Okay, a couple months ago there was an order supply sheet in our copy room which got a bunch of random comments from bored people making copies. One comment was lamenting the lack of raises this year. The response was “Don’t worry, deflation will happen soon.” I’m confused.
I understand inflation (I think). Isn’t deflation falling prices? Wouldn’t falling prices effect interest, loans and stocks? So yes, things would be cheaper but all of us would be poorer. And if deflation falls enough, wouldn’t we have another Great Depression? So why shouldn’t we worry? Or am I missing the sarcasm in the response?
Deflation would increase the value of your salary, but it would also increase the value of any debts you owe. Deflation is the sign of an economy that is going down the tubes directly. Methinks that the person leaving the note was being sarcastic.
Yes, deflation is a Bad Thing. Falling prices leads to a lack of demand because people defer purchases in the hope that they can get a better deal in a few weeks. Lack of demand leads to further falling prices as retailers scramble to get people back in the shops. Lack of demand means that producers cut back production, so people get laid off. Increasing joblessness drops consumption further. The result is a viscous spiral of dropping prices, dropping consumption, and rising unemployment.
So you’re saying we could find ourselves in a sticky situation?
Not likely. The US economy remains extremely strong as compared to those that have suffered actual deflation in the past. You have to have a pretty messed up situation before deflation begins to occur, and this recession is fairly typical.
AmericanMaid, the sarcasm in the remark was merely that “Management didn’t give us a raise, but we’ll get an effective raise when our salaries stay the same but prices fall. That’s the best we can hope for.”
Deflation is not always as catastrophic as previous posters have made it appear. During most of the Nineteenth Century, for example, prices tended downward in most Western countries, and these were decades (for the most part) of robust economic growth. In modern times, with the world on fiat money, deflation is less common, and is usually a symptom (not so much a cause) of a sputtering economy.
Japan has been suffering from deflation for the past ten years, it’s an economy killer. Here’s an illustration of why deflation is a nightmare:
You want to buy a $100,000 house. But housing prices keep falling. You know based on reports, that that same house will be worth $75,000 three years from now.
That $40,000 brand new car? $20,000, brand new, three years from now.
What do you do? You horde your money, and so does everyone else. This forces suppliers to lower their prices even more . . . causing MORE deflation, and its a downward spiral.
No one buys stuff . . people lose jobs . . . people horde their money even more . . . . buy less stuff . . . more people out of work . . egads.
You don’t want deflation. Double digit inflation is no picnic either . . . about 4-6% inflation a year seems to be ideal, I think.
Rub THAT in the face of your grandparents when they start droning on about how cheap things were back int the day.
The biggest danger of deflation isn’t it’s effect on consumer spending as many are trying to say above. Consumers don’t generally think that far in advance when buying most goods, exception perhaps for homes and vehicals. The biggest problem with deflation is what it does to long-term debts.
If you take out a $10,000,000, 30 year loan(or some other debt instrument such as bonds) to build a factory during strong economic times you’ll plan your production and pricing such that you can meet your debt payments and make a profit. Let’s say that for ten years things go according to plan, the economy is growing and inflation is healthy. Then something happens, and by year 15 of operations the economy has entered a deflationary cycle, prices and wages are falling. In order to move inventory you have to lower prices, the deflationary market simply won’t bear your original prices. So revenue drops. On the bright side because of deflation your variable costs (raw materials, wages etc…) also decrease. However the fixed cost of your debt payments remain the same. If deflation goes on for too long, or comes on too quickly your factory won’t be able to generate enough revenue to meet your debt payments you go bust.
Depending on the debt instruments used and the terms of said intruments it may be possible to refinance them under favorable terms but no matter what you do with the interest rates the sad fact remains that the 10,000,000 you borrowed 15 years ago is worth alot more after a period of deflation than it was when you borrowed it, and your gonna have to repay it somehow. Or go bankrupt.
This actually happened to a lot of farmers and middle class shop owners in the 19th century just after the Civil War when the US economy went into a sharp deflation cycle. Just like with inflation a small amount of deflation that is steady of a long period of time can be surviable, but the percentage of deflation that isn’t harmful is much lower than with inflation. It’s also much more of a danger now than it was 200 years ago because debt financing is much more common now than it used to be.
Just to summarize some of what has been said about deflation being bad: Deflation is very bad for the banks’ loan business, esp. pre-deflation loans. Banks get into trouble, stop making loans, maybe even go under. Capital disappears. Economy grinds to a halt.
Cf. Japan last 10 years.
What about people who have money and owe nothing?
Example: my father-inlaw is retired, and owns his home outright. He owes no money.
His only income is social security, but…he had sold his business to retire. I think he has about 450 grand in actual cash.
Wouldn’t deflation be a huge boon to someone like him (while it ruins the rest of us).
pkbites, yes, deflation is the cat’s pajamas for people who operate in cash. For a taste of this, cpnsider the steadily-dropping prices of many computer components. (BTW, I’ve read that this isn’t actually deflation, but is a typical price-drop that occurs at the introduction of a new technology.)
As an example, a week ago I bought a DVD recorder that cost CAD 280.00 plus taxes. It does more than a DVD recorder I priced in January (eight months ago) that cost CAD 500.00. Both were the lowest-cost units in Toronto at the time. I simply waited because I knew the prices would drop until they matched my savings for the purchase.
Now, imagine that happening to everything, and that’s what deflation would be like from a consumer perspective. But FunkySpaceCowboy is right; if you have debt it’s a killer.
During the height of the Great Depression, there was some deflation. People were earning much less money then, and thankfully deflation allowed their money to go farther (cheaper groceries etc.). Some economists have suggested this effectively offset the tight supply of money to some degree.
“Wouldn’t deflation be a huge boon to someone like him (while it ruins the rest of us).”
Not if interest rates drop for savings… in 2001 my Bank of America branch interest rate on their savings account was .25%, the next year it was .50% . That’s correct, one half of one percentage point. When there was inflation, interest rates were high, around 9 to 10%. So you make alot more interest.