Deflation, What Is It? & Why Is It Important?
Deflation, Inflation & Disinflation- Defined
For the purposes of this article, the following definitions will be used:
- Deflation occurs when asset prices fall considerably
- Inflation occurs when asset prices increase
- Disinflation occurs when the rate of inflation slows.
The World Is Deflating:
As a general guideline, economists and central bankers around the developed world want to see a rate of inflation around 2%. That is ideal and considered healthy in most developed economies. As of this writing (Jan 2015), the world is deflating, not inflating and that is not a healthy sign for Wall Street & Main Street.
Why Is Deflation Bad; The Deflationary Spiral
FindLeadingStocks.com members frequently ask me why is deflation bad? I am asked:
Isn’t it better if I pay less for food and energy? Why is it bad to see prices fall? So on and so forth…
“Deflation Begets More Deflation” – Adam Sarhan
In the short term, deflation may appear “good” for your wallet but if it persists, the ramifications are ominous. The primary reason is that deflation begets more deflation and pretty soon it morphs into a negative deflationary spiral that could cripple the general economy. Broad scale deflation is bad for the economy because the primary reason why deflation occurs is due to waning demand, which occurs when people spending less money. That, in turn, reduces money supply and credit and hurts the economy, earnings, incomes, and general economic growth. To sell their products, companies are “forced” to lower prices and that tends to lower earnings. In time, salaries are reduced, and people have less money to spend. All this causes more deflation which sparks a negative deflationary spiral.
Right Now, Deflation Is A Bigger Threat Than Inflation
Over the 12 months we have seen deflation spike as a slew of widely used asset prices are imploding. Right now, Metals (Gold, Silver, Copper), Energy (Crude Oil, Gasoline, Nat Gas), and Agriculture commodities (Soybeans, Corn, Wheat) are all in private bear markets and the prices are accelerating to the downside. This is not healthy action and something investors across the globe are watching closely. In the last six months, a lot of attention has been paid to imploding energy prices. The concern going forward is that eventually stock prices will be dragged lower if “deflation” continues or gets worse. This is something that central banks across the globe are watching closely and we are doing the same thing. Stay tuned, it is never a dull moment on Wall Street.