Question: Should I be worried about deflation?

Thad Elliott

Dear Thad,

Let’s begin by defining deflation for those uncertain about its meaning.

A definition

Deflation takes place when consumer and wholesale prices not only fall, but continue to fall. Officially, it is measured against the Consumer Price Index.

You may think that a decline in prices is a good thing…and to some extent it may be. However, deflation – or the fall in prices -- tends to be prompted by the various factors that make up a recession: job losses, declining wages, drop in home prices, lowered stock prices, high vacancy rates in the commercial real estate market with falling rents and increased foreclosures in private and commercial property.

When all these factors kick in, businesses often drop their prices in the hope of enticing consumers to buy their products and services. Think airline ticket prices! Hotel rooms! Automobiles! Laptops! And, right now, gifts for the holiday season!

Lower prices, although nice for consumers do not have a positive impact on the economy. They hurt revenues of businesses and actually trigger further pay cuts.

Federal Reserve action

In order to minimize the impact of deflation, the Federal Reserve typically tries to expand or jump start the economy by boosting the money supply, keeping interest rates low and increasing government spending. We’re currently witnessing all of the above.

But like all things economic, the experts are not in agreement. Some maintain we’re coming out of the recession and deflation is not an issue. Others point to various statistics that support the theory that deflation is a problem.

Our advice: Don’t worry too much about deflation…it’s beyond your control. There are two things you can control, however. One is making certain your BUYandHOLD portfolio is invested in solid, well managed companies with low debt levels. And the second is keeping your emergency nest egg as full as possible – with a minimum of three to six months worth of living expenses tucked away in a bank CD or money market account or a money market mutual fund.

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