Next Year the Bigger Problems Are Coming
D…d…d…a central banker will dare not say this word out loud.
Back in April this year, our own head of the Reserve Bank of Australia said:
‘The large fall in oil prices, combined with the introduction of free childcare and the deferral or reduction in some price increases mean that it is quite likely that year-ended headline inflation will turn negative in June.’
Did you see that?
Why can’t central bankers just call a spade a spade and call it deflation…
The D word
Governments don’t like it.
Central banks hate it even more.
And the press is out to convince it’s bad for you…
But the word they dare not utter isn’t as bad for you as they want you to believe.
The dreaded D word has appeared periodically since April.
The thing is, when you see the press talking about deflation, they always talk about how bad it is. Take this from Bloomberg back in April:
‘The economic contraction wrought by efforts to contain the coronavirus is shredding inflation. Now deflation, a prolonged period of falling prices, is stalking the globe. The collapsing oil market is both a symptom of weaker demand and cause for a deepening slump.
‘That’s a mistake. For decades, inflation was the most-preferred way to assess economic health; whatever its flaws, targets in the vicinity of 2% gave global central banks a quantifiable guidepost. If there are alternatives, they haven’t been proposed.’
This is the thing when it comes to writing about deflation, the angle you’ll see from the press is always towards shaping your view that it’s bad.
But is deflation really that bad?
As fancy sounding as it is, deflation simply means the falling prices of goods and services. That’s in contrast to inflation, which is rising goods and services.
The thing is though, the only people deflation is really bad for is governments and central bankers.
The argument behind ‘inflation is good’ is driven by central banks and governments.
If the value of goods and services will rise in the future, people are more likely to buy those items today rather than tomorrow and risk the price of those goods increasing.
Whereas for deflation, people expect prices to fall in the future, so purchases are delayed as folks hope they’ll get it cheaper later on.
Central banks base their central banking business on anything that ‘stimulates’ the economy and encourages it to grow.
Therefore, inflation forces us to buy things earlier than we would have, bringing demand forward. In other words, we are more likely to buy more stuff today rather than risk it getting more expensive. And buying things sooner rather than later benefits others in the economy.
That way, the economy ‘expands’ because we continue to consume items.
If we travel a little further into the economic textbooks, prices going higher is meant to encourage the value of wages and assets to increase. They say we get wealthier as ‘inflation’ filters through the economy.
And here’s the crux of inflation that you don’t normally hear about.
The higher prices and wages increase…the lower the debt burden becomes.
That is, if your wages and asset values are rising, then your debts in theory become smaller against rising prices. Assuming the debt value is fixed (like with a house or a car loan, for example).
Central bankers love inflation, because by pulling a few levers they believe they can stimulate demand, increase prices, and encourage debt while ‘growing’ the economy.
Deflation is the opposite of all this.
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Falling prices delay consumption. Why buy today what you can buy tomorrow? If prices are falling, there’s less pressure on companies to increase wages.
Furthermore, it reduces a bank’s willingness to lend for an item if there is a risk the goods will be worth less than the debt attached.
And more to the point, it makes the existing debt much harder to pay off…
To boot, if we are all consuming less, the economy doesn’t ‘expand’ by a central banker’s playbook.
Australia’s lost decade
Back in January this year ANZ was already talking about Australia facing a lost decade. That is, a period of flat economic growth where deflation gripped Japan during the 1990s.
The Age point out that stagnant wages and high costs of living were going to slow economic growth for the 20s, writing:
‘Australia is facing a lost decade of economic growth, ANZ has warned, that will see living standards slip and wages grow modestly while putting pressure on the Morrison government’s plan for a string of budget surpluses.’
Meaning pre coronavirus, Australia’s economic growth already had an uphill battle.
Then just this morning Ray Dalio of Bridgewater Associates waded in, telling us that this could be a global problem, saying:
‘Globalisation, perhaps the largest driver of developed world profitability over the past few decades, has already peaked…
‘Now the US-China conflict and global pandemic are further accelerating moves by multinationals to reshore and duplicate supply chains, with a focus on reliability as opposed to just cost optimisation.
‘Even if overall profits recover, some companies will die or their shares will devalue along the way. Left with lower levels of profits and cash shortfalls, companies are likely to come out on the other side of the coronavirus more indebted.’
The thing is, we’re all still coming to grips with what the virus has done to the economy today. We aren’t looking forward enough.
And that’s a problem.
Because while I suspect Australia will have a bout of deflation, I suspect it will be short term.
I think next year the bigger problems will begin, as we see stagflation taking hold. That’s right. The very thing the old-school economic texts said couldn’t happen…
What does that mean for you and your wealth during this turbulent time?
I’ll explain more next week.
Until next time,