the lowest price. I finally came to my exit and thought,"I'll fill up tomorrow. It'll most likely be cheaper anyway."

Now imagine that that kind of thinking set in, not just about gas, but about everything. Demand falls with the expectation of lower prices "down the road" and PRICES will fall with them - a deflationary spiral which, as the Japanese will tell us, is very difficult to get out of. Bad for business (price pressure), bad for workers (cutbacks in labor under pressure from falling demand), and bad for those in debt (e.g., anyone with a mortgage).

Why is this bad for mortgagees? Because many of us (I include myself in this group) purchase with the idea that over time and with moderate to low inflation, we will pay back the mortgage with cheaper/less valuable dollars. DEflation leaves us paying back with MORE EXPENSIVE dollars.

Low/moderate INflation, so the theory goes, is actually good for economic activity because it spurs demand (ie, "I'd better but that has today because it may well be more expensive tomorrow"), which is good for the labor market and, it is thought, leaves most feeling a little more flush.

Most of us on this board (I'm 50) grew up against a backdrop of inflation (sometimes somewhat high inflation). That's what we know, that's what we fear. Deflation may be far scarier. Imagine, for example, negative nominal interest rates on Treasuries.

Now, I'm going to fill 'er up. Maybe.
Last edited by RNJ on Mon Jan 12, 2015 8:45 am, edited 1 time in total.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by bottlecap » Mon Jan 12, 2015 8:40 am

My guess would be cash, which is also why some people are worried about deflation.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Grt2bOutdoors » Mon Jan 12, 2015 9:01 am

bottlecap wrote:My guess would be cash, which is also why some people are worried about deflation.

JT
Most people don't have any cash, just read the posts here "I hold 3 months in my e-fund", a visit to the local brick and mortar and a chat with the teller behind the window tells me the same thing - most folks are just scraping by, it's rare to see folks with $25K or more held in a deposit account. If there ever was wide spread deflation, the first folks to fall will be those who are leveraged with little in the way of cash holdings, including margin accounts, the next might be the pensioners - can't pay a pension if the assets in the pension plan have suffered a material adjustment downwards in valuation, the next will be everyday folk who can't hold down a job, any job - all work has dried up. Believe me, you don't ever want to see widespread deflation, once it takes a hold, it's very very difficult to put the genie back in the bottle. Everyone will hold out for a lower price, no sales = no business, no ability to pay wages, no ability to pay taxes. The Depression was a very tough time. I hold a larger pile of liquid investments (call me conservative), but a 3 or 6 month fund isn't going to work when it takes you 24 months to find a job. Don't think for a minute some jobs are extremely stable, oh yes, they'll always be a need for a doctor, but the means to pay for services might resort to "I can pay you a dollar today Doc, and another dollar next week Doc, and it will just drag and drag.........
I saw that happen in a service business during the 2008 debacle when work just dried up but the receivables were still there, took some businesses a year to pay back bills (and with no interest to boot). The banks would have their books filled with bad loans, you know what that would mean right? They would be forced to resort to drying up credit - how can you extend credit to someone who's unable to pay you back or show where the money to pay back will come from? That will cause further contraction in the economy. The story can become much worse......so don't think for a second that Deflation is NOT a BAD Thing, its the WORST THING!
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by richard » Mon Jan 12, 2015 9:50 am

One of my favorite economists is fond of saying "don't reason from a price change". The message is to look at the underlying causes.

Deflation is a sign that the economy is seriously messed. Deflation can cause bad things, but you're not likely to see deflation in a healthy growing economy.

Individual prices can rise and fall, not necessarily in sync. Low inflation most likely means many prices are falling. It's not a binary situation in which there's a major difference between +0.1% and -0.1%, it's a continuum.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by SSSS » Mon Jan 12, 2015 10:23 am

awval999 wrote:Because the majority of US citizens are in debt
...
people would stop purchasing things.
These points seem contradictory. If the majority are currently financially irresponsible and unable to practice delayed gratification, what makes you think they'd suddenly all become responsible, prudent, and forward-thinking in a deflationary environment?

Yes, the people here on this website might be more likely to delay purchases (although isn't predicting continued deflation based on recent past deflation exactly the kind of thing we don't do?), you have to consider that we're a small minority -- I think most people would think, prices have dropped, must buy things NOW.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Valuethinker » Mon Jan 12, 2015 10:26 am

If you look at what is happening in Greece, Italy, Spain or Japan right now you see why deflation is a bad thing.

The first 3 have double digit unemployment and youth unemployment over 45%. As part of the Euro they are undergoing a forced deflation to lower their wages and prices to below German ones.

The problem is 'sticky wages'. Even in Spain, the average wage settlement is 0%. To achieve full employment in a fixed exchange rate regime (ie the Euro) Spain would probably need wages to fall by c.-20%. Since that cannot happen, instead companies just sack workers/ do not hire more workers.

This of course also raises government expenditure and cuts tax revenues. The fear of being unemployed means those who have money don't spend it, further weakening the economy. So deficits soar, necessitating more cuts, more deflation, more misery.

Japan has been stuck in this cycle for nearly 20 years.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Valuethinker » Mon Jan 12, 2015 10:29 am

Note it's likely that the deflationary effect of a positive supply side shock (like the oil price falling) is much less harmful than a demand side shock (like a financial crisis).

Inflation may well dip negative, but that extra real income may well get spent, thus stimulating the economy in other areas. Transportation, travel, retail etc.

A gas price cut is like putting a little extra into every American household's pocket every week. Evidence says that kind of 'tax cut' gets spent.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by fanmail » Mon Jan 12, 2015 10:31 am

OP, you are kind of all over the place, but I will answer your questions anyway.

Deflation is good for consumers getting lower prices.

Deflation is bad for sellers of goods & services at lowering prices. Those with debt whose dollars borrowed are worth less than those they must return suffer. Deflation shrinks or freezes wages and also reduces employment. These aspects are worse for the economy than the benefit of some cheaper prices.

Cash and fixed income do well in such an environment.
Stock markets do poorly in this environment.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by white_water » Mon Jan 12, 2015 10:48 am

Taking the other side of the discussion; a few farsighted people were able to buy houses, businesses, farms and ranches during the depression(s) because they had cash.

My question; where did they put that cash as banks collapsed?

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by thx1138 » Mon Jan 12, 2015 11:03 am

Apart from the myriad bad things about deflation already posted, another one is nominal price/wage behavioral errors. People don't think in real terms particularly well, and this also applies to wages. One reason slightly positive inflation is a good thing is that people hate having their pay cut but object less when you forgo a raise even in an inflationary environment. Of course stagnant wages during inflation is a real wage cut, but people mostly think in nominal terms. So in a deflationary environment it is much more difficult to adjust wages as market conditions change.

Anyway, that's a rather minor effect to the far more dramatic problem of deflation essentially cutting off all investment and lending.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Mountain Man » Mon Jan 12, 2015 11:12 am

As I understand it, if you think bad deflation is coming and you need to alter your AA, then you need to:

1) pay off all your debt
2) raise your level of cash
3) buy long-term Treasuries or Zeroes.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Valuethinker » Mon Jan 12, 2015 11:32 am

white_water wrote:Taking the other side of the discussion; a few farsighted people were able to buy houses, businesses, farms and ranches during the depression(s) because they had cash.

My question; where did they put that cash as banks collapsed?
Not all banks collapsed. And deposit insurance came in in 1933 after Roosevelt closed the banks (for 3 days? would have to check).

Bank of United States did collapse, and devastated the NYC rag trade. Arthur Miller's plays Death of a Salesman (indirectly) and The Price (almost autobiographical- -his father lost his business in the 1930s) and Broken Glass allude to those events. It's fairly clear one of the reasons WASP run Wall Street banks did not bail out B of USA was that it was seen as a 'Jewish bank' with Jewish customers-- Milton Friedman covered that.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Valuethinker » Mon Jan 12, 2015 11:33 am

Mountain Man wrote:As I understand it, if you think bad deflation is coming and you need to alter your AA, then you need to:

1) pay off all your debt
2) raise your level of cash
3) buy long-term Treasuries or Zeroes.
Yes. Probably the best strategies. Unfortunately the horse has rather bolted in that the 30 year Treasury already yields what, 2%?

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Valuethinker » Mon Jan 12, 2015 11:34 am

thx1138 wrote:Apart from the myriad bad things about deflation already posted, another one is nominal price/wage behavioral errors. People don't think in real terms particularly well, and this also applies to wages. One reason slightly positive inflation is a good thing is that people hate having their pay cut but object less when you forgo a raise even in an inflationary environment. Of course stagnant wages during inflation is a real wage cut, but people mostly think in nominal terms. So in a deflationary environment it is much more difficult to adjust wages as market conditions change.

Anyway, that's a rather minor effect to the far more dramatic problem of deflation essentially cutting off all investment and lending.
From a macro model point of view it is *the* effect. Basically it's like putting a price floor on the labour market, above the price dictated by the meeting of supply and demand. The result is massive unemployment. And that has other big macro effects, all bad.

Spain, Italy, Greece -- they are all there, now.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by market timer » Mon Jan 12, 2015 11:35 am

Deflation isn't necessarily a bad thing. In fact, in many theoretical models, the optimal monetary policy involves deflation, such as the Friedman rule. The US economy enjoyed robust growth in the 19th century, during which prices experienced mild deflation.

Image

Personally, I've never bought into the argument that deflation causes people to delay purchases. What should matter is the real interest rate, not the rate of inflation. For example, I'm much more likely to delay a purchase if inflation is 2% and my savings account is paying 8% (real rate of 6%) than if inflation is negative 2% and my savings account is paying 1% (real rate of 3%).

What I think most would agree on is that unexpected inflation or deflation is harmful. So, if the Fed says they are targeting 2%, they should try to stay close to their target. In that sense, deflation is a bad thing.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Angst » Mon Jan 12, 2015 12:06 pm

Valuethinker wrote:
Mountain Man wrote:As I understand it, if you think bad deflation is coming and you need to alter your AA, then you need to:

1) pay off all your debt
2) raise your level of cash
3) buy long-term Treasuries or Zeroes.
Yes. Probably the best strategies. Unfortunately the horse has rather bolted in that the 30 year Treasury already yields what, 2%?
One can still pony up $10,000 worth of 20-yr zero coupon series EE savings bonds paying 3.5% :wink:

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Ged » Mon Jan 12, 2015 12:14 pm

The main reason that deflation is bad is that it suppresses investment. If the value of your money is going to grow without taking on the risk of investment what in fact would be the motivation to invest it in some inherently more risky enterprise?

We are told that the greatest threat to a fixed pension or cash holdings is inflation, and to preserve wealth investing is necessary. What if that weren't true? How many retirees would hold stocks? Why take that risk when your money would grow in value just sitting in a savings account?

The result would be a disaster for the economy at large, as Japan found out in its lost decade.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by nedsaid » Mon Jan 12, 2015 12:27 pm

It depends a lot on what causes deflation. If deflation is caused by the destruction of debt through bankruptcy and write-offs, in the shorter run, it is a bad thing. Not only would prices for consumer goods fall but also asset valuations. It would be a "reverse wealth effect" where people would feel poorer because their real estate and financial portfolios would be worth less in dollars. People would want to save more in an attempt to rebuild that wealth thus having a depressing effect on the economy.

On the other hand, America experienced deflation during the latter part of the 1800's as technology made the production and the shipment of goods cheaper and cheaper. It was largely beneficial as the dollar gained purchasing power through greater productivity in the economy. Still, it was an important issue for the country. As I recall, the bankers loved it and the farmers hated it. The banks got paid back in money that had more and more purchasing power and those with debts had a greater and greater burden.

Perhaps, somebody with a background in US history could comment on the later 1800's after the Civil War. There were definitely winners and losers.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by billyt » Mon Jan 12, 2015 12:28 pm

You thought 2008 was bad? If deflation takes hold it will absolutely kill the real estate market. Who would take out a 30 year mortgage to finance something that is going to drop in value year after year? If all asset prices are going to fall far into the future, the only thing to do is sell everything right now and hold cash. Of course, then you have to worry about the safety of that cash.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Valuethinker » Mon Jan 12, 2015 12:33 pm

market timer wrote:Deflation isn't necessarily a bad thing. In fact, in many theoretical models, the optimal monetary policy involves deflation, such as the Friedman rule. The US economy enjoyed robust growth in the 19th century, during which prices experienced mild deflation.

Image

Personally, I've never bought into the argument that deflation causes people to delay purchases. What should matter is the real interest rate, not the rate of inflation. For example, I'm much more likely to delay a purchase if inflation is 2% and my savings account is paying 8% (real rate of 6%) than if inflation is negative 2% and my savings account is paying 1% (real rate of 3%).

What I think most would agree on is that unexpected inflation or deflation is harmful. So, if the Fed says they are targeting 2%, they should try to stay close to their target. In that sense, deflation is a bad thing.
I don't think people carry a real interest calculation around in their heads. I think money illusion is quite strong. Even Friedman did not believe people were totally rational.

The current situation is prices are maybe rising at 1% and bank interest rates are 1-2%. If people respond to a real interest rate, then we should be having a spending boom in the US, UK etc. Which is not what we are seeing.

On the 19th century first there was a depression in 1872 which was probably every bit as bad as the one in the 1930s. It's certainly held that inflation in the money supply (gold from Yukon/ Alaska and Australia was part of economic recovery at the end of the century).

Also the deflation of the post 1865 era in the US was almost certainly the result of supply side shocks- -to a substantial extent anyways. And that's probably also true of the pre Civil War period. You saw an incredible number of technological innovations, actually *adopted* each one of which would have increased the potential output of the economy for a given price level:

- Erie Canal
- railways
- telegraph
- Eli Whitney and the cotton gin, also mass production of rifles (originally) and then other manufactured goods
- spinning mill
- steam engine and the mechanization of factories
- discovery of oil in Pennsylvania (replacing whale oil which was in short supply)
- gas lighting
- municipal sewage works
- germ theory of disease and the rise of sanitation and disinfection
- John Deere's plough
- opening up of the far more fertile lands in the west (against farming on rocks in New England)
- mass literacy
- constant new discoveries of raw materials and innovations in extracting them

Finally you had huge demographic forces. Immigration to the US and then mechanization of agriculture releasing huge numbers of workers for the rising factories.

As per my previous posts a supply side shock which is deflationary (arrival of China into world markets; the internet; new oil supplies) is almost certainly less harmful to economic growth than a demand side one.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Valuethinker » Mon Jan 12, 2015 12:43 pm

nedsaid wrote:It depends a lot on what causes deflation. If deflation is caused by the destruction of debt through bankruptcy and write-offs, in the shorter run, it is a bad thing. Not only would prices for consumer goods fall but also asset valuations. It would be a "reverse wealth effect" where people would feel poorer because their real estate and financial portfolios would be worth less in dollars. People would want to save more in an attempt to rebuild that wealth thus having a depressing effect on the economy.

On the other hand, America experienced deflation during the latter part of the 1800's as technology made the production and the shipment of goods cheaper and cheaper. It was largely beneficial as the dollar gained purchasing power through greater productivity in the economy. Still, it was an important issue for the country. As I recall, the bankers loved it and the farmers hated it. The banks got paid back in money that had more and more purchasing power and those with debts had a greater and greater burden.

Perhaps, somebody with a background in US history could comment on the later 1800's after the Civil War. There were definitely winners and losers.
It's a very good point: William Jennings Bryan, Free Silver and the 'Cross of Gold' speech was all about switching to a more inflationary money supply to help indebted farmers facing low food prices. Nisiprius has pointed out that the Wizard of Oz is a riff on all this.

The US endured a bitter recession 1872-1880, perhaps as bad as the 1930s one, we just don't have the data to know. So financial crashes (the collapse of Grant-Cutler, a broking firm owned by *that* General Grant, kicked it off-- he was destitute and his family would have been except for his memoirs. Dying of throat cancer, encouraged by Samuel Clemens/ Mark Twain, he finished his memoires only weeks before he died. They are, apparently, among the best of general's remembrances from a historical point of view. And became a bestseller after his death, securing his family's wellbeing*).

But yes the second half of the 19th century saw technological progress probably more significant than our own. Such innovations as the telegraph and the steamship. Municipal sanitation. Completion of the transcontinental railway network. Innovations in agriculture. Steam powered factories. Optics. Chemicals.

* There is something moving about Grant's Tomb, up there in Mornington Heights in Manhattan. The general lies there, surrounded by the figureheads of his generals: Sherman, Sheridan, the lot. One of the Republic's greatest generals (if not a well remembered president). A man who understood the limitations of the tool with which he worked, the Union Army, but drove it on, relentlessly, to save the Republic-- who never swerved from his final goal. He lies in that Pantheon with Washington (and who beat Tarleton in the Carolinas?), Winfield Scott, Lee and Jackson (ironically), Sherman, Pershing, Patton, Eisenhower, Matt Ridgeway, Creighton Abrams.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by bobcat2 » Mon Jan 12, 2015 12:51 pm

For there to be sustained deflation in an economy the price of the biggest item in that economy will almost certainly be falling. That item is wages. Either nominal wages on average will be falling, or unemployment will be growing rapidly, or some of both.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by itstoomuch » Mon Jan 12, 2015 1:11 pm

IMO,
Most of deflation has already been priced into the market. ie bonds, preferreds, dividend payers. There are some pockets in housing with slowing inflation. I think that some utilities are a reasonable play.

Cash will be King.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by nedsaid » Mon Jan 12, 2015 1:14 pm

Valuethinker wrote:If you look at what is happening in Greece, Italy, Spain or Japan right now you see why deflation is a bad thing.

The first 3 have double digit unemployment and youth unemployment over 45%. As part of the Euro they are undergoing a forced deflation to lower their wages and prices to below German ones.

The problem is 'sticky wages'. Even in Spain, the average wage settlement is 0%. To achieve full employment in a fixed exchange rate regime (ie the Euro) Spain would probably need wages to fall by c.-20%. Since that cannot happen, instead companies just sack workers/ do not hire more workers.

This of course also raises government expenditure and cuts tax revenues. The fear of being unemployed means those who have money don't spend it, further weakening the economy. So deficits soar, necessitating more cuts, more deflation, more misery.

Japan has been stuck in this cycle for nearly 20 years.
Indeed, this is one thing that economists argue about the US Great Depression. One reason the depression lingered was that wages were not allowed to fall according to some economists. There also were attempts to stimulate the economy during the depression but such efforts were relatively modest. There was still a lot of concern about budget deficits. The public debt didn't grow enough to cover the destruction of debt in the private sector, so asset prices fell. It took WWII to stimulate demand, raise wages, and create enough pubic sector debt to overcome the destruction of the private debt during the depression. Though I am not a Keynesian, I think Keynes was a brilliant fellow and had his finger on what ailed the economy.

Another factor is the expectations of the public, it is what I call a "depression mentality" where you save, save, and save some more with the anticipation that tough times will continue or possibly return. You make do with what you have and don't throw anything away until you squeeze out every possible use. It is very difficult to en masse change public expectations. Obviously, this mind set is not stimulative to the economy.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Tanelorn » Mon Jan 12, 2015 1:14 pm

I think the simplestic argument that deflation is bad (because of falling short term demand / delayed gratification) doesn't hold water. We've had massive deflation in consumer electronics prices for decades and that industry is doing a whole lot better than most. Perhaps this is the difference between expected and unexpected deflation - if everyone expects electronics to get cheaper (they do), the companies can plan accordingly and it all works out. On the delayed gratification side, well, I sure don't have much confidence in the average person (or government!) doing that - just look at how much debt is out there incurred by people or institutions who want more now than they can afford.

It seems to me that basically deflation is good for savers and bad for debtors. Most people here are savers, so you'd think that would be good.

I'm not really qualified to say about how macro economic factors might play out, or how some bad events (like the Great Depression) might or might not correlate with deflation. I think it's probably not simple, so sticking to the basics (pay off your debt if you're afraid of deflation) is probably the way to go.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Ged » Mon Jan 12, 2015 1:16 pm

Removed for redundancy.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by nedsaid » Mon Jan 12, 2015 1:17 pm

Tanelorn wrote:I think the simplestic argument that deflation is bad (because of falling short term demand / delayed gratification) doesn't hold water. We've had massive deflation in consumer electronics prices for decades and that industry is doing a whole lot better than most. Perhaps this is the difference between expected and unexpected deflation - if everyone expects electronics to get cheaper (they do), the companies can plan accordingly and it all works out. On the delayed gratification side, well, I sure don't have much confidence in the average (or government!) person doing that - just look at how much debt is out there incurred by people or institutions who want more now than they can afford.

It seems to me that basically deflation is good for savers and bad for debtors. Most people here are savers, so you'd think that would be good.

I'm not really qualified to say about how macro economic factors might play out, or how some bad events (like the Great Depression) might or might not correlate with deflation. I think it's probably not simple, so sticking to the basics (pay off your debt if you're afraid of deflation) is probably the way to go.
Thank you, deflation caused by innovation and productivity is a good thing. Great point. Yes we have seen prices on certain items in the economy fall over the years. Consumer electronics is a great example.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by ogd » Mon Jan 12, 2015 1:31 pm

Deflation is bad because the economy slows down to a crawl. You can think of it in terms of credit (which becomes a great burden), something that the entire economy runs on whether you like it or not. That leaves open the simplistic moral argument that maybe debt is a bad thing, but you can also think of it in terms of capital investment. If I'm an entrepreneur with a suitcase of cash, I could invest it in my business and hope I can recoup it from declining prices, or I can just leave it in the suitcase whereby it will appreciate on its own. Under deflation I'm far more likely to choose the latter. Hence, economic depression.

You can also talk about real interest rates like market timer above, and I agree that there's a certain equivalence. But because of the zero interest bound on nominal rates (i.e., the suitcase, which as an alternative does not allow nominal rates to drop below zero by much more than a "convenience fee"), deflation necessarily means high real interest rates, only without the control knob that exists at higher inflation/nominal rates.

So it's altogether really bad if you're in any way part of the economy. It may look like you can buy more with your money, but if you don't get paid and stuff simply doesn't get produced (both of which happen in depressed/deflationary scenarios), everyone is poorer.

The best deflation hedge that I'm aware of is nominal Treasuries, the longer the better. And no debt that can't be easily refinanced.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by itstoomuch » Mon Jan 12, 2015 1:37 pm

Certain sectors will find deflation very tough.
Farming where you buy or finance capital equipment and seed at today's prices but repay at future income from sales. Hence in the previous eras of deflation we have seen future and option markets developed. Having farmed, the best income scenario is a crop failure.

The three legs of money creation
Banks will be bad.
Insurance may benefit.
Brokerage, stocks/bonds may benefit.

The nonprivate Government will have problems in receiving taxes to pay off debt.

Natural resources that were on developed yesterday's valuations but repaid on tomorrow's lower valuation (crude, coal, energy)
Long investment will eventually stop which means lower longterm employment.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Twins Fan » Mon Jan 12, 2015 1:38 pm

It seems the thread here is talking mainly about the "majority of Americans". I would say the majority of Americans have had stagnant wages for decades now while inflation kept on keeping on. Sure, maybe inflation was at lower rates, at least recently...

Most Bogleheads would probably say deflation is bad...

The majority out there would probably welcome deflation.... or, welcome some wage increases while prices were stagnant for a while.

Yes, plenty of folks lived above their means and took on unneccessary debt. But, plenty of folks still have debt because prices/bills went up and wages have not. If folks can afford to pay off debt and buy at lower prices, they will buy things at lower prices.

Just my take on it, if you look outside Boglehead folks and look at the majority of folks.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by user5027 » Mon Jan 12, 2015 2:02 pm

white_water wrote:My question; where did they put that cash as banks collapsed?
My grandfather hid it in the walls and floors of his house.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by richard » Mon Jan 12, 2015 2:08 pm

Twins Fan wrote:<>The majority out there would probably welcome deflation.... or, welcome some wage increases while prices were stagnant for a while.<>
The problem with this is the relation between wages and price levels. It's rather unlikely we're going to see a general increase in wages while seeing a general decrease in prices. There will of course be many individual exceptions, but at the aggregate level it's not likely to be sustainable.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by richard » Mon Jan 12, 2015 2:09 pm

bobcat2 wrote:For there to be sustained deflation in an economy the price of the biggest item in that economy will almost certainly be falling. That item is wages. Either nominal wages on average will be falling, or unemployment will be growing rapidly, or some of both.

BobK
Good luck convincing anyone of that. Almost no one sees the connections between general prices, the health of the economy and wages. Perhaps it's a problem understanding aggregates.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Epsilon Delta » Mon Jan 12, 2015 3:01 pm

Tanelorn wrote:I think the simplestic argument that deflation is bad (because of falling short term demand / delayed gratification) doesn't hold water. We've had massive deflation in consumer electronics prices for decades and that industry is doing a whole lot better than most.
The difference with electronics is that it is a high growth industry. While prices are falling per unit, the number of units is increasing much faster, so the nominal value of total sales is still increasing. Look at how this impacts employment. Productivity is increasing, but production is increasing faster, so employment still grows, so promotions and new hires continue to dominate the employment picture, instead of stagnation and layoffs.

On a macro scale, if growth is greater in magnitude than deflation, the nominal economy is still growing, you avoid many of the worst effects of deflation.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by Mel Lindauer » Mon Jan 12, 2015 3:27 pm

Swampy wrote:That said, where does one position investments to safely capitalize on deflation?
Lots of ideas, but one thing that hasn't been mentioned is I Bonds. While most folks think of I Bonds for INflation protection, most don't realize that they also provide DEflation protection. Since the composite rate on I Bonds can never go below 0%, the greater the rate of deflation, the greater the REAL return on I Bonds will be.

For example, a 0% fixed rate I Bond would return a REAL yield of +5% if deflation were 5%. So, the greater the rate of deflation, the greater the REAL return I Bonds would provide.

Botton line: I Bonds protect against both unexpected inflation as well as deflation.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by kenner » Mon Jan 12, 2015 4:34 pm

Perhaps the scariest thing about deflation is that no one seems to know how to reverse its harmful effects. In the U.S, the Fed has tools to combat inflation, but almost none to fight deflation.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by aeronina » Mon Jan 12, 2015 5:06 pm

I still find the whole idea of deflation confusing, especially in the case of Japan. People speak of Japan as having deflation for the past 10 -20 years, yet what I've seen on two visits to Japan (1971 & 2007), roughly one month each time, is people everywhere in Japan living well, no visible poverty, and plenty to purchase & variety in stores. If only there was as little visible poverty here in the United States or in most countries in Europe (with the exception of Germany)! Granted I have little insight into the real estate markets or the stock market there, but for average people renting, there appeared to be very little difference between 1971 (no deflation) and 2007 (deflation).

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by nedsaid » Mon Jan 12, 2015 5:12 pm

aeronina wrote:I still find the whole idea of deflation confusing, especially in the case of Japan. People speak of Japan as having deflation for the past 10 -20 years, yet what I've seen on two visits to Japan (1971 & 2007), roughly one month each time, is people everywhere in Japan living well, no visible poverty, and plenty to purchase & variety in stores. If only there was as little visible poverty here in the United States or in most countries in Europe (with the exception of Germany)! Granted I have little insight into the real estate markets or the stock market there, but for average people renting, there appeared to be very little difference between 1971 (no deflation) and 2007 (deflation).
I was in Japan in 2002 and saw a homeless tent village in Kobe, Japan. So Japan does have a homeless problem. Their homeless are neat and orderly where our homeless tend to have trash strewn all around. But they do have problems. During that time, I read about a lady that stepped in front of a commuter train because she was experiencing financial problems. Their problems with poverty are less apparent than here.

But I agree with your general observation that Japan appears to be very prosperous. I suspect the strong YEN has a lot to do with this and the trade surplus Japan has with other nations, particularly the United States. And I think the deflation experienced in Japan has been very mild. They certainly are not experiencing a 1930's depression. Just a stagnant economy that has a hard time of growing. I suppose demographic factors play a role here, Japan's workforce and population are starting to shrink. They aren't having enough kids.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by newbie001 » Mon Jan 12, 2015 5:33 pm

aeronina wrote:I still find the whole idea of deflation confusing, especially in the case of Japan. People speak of Japan as having deflation for the past 10 -20 years, yet what I've seen on two visits to Japan (1971 & 2007), roughly one month each time, is people everywhere in Japan living well, no visible poverty, and plenty to purchase & variety in stores. If only there was as little visible poverty here in the United States or in most countries in Europe (with the exception of Germany)! Granted I have little insight into the real estate markets or the stock market there, but for average people renting, there appeared to be very little difference between 1971 (no deflation) and 2007 (deflation).
I think it's been pointed out on BH before that Japan's per capita GDP growth actually hasn't been too shabby relative to the U.S. This site lets you play around with per capita GDP growth for the two countries based on World Bank Data:

http://www.tradingeconomics.com/japan/gdp-per-capita

http://www.tradingeconomics.com/united- ... per-capita


Although it has also been pointed out that a growing population is better for stocks, all other things being equal, regardless of per capita GDP growth.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by bhsince87 » Mon Jan 12, 2015 5:46 pm

To prepare or profit from deflation, first get out of debt. Debt is toxic during deflationary periods.

To profit from it? That's the rub. You can do OK with bonds, preferably government bonds. Just having a steady job is a good thing too. Basically any kind of fixed income stream.

In theory, deflation isn't always a bad thing. But pretty much anyone with debt suffers. Governments, businesses, and individuals.

Governments can take a double whammy, because tax income goes down (especially in countries with highly progressive rates like the US), yet they still have to maintain payments on their bonds. The US is one of the few countries that can literally just print money to meet it's obligations. This can act as an automatic offset to some forms of deflation.

Countries that can't do that (Like the European Union, for example), don't have that option.

The real trouble begins if/when deflation becomes self-reinforcing, and a vicious circle can occur.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by cubedbee » Mon Jan 12, 2015 5:52 pm

RNJ wrote:On my highway drive home I pass a number of gas stations. Yesterday, I found myself passing station after station, looking for for the lowest price. I finally came to my exit and thought,"I'll fill up tomorrow. It'll most likely be cheaper anyway."

Now imagine that that kind of thinking set in, not just about gas, but about everything. Demand falls with the expectation of lower prices "down the road" and PRICES will fall with them - a deflationary spiral which, as the Japanese will tell us, is very difficult to get out of. Bad for business (price pressure), bad for workers (cutbacks in labor under pressure from falling demand), and bad for those in debt (e.g., anyone with a mortgage).
This is the standard example of why deflation can start deflationary spirals...but I just don't buy it.

If you choose to fill up tomorrow, it's because your tank was not empty. Tomorrow, or the day after, your tank will be empty, and you will purchase more gas. Your expectation of deflation influenced your purchasing patterns (if you expect deflation wait as long as possible to fill up. If you expect inflation, top your tank off every day. If you expect prices to fluctuate up and down, buy when you see a down fluctuation or just ignore all the fluctuations and fill up when you need it). But, your expectation of deflation does not influence how many total miles you drive. Who is going to defer driving someplace that they need or want to be, because they can make the same drive cheaper tomorrow? The whole purpose in owning a car is to give one the ability to travel when one needs....if one is able to defer ones travel to save money, then one probably should sell the car...


I think this is true of all major categories of the CPI. We all need shelter over our heads --- the fact that housing will be cheaper next year than this year does not mean we will go homeless for a year to get a cheaper house next year. We all need to eat a certain number of calories a day, and the fact that food prices will be cheaper next week than this week doesn't mean we're going to starve ourselves to save some money. Deflation patterns will change our buying patterns, and will harm and help different producers/retailers in different ways....but that's not the same as lowering demand.

I don't believe there's any major category of spending where consumers demand will actually decline in the face of deflation. The essentials won't decline because they are essential. Non-essentials, like consumer electronics, are the categories that deflate the most in actuality....and clearly deflation is driving consumer demand to increase, not decrease....the smartphone market is vastly bigger today than five years ago.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by bpp » Mon Jan 12, 2015 6:01 pm

market timer wrote:Personally, I've never bought into the argument that deflation causes people to delay purchases.
I agree with you. I have been a consumer in Japan during the deflation here. We have also had inflation starting a year or two ago, by force. My personal reaction to incipient inflation has been to pull in my horns and reduce spending, because my income has not gone up commensurate with the inflation, and I know as a result I will have less real income to spend in the future. So I cannot afford to waste money now.

I think inflation/deflation by themselves do not spur or inhibit consumption. Rather, real wages going up or down do. If I see my wages going up faster than inflation (or down slower than deflation), then I feel free to spend. In the reverse case of real wages going down, I feel inhibited from spending.

But what do I know, I'm only a stupid consumer. I must be wrong about how I think, because all the smart economists insist that I think differently than I think I do.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by scone » Mon Jan 12, 2015 6:04 pm

Deflation is "good" if the price of your new iPad falls, even though it has more and better features. Deflation is "bad" if people are losing their McJobs because other people are losing their McJobs, because other people are losing their McJobs. If deflation gets out of control, even large stable corporations can go bankrupt-- their stocks and bonds become worthless, their assets are sold for pennies on the dollar, or don't sell at all. Homes and small businesses don't sell at any price. Bankruptcy and unemployment become the natural state of affairs. At some point of extreme stress, you can get a breakdown of civil society. That's what happened in Europe during the Depression. It very nearly happened here.
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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by richard » Mon Jan 12, 2015 6:05 pm

kenner wrote:Perhaps the scariest thing about deflation is that no one seems to know how to reverse its harmful effects. In the U.S, the Fed has tools to combat inflation, but almost none to fight deflation.
There's a difference between having the tools and being willing to use them. Look how eager the Fed is to deploy tools to fight inflation, even though inflation has been below its % target for quite a while and there's not much indication of incipient inflation reaching its target. Look at the rhetoric demanding the Fed tighten.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by ogd » Mon Jan 12, 2015 6:07 pm

cubedbee wrote:I think this is true of all major categories of the CPI. We all need shelter over our heads --- the fact that housing will be cheaper next year than this year does not mean we will go homeless for a year to get a cheaper house next year. We all need to eat a certain number of calories a day, and the fact that food prices will be cheaper next week than this week doesn't mean we're going to starve ourselves to save some money. Deflation patterns will change our buying patterns, and will harm and help different producers/retailers in different ways....but that's not the same as lowering demand.
You're only thinking of non-discretionary spending, which is indeed as the name implies. You need to also think of discretionary spending, like a car upgrade which can be put off for quite a while. And much, much more importantly, capital investment. This is the one that really, really hurts. See my post above with the suitcase full of cash being a better investment than a new production line that will produce stuff to be sold at lower prices.

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Re: Why Is "Deflation" A Bad Thing??? How To Prepare/Profit

Post by wcmFun » Mon Jan 12, 2015 7:10 pm

Twins Fan wrote:It seems the thread here is talking mainly about the "majority of Americans". I would say the majority of Americans have had stagnant wages for decades now while inflation kept on keeping on. Sure, maybe inflation was at lower rates, at least recently...
Glad I decided to keep reading instead of posting ;)

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