Today I’m talking about the case for — and risk of — deflation.
Specifically, in this episode, I cover:
- What deflation is
- How deflation impacts our economy
- Why it’s a risk we should be considering
If you’re ready to learn about the often-overlooked risk of deflation, this episode is for you.
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How to Listen to Today’s Episode
- Bonds, Recessions, and Withdrawing Money in Retirement [SW Episode #152]
- Inflation vs Deflation [Investopedia]
- Recessions Typically Reverse Inflationary Trends [SeekingAlpha]
- Daily Inflation Data Likely Not Useful [Cullen Roche
The Risk of Deflation
Taylor Schulte: Welcome to the Stay Wealthy podcast! I’m your host Taylor Schulte and I am excited to be back on the mainland and behind the microphone after an amazing trip to Hawaii with the family. This year is my 10-year wedding anniversary and while on our honeymoon in Kauai, my wife and I always said that if we were fortunate enough to have kids, we would take them there to celebrate 10 years. So, that’s what we did. And while it was a long 6-hour battle with my one-year-old on the plane each way, we enjoyed every minute of the trip.
But, it’s good to be back, and before we kick things off today, I just want to publicly thank Jeremy Schneider for stepping in and taking over the podcast while I was out. If you’re on Instagram and haven’t checked out his account there yet, I highly recommend it. There’s a reason he has created a very engaged tribe of over 400,000 people there. He has such a unique gift of distilling complex finance and investing topics into easily digestible images that he designs himself.
You can find him at @personalfinanceclub. And if you’re not a regular Instagram user, like yours truly, check out his website personalfinanceclub.com which has tons of investing resources and an online forum to engage with and ask questions.
Ok, let’s get into today’s show. I was only away from the mic for 6 weeks, but A LOT happened during that time period.
The S&P 500 rebounded over 9% after plummeting 20% to start the year.
The Fed announced another 75 basis point interest rate hike.
The definition of a recession is, I guess, now up for debate.
And, of course, the elephant in the room, inflation jumped to 9.1%, setting a new 40-year high.
While inflation continues to be a hot topic, today I want to talk about the case for, and risk of, deflation. Specifically, I’m going to cover what deflation is, how deflation impacts our economy, and why it’s a risk we should be considering.
To grab the links resources mentioned today, just head over to youstaywealthy.com/163.
I think it’s safe to say that everyone knows what inflation is.
Inflation is the rise in prices for goods and services over a given period of time. This increase in prices, in turn, causes our purchasing power to decline. For example, during inflationary time periods, it takes more of our money to buy that same gallon of milk.
Moderate inflation is normal and expected. Hyperinflation, as discussed here on the show, is catastrophic and unexpected.
While pundits have been screaming about hyperinflation since the 08/09 great recession, and have doubled down since the covid crash, the risk of deflation is probably a more realistic one to understand and consider as a possibility.
Deflation is when prices decrease, it's the opposite of inflation. During deflationary periods, our purchasing power is increased. In other words, we can buy that same gallon of milk at a lower price.
So, why then is deflation a risk? If prices are going down and our purchasing power is going up, why is deflation something to worry about?
Well, for one, if prices are going to be lower in the future, you and I might be more inclined to save your money versus spending it.
In addition, during deflationary time periods, wages typically decline, and worse, unemployment spikes. A decrease in consumer spending coupled with smaller paychecks will, not so surprisingly, weaken the economy.
To top it off, despite people losing jobs and making less money, consumer debt obligations typically don’t change. In other words, in a deflationary environment, consumers are now trying to make that same mortgage payment (or auto loan payment) with a smaller paycheck, or maybe no paycheck at all.
Finally, with prices on goods and services dropping, corporate profits can be squeezed during deflationary times, causing stock prices to drop which in turn, causes our investment account values to go down.
To recap, during deflationary time periods, we often see 5 things hinder the economy; a decrease in consumer spending, lower wages, higher unemployment, debt obligations unchanged, and corporate profits squeezed, causing lower stock prices.
When deflation comes up in conversation or makes headlines, we often immediately think of the great depression in the 1930s. This was, of course, the most dramatic recession and deflationary environment we’ve ever experienced.
Since then, the only other deflationary period here in the U.S. was in 2008/2009, the second worst recession in history, aka The Great Recession. And, thankfully, deflation wasn’t as severe as some had predicted during The Great Recession.
Look, my goal is not to ring the alarm bells today or suggest that 2008/2009 round two is around the corner. My goal is to simply make sure we’re aware of potential risks. To be informed. To understand what’s possible and what it means to us as investors so we don’t get caught off guard, react irrationally, and let our emotions lead us to harmful decisions with our money.
When everyone is looking left, we might want to look right. Inflation is getting all of the attention. But what if the longer-term risk isn’t inflation?
You might recall episode number 152 when I talked briefly about stoic philosophy and shared a quote from Ryan Holiday that said, “the only guarantee, ever, is that things will go wrong. The only thing we can use to mitigate this is anticipation because the only variable we control completely is ourselves.”
So, now that we have a basic understanding of deflation and why it can be bad for the economy, let’s explore why I’m even talking about this as a potential risk and why it's at least a possibility to consider.
Some of the commonly referenced reasons for considering deflation as a possibility include covid-related shutdowns moderating and supply chains improving while consumer demand is slowing (i.e., high(er) supply, low(er) demand). As well as two quarters of negative GDP growth and the likelihood of fiscal drag on the economy continuing and a very recent report showing that US personal savings rates are now below pre-covid levels.
But, there might be a bigger reason for considering deflation as a possibility, and that is the housing market. As we all know too well, housing has a major impact on the US economy. When housing goes through difficult time periods, so does everything else.
And, while the housing market is much healthier today than it was in 2008/2009, we have a unique scenario where real estate has been skyrocketing to record levels and now mortgage rates have spiked and joined the party.
We’re seeing some early signs of slowing down in the housing market, but we may not be able to clearly see how this sector is impacted until next year. If housing prices, rent, and interest rates continue to remain high, the likelihood of deflation certainly increases. Much of what happens is also dependent on what the fed does and if it continues to aggressively fight the inflation narrative and the risk of a recession or if they back off.
Speaking of a recession, historically, recessions have reversed inflationary trends. So, if we can ever land on a definition of a recession, and do officially find ourselves in one, the chance of deflation or even disinflation increases.
And disinflation is where I want to wrap all of this up. Disinflation is when the rate of inflation slows. If the rate of inflation goes from 9% to 5%, prices are still increasing, but at a slower rate. Many of us are very familiar with disinflation because it’s largely what we experienced from 1980 to 2015.
As you might imagine, in today’s current environment, disinflation would be a positive. Because a certain degree of inflation is healthy and normal for an economy. And we know now know that deflation can do some serious damage, so slowing the rate of inflation (i.e, disinflation) would be much more appealing than the rate of inflation going below 0 (i.e., deflation).
The good news is that have to wait very long to get an inflation update. Tomorrow, Wednesday, August 10th, we will be presented with the CPI report for the month of July. Speaking of these monthly reports, someone recently posed a good question which was why we don’t have access to daily inflation readings and why we have to wait an entire month to see get this backward-looking information.
My good friend Cullen Roche chimed in and shared that there are, in fact, a handful of companies that sell daily inflation data but it’s very, very expensive. He also noted that he’s not sure how helpful it really is since a lot of important prices that impact CPI (like rents) don’t change very often, so daily inflation data might not be as useful as monthly.
Lastly, before we part ways, I want to mention two important things.
Number one, high, prolonged inflation is certainly still possible. My goal today was to bring a different topic to the surface for us to intellectually explore and be aware of as a potential risk. If the war in Ukraine and Taiwan worsens, supply chain issues continue, etc., high inflation could very well continue.
Number two, oftentimes, we feel compelled to do something, to take action, when we learn of new potential threats. I was tempted to discuss what investors can do to protect their portfolios during a deflationary event, but I just didn’t think that would be constructive. As always, your financial plan, needs, and goals should drive your investment decisions, not the possibility of an event that we have zero control over.
If you have any comments, questions, or ideas for future episodes, please shoot me an email at email@example.com.
To grab the links and resources for today’s episode, just head over to youstaywealthy.com/163.
I’m really excited to be back and have some great content lined up for the rest of this month and beyond.
Thank you, as always, for listening, and I will see you back here next week.
Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.