Barclays warn of coming 'Inflation Storm'

LittleMissAspie

Can someone explain really simply why deflation is bad? The only bad consequence I can see is loss of jobs as companies get less money for their goods. But the people still in jobs will be able to buy more so that might even it out a bit?

I don't quite get it because deflation seems like prices going back in time, and if we managed fine on 2001 prices in 2001, why can't we manage fine on 2001 prices in 2008?

Generali

LittleMissAspie wrote: »

Can someone explain really simply why deflation is bad? The only bad consequence I can see is loss of jobs as companies get less money for their goods. But the people still in jobs will be able to buy more so that might even it out a bit?

I don't quite get it because deflation seems like prices going back in time, and if we managed fine on 2001 prices in 2001, why can't we manage fine on 2001 prices in 2008?

The biggest problems are:

1. People and companies spend less as prices will be lower tomorrow. As a result people that sell things and people that make things that are sold lose their jobs.

2. People and companies borrow money assuming that their income will be £x. If prices fall by 10% then that income is likely to fall by 10% too. That makes repaying debt harder.

LittleMissAspie

So basically deflation is likely to cause a recession? And a recession would make deflation worse I presume so vicious circle?

Generali

LittleMissAspie wrote: »

So basically deflation is likely to cause a recession? And a recession would make deflation worse I presume so vicious circle?

Correct! You win today's special prize.

It's what happened in Japan since their property bubble burst in the late 80s. Things got really out of hand over there - the land the Imperial Palace stands on in Tokyo was worth more than the whole of California apparently. The Aussies sold some land next to their embassy and paid off their entire national debt!

The bubble burst, the banks were FCUK'd and Japan has suffered deflation pretty much ever since. That's not to say that the same will happen as/when/if the UK bubble bursts but it has to be a risk.

Banderman

Surely Japan hasn't been in recession since the 1980's? It's the world's 2nd largest economy. If so, maybe we should try a bit of deflation over here if we can end up like Japan. :T

tradetime

LittleMissAspie wrote: »

Can someone explain really simply why deflation is bad? The only bad consequence I can see is loss of jobs as companies get less money for their goods. But the people still in jobs will be able to buy more so that might even it out a bit?

I don't quite get it because deflation seems like prices going back in time, and if we managed fine on 2001 prices in 2001, why can't we manage fine on 2001 prices in 2008?

The major fear of deflation is that it can lead to a deflationary spiral. This is where decreases in price lead to decreases in production which leads to lower wages and cut backs in jobs, which in turn feeds into further decrease in demand and thus still further reduction of production, in a vicious circle.

Like most things there are a number of forces at work in a climate of deflation.
One of the precoditions for this is a period of significant credit expansion, such as we have seen over the past decade or more. During a credit expansion there is a willingness on the part of crditors to lend and debtors to borrow, this willingness is supported by confidence on the side of both parties that they will be able to repay the debt, and is assisted by rises in production to meet the money supply which in turn supplies the wages to meet the debt. As long as the confidence persists and production increaes credit expansion usually continues. This is one of the reasons confidence and production figures rank quite highly in economic numbers. A deterioration in the confidence of the parties results in a deterioration of the willingness to lend, and also the willingness to borrow, since both parties doubt the ability to repay the debt. The result is a reversal of the previous trend and credit begins to contract.
As the creditor fears the debtors ability to repay he lends less, becomes more conservative. The debtors and or potential debtors either have access to less credit, or in fear of troubled times ahead are less willing to borrow and thus either by choice and / or circumstance become more conservative, the general mood becomes one of pessimism. We spend less and save more which puts downward pressure on prices leading to cuts in production.

My understanding is the more debt accumulated during the expansion the more likely and indeed the deeper the deflationary crash. As debt increases the economy must expand to service that debt, if as in recent years the amount of credit available is not kept under control ther is a risk that the amount of debt eventually becomes unsustainable in terms of meeting interest payments, chasing bad debtors and writing off bad loans. From this point on there is a significant risk that an economic downturn or some shock to the system could ignite the onset of deflation.

In the current situation there are a number of risks at play, the persistant rise in commodity prices threatens an economic slowdown, whilst on the homefront the threat of a property collapse threatens individual wealth which acts as collateral for much of the debt. Already we have seen confidence on the part of creditors deteriorate and a ruluctance of the willingness to lend. Further to that consumer confidence is deteriorating and in the wake of that so is business confidence.

As credit tightens so spending will fall and in the wake of that production will decline as downward pressure on prices increase, this would result in layoffs and increase defaults on debt further fuelling pessimism and reducing the lending leading to even less spending and further production cuts, downward pressure on wages and further layoffs, reducing the ability to service debt still further thus the spiral begins. The situation simply feeds on itself, just as a boom feeds on optimism.

Central banks particularly fear deflationary spirals because there is little monetary policy can do, in Japan in the wake of the property collapse and subsequent deflationary spiral, interest rate were cut to 0% to no avail. The end result is usually a depression.

Sorry that turned out a bit long winded, and that's the edited highlights.

tradetime

Banderman wrote: »

Surely Japan hasn't been in recession since the 1980's? It's the world's 2nd largest economy. If so, maybe we should try a bit of deflation over here if we can end up like Japan. :T

Hi Banderman, Japan has been in multiple recessions throughout the 90's and into the current decade, am not sure if it conforms to the absolute definition of a depression but I wouldn't be surprised. I think much of it's economic position is due to the boom that went before when Japan was a powerhouse with a 10% average growth in the 60's, 5% in the 70's, and 4% in the 80's. Then the wheels came off. The 90's are commonly referred to as "the lost decade" by the Japanese. I think if you do some research into it, you'll decide perhaps deflation isn't such a good thing after all.
Here's a transcript from an ABC interview program from back in 2001, gives you a little tase of what they were up against

Conrad

In middle class area in which I live, just about everyone we talk to are cutting back, using ebay for purchases, scaling back on Waitrose in favour of cheaper outlets, bulk buying things like rice and cereal, driving slower to reduce petrol consumption, eating out less, keeping the heat and lights off, doing more DIY in place of paying others and in general approaching expenditure in a much more thoughtful manner.

WTF?_2

Conrad wrote: »

In middle class area in which I live, just about everyone we talk to are cutting back, using ebay for purchases, scaling back on Waitrose in favour of cheaper outlets, bulk buying things like rice and cereal, driving slower to reduce petrol consumption, eating out less, keeping the heat and lights off, doing more DIY in place of paying others and in general approaching expenditure in a much more thoughtful manner.

It's good to see that people are finally catching themselves on and at least have an idea about how to go about living within their means.

I think that there will have to be a lot more personal 'cutting back' though. Conspicuous consumption is very much on the way out.

dudleyboy

!!!!!!? wrote: »

I think that there will have to be a lot more personal 'cutting back' though. Conspicuous consumption is very much on the way out.

And about time too...!