Preventive Medicine
If economists are split on whether the future will be defined by inflationary or deflationary pressures, they’re much more united on which they’d rather avoid. While inflation can be corralled by interest rates and borrowing policies, deflation is far more difficult to control. It is the economic equivalent of a death spiral, one in which lower prices lead to lower wages, which in turn suffocates demand and produces still lower prices, lower wages and diminished demand. The Japanese economy has been stuck in its own deflationary spiral for almost two decades now, and there are worries that North Americans may soon face a similar situation.
Once deflation has set in, strong medicine is required in order to prevent the patient from getting worse. That medicine usually takes the form of direct fiscal stimulus, and in particularly grave cases the deliberate expansion of the money supply. But like most strong medicines, the cure can sometimes be nearly as dangerous as the disease. Too much stimulus can send the economy racing wildly away in the other direction at a clip too fast for even the most responsive policy-maker to keep pace.
Economists and elected officials are hoping for something closer to equilibrium, the state of rest between demand and supply that the market is theoretically supposed to seek out. But as Nobel Prize-winning economist Joseph Stiglitz says, “The reason that the invisible hand often seems invisible is that it is not often there.” In its absence, here’s how to deal with the alternatives.
| Deflation RISKS: Intense deflationary pressures can create strong disincentives for both consumer purchases and capital investment, since the price of a good or service down the road will almost certainly be lower than what it is today. As a result, jobs disappear and the value of almost every physical asset drops substantially, while debt becomes an even more punishing burden. UPSIDE: Less is more, particularly for those holding liquid assets AVOID: Debt and consumer-oriented equities HOARD: Cash and fixed income products | Inflation RISKS: In extreme cases, the erosion of purchasing power associated with inflation can wipe out a lifetime’s worth of savings. Meanwhile, the interest rate hikes needed to keep it in check punish investment and borrowing and suppress opportunities for economic growth. UPSIDE: A dollar won’t be worth as much as it used to be, but neither will your debts. AVOID: Fixed income products HOARD: Gold, physical assets |
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