Deflation Woes
Posted by Gail | Filed under Economics 101, In the News
Remember, the site is undergoing it’s medical today. Don’t get frustrated if you can’t post. Just come back and have your say later. This may take a day or two. Chillax. We’ll be back to normal, God willing, by Wednesday or Thursday.
The financial news has been full of talk about deflation. Almost everyone knows that inflation means the price of stuff is gonna go up. But the flipside of inflation – deflation – is something most people have far less experience with. Like it or not, you might just have an opportunity to share in this interesting reversal since economic indicators say we may be headed for a period of deflation.
So what is deflation, and how will it affect you?
When an economy experiences a reduction in prices for it’s goods and services, that’s called deflation. Don’t confuse “deflation” with “disinflation” which is simply a slowing of inflation. Deflation is a full on reversal. And for many economists, deflation is a way more serious problem, largely because it’s tougher to control.
People are always bitchin’ about how inflation makes things more expensive, so one would think that a period of reduced prices would a be welcome respite. After all, if stuff becomes cheaper to buy, money will go further, right?
Yes and no. Yes, things will get less expense, and that can be good in the short-run, particularly for people living on fixed incomes. The No comes in when deflation drags on. When prices are falling, consumers are willing to wait for even lower prices before putting down their hard-earned dough. Inventories pile up. Sellers are forced to cut prices further to increase demand. Companies’ profits fall. That leads to production cut-backs, reductions in wages, layoffs and even the closing of facilities. Unemployment increases and since fewer people are working and have less money to spend (and less taxes are being paid) the economy cannot expand. There is no growth. People get even more scared, spend less, and the whole thing just spirals down.
The U.S. fell into a deflationary period during the Great Depression in the ‘30s; deflation hit 10% and unemployment hit 25%. Japan went into a deflationary period in the ‘90s and that economy still hasn’t really recovered.
The big benefit of deflation is, of course, the fact that stuff gets cheaper. Yes, it’ll cost less to live. But less is relative, since deflation also brings reductions in income.
So what can you do to protect yourself (kinda) if we do fall into a period of deflation.
Reduce your debt. (Gee, Gail, that’s your answer for everything.) As we’ve already seen happening, interest rates go up for riskier borrowers during a period of deflation. Since growth is at a standstill, lenders are less willing to let you spend money you’ve haven’t yet earned.
Get your fixed expenses under control. If you lose your job, you’re going to be working on a bare-bones budget. High fixed expenses are anathema to survival. So those mortgage payments. car payments, loan payments that are gobbling up your paycheque are going to get even harder to stomach.
Build up your emergency fund. Since deflation brings higher unemployment, if you’re one of the newly unemployed, you’ll need an emergency fund (cash not a line of credit!) to survive.
Focus on increasing your personal marketability. Get some new skills. Keep your resume up to date. Look for ways to shore-up your employment prospects.
During periods of deflation, cash is king. Do whatever you can to store up your money. If the deflation thing never comes to fruition, you won’t be any worse off having some extra cash available for investing. If it does, you’ll breath more easily knowing you have some resources to see you through.
August 16, 2010 at 9:52 pm
Aren’t 5-year mortgages going down this week?
August 16, 2010 at 11:29 pm
hmmm gail, much food for thought. though i’m quite aware that this has been predicted for the past months, thinking it through to the higher unemployment, less production, etc is rather frightening. helps keep that fire lit under my butt, encouraging me to stay the course, pay my debt off, and save save save.
i’ll be interested to read what others have to say. in my area the statistics say that there are currently 5-8 qualified applicants for each open job. i would hate to be amongst those job searching right now. my manager is singing the “i hate my job” chorus while i am just happy to have my job, earn a great paycheck, and have the ability to pay my bills and keep the roof over my head. i spoke with my director last week; he reassured me that i will continue to have a job and i ought not pay attention to my manager. that helped relieve a lot of the anxiety.
as does this post gail. i think forewarned is best…the better educated i am, the more prepared i will be when the ca-ca hits the fan. thank you for another great post!
August 17, 2010 at 8:46 am
Forewarned for sure. Thanks for this post Gail. The situation in US is quite severe, with a large upswing in the long-term unemployed. There’s a term for them called the 99ers Club – the people who have exhausted the limit of the many extensions of unemployment insurance – 99 weeks. That’s almost two years. The real unemployment rate in the US (including those who have given up looking for work) is approaching 18% and is over 20% in some areas. You can’t have one-fifth of your working age population unemployed and it not have a severe impact on your economy. There are school boards laying off teachers, cities laying off municipal workers, libraries closing (one-fifth of the population not earning means taxes aren’t being paid), cutbacks in services like garbage collection. States can’t afford the upkeep of their prisons so are letting criminals out early. Infrastructure is crumbling in some states meaning reliable transportation that business needs is slowly decaying.
And as we saw in 2007-2009, a declining US economy affects the world economy.
So get ready for a bumpy ride everyone.
August 17, 2010 at 8:55 am
This really hit home for me. Where I live we have a new sewer plant and water plant so they have doubled our water bill to pay for this!!!
so I have a $ 500 water bill. yikes! Thats the inflation part.
Where I work they have reduced wages and layed off lots of people this summer!
thats the deflation part.
Very scary and walking on egg shells it seems to stay afloat. Working as hard as you can to get ahead can be very exhausting.
Thanks for the post Gail. Nice to know its just not happening to me
August 17, 2010 at 8:37 pm
Roxy, I think you’ll find a lot of places (in Ontario anyways) in a similar situation where replacement of municipal works will start to drive up rates and taxes.
In the early 70’s there was a lot of stimulus funding available to municipalities for infrastructure and recreation works but as those facilities start to age past their useful lives (think arenas, pools, libraries, water and sewer treatment plants, bridges), many municipalities are going to be facing a tough decision on how to provide replacements for such services (new accounting requirements for municipalities will ensure proper capital budgeting for future replacements, but unfortunately some places haven’t been aggressively budgeting over the past 40 yrs..)
I know in our area, the taxes will be going up 3-5% per year for the next four years, development charges will be increasing by 300% over the next 10 year period and our water and sewer rates doubled over the past year.
While I certainly see what Gail is driving at (deflation of costs), I think that some of the core costs (taxes, water/sewer, energy, fuel) will continue to rise as we haven’t been paying the true cost of these services in the past and are just now starting to realize the error of our ways.
I agree, we’re in for a bumpy ride.
August 18, 2010 at 9:54 am
After the website update, I have not gotten any of the postings through RSS feed (yahoo). Is there a glitch somewhere?
PS. I LOVE TDDUP and this blog! Looking forward to the new episodes (although I faithfully watch the re-runs each week).
August 18, 2010 at 10:24 am
@ Diz and Roxy: And the good side of all of that is, it gives jobs to the tradespeople. A LOT of upgrades are being done to water treatment plants, and sewage plants in various cities/townships. It’s been keeping my husband very busy, and his paycheque looking good! And yes, some of them were in much needed states of repair, not having been really touched in 40 years.
August 18, 2010 at 12:17 pm
I’ve noticed that the prices of some things has gone down drastically, like clothes, appliances, electronics and brick a brack (anything that can be made overseas), but also the expectations for quality of these things has also gone down considerably! People seem content to get a season from footwear, 3 years out of a TV or 5 years from an appliance these days! Not good enough for me, I want 10-20 years from anything I’ve scrimped and saved to purchase — it’s still a major purchase even if it is less expensive than it used to be. The other thing that seems to be really a “bargain” is entertainment… cellphone plans, long distance, vacation packages, etc… they seem to get cheaper every year.
But the flip side to that coin is that the ESSENTIALS seem to be getting crazy expensive! Water, heat, shelter and real, wholesome groceries are alarmingly costly in proportion to the other things. Also, house, life, medical and car insurance take up a huge amount of my monthly budget — ( a big chunk for a service that I hope NOT to cash in on).
We carry on…make due and budget for it…. what else can we do?