fby Will Hepburn

Deflation: a Primer

Econ 101 says inflation is when too may dollars chase too few goods and prices go up. Deflation, on the other hand, is when too many goods chase too few dollars and prices go down. Right now the world has excess factories producing the “too many goods” and this is the beginning of deflation. Since we haven’t had deflation since the 1930’s it will catch many investors unaware. We, here at Hepburn Capital Management, manage money to protect our investors from deflation, but there are also many other facets of your life that could be affected by deflation, so it behooves each of us to learn about this problem.

We are all consumers, so deflating prices feel good. But our good feelings are very costly to the economy as a whole. The folks who have lost jobs recently as factories move overseas know this. And we can’t really blame the companies. The cost to a company for lower prices comes out of profits first and then out of payroll. It’s either move the plant or shut it down when the company is bleeding to death from lack of profit (losses). Jobs get lost either way if a company can’t earn enough to survive. This is bad for everyone, workers, holders of stocks or bonds or mutual funds of those companies. Even the real estate markets get hurt as laid off workers sell their homes Deflation is bad for everyone.

Internet shopping is another factor in deflation. On the “web”, pricing something at many different stores takes just a minute. Gone is the advantage a store has from a good location. On the internet, location and service barely matter. Only price matters. This highly efficient price shopping instantly cuts out all but the one middleman willing to work for the lowest amount. All the other middlemen lose their jobs, too.

This is the stuff we are hearing about in Presidential politics, but don’t expect it to change. Bush is not in control of it, and neither will be Kerry or Nader or Al Sharpton. You and I and consumers the world over, continually vote with our dollars for lower prices and more deflation. And I don’t see anything coming that will change that.

The government wants to keep price deflation from becoming asset or debt deflation, and is lowering interest rates to get more money circulating. Remember, deflation is too many goods and too few dollars. But just having more dollars available does no good if people don’t spend it. However, no one, not even Alan Greenspan, knows how this battle will play out. The government is risking inflation to whip deflation. Whichever way the economy goes will profoundly effect your life. Stay tuned.

Paul Pilzer, a visionary economist, refers to inflation as a tax caused by inefficiency. It appears that deflation may be a tax caused by efficiency. The irony is deep, indeed.