Surely inflation is our greater
enemy, isn’t it? Rising prices are bad for the economy. Falling prices are a
good thing, aren’t they?
Inflation and deflation are due
more to mindset than anything else. Let me explain.
Whether you realize it or not,
you are infected with inflation mentality, which goes back to at least the
1970s. I can illustrate that for you:
Let’s say your favorite loaf of
bread at your local store costs $3 today. If you go back to that same store in
ten years time and are able to buy a loaf of bread identical to today’s, how
much will you pay? Will it still cost $3 or will you pay more or less than $3?
Did you answer more? Why? Because
you are conditioned to assuming that
prices will keep rising. You would not have answered that way in 1937 and you
probably would not answer that way today in Japan,
where prices have been falling for many years.
What’s wrong with that? It’s true
that inflation erodes the purchasing power of money, but as long as your income
keeps up, rising prices are not the end of the world, are they?
There is a consequence of
inflation that is far more sinister than the erosion of purchasing power and you
are not even aware of it. Inflation sucks
you into debt. Let me illustrate that for you as well:
Your car is three years old and
you want to replace it, but you would rather wait another year. The new model
costs $25,000, but you expect it could be $30,000 in a year’s time. Will you
wait another year and save up a further $5,000 cash, or will you go into debt
and buy it now? You will almost certainly borrow and buy the new auto now,
won’t you? Why? Because you expect the
price to rise. You go into more debt
because of inflation. And you are infected with inflation mentality, which
is the cause of the crazy, unsustainable debt bubble today. When you borrow
that money from the bank, it is injected into the economy, increasing the money
supply and fuelling yet more growth in consumer spending and thus the economy
(and probably prices).
Now let’s reverse that situation.
Let’s say you believe the price of that new auto you want will be lower next year. Say $20,000. Now will
you be in such a hurry to buy it? No. You will almost certainly wait. And let’s
say in 12 months time you expect the price to fall even further in the
following 12 months, say to $15,000? Chances are you will make the old jalopy
last yet another year.
But you will not be the only
person thinking this way. Everybody will be putting off buying a new car. To
such an extent that auto makers, who have failed to increase sales, even by
slashing prices, have to scale back production and lay off employees. And if
auto workers lose their jobs, will they be able to spend as much on shoes and
clothes and restaurants and gadgets? No. But stores need cash flow to pay their
rent and wages, so “50% off" sales appear everywhere. But even they do not
work, and retail stores also have to shed staff. And the more prices fall the
more the consumer expects them to fall, so the more they put off buying
everything that is not absolutely urgent. And so the economy begins to contract
and unemployment rises, all because of deflation
mentality.
The lifeblood of an economy is
consumer borrowing and spending, which is fuelled by the ready availability of
money. When the mindset changes from inflation mentality to deflation mentality,
people not only stop spending. They stop borrowing. In fact, reckless abandon
changes to conservatism, and they even try and speed up the repayment of loans
they already have. This disappears money from the economy back to the banks
from whence it came, and so reduces money supply.
And thus the economy spirals down
into a deflationary recession or even worse. Every depression in history has been accompanied by deflation, not
inflation.
In the 1930s, was there any
shortage of goods? Not at all. Stores were fully stocked. Was there any
shortage of manpower? Hardly.
Unemployment reached 25%. So what caused the
depression? What was in short supply? Only one thing. Money. And the only way
money comes into existence is by way of a loan from a bank. When people are
reducing their indebtedness rather than increasing it, money supply shrinks and
the economy contracts. Interest rates can be reduced to zero (as in Japan
in recent years), but if people lose the courage and the capacity to take on
more debt, they will not borrow. This is called “pushing money on a string."
In my book “How to Profit from
the Coming Great Depression" one entire chapter is devoted to this subject of
deflation. You will learn why the coming downturn is inevitable and what you
can do to escape the most serious consequences.
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