Thursday, November 20, 2008

Should We Be Scared of Deflation?

Deflation: Many never saw it coming. Some still don't think we're in a deflationary period right now. First of all, what is deflation? There are many definitions, and thus the debate over when (or if) deflation arrived. In general, deflation is the reduction in available money, credit, and ultimately, consumer prices decreases.

So if inflation (and hyperinflation) is a bad thing (skyrocketing food prices, house prices, stock markets, while our wages stay about the same), does deflation imply a good thing? If you have any debt, then deflation is a very bad thing. During deflationary periods, prices of goods and services will drop, but so will your take-home pay eventually (companies can't sell their products at lower prices without decreases wages). If you have debt, this will not change. You will still owe the same amount, even though you might be earning less.

If you don't have any debt, deflation will not be as frightening a prospect. But beware, a deflationary period will mean job losses and wage reductions for many. This can't be avoided.

Martha C. White writes an informative article:

The Federal Reserve today dropped the benchmark fed funds rate to 1 percent, a nearly unprecedented move. While the Fed has flirted with low rates before and even dropped the rate to 1 percent between June 2003 and June 2004, that was when the housing boom was in full swing and everyone was operating under the assumption there was nowhere to go but up.

These are different times. Now, the finance industry is in a state of disarray, and global markets are seesawing. It's a telling sign, though, that even as Treasury yields plummet in response to en masse investors seeking a safe haven, their inflation-adjusted counterparts, otherwise known as TIPS, have been on an upswing, sometimes even surpassing comparable conventional Treasury bills. Economists aren't really worried about inflation right now-because they're too busy worrying about deflation instead. Deflation is when across-the-board prices for goods drop and assets lose value. But wait-weren't we just wringing our hands over $4.50 gas and $4 milk? Don't we want low prices?


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