When the price of goods and services rises, inflation happens; when the price of goods and services falls, deflation occurs. The delicate balance between these two economic circumstances, which are opposite sides of the same coin, is difficult to maintain, and an economy can quickly shift from one to the other.
Which is more dangerous: inflation or deflation?
Consumers anticipate reduced prices in the future as a result of deflation expectations. As a result, demand falls and growth decreases. Because interest rates can only be decreased to zero, deflation is worse than inflation.
Is deflation beneficial to the economy?
This general price decrease is beneficial since it offers customers more purchasing power. Moderate price cuts in certain products, such as food or energy, can have a favorable influence on nominal consumer expenditure to some extent. A general, sustained drop in all prices, in addition to allowing people to consume more, can support economic growth and stability by improving the function of money as a store of value and encouraging genuine saving.
Which is preferable: inflation or deflation?
Inflation that is moderate is thought to be good to the economy. Inflation is thought to be helpful to goods and service producers. Deflation is thought to be harmful to the economy. Consumers are said to benefit from deflation.
Inflation and deflation benefit who?
- Inflation is defined as an increase in the price of goods and services that results in a decrease in the buying power of money.
- Depending on the conditions, inflation might benefit both borrowers and lenders.
- Prices can be directly affected by the money supply; prices may rise as the money supply rises, assuming no change in economic activity.
- Borrowers gain from inflation because they may repay lenders with money that is worth less than it was when they borrowed it.
- When prices rise as a result of inflation, demand for borrowing rises, resulting in higher interest rates, which benefit lenders.
In a deflationary environment, where should I invest?
Companies that supply products or services that we can’t easily cut out of our lives are considered defensive stocks. Two of the most common examples are consumer products and utilities.
Consider toilet paper, food, and power. People will always require these commodities and services, regardless of economic conditions.
You may invest in ETFs that track the Dow Jones U.S. Consumer Goods Index or the Dow Jones U.S. Utilities Index if you don’t want to invest in specific firms.
iShares US Consumer Goods (IYK) and ProShares Ultra Consumer Goods are two prominent consumer goods ETFs (UGE). iShares US Utilities (IDU) and ProShares Ultra Utilities (PUU) are two ETFs that invest in utilities (UPW).
How does deflation benefit you?
- Investors must take efforts to protect their portfolios against inflation or deflation, that is, whether prices for goods and services are growing or declining.
- Growth stocks, gold, and other commodities are all good inflation hedges, as are foreign bonds and Treasury Inflation-Protected Securities for income investors.
- Investment-grade bonds, defensive equities (those of consumer goods companies), dividend-paying stocks, and cash are all strong deflation hedges.
- Regardless of what happens in the economy, a diversified portfolio that contains both types of assets can provide some security.
What happens to property values in a deflationary environment?
Your dollar would be worth 95% less today than it was in 1915 if you kept it in cash for the previous 100 years. This is due to the fact that the value of your money depreciates over time and may buy you less each year due to inflation.
Debt operates in a similar way. In nominal terms, the debt’s worth does not change (assuming you do not pay it off). However, the value of that loan depreciates over time in the same manner that currency does. In today’s dollars, $100 in debt would be worth less than $10 over the last 100 years. This is why using leverage during inflationary periods is so valuable. It lowers the value of your loan over time.
Deflation is different when it comes to debt
While inflation gradually erodes the value of debt, deflation has the reverse effect. It increases the debt’s value over time. This is how a mortgage can deplete your property value. Here’s another look at one of the graphs from before.
While the cost of goods and services is falling, the cost of debt is staying the same. In fact, it improves in contrast. This is why, if there is a negative inflation rate, it is critical to minimize or erase your debt.
Help me! Deflation is confusing
It can be difficult to understand the distinction between future dollars and today’s dollars. Especially if we haven’t dealt with deflation before. Another approach to demonstrate how deflation can effect your investment property mortgage is to consider the following scenario:
Let’s imagine you wanted to buy an investment property for $125,000 today and decided to take out a $100,000 mortgage on it. Most mortgage contracts are relatively similar in that, depending on the sort of mortgage you have, you must make either fixed or variable installments.
In this case, there is no inflation, but the bank adds $3,000 to the balance of your mortgage each year, in addition to any interest payments you due. You would pay the interest due at the conclusion of year one, and your principal sum would be boosted to $103,000. Do you find this to be an appealing proposition?
This means that if you have a 3% interest rate, you will owe a net of 6% every year. 3% in interest and 3% extra on top of the principal.
Hopefully, you’ve realized that while you’re employing leverage, deflation hurts a lot.
To summarize, when there is deflation, the value of your real estate declines, your cash flows drop, and if you are utilizing leverage, those drops are compounded. Remember, if there is deflation, you should not have a mortgage.
We have had inflation for over 50 years, why should you worry about deflation?
We can assume that if housing prices are a good hedge against inflation, they will also be a strong hedge against deflation. However, why should we be concerned about deflation?
What happens to the economy when there is inflation?
Inflation raises your cost of living over time. Inflation can be harmful to the economy if it is high enough. Price increases could be a sign of a fast-growing economy. Demand for products and services is fueled by people buying more than they need to avoid tomorrow’s rising prices.