We Are Not Prepared for Deflation

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The exchange with your boss goes something like this:

Boss: ‘No pay rise this year.’

You: ‘That’s great news. Thank you so much.’

Boss: ‘Thought you’d be happy.’

You: ‘Delighted.’

If you are one of the lucky ones to be told your income remains the same, then high fives all round are in order…you can’t wait to tell your partner the good news…

No pay rise is good news? In a world gripped by deflation, it’d be great news.

This mindset is alien to us now. But we could become acquainted with it very soon.

Milton Friedman saidInflation is always and everywhere a monetary phenomenon…’

 Inflation has been our constant companion for the best part of the past 70 years. We’ve known nothing different.

We are programmed to expect higher prices, higher incomes, higher profits, higher property values and higher superannuation balances. The perpetual growth machine has had occasional splutters, an odd recession along the way. But an interest rate reduction here, a tax cut there, usually does the trick. And higher we go.

A modest level of inflation, we are told, is good for us. Most of us accept this and never question it.

Central bankers and economists have perpetuated the inflation myth for decades.

How can inflation be good for us when all of us would like to see lower prices?

An economy that relies on increasing levels of credit based consumerism to achieve growth is in need of constant inflation.

Without inflation, there’s no compelling reason to borrow today. In a world where prices will be lower next year, it’s better to save and wait.

This is the polar opposite of how the global economy has functioned since the Second World War.

Deflation (falling wages and prices) ‘robs’ government of projected higher tax receipts from income taxes, GST, stamp duties, royalties, etc. when they need them most…retiring boomers, rising health costs and rising interest on mountains of debt.

‘Inflation is good for us,’ is a construct of governments and central banks. Yes, we (I mean, boomers) have benefitted greatly from a sustained period of inflation. That’s one reason most of us can’t comprehend the prospect of this 70 year phenomena coming to an end.

Over the past 12-months, the tone appears to be changing from ‘deflation, what deflation?’ to ‘perhaps deflation is not all that bad’.

Deflation is not in the cards, according to hundreds of economists polled last week, none of the more than 150 economists polled by Reuters forecast even a quarter of consumer price declines in any of the Group of Seven countries.’

 MoneyNews.com, 19 January 2014

 

‘Deflation Stalks the Globe: If deflation becomes a reality in 2015, we may find out whether it’s an evil to be avoided at all costs, or a boon to be championed.’

Bloomberg, 17 December 2014.

 In a world of ‘too many factories producing too many things for people who no longer desire or have the financial capacity for those things’, deflation is now a very real possibility.

The following is from Gowdie Family Wealth when it was launched nearly two years ago (emphasis added):

 The [Gowdie Family Wealth] model portfolio has been designed to protect and prosper from the big picture view we hold. Which is:

  1.  The forces of The Great Credit Contraction (debt repayment or default) will exert a deflationary influence on the global economy. During this phase, “Cash is King”.
  2.  In the near term (next 2‒3 years), as the global economy weakens, Australian cash rates could possibly fall into the sub-2% range.

 Very few people believed either scenario was possible at the time. They humoured me.

 It’s taken a little while (as markets often do), but the big picture scenario underpinning our model portfolio is slowly beginning to play out. This year may bring these outcomes into clearer focus.

Deflation belongs to a world far, far removed from anything we have ever experienced. We, society on all levels, are ill-equipped to handle it.

First, government is struggling to fund yesterday’s promises with today and tomorrow’s revenue. This is Joe Hockey’s current dilemma. In Japan, the US and Europe, they have resorted to printing money to indirectly (via bond purchases) finance government budget deficits. Printing money has a limited shelf life.

The greater the grip deflation gains on the global economy, the larger the budget deficits become. At some stage, printing money to paper over the cracks will no longer work. What happens to welfare, healthcare and warfare spending?

Second, businesses all set themselves ambitious growth targets. We know from the corporate reporting season that not all companies achieve their stated objectives. Some fall woefully short. In a deflationary world, growth projections (even modest ones) become difficult to achieve. It relies on gaining market share from bankrupt competitors; reducing labour costs; squeezing suppliers — all of which further feeds into the deflationary loop and increases unemployment. Lower or stagnating profits translates to lower or stagnating share prices — especially if social mood is sombre and P/E ratios fall to reflect this new found cautiousness.

Finally, households are currently loaded up on debt under the perpetual assumption that next year will deliver higher incomes, higher house prices, and higher share markets. What happens if this cycle goes into reverse? Indebted households are likely to embark on a debt reduction program (forcibly or voluntarily). Another negative feedback loop.

The interlinking of private, corporate and public sector (mis)fortunes is likely to make the deflationary phase we’re on the cusp of entering much more destructive than people believe possible.

Deflation is made to appear evil. But that’s yet another lie from the truly evil central bankers. You cannot borrow to prosperity. Society has been dumbed down to the point that hardly anyone realises they’ve been duped. Deflation is nothing to fear — that is, if you have no debt, live within your means and save. The problem is that this applies to precious few.

Everyone has been encouraged to gear up (pun intended) for an inflationary world.

As deflation takes hold, expect to hear the cries for help grow louder from all sectors.

And the central bankers will have license to further practice their voodoo economics. As desperation mounts, all sorts of weird and wonderful stimulus schemes will come into play.

These ivory tower academics are the problem, not the solution. They’ll make a bad situation even worse.

Take heed and take precautions. Reduce unnecessary debt. Trim your budget. Increase cash holdings.

 Vern Gowdie,
for The Daily Reckoning Australia

Vern Gowdie

Vern Gowdie

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top 5 financial planning firms in Australia. He is a feature contributing editor to The Daily Reckoning and is Founder and Chairman of the Gowdie Family Wealth advisory service and editor of the Gowdie Letter To follow Vern's financial world view more closely you can you can subscribe to The Daily Reckoning for free here.
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3 Comments on "We Are Not Prepared for Deflation"

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Chris
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Vern, your continuing analysis of the ‘global economy’ is completely logical and makes excellent informative reading…just wish it didn’t scare me so much!

David Griffiths
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Hello Vern,
You probably get this question a lot, and I wont hold you to it, but how long is it until the worst effects of this deflationary event become manifest? Thanks.

Rob Gray
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Deflation…bring it on, I’m sick of this “everything must grow” mentality.

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