4 Reasons Why You Should Be Afraid Of Deflation

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young woman shoppingIf you’re like most people, you’d be thrilled about bargains. Who doesn’t like saving money? Who wouldn’t get excited about steep discounts? Well, too much of a good thing can be a bad thing. When it comes to economic trends, continuous price cuts and price declines make for very bad news. Here are the four reasons why.
Reason #1: Consumers spend less when they feel prices are dropping
Consumers will hold off on purchasing decisions if they suspect that prices will continue to drop. They feel they can get more bang for their buck if they hold off a week, a month, or even a year. This decrease in consumption hurts the economy’s growth rate.
Reason #2: Companies hire and expand less if prices are dropping
When prices drop, companies don’t have much leeway regarding their profit margins. Their profit margins shrink. This cuts into how much money they can devote to hiring people or expanding operations.
Reason #3: Lower prices push companies to slash prices even more
Once prices drop, market share competition can get really fierce. As companies cut their prices to protect their market share, their competitors are pushed to cut their pricing as well. This might not do much good since consumers, used to the price cutting, will hold off on making purchases in anticipation of more price cuts. This can make companies unprofitable.
Reason #4: Debt loads don’t get slashed when prices drop
Sadly, even when the prices of goods are dropping, the loans consumers and businesses have don’t drop. They stay the same and their interest remain the same. This can lead to an impossible situation with businesses because they can’t increase prices to boost profits. Instead, they are forced to pay off loans with less and less revenue due to price wars. Not surprisingly, deflationary spirals lead to many companies going belly up.
Keep the reasons above in mind the next time you read or hear about deflationary pressures. One thing is clear: deflation is bad news.

Jacob Maslow is our Editor, and has extensive experience with writing about global financial matters. He also runs a successful SEO consulting business, Mekomi Marketing

  • Stephen Taylor

    Rubbish – Deflation is good. It is a market mechanism to sort out imbalanes in the economy. The QE measures (inflationary) taken by governments are self defeating, because they do not allow the imbalances to unwind.

    • Paul Bond

      +1 Completely agree with you.

  • herbaled

    This article sounds like rote theories and not actual facts … esp. the part about people waiting for prices to drop even more and thus don’t buy anything.

  • windslice

    I am fed up with this anti-deflation nonsense.

    Reason #1 only applies to real estate. Everybody knows that in twelve months the LCD TV will be out of date, the mobile phone will be superseded. The world’s producers are constantly striving to manufacture stuff more cheaply, if people can buy stuff more cheaply, then they have more cash left to spend on other stuff.

    Reason #2. A company will look at its profitability and potential to sell stuff at a profit into a competitive market. It is the competition that drives the prices. No company looks at inflation and thinks “great, I’ll be able to sell at a higher price”, because it also knows that its production costs will also be going up.

    Reason #3. This is normal competition. Efficiency is rewarded. Inflation does not protect against it, per se.

    Reason #4. Now you are getting closer. It is all about the debts. However, with a bit of deflation people have more cash left to pay off the debts. But again you have confused competition with deflation. It is normal in competitive markets for prices to be held down by competition. It is also normal that inefficient companies will go out of business, this is positive and healthy for the economy.

    A Stephen says, there are a lot of imbalances in the global economy, and they have to be re-balanced. This should be left to trade, and not the massive interventions by Central Banks, which are creating way more issues through the current actions. QE was required as the shadow banking system dried up of liquidity. Now they are simply pumping up asset prices and destroying currencies.

    It is ridiculous that over 50% of government bonds in the world are returning zero or negative interest rates.