Deflation

You may or may not have seen the article today on MSNBC regarding the concerns that are rising about deflation. It's an interesting read and I'll include a link to the article in this post for your convenience.

We've all heard of deflation but it seems like all we ever hear about is its counterpart, inflation. So what is deflation? Deflation is a decline in general price levels sustained for several months often caused by a reduction in the supply of money or credit.

John Schoen writes, "While deflation might sound welcome, in fact it can be devastating to borrowers, banks and businesses. The Great Depression in the 1930s was accompanied by deflation of 10 percent per year, reflecting the widespread lack of demand."

He goes on to explain "As prices fall, consumers and businesses become less willing to spend and invest, worsening the economic downturn, as happened in Japan's "lost decade" of the 1990s.
A sustained drop in prices hurts in two ways. First, because consumers and businesses anticipate prices will continue to fall, they would likely cut back further on spending and investment. Why shell out $1,200 for that flat-panel TV today when you can get it for $800 six months from now?"

The problem with this logic is that as people and businesses stop purchasing the economy starts suffering, businesses suddenly have too much inventory, employees get laid off, spending further reduces because of unemployment, etc., etc.

The second pain that Schoen describes is the debtors pain. "Inflation is good news for anyone who owes money because, as prices rise, spending power is eroded and the real value of money declines. When inflation is rampant, you get to pay back the $1,000 you borrowed last year with dollars that are worth a little less each year. That debtor advantage is turned upside down if deflation takes hold. As prices fall, the spending power of your money goes up. But so does the real value of your debt — because you have to pay it back with money that has increased in real value."


Read the article here on MSNBC.com. I think you'll at least find it interesting and something to continue watching.