“There’s a lot of talk about inflation these days, but what about its’ mirror image- deflation? Deflation could be what eventually unravels the world’s economies. Orlando McCall
When consumer and asset prices decrease and purchasing power increases, you have what’s known as “deflation.” Although most of us are paying attention to the more obvious impact of inflation on our wealth, deflation can also wreak havoc on economies.
After months of punishing price hikes for nearly everything, price decreases seem like a good thing, especially if you like to shop for bargains. However, when you discover more about deflation, you soon realize that it is ultimately bad news for your finances and for your nation.
Deflation defined
As noted, deflation is a situation in which asset prices and the prices of consumer goods, decrease while purchasing power increases. Deflation is the lesser-known mirror image of inflation, which is a gradual increase in prices across an entire economy. Deflation may be caused by many different factors including a decrease in demand for products, overproduction of goods, or a contraction in the money supply or credit.
On the surface, deflation may seem like a good thing. However, there’s a problem. Deflation often points to impending recessions and challenging economic conditions. The most dramatic deflationary event in America happened between 1930 and 1933 during the Great Depression. The Great Recession of 2007-2008 is the most modern example of a deflationary cycle.
Deflation works against an economy because many times when people see things decreasing in price, (for example, home prices), they tend to wait out purchasing those things. “Car prices are trending downward. If I just wait a year, I can get a better deal.” “Real estate is getting cheaper. If I sit on the sidelines for a while, I can get a much better price.” These seem like wise decisions. After all, why pay more for something than is necessary? When you dig a little deeper, though, you will discover that lower consumer spending means less operating capital for companies. Many businesses are unable to pay debt, expand their operations, or innovate when deflation is on the rise.
A deflationary cycle often presages mass unemployment and higher interest rates. Debt becomes more expensive during a deflationary period. This in turn has an obvious negative impact on lending institutions, such as banks and finance companies. Also, while there are procedures and protocols your financial advisor can implement to help buffer the effects of inflation on your nest egg, protecting against the ravages of deflation is a little trickier.
How can you protect yourself against deflation?
Deflation is somewhat of a mixed blessing for retirees and pre-retirees since it does not affect everyone equally. For instance, if you are already retired and have little to no debt, falling prices associated with deflation could be beneficial.
On the other hand, if you have riskier investments in your portfolio, or you have a lot of debt, deflation could have serious consequences.
During a deflationary cycle, many financial advisors have their clients move money into cash investments, most of which earn minuscule returns, or none at all. Assets such as stocks, corporate bonds, and real estate become riskier in a portfolio.
If you are only a few years away from retirement age and find yourself stuck in a deflationary period, safe money instruments, such as fixed annuities could help protect your wealth. Now is a great time to look at your assets allocated and seek guidance from a retirement income specialist. Your advisor can ensure that your retirement blueprint is correctly balanced and adjusted so that your money will weather deflation. Deflationary cycles can be challenging, but they don’t have to completely derail your retirement plans.
