CHICAGO (AP) — Deflation is the potential new boogeyman for consumers, replacing inflation.
Absent in any significant way since the Great Depression, deflation — a prolonged period of downward-spiraling prices of goods and services — is seen as a possible threat after three straight months of falling prices.
Lower prices might sound appealing, making the cost of everything from cars to food to vacations cheaper. But prices decline because of a lasting drop in demand, which also means employers lower wages and consumers slow spending. It’s a combination that can drag down an economy for years.
The fear is going the way of Japan, which has battled periods of deflation for two decades. The country still hasn’t recovered from its “Lost Decade” of the 1990s, when bubbles in the stock and real estate markets burst and the economy fell into years of recession and stagnation.
The danger doesn’t appear imminent. The Federal Reserve has signaled it’s ready to take the necessary steps to prevent anything similar occurring here. And the chances of deflation receded somewhat with the disclosure that the consumer price index edged up 0.3 percent in July.
Still, the slight rise hasn’t erased the issue because concerns remain about a double-dip recession.
Consumers wondering what it would be like need look no further than the housing market, which has been in steep deflation for four years. “It’s much easier to tame inflation than it is to derail deflation once it gets started,” says Diane Swonk, chief economist at Mesirow Financial Inc., a Chicago-based financial services firm.
Over the next three to five years, she says, it’s a greater risk than inflation.
Here are some points for consumers and investors to keep in mind if deflation occurs:
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1. Reduce your debt.
One of the best ways to prepare for deflation is to focus on paying off debts. In a period of widespread price declines, your wages may fall and it gets tougher to pay off credit cards, auto loans, student loans and mortgages.
“For most people, the best way to get a good return on investment is to pay down whatever debt they have,” says Jerry Webman, senior investment officer at OppenheimerFunds Inc.
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2. Buy high-quality bonds.
U.S. Treasurys, and to a lesser extent high-quality municipal and corporate bonds, are the best defense against deflation. Bond prices rise as interest rates fall.
Treasurys also are a particularly welcome refuge because of the safety factor, because bankruptcies rise in deflationary periods as companies go under in the tougher economic conditions.
Relying too heavily on bonds carries its own risks, however, so don’t lock up the bulk of your holdings in Treasurys. It is possible to lose money in bonds.
“If we see inflation with long-duration, that will be a painful part of your portfolio,” says Webman. “Getting 2.6 percent on 10-year Treasurys will have proven a bad investment.”
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3. Don’t load up on stocks.
The stock market fares poorly under deflation.
Companies are pressured by falling prices and cannot keep up revenues or profit margins, driving investors away. And investors have less to put into the market.
That makes it a better time to have your money in cash. But not all of it. Most experts agree that it’s necessary to keep a significant amount of your money invested in stocks in order to ensure the best returns over a long period.
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4. Keep an eye on these sectors.
Some sectors and stocks may provide protection against deflation.
Companies with strong brands, an international presence, below-average debt and lots of cash are the safest bets because they should be the best-positioned to withstand an extended economic slowdown.
Using what happened in Japan as a gauge, investors should avoid food and beverage makers, household product manufacturers, as well as mining and other materials companies, according to Sam Stovall, chief investment strategist at Standard & Poor’s. They would want to embrace energy and financial stocks and keep an eye on health care and technology.
Stovall recommended the following companies as good investments during deflation: drugstore operator CVS Caremark Corp. (CVS), retailer Wal-Mart Stores Inc. (WMT), oilfield services company Schlumberger Ltd. (SLB), credit-card company Discover Financial Services LLC (DFS), bank JPMorgan Chase & Co. (JPM), drug distributor McKesson Corp. (MCK), package deliverer FedEx Corp. (FDX), defense contractor ITT Corp. (ITT) and Korean steelmaker POSCO LLC (PKX).
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5. Don’t lose sleep over the risk.
Deflation can be difficult for people, and whole economies, to endure. But we’re not there yet, and most economists think the chances are below 50-50.
“Our expectation is that the U.S. will skirt deflation, but that the low saving rates in the U.S., still-growing populations, and quick and decisive Federal Reserve moves to expand the money supply can avoid the trap,” Standard & Poor’s said in a report last week.
Unemployment and debt pose more immediate problems for the economy.
“I would tell people to calm down about it,” says Webman of OppenheimerFunds. “It’s not the greatest risk we’re facing right now.”
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Some deflation may be needed to offset the devaluation of the dollar caused by deficit spending with the stimulus package.
I am not seeing generally falling prices. Quite the contrary, the prices I pay for food, utilities, clothing, taxes are generally going up. The fact that house prices have fallen doesn’t mean deflation. Real estate values have to decline and find realistic levels that people can afford. But generally decreasing price deflation (measured by the CPI or GDP deflator) is not happening.
Stocks are down due to uncertainty in economic policies, decreased profits, the prospect of higher taxes, and increased regulation. The current administration and Congress are anti-business and don’t seem to realize that the private sector is the provider of goods and services and real jobs.
Bonds aren’t a safe haven. Eventually bond prices will fall and interest rates will go up. Those holding a bond portfolio will find that the market value of their fixed-income securities will tank, particularly long-term bonds.
While there maybe deflation in the private sector, governments from city to federal are inflating prices.
Look at the extra fifty cents to two dollars per month of gov’t fees that have shown up on utility bills.
In Calif., my daughter rec’d her DMV renewal on her 2006 Jeep. Instead of depreciating, as it has year over year, she rec’d an increase of $100. I travel to Calif. on business once a month. In San Francisco, a quarter buys you 8 minutes on a parking meter. A year ago, it would get you 20 minutes.
Incidentally, if you drive in Calif., make sure you don’t get any traffic citations. I accidentally drove through a flashing red light and I was fined $440!
I think the author doesn’t understand the true nature of the economy. These writers and fund managers obviously aren’t pro free-market people. Deflation is actually a good thing for the average person. Its a good way to control costs and stop over spending. The only ones that deflation isn’t good for are groups that rely on fractional reserve banking to fund their operations.
Deflation will thin out their reserves and make cooking the books harder because of the lower costs. The high and fast inflation is actually bad, it causes bubbles and then the bubbles bursts. You can thank your Federal Reserve for the bad economy. It says on their website that it’s there job to prevent recessions when they actually cause them and make them worst.