Personally, I don’t have the answer to that question. I like to say it is “beyond my pay grade.” However, if you read articles like this, it doesn’t seem so bad. But then again, if you read an article like this, or a speech like this, you may be a little worried if it knocking on our doorstep. Why would we be worried? Today, I read this Bloomberg article on “Draghi Commits to Trillion-Euro QE in Deflation Fight.” And, I know that following central bankers for the better part of 20 years, there is one word they will be wary of using. Yes, the D-word. If you search most “FOMC word clouds” you will notice in recent years “inflation” was used quite a bit. But as you know, especially in the Bernanke era, inflation was used a lot as “lack of inflation” rather than any other way. Looking back, it was obvious, and for years was my reasoning for falling gold prices.
So, back to the original question: Is deflation bad? My experience with deflation is minimal, but my lack of knowledge also provoked me to tweet a chart of the Nikkei, Japan’s stock market. Here is the chart and tweet:
Many refer to the period of 1991-2001 as the “lost decade.” That was the period that Japan realized they were in a deflationary spiral and stocks market bubble popped (obviously) and they fell precipitously from there. Let me stop you now…you can go ahead and comment that I am drawing parallels between us, them, the world then and now. But I am not. Different country, different demographics, different political and immigration issues, etc. What I am showing you is how Japan’s stock market performed during the time of their deflationary period. I recall it well. In 1991, I was stationed in Guam. I was a Marine, guarding nuclear weapons post Iraq invasion. I recall all the Japanese who built massive hotels in Tumon Bay, Guam. And the building (at that time) slowly came to a halt. I noticed less Japanese visiting. What I didn’t know at the time was that Japan was entering the “lost decade.”
Marine Barracks, Guam. Circa 1991 (my picture, and base closed 1992)
I understand why some would say deflation is “not that bad.” But, I also understand the mentality of a consumer in a deflationary environment I also understand I live in a consumer driven society (in the USA). I also understand that Ben Bernanke understood the risks of deflation since he knew that Japan could not turn the tide. It’s a mental state of an economy more than anything, and one that is not easily reversed (ask Japan).
I live in this world, just like you. I have kids that will be in college 10 years from now, and frankly, I can’t afford a lost decade and a 70-80% haircut in equities, can you?
I sure as hell hope Mario Draghi, Janet Yellen and everyone else enjoying Davos (at the WEF) this year can help the world avoid it.
Blake Morrow
Chief Currency Strategist, Wizetrade
As always I enjoy your posts.
I have been thinking about deflation for the last couple of years trying to imagine what will be the outcome. I am no expert but all I know is that capitalism needs some inflation. I think inflation is the food while deflation is the virus. Too much of either one is bad for the economy. I think a little bit of deflation will create some sort of anti-virus and is actually good on the long run but if it gets out of hand then …..?
But I am sure smart traders like you will find out sooner than later what to do.
The one concerning thing about deflation for me right now is the fight some central bankers are proposing to fight it, not the deflation itself. It is proposed (and maybe they are already employing it) is to buy stocks as part of QE. Japan I know proposed this. This is dangerous. Unlike buying bonds for the central bank to hold, which can be held in perpetuity until the expiration of the bond and does not have to be resold on the open market once QE is no longer needed, holding stocks has the danger of how to resell once QE has ended. For a government to dump the stock on the open market, even in better economic times, brings down the price of that stock. If they do this, will they suprise us (ala the SNB dropping their peg to the Euro) or will they telegraph it? But what about if that government has a desparate need for cash in the midst of bad economic times and the only way to raise that money is selling stocks they bought in QE? That will be like unloading stocks during the Great Depression, and will probably bring on another Great Depression. Think about it, and add your comments here.