The Bear Market Blog

By Ken Knight, MBA

DEflation, the new norm and why is this important to us?

In my first blog, I talked about INflation and by removing the link of gold to the dollar, inflation since then has been the norm.  Until now.  The government(s) want a small amount of inflation to show that productivity is improving compared to previous years.  First we need to define what we mean by inflation.
If you look it up on the Internet, it says: "Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly." (Investopedia).  But actually this is incorrect.  Inflation is actually an increase in  the amount of credit and money in society (Socionomist).  An increase in credit produces rising prices.  The amount of credit available is based on what the "mood" of society decides.  During the years of the 2000's, bankers made mortgages to anyone who was breathing, thus causing the real estate bubble that burst. The rise in credit caused prices to increase.  Prices of homes became "inflated".

Now obviously DEflation is the opposite.  When debt becomes "too" large, because of increased spending and mood change, there becomes a decrease in demand for credit putting pressure on prices forcing them lower.  This is caused by a mood swing from positive to negative.   Let's look at the example of the Chevy I mentioned earlier.  What happens if everyone is in a great mood and Harry wants to buy that Chevy.  Well, so do many others, causing a high demand for that car.  The dealer has them lining up so he can charge a higher price.  So car price inflation has occurred.  Not many people can afford to pay cash for the car so they take out a loan increasing debt.  What happens when the opposite occurs?  Less demand means a lower price.  What's wrong with lower prices you ask?  Less demand means fewer cars are sold.  Fewer cars sold means worker layoffs. This has recently occurred with the price of oil.  Everyone raved about the lower price of oil.  Except the oil field workers and the ancillary workers who support the oil industry.  They were laid off by the thousands.  There have been 83 U.S. energy company bankruptcies since 2015, with more on the way (Yahoo Finance)

So my premise is that we are entering a period of DEflation that started around 1999.  Let's look at some wholesale prices of raw commodities:
Oil:    

Corn:

Pork:

Sugar:

Coffee:

You get the picture.  For the last 6 to 10 years, prices of basic commodities have been GOING DOWN! This is the result of DEflation.  These price reductions have been subtle to the point that we haven't felt them (except for gas and oil).  The retail prices haven't really been affected but one of these days, we'll all "wake up and smell the coffee".  That is, how come we're paying $5 for a latte when the price of coffee has gone from $375 a ton to $140 a ton?  That's a price cut of over 1/2!  I assure you that day will come!

So why the INflation and DEflation?  Let's talk about credit. Credit is issued by the bank.  The person who borrows the money creates debt.  So as the amount of credit goes up, so does the amount of debt.  There is government debt (currently at 19 trillion dollars)(Wiki), there is corporate or business debt, and there is consumer debt (currently at 3.6 trillion dollars)(Federal Reserve).  Add it all up and we have one heck of a debt on our hands.  (60 trillion dollars to be exact )!   Here is a chart showing U.S. debt from 1950 to 2014.  It has actually turned down since then.

"In 50 short years, debt has gone from being a luxury for a few to a convenience for many to an addiction for most to a disease for all,” James Butler wrote in an Independent Voters Network (IVN) op-ed. “It is a virus that has spread to every aspect of our economy, from a consumer using a credit card to buy a $0.75 candy bar in a vending machine to a government borrowing $17 trillion to keep the lights on.”(RT News).

  So What happens when "the party is over?" and people stop buying and buying everything on sight with credit?

Like all other "parties" this huge bubble will eventually burst. As a matter of fact, the tide has turned.  Here's an update on the amount of consumer credit:

(Money and Markets)
  As mood continues to deteriorate, people become more conservative with their money by paying off debt and spending less. This will have a negative impact on the economy.  If you think the economy is sluggish now, just wait. 

This is occurring globally. There are also other ways of shrinking this enormous debt as we have learned from other countries.  "Italian Banks in Big Trouble"(World Press),"Venezuela is on the brink of complete economic collapse"(The Independent) , Puerto Rico, Spain, Brazil, the list goes on.  Some will claim bankruptcy and others will just walk away from the debt by defaulting.  Of course the ones holding the bag are the ones holding the loans.   And there will be no big bailouts like before.  All of this will eventually lead to higher interest rates.  The creditors will demand higher interest rates to counteract increased risk.

So what does this mean for you and me?  Beat the crowd and get out of as much debt as fast as you are able.  If you have credit card debt, pay it off.  Car loan?  Either downsize or pay it off.  As interest rates increase your payments will increase with no monetary gain for you.  Cut back on spending and start saving for a rainy day.  All hard to do but it will be worth it and it will make you feel like you accomplished something important!

So if the price of everything starts going down, what happens to the value of a dollar (in your pocket)?  We'll discuss this important lesson next.

Best regards,
Ken Knight