Sunday, October 26, 2014

Is Deflation Really All That Bad?

Lately people are noticing the price of gas really dropping. It went from $3.37 per gallon to $2.87 per gallon in one month at a gas station in Millersville, Maryland. To someone who drives 300 miles a week or 1200 miles a month that represents a twenty dollar bill back in their pocket (assuming their car gets 30 miles per gallon).
Royal Dutch Shell Station, Annapolis 48997

350 million-year old Nautlius Ammonoid 70495
(downward spiral to be continued)

However there were some other things that started to happen during that time. The first was that the driver avoided going to the gas station until the tank was almost empty. This was because she expected the price of gas to drop even lower a few days later.

If it doesn't last very long deflation is not so bad. But deflation is like a house guest, if he stays around too long, he starts to stink up the place. Deflation often does hang around and it eats all the food in the refrigerator too!

When an economy is in deflation people delay purchases of big ticket items like houses, cars and washing machines as well. People figure the price will be lower next month so they wait before buying.

When prices are dropping employers cannot afford to give people big pay raises or possibly even any pay raise at all. In fact, overtime offers will dry up and some part-time workers will get fewer and fewer hours of work.

Suddenly this deflation thing does not sound like such a good deal.

It gets worse. People who make less money spend less money, they don’t go out to eat as often, they don’t take expensive vacations, and Grandma’s monthly Social Security check stays the same every year. That's okay, she can always come to live with you, right?

Businesses delay expanding factories or opening new locations if they think it will be cheaper to do so next year. People who have a lot of money already tend to hold on to it even tighter when there is deflation. That means less work or pay for all of us who work for people that are wealthier than we are.

Tax revenue drops. That may sound cool but not if you work in any type of government job or have holes in your roads or need a cop, ambulance or firetruck to come around once every so often. Despite certain politicians cries for “No new taxes,” tax rates will need to go up or else government services and government jobs will need to go away.

But wait, there’s more! If you buy into this idea that deflation is a good thing, then we’ll throw in rising unemployment, more business closings and a much lower 401k balance at no extra cost!

Interest on any savings will drop even lower than the measly rates a savings account brings now. Investment income typically drops during times of deflation. The stock markets fall. You probably don’t think about it but if you have a 401k at work you buy stock or mutual funds every time you get a paycheck. If you want to retire some day, you’ll need retirement savings along with Social Security. It is very difficult to live on a Social Security check alone. Deflation eventually undermines all income, including retirement income.

Deflation is described as a downward spiral because all of the above happens but somehow college tuition, health care costs and home mortgage payments do not seem to go down with everything else. You might be able to re-finance that mortgage, true, but you will have a lower or stagnant paycheck to use to make the payment.

So the next time you get happy about the lower price of gas at the pump, consider some of the other complications. Start saving more now or at least start to save some of your paycheck now, or else you may get stuck at the bottom of a downward spiral yourself.

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