Ted Allrich is the founder of The Online Investor and author of the book: Comfort Zone Investing: Build Wealth and Sleep Well at Night. In this weekly column, he'll offer advice to investors who are just getting started.
... wait until deflation hits the economy. That's when prices go down instead of up. What could be wrong with that? Plenty.
When there's inflation, people scramble to buy things now, right now. The overriding psychology is that prices will go up forever so buying something has to be cheaper today than it will be tomorrow.
We all felt this in the '70s when the famous "guns and butter" government programs of Lyndon Johnson fueled purchases for everything and anything as well as payments for the Viet Nam war. Inflation was rampant. Long term treasury bonds yielded over 18%. It was only the fortitude of a very brave Paul Volcker, then Fed Chairman, that finally broke the trend. He kept raising interest rates until borrowing money made no economic sense. Over a long period, prices started to recede.
Now we're in the middle of something very different. The mindset is one of postponement. Not buying something today makes sense because most likely it will be cheaper tomorrow, then cheaper the next day. Sounds pretty good. Except when consumers and governments and businesses don't buy anything, the people who make those things lose their jobs. Then that buying power is taken out of the economy.
Japan had this happen for most of the '90s and still suffers from it. It is a nation of savers which is usually a very positive attribute until it becomes so extant that the economy stalls. Their economy has been stalled for over a decade.
And it gets worse. As prices decline, businesses sell less, then go out of business. Fewer goods and services are offered. Less doesn't become more. It becomes less.
As businesses fold, capital dries up because investors don't believe any business will make it, no matter what the product or service. Investors hang on to their cash. Hording becomes synonymous with survival. Wall Street (what's left of it) can't find capital for new companies to grow. Investors won't invest.
Of course, before companies can get to Wall Street, they have to go through venture capital, which won't be there. Venture capitalists don't invest in companies when they know there is no exit strategy. Without Wall Street as an exit point, venture capitalists have few options to get their money out.
So with deflation, there is less of everything. Businesses don't grow. Jobs are fewer. Capital is not available. Everything comes to a slow and grinding halt.
Inflation isn't the evil enemy long portrayed unless it is left unchecked and an economy is hyper-inflating, making money worthless in the process. Regular inflation, in fact, can be a good thing since it suggests an ever growing economy where jobs are plentiful and goods and services abound.
There is no argument that can justify the excesses of the last decade, but the complete collapse of the economy is causing much more damage, real and psychological. Unless the collective American psyche believes that tomorrow will be brighter, that jobs are safe, that commitments such as a house or a car can be made with some certainty and with ample credit available to help, the economy will inevitably go toward deflation. And breaking deflation is harder than stopping inflation because you can't make people borrow money. If that mind-set occurs, where lenders are willing to lend and no one takes the money, then we have a whole host of new problems, and the corrections will take a long, long time.
The antidote for deflation? Simple: spend money. But your job has to be safe, and you have to access to credit. Those seem to be the top priorities for the new administration. We all need to hope it's successful.
Reader Comments (Page 5 of 5)
11-30-2008 @ 11:31PM
Ray said...
It is hard to take your advise when you have your first fact wrong: Johnson was not President in the '70's.
11-30-2008 @ 11:48PM
bill said...
Deflation? give me a break . We're in for inflation.
12-01-2008 @ 12:04AM
mgslr said...
I would not be so quick to assume the deflation will continue. We have a strong dollar (why?) right now and that has much to do with the cheap oil. It has affected nearly all commodities. Sooner or later the 24/7 running of our printing presses will show up in the devaluation of our currency (inflation). The fact that we import so many items will really affect our buying power - especially if China discontinues the policy of tying their currency to the US dollar or if OPEC decides it now wants Euros instead of fiat Fed reserve notes.
12-01-2008 @ 12:45AM
Luis said...
ok, so all of these experts say inflation is bad, deflation is bad so which one is it or do these so called experts not have a clue, maybe they are sitting in a office and not going out to see how the public reacts to the economy. Deflation is good, it allows the people to get more value for the money which in return creates a spike in spending. the only thing missing is the job security. Once they are secure in there employment and getting more value for there money, then they have no problem spending. it's when our job are in question and prices are so high that they cannot afford a loft of bread or a gallon of milk that's when it becomes a problem. All Companies that want to sell goods or provide services must employ Americans in order to do business in this country. American companies must have 85% of all employees Americans or pay a hefty tax for corporate greed. Do not allow necessities to be traded as commodity which opens the doors for greed,corruption,speculation and market manipulation which affects us all. lower prices feel good to the average joe when they are able to feed there famalies and not have to take a loan out to do it. Get out of your office and talk to the average joe not special interests.
12-01-2008 @ 2:03AM
Vic said...
The author worries about deflation, but he's off base in defining it as price deflation. Read deflation is monetary deflation. Price deflation is a correction of the excesses of the past decade, yet he says that this price deflation needs to be corrected because jobs will be lost. Why correct a correction?
Let the price deflation do its job, that is to correct the excesses of the past decade. Save as much as you can now, because anyone who has seen the adjusted monetary base from the FED will see an extreme spike in monetary inflation. That will translate into price inflation down the pipeline.
And don't even bother putting your "hope" into the next president. Neither he, McCain, nor any of his economic advisors have an inkling of the Austrian School of Economics. Their Keynesian policies will only exacerbate the problem.
12-01-2008 @ 2:33AM
B.L. said...
I am a republican... or maybe I should say was? We NEED a few stimulus check's for the American people with the requirement that the money be SPENT!! ... and we need it now!!! Did I say now?
George, what have you done to our country??? ... or haven't done?
12-01-2008 @ 3:13AM
John said...
This is a poorly written article based on assumptions that contradict. The author states saving is a "very positive attribute", while describing how not spending is detrimental.
12-01-2008 @ 3:19AM
Larry Cox said...
If you want those businesses back, then get rid of the income tax system. That's the main reason we're in this pickle today plus people making rash decisions like "We'll pay the interest only on our new house." Then the bank wants the money for the principle and well, you get to live in your car or rent for the rest of your life. Get real people! We didn't pay ANY income tax until Prez Woodrow Wilson intituted the 16th amendment in 1913. Ever since then, America has gone into diving spiral we can't pull out of. All the factories have gone to other countries because of the taxes and tariffs. It used to be that we were proud of the label "Made in the USA". It meant quality work went into the product and you could trust the product. Now everything's made overseas and the stuff breaks after a month or the dye washes out of the clothing etc. Check out www.fairtax.org and you'll see what I mean.
12-01-2008 @ 4:16AM
BHarrison said...
As simplistic as it may sound, "INTEGRITY" is the key pivatol issue to achieving conomic recovery. The american people are NOT going to invest in an unstable and highly manipulated market.
Restoring INTEGRITY in the markets requires implementation of basic regulation of the markets and the corporations by:
1. Enforcing "accounting standards" used by corporations and financial auditing firms; and the elimination of "creative accounting practices" which were the means by which the pyramid and Ponzi fraud schemes were orchestrated.
2. Requiring FULL DISCLOSURE and Transparency in all Financial Reporting.
3. Outlawing "short selling" which is artificially driving the values of many stocks down, and is a devisive "tool" used to manipulate market values.
4. Heavy regulation of the futures markets to prevent price manipulations such as petroleum.
5. Diligent and vigorous prosecution of all corporate while collar crimes.
6. Firing/replacement of all ALL CEOs and upper management of corporations that suffered losses due to pyramid and Ponze schemes. CEOs and management MUST be held personally responsible for all criminal actions.
The American people are not going to have the "faith and confidence" to invest their hard earned savings in the markets and corporations until there is an acceptable level of INTEGRITY restored to the market and corporate operations.
12-01-2008 @ 7:28AM
Gary said...
When government prints lots of money and floods the market with dollars, the end result is inflation. Just because you see a fall in prices doesn't mean we are in a period of deflation. Most of what we are experiencing is due to falling housing values. In the meantime, oil will eventually rise again in the next six months as OPEC cuts production and reserves dry up. As existing houses get bought up and supply dwindles, look for a period of higher inflation, probably at the end of 2009. Inflation will actually help the government. Right now they are borrowing at almost 0%, when inflation kicks in and money is worth less, the borrowed money is actually easier to pay back. This is basic economics 101. I've listened to these so called experts and so far they are batting at about .250, meaning 3 out of four times they are wrong (remember $200 oil by the end of the year?).
12-01-2008 @ 7:54AM
Robert Alexander said...
The only thing we have to fear is fear itself. When we begin investing in alternative energy companies that produce equipment for more efficient uses and energy to replace oil our economy will grow by millions of jobs and trillions of dollars. Just do the math. We import 700 billion dollars of oil each year! Over a ten year period take that money and invest it here in replacement industries that are given a low interest loans to keep the jobs here. Only companies that produce the energy with American jobs would qualify for assistance. Industries that have moved from our nation would be taxed as normal industries and not given a break as they are now. Yes, WE can turn our economy around when we become the home of the brave again. Deflation is a fear we can out produce and out invest by an inspired population who understands economic war.
12-01-2008 @ 8:43AM
ken said...
simple solution.....quit allowing said bussinesses to send good manufacturing jobs overseas to china and such...the new world order is destroying America..except for a few mega rich at the top...bring the jobs back and people will buy...one doesnt need to be a formally educated moron to see this....just be a little less greedy and have common sense
12-01-2008 @ 8:50AM
Ken said...
We don't really produce anything. It's all been moved to the cheapest producer. This model of deflation driving manufacturers under isn't what it was - It's all made elsewhere, and the "service" economy we built can't possibly survive.
12-01-2008 @ 9:21AM
nick said...
Current stock market quotes are like a bad dream of the 1933's. The folks like MSNBC punks giving people rosy reports to try to sure up someones balance sheet is a joke. The greed of folks like the ones on MSNBC are the root cause of our problems. The liberals who are backed by MSNBC, like REP WATERS, SEN DODD, SEN SHUMMER, these and REP FRANKS, and people like FRANKLIN RAINES, who brought down FANNIE MAE and FREDIE MAC are what tipped us over the edge. Lived at the tail end of the last depression and the same things got us into that mess, the one word to decribe it all is greed rpt greed.
12-01-2008 @ 9:26AM
victor rugg said...
It was so simple to see it comming and soi many did nothing. Who is to blame well the media had a big part in it but lets not leave out greed. The media said the buble was about to pop in real estate until this became the mantra of the press well thank you as you sold papers and crushed the economy. Dumb very dumb and look where we are now. Ok if you just took a moment and looked at your house and what is in it you would see why the economy went down the drain. So ad to that the automobile industry and well the rest is history. WHat can you do now? Well I hate to say it but watch and waite is best and hope the papers start saying something positive and it turns around. Does this sound to simple well guess what folks it is. We need some positive news to get the ball rolling but don't count on that to soon as the press makes more money on negative news. Think about it how many news services are there out there with mostly positive news.
12-01-2008 @ 10:16AM
FMiller said...
Who was president when NAFTA was enacted? If I rember right it was Clinton. That is where we should place the blame! Let's bring our jobs back to the USA!
12-01-2008 @ 11:49AM
gary said...
Wrong!!!! The author fails to account for the rapidly increasing population and the fact that the current want it now rather than need it generation buys regardless of price because of its instant gratification philosophy characterized by "I want it today regardless of the price even though it may be cheaper tomorrow."
12-03-2008 @ 10:59AM
joe said...
What a bunch of garbage! Inflation is bad, deflation is bad. Come on! Everything is relative. Americans are not a nation of savers s we differ with the Japs because we have no money to spend or save with a recession! People think that if the market is up, the economy is good, Horse shit! just go back 8 months ago, the market was at an all time high. We are lied to every day by the government and the media.
Secret to success? Pay yourself first, stay out of credit card debt, live within your means, NEVER buy a new car. Max your retirement savings along with a good life ins, disability insurance and stop buying all these jerkoff author's books!
12-13-2008 @ 9:50AM
Larry Clockwant said...
In all the years I have been investing in the market I have never seen such an irrational market.
You think its going to go up and it goes down, you think its going to go down and it goes down.
You buy a call you should have bought a put, you buy a put and you should have bought a call, you sell a call and you should have sold a put.
If everyone just does the opposite in the stock market, we will all prosper and all other jobs will be unecessary.
Everyone will suceed as a day trader, but just do the opposite of what is rational in order to become sucessful and prosper.
Thank you and don't worry any longer, the market scare is over and the economy is back in repair.
Full details at:
http://www.youtube.com/watch?v=d4oyTI0YlBU