8.19.2010

Is Deflation already here?

Is a Crash Coming? Ten Reasons to Be Cautious

Excerpt:

Deflation is already here. Consumer prices have fallen for three months in a row. And, most ominously, it's affecting wages too. The Bureau of Labor Statistics reports that, last quarter, workers earned 0.7% less in real terms per hour than they did a year ago. No wonder the Fed is worried. In deflation, wages, company revenues, and the value of your home and your investments may shrink in dollar terms. But your debts stay the same size. That makes deflation a vicious trap, especially if people owe way too much money.


What Deflation Means for Your Money

Excerpts:

In deflation, cash wouldn't be king. Income would be king.

Investors would be struggling to find safe, dependable sources of income.

So top-quality bonds, which provide that income, would boom. Bond prices would rise, and the yield, or interest rate, falls. (In Japan, at one point, long-term government bonds yielded nearly nothing).

That would be good for Treasurys, especially longer-term bonds, as well as for better quality municipals and corporates.

Cash would still be prince, though. If a savings account earns you zero percent interest, but prices fall 2%, you've still made 2% in real terms. And it's tax free. (Contrast that with earning 4% interest in an era of 2% inflation).

...

If income would be king and cash would be prince, in an era of deflation, debt would be the devil.

Your credit card bill. Your car and student loans. Your mortgage. As incomes and prices fall, the bills stay the same, which means they grow in real terms. It gets harder and harder to pay them off. "You're paying down debts but your income is falling," says SG strategist Albert Edwards. "So you have to pay down your debt even more quickly. You get into a vicious cycle."




Comment: Is Deflation already here? No sure. But two good articles about the dangers of. I've long considered "debt to be the devil" (not speaking theologically!)

2 comments:

  1. Thinking about this a little more - there has been deflation in the housing market. I know a couple who bought a house in the mid $ 300K. The house is now worth $ 100K less. They are divorcing and are forced to sell the house.

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  2. True about housing--we're trying to sell, and OUCH. Thankfully our marriage has never been better....

    Given that we may be seeing real deflation (not just stagnation in prices), I think I'll keep quiet about a cost of living adjustment from my employer.... :^)

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