I was having a conversation yesterday with a good buddy of mine who doesn’t understand the big fuss about deflation. In his mind, what’s not to like?
Rent on his apartment is significantly less now than during the pre-financial crisis days and he boasts about walking around the mall and finding everything on sale for 40%, 50% or even 60% at any given time. So when he pulled out the print edition of the Journal yesterday and saw the headline “Big Investors Fear Deflation,” he was puzzled.
Yes, for people who still have decent-paying jobs and some dough in the bank, and not a lot of fixed debt, a little deflation doesn’t hurt. But in a broader economic sense, the prospect of deflation is downright frightening.
The Journal’s deflation piece, which Paul referenced yesterday, explains how some big-name investors, including Bill Gross, Jeremy Grantham, David Tepper and Alan Fournier are changing their investment strategies in light of deflationary fears. Even St. Louis Fed President James Bullard last week publicly warned about deflation and the potential of a Japanese-like lost decade, or period of slow growth.
Why all the fuss about deflation? WSJ explains in a nut shell:
Deflation is seen as pernicious and hard to address once it sets in. Falling prices can make businesses and consumers reluctant to spend and invest, hurting profits and crippling the economy. It can be caused by a drop in the money supply and credit, declining spending and high unemployment, all of which can encourage companies to cut prices.
That’s tough to grasp, especially since a deflationary environment doesn’t seem so bad on the surface; who doesn’t love cheaper prices on, well, everything? But Paul Krugman further explains the dangers of deflation and why it’s such a bad thing.
“When people expect falling prices, they become less willing to spend, and in particular less willing to borrow,” he says. “When that happens, the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed. That’s the deflationary trap we keep worrying about.”