We have been through economic phases of sky-rocketing inflation many times, but it’s rare to find any living person who has been through the Great Depression of 1930’s. Current inflation can have serious implications on our spending habits as purchasing power is hard hit amid rising costs. You might think that depression on the other hand would be a good thing to experience as prices fall at a fast pace. But that’s not how it is.
Deflation, as the term suggests is a fall in demand followed by sharp declines in prices, and not to forget that money supply can remain largely restricted in such scenario. Often we consider only one factor to be associated with deflation i.e. decreased demand, but what follows is even worse.
Recently we have seen US Fed pumping liquidity into the system to keep the economy away from deflationary scenario. This move has worked well so far but there will come a time when Fed will be in no state whatsoever to print any more money. If the consumer spending does not get back on track, unemployment will remain high and all these government stimulus efforts will eventually fail.
So far, its working fine (Says the Fed), but in reality things are headed towards a very obvious economic depression.
Well, deflation can even occur in relatively much better times, given, the right mix of conditions are there to support. I won’t call current times any more prosperous than what we had back in 2007, when it all started. Unemployment is still high and whatever signs of improvement we have seen do not hold grounds for a stable economic recovery. Consumer spending is at record lows since 2009, and we cannot ignore its importance as it’s the prime factor that decides where the economy is headed next.
Taking about the right mix of conditions that lead to depression I would like to make a point here.
See, all the efforts by the governments to push global demand led us out of recession. But what we do not understand that recession never happened. It was a depression cycle that started way back in 2006, when the housing market bubble was peaking out.
What Fed does not understand (or pretends not to) as the spread of D word could easily refrain consumers from spending anymore and that would eventually bring the economic activity to a standstill.
Then, the Middle East situation is giving us no signs of improvement anytime soon. Rather, such revolutionary activities only spread like a viral, and I won’t be surprised to see it changing political boundaries.
Then, the ‘black gold’ oil is shooting inflation around the globe and this will continue till global tensions are resolved. Why do you think gold and precious commodities are making multi- decade highs? Growing concerns of government shutdown, where do they lead us? Why the interest rates are kept so low?
In the Great Depression average deflation was around 10% and people lost jobs on a much wider scale. General decline were not sufficient to foster demand and liquidity was sucked out of the system as people hoarded on to cash and precious commodities. Same things are happening right now, although the magnitude is not that high (still).
Some might argue that the unemployment situation is improving and this might trigger consumer spending. Wrong, as wages are not increasing, consumers will try to save more than they spend. We cannot ignore that consumer spending accounts for more than 70% of total GDP, so as consumers tighten up GDP will fall into negative territory.
Then corporate profits will shrink as price declines will eat out the operating margins. This will eventually have a ripple impact on people largely accounting for profits from stock price appreciation. So it’s a vicious circle that makes it difficult for the economy to get out of the deflationary patch.
Your only way to survival in such economic scenario would be to hold on to a job and keep away from debt. Save your way through the cycle and do not spend on avoidable purchases.