Here’s Why Everyone’s So Freaked Out About Deflation

From TechTicker:

Over the past six months, the main concern among investors and economists has shifted from inflation (rising prices) to deflation (dropping prices).  In other words, instead of worrying about how your dollars are going to buy less stuff in the future than they do today, everyone’s now panicked by the thought that your dollars are going to buy more.

But what’s so horrible about your dollars buying more?  On its face, persistently declining prices would seem to be a good thing for consumers, not a bad one.

And in that limited respect–stuff costing less tomorrow than it does today–deflation WOULD be good for consumers, especially consumers with savings.

But in other ways, as Greg Zuckerman of the Wall Street Journal explains, deflation can be bad for consumers.  And, more importantly–from the perspective of investors and economists–it can be bad for the economy as a whole.

In a recent blog post, economist Paul Krugman explained the theory of why deflation is bad:

•    When people expect prices to drop tomorrow, they stop spending today (to wait for tomorrow).  This isn’t always true, of course–people still buy plenty of flat-screen TVs, even when prices drop every week, but economy-wide deflation would encourage savings at the expense of spending. (Many folks, of course, could do well to save more, but, again, this is not good for the short-term growth of the economy as a whole).

•    Deflation makes the real burden of debt grow rather than shrink.  If you owe $100 today, you’ll have to work harder to pay it back with dollars you earn tomorrow (because you’ll get fewer of them for the same amount of work).

•    Wages adjust more slowly than prices, which puts pressure on company profit margins.  In other words, it’s harder for companies to pay employees less than to charge less for their products.  Again, that’s not a bad thing for the employees, but it hurts profitability–and, therefore, the stock market.

The bottom line is that deflation is good for people with high savings and low debts…and bad for people with low savings and high debts.  And the US as a whole is in the latter category right now (very low savings and sky-high debts).  That’s why economists and investors are so terrified by the prospect of deflation.

See Also: Here’s A Quick Look At America’s Coming Deflationary Debacle