How To Make Money During Deflation – Deflation is a decrease in the overall level of prices in an economy and an increase in the purchasing power of the currency. It can be driven by an increase in productivity and the abundance of goods and services, by a decrease in total or aggregate demand, or by a decrease in the supply of money and credit.
Changes in consumer prices can be observed in economic statistics compiled in most countries by comparing changes in a basket of various goods and products to an index. In the US, the Consumer Price Index (CPI) is the most commonly referenced index to evaluate inflation rates. When the index is lower in one period than in the previous period, the general level of prices has fallen, indicating that the economy is experiencing deflation.
How To Make Money During Deflation
This general drop in prices is a good thing because it gives consumers greater purchasing power. To some extent, moderate declines in certain products, such as food or energy, even have a positive effect on increasing nominal consumer spending. Beyond these basic staples, a general, sustained fall in all prices not only allows people to consume more, but can promote economic growth and stability by enhancing the function of money as a store of value and real savings. to encourage.
Inflation Vs Deflation: Guide To Bitcoin & Cryptocurrencies Deflationary Nature
However, under certain circumstances, rapid deflation may be associated with a short-term contraction of economic activity. Generally, this can happen when an economy is heavily indebted and dependent on the continuous expansion of the supply of credit to inflate asset prices by financing speculative investment, and subsequently when the volume of credit contracts, asset prices fall and speculative over investments are liquidated.
This process is sometimes known as debt deflation. Otherwise, deflation is usually a positive feature of a healthy, growing economy that reflects technological progress, increasing abundance, and rising living standards.
If, as the common saying goes, inflation is the result of too much money chasing not enough goods in the economy, then deflation can conversely be understood as a growing supply of goods and services chased by a constant or slower growing supply of money.
This means that deflation can be brought about either by an increase in the supply of goods and services or by a lack of increase (or decrease) in the supply of money and credit. In both cases, if prices can adjust downward, this leads to a generally falling price level.
What Is Inflation
An increase in the supply of goods and services in an economy is typically the result of technological progress, the discovery of new resources or an increase in productivity.
Consumers’ purchasing power increases over time and their living standards rise as the increasing value of their wages and business income enables them to buy, use and consume more and better quality goods and services. This is an unambiguously positive process for the economy and society as a whole.
Some economists have sometimes expressed fears that falling prices will paradoxically reduce consumption by inducing consumers to hold off or postpone purchases in order to pay lower prices in the future; however, there is little evidence that this actually occurs during normal periods of economic growth accompanied by falling prices due to improvements in productivity, technology or resource availability.
Moreover, the vast majority of consumption consists of goods and services that cannot be easily deferred into the future even if consumers wanted to, such as food, clothing, housing services, transportation, and health care.
How Deflation Could Doom The Economy To A New Great Depression
Beyond these basic needs, even for luxury and discretionary spending, consumers will only choose to reduce current spending if they expect the rate of decline in prices to exceed their natural time preference for current consumption over future consumption.
The one type of consumer spending that will suffer from falling prices will be items that are regularly financed by taking on large amounts of debt, since the real value of fixed debt will increase over time as prices fall.
In a highly financialized economy, where a central bank, another monetary authority, or the banking system, in general, is involved in the continuous expansion of the supply of money and credit in the economy, the reliance on newly created credit is to finance business operations, consumer spending, and financial speculation, leads to ongoing inflation in commodity prices, rents, wages, consumer prices, and asset prices.
More and more investment activities are beginning to take the form of speculation on the price increase of financial and other assets, rather than profit and dividend payments on fundamentally sound economic activity.
Velocity Of Money Picks Up: Inflation Coming? Stagflation? How About Deflation?
Likewise, business activities tend to depend more and more on the circulation and turnover of newly created credit rather than actual savings to finance ongoing operations. Consumers are also coming to finance more and more of their spending through heavy borrowing rather than self-financing from ongoing savings.
Gold is usually considered a good hedge against inflation, but it can also be a good hedge against deflation.
To compound the problem, this inflationary process usually involves suppressing market interest rates, which distorts decisions about the type and time horizon of business investment projects themselves, beyond simply how they are financed. Conditions are ripe for debt deflation to step in at the first sign of trouble.
At that point, either a real economic shock or a correction in market interest rates could put pressure on heavily indebted businesses, consumers and investment speculators. Some of them struggle to turn around, refinance or make their payments on various debt obligations such as business loans, mortgages, car loans, student loans and credit cards.
Understanding The Differences Between Inflation, Deflation & Stagflation
The resulting arrears and defaults lead to debt liquidation and bad debt write-offs by borrowers, which begin to eat away at the accumulated supply of circulating credit in the economy.
Banks’ balance sheets become shakier, and depositors may seek to withdraw their funds as cash if the bank fails. A bank run can occur, whereby banks have overextended loans and obligations against insufficient cash reserves and the bank can no longer meet its own obligations. Financial institutions begin to collapse, removing liquidity after which debt borrowers have become even more desperate.
This reduction in the supply of money and credit then reduces the ability of consumers, businesses and speculative investors to continue to borrow and bid up asset and consumer goods prices, allowing prices to stop rising or even begin to fall.
Falling prices put even more pressure on indebted businesses, consumers, and investors because the nominal value of their debt remains fixed as the corresponding nominal value of their income, revenue, and collateral declines through price deflation. And at that point the cycle of debt and price deflation feeds back on itself.
Disinflation Is A Bigger Threat Than Inflation
In the short term, this process of debt deflation involves a wave of business failures, personal bankruptcies and rising unemployment. The economy experiences a recession and economic output slows as debt-financed consumption and investment decline.
Deflation is when the prices of goods and services fall across the economy, increasing the purchasing power of consumers. It is the opposite of inflation and can be considered bad for a nation as it can indicate a downturn in an economy, leading to a recession or depression. Deflation can also be caused by positive factors, such as improvements in technology.
It depends. Deflation can be worse than inflation if it is caused by negative factors, such as a lack of demand or a decrease in efficiency throughout the markets. Deflation can be better than inflation if it is brought about by positive factors, such as improvements in technology that make the cost of goods and services cheaper.
To hedge against deflation, investors can buy investment grade bonds, consumer food stocks, dividend stocks and keep their money in cash. A diversified portfolio can protect against a variety of economic scenarios.
Gold, Inflation, Cash Or Deflation: Which Side Are You On?
A little bit of deflation is a product of, and good for, economic growth. But in the case of an economy-wide, central bank fueled debt bubble, followed by debt deflation when the bubble bursts, rapidly falling prices can go hand in hand with a financial crisis and recession.
Fortunately, the period of debt deflation and recession that follows is temporary and can be avoided entirely if the constant temptation to inflate the supply of money and credit in the first place can be resisted.
All in all, it is not deflation, but the inflationary period that then leads to debt deflation that is dangerous for a country’s economy. Perhaps consistent and repeated inflation of this kind of debt bubble by central banks has unfortunately become the norm over the past century or so.
In the end, this means that while these policies continue, deflation will continue to be associated with the damage it does to the economy.
How To Invest For Inflation & Deflation
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