Inflation Versus Deflation
Which One's Worse
Well here we go again. Between the “swamp”, the Federal Reserve and other factors that control our macroeconomic, geopolitical world we’ve reached another point of no return. Inflation is too high, there’s no liquidity in the marketplace, loans are hard to come by yet consumers are still spending; why? The herd mentality, “keeping up with the Joneses”, I’m not sure what it is but one thing for certain; like anything else it is going to come to and end and that end is not going to be pretty.
Before discussing the several, varied potential outcomes let’s take a couple paragraphs to define what we’re about to discuss; inflation and deflation. A number of you already know the meaning of both but “newly minted” traders haven’t really been exposed to deflation, at least not a deflationary period that wasn’t artificially “clouded” with the effects of our government running the “printing press” at full speed.
Inflation & Deflation Defined
Inflation and deflation are contrasting economic phenomena that refer to the general movement of prices in an economy over time.
Inflation is the sustained increase in the general price level of goods and services in an economy over a period of time. When inflation occurs, the real purchasing power of money decreases, meaning that each unit of currency buys fewer goods or services. Inflation can be caused by various factors, such as increased demand for goods and services, rising production costs, changes in governmental policies, or expansionary monetary policies. Moderate inflation is generally considered normal, desirable in an economy, as it indicates healthy economic growth. However, high or “hyperinflation” can be detrimental to an economy, leading to reduced consumer purchasing power, uncertainty, and economic instability.
Deflation, on the other hand, is the sustained decrease in the general price level of goods and services in an economy over a period of time. In deflationary environments, the purchasing power of money increases, as each unit of currency can actually buy more goods or services. Deflation can occur due to factors such as reduced demand, declining consumer spending, technological advancements leading to real increased productivity and lower production costs, or tight monetary policies. While deflation may initially seem beneficial to consumers, as prices continue to decrease, it can have severe negative consequences for an economy. It leads to decreased business profits, reduced investment and spending, and a downward spiral, the “deflationary spiral”, where falling prices coupled with expectations of further price declines discourage consumption and investment, causing economic stagnation or recession.
Both inflation and deflation can have significant impacts on an economy. Our central banks and policymakers strive to maintain stable, almost controlled levels of inflation to promote sustainable economic growth. They’re in a battle at this present time with an outcome that’s far from being achieved and controlled.
The United States has experienced several significant deflationary periods throughout its history. Here are some of the worst deflationary periods in U.S. history:
1. The Great Depression (1929-1933): The Great Depression was one of the most severe economic crises in U.S. history. It was characterized by a massive contraction in economic activity, skyrocketing unemployment rates, and a significant deflationary spiral. Prices dropped sharply as the Consumer Price Index fell by around 27% from 1929 to 1933. The deflationary pressures worsened the economic situation, as falling prices reduced business revenues, leading to wage cuts, further reducing all consumer spending, and causing a vicious cycle of economic contraction.
2. Long Depression (1873-1879): The Long Depression, a global economic recession began in the United States in 1873 lasting until 1879. This period was characterized by a extremely prolonged period of deflation, widespread bankruptcies, and coupled with high unemployment rates. The deflationary pressures during this period were driven by a variety of factors like the collapse of several major banks and the contraction of credit. Prices fell and the economy experienced a decline in industrial production and agricultural output.
3. Post-World War I (1920-1921): Post World War I, the United States experienced a short, severe recession. During this period, prices dropped rapidly, leading to a period of deflation. The ensuing recession, triggered by the demobilization of the military, a decline in government spending, and tightening monetary policies created havoc in the United States and worldwide but was short lived as it’s solution resulted in what we know today as "The Roaring 20s”. Deflationary pressures, including but not limited to a contraction in economic activity, high unemployment rates, and financial distress for many businesses quickly turned into a period of expansion that ended badly.
It's worth noting that while deflationary periods are challenging for an economy, they vary in severity and duration. The Great Depression was the most severe deflationary episode in U.S. history, with long-lasting and devastating effects on the economy.
The question of whether inflation or deflation is worse is a matter of perspective and depends on various factors. Both inflation and deflation have negative consequences for an economy. The ideal scenario is typically a moderate level of inflation or price stability. Here are some considerations for each:
Inflation:
1. Reduced Purchasing Power: Inflation erodes the purchasing power of money, meaning that over time, each unit of currency buys fewer goods and services. This can reduce the standard of living for individuals and create challenges for savers.
2. Uncertainty: High or volatile inflation introduces uncertainty into the economy, making it difficult for businesses and individuals to plan. This uncertainty can hinder investment and economic growth.
3. Redistribution of Wealth: Inflation can lead to a redistribution of wealth from savers to borrowers. Those holding cash or fixed-income investments may see their real value diminish, while borrowers benefit from repaying their debts with money that is worth less.
Deflation:
1. Deflationary Spiral: Persistent deflation can lead to a deflationary spiral, where falling prices and expectations of further price declines discourage consumption and investment. People simply stop spending resulting in what is economic stagnation or recession.
2. Increased Debt Burden: Deflation can increase the burden of debt repayment. As prices fall, the real value of debt remains consistent or even increases, making it more challenging for borrowers to meet their obligations.
3. Reduced Business Profits: Falling prices negatively impact businesses' revenues and profitability. This leads to drastic cost-cutting measures, employee layoffs, and an overall contraction in general economic activity.
The severity and impact of inflation or deflation depend on factors like rate, duration, and predictability of price changes coupled with the underlying causes and the overall state of the economy. A moderate level of inflation is actually beneficial as it promotes economic growth and investment. Deflation is generally seen as more problematic due to the risks of a deflationary spiral and its impact on debtors and businesses.
So what’s worse, inflation or deflation? In the way the Federal Reserve has attacked its own decisions creating today’s problems of inflation one might answer that question too quickly and say inflation. Before deciding let’s examine both in a slightly different light.
Recently inflation has been the biggest problem but keep in mind, we caused it. First, for far too many years post the 2008 banking crisis, interest rates were kept at far too low of a level. Inflation was basically nonexistent and Bernanke and Yellen had little to do except make speeches and accept honorary awards. Augmented by the COVID crisis, governments ran massive deficits and spending programs to provide stimulus. Central banks pumped a tidal wave of liquidity into financial sector pushing prices higher. That was our way of handling our own “man-made” prior problems but now that inflation is starting to come down we need to ask; how are we going to handle what’s next, deflation in this credit oriented macroeconomic, geopolitically upside down worldwide economy.
Everyone looks at the various price indices to get their information, most of which are lagging indicators at best. The CPI month-over-month is declining but in my opinion there’s better indices to follow; Truflation and the Adobe Digital Price Index (ADPI). Both are a little more in line with what’s happening today and both are tracking lower. Take the time to “click” on both; they offer an alternative source of information and at this time a reason to start worrying about deflation not inflation.
Inflation primarily benefits fixed debtors, corporations, commodity producers and the like while deflation, at least initially, benefits consumers, savers and lenders. Problem is that over time the spiral of decreased demand takes hold. The effects of continued sinking consumer demand are diabolical. The “herd” stops spending, the demand for goods and services are reduced, business bottom lines decrease and people lose their jobs. As employees lose their jobs consumer confidence weakens, the downward cycle gains speed leading perhaps to a prolonged recession or even a depression. Let’s face it folks, we’re due.
When it comes to repaying your debt and the basic bills you’ve created, the less you have coming in makes that harder and harder. The percentage of what you planned to use to pay back your debts increases leaving less to spend elsewhere. Additional credit is unavailable leaving the only source of money being your retirement plans and that’s not a good place to borrow.
If you’re concerned about “keeping up with the joneses” chance are you’re not going to be able to as falling wages exacerbates and widens income inequality. You’re going to have a tough enough time figuring out how to pay for all of the “stuff” you just had to have as credit tightened then disappeared. When debt burdens exceed what you can earn, deleveraging, selling off your assets and reducing your spending become logical alternatives. This may help you personally to survive but it’s going to reinforce further deflation as demand continues to drop.
If you are counting on the Federal Reserve or Congress, affectionately known by most as the “swamp” think again. Neither are in the position at this time to alleviate effects of deflation. Yes, interest rates will fall but not because of their monetary of legislative decisions. Makes sense from my side; if there’s no demand for money other than just paying back what you owe, demand for credit ceases along with consumer confidence, growth and corporate profits. It’s a bleak scenario but one i think we are headed for.
Deflation is often overlooked or dismissed as a benign economic trend, generally as a ‘good’ thing but it’s not. It can cripple a macroeconomic environment especially one mired in debt. Things like fading demographics, automation, and excessive debts are only some of the deflationary overhangs. Still thinking positively about AI?
If there is a trade or investment that works in a deflationary environment it’s buying long term U.S. Treasury Bonds. In a deflationary model, interest rates are going to go down. Inversely the underlying value or price of the bond is going to go up and you’ll have locked in a higher rate of interest payments in a secured, guaranteed instrument; that is if we raise the debt ceiling and we all know that’s going to happen, right?
In tomorrow’s post I discuss an investment or trade in bonds but I have to reflect on the “deal” our politicians struck to raise the debt limit. Remember the television show “Deal or No Deal”? In my opinion, after reading parts of the text of this latest deal it might have been better if there was “no deal” and that still might be the outcome. The “swamp” has done it again. They didn’t curtail spending; they turned the spigot back on failing to address the effects of inflation as they continued to “kick the can” down the proverbial road. Yellen says June 5th was the drop dead date when our country’s bank account would be empty. If she had the “balls” ad truly sought to “do the right thing” she’d realize that as of June 15th the country’s bank account would be flush with cash from quarterly tax revenues but no; never let a crisis go to waste. It’s going to be an interesting week; I wonder how it’s going to be reported.
Because of you, our early adopters, Substack has taken notice. Our thanks go out to Barchart as well as they’ve adopted us. They’re going to form the foundation of how we teach “what we use & how we use it” but like anything else, it’s all on a learning curve. Back to the “curve”, it’s a long one, longer than anticipated so I’ll just keep to the content.
Hope you enjoyed this post. I’m just a young 68 years old; my Dad became a broker when I was 13. It’s time for me to ‘give back’ to all of you what’s in my head. It’s not always pretty but it’s based on history . . . and history, unchecked, repeats itself as you are witnessing..
Everyone learns at their own pace. If you pick everything up the first time through, great but if not email me at david@thetickeredu.com so we can further help. Again, let me know what you want to learn, I’m all ears.
There’s two ways to make money; (1) make it and (2) don’t spend it. You’re about to find out why. In the interim please enjoy some Pink Floyd and “Money” and thanks for stopping by.