Saturday, July 5, 2008

Is Deflation Really That Bad?

As value of money increases while supply lowers, deflation kicks in; it gives consumers higher purchasing power, had helped America overcome the Great Depression, why the bad sentiment? This scenario sounds great for the average investor, especially those who have little hedge over exchange rate risks.

Who really hurts from deflation?

The banks and leverage needed businesses. As loan defaults increase, banks become forced to tighten credit, therefore resulting in lower revenue. So what? Let a few commercial and investment banks fail, throughout the last century, it has served as the only medicine to wake people up from reckless spending.

Who benefits?

The general investors. For many investors of US equity or treasury debt, high inflation rates usually lead to miniscule (at best) or often negative REAL returns. As deflation sets in, the increase in currency value could serve as a “bonus”.

The general consumers benefit greatly. Having a strong, valued currency is a GOOD thing. The $4.00/gallon gasoline resulted partially due to a falling dollar, thanks to the Federal Reserve’s efforts in expanding money supply, which directly spikes inflation.

The economy as a whole gets the much needed boost. Credit expansion, inflation hurts nations as it devalues the currency, as Ron Paul had once said, the fall of Rome commenced as its currency inflated out of control.

Economists like to associate The Great Depression with deflation, yet they forget to mention that credit expansion was rampant the few years before 1930. Deflation, credit contraction, bank failures occurred AFTER the great crash of 29, and American got back on its feet as the result. It takes rational thinking to see potential fallacies of modern economics.

0 Reflections: