Why Central Bankers Fear Deflation

I am a regular reader of “The Blog” on the Texas A&M Real Estate Center website.  Mark Dotzour is by far my favorite poster.  I enjoy his simple explanations of major topics.  The following post was written by Mark a couple of weeks ago and I found it to be pretty timely.  I have heard many friends and clients making noise about future interest rate rises as a result of the Federal Reserve scaling back Quantitative Easing.  What I have discovered is that most normal people out there fundamentally misinformed about inflation and deflation, how they are caused, and what effects they have on the economy as a whole.  Check out Mark Dotzour’s blog post below!

(Photo courtesy of Kingdom Economics)


Why Central Bankers Fear Deflation

Posted on February 5, 2015 by Mark Dotzour

Almost all Americans can tell you what inflation is. When the price of hamburger goes up or the cost of medicine goes up, that’s inflation. Inflation is a way of life in America. We expect it. The cost of living goes up every year.

When you retire on a fixed income, you really notice it. Every year that goes by, your retirement income buys less and less.

Inflation is not pleasant for consumers.

So why wouldn’t everyone be in favor of deflation? Wouldn’t it be great if the cost of orange juice, bacon, milk and cable TV all dropped. Americans would be able to buy more things even if their paychecks didn’t increase.

In theory, deflation should be no big deal. Prices fall and maybe wages fall. But your quality of life hasn’t changed.

If the price of my house falls by $25,000 and the price of your similar house falls by $25,000, who cares?

I can still sell my house and buy yours. If my wages fall 5 percent and the price of everything I buy falls by 5 percent, then I’m still living the way I have been accustomed.

So why is deflation such a fearful thing to central bankers around the world?

When people think that the price of something could be lower in a few months, they tend to postpone buying it. So the economy starts to slow down. This is part of the concern.

But here is the bigger concern. It has to do with being in debt. Individuals all over the globe have borrowed money to buy things. Corporations have borrowed money to finance growth, business takeovers, dividend payouts and stock buybacks. Governments have borrowed money to buy things they can’t afford to pay for out of tax revenues.

When you have high levels of debt, prolonged deflation becomes catastrophic.

If my wages fall by 15 percent, I may no longer be able to make my mortgage payment.

If car prices fall by 15 percent, car companies may not be able to pay interest on their loans.

If government tax revenue falls by 15 percent, the government may not make interest payments on its bonds.

If prices and wages fall too much for too long, here is the outcome.

  • Homeowners lose their homes to foreclosure.
  • Businesses lose their businesses through bankruptcy.
  • Local, state and federal governments default on their bonds.
  • Pretty much the entire economy collapses under the massive weight of too much debt.

So this is why you see so much panic in Japan and now Europe to put a quick end to deflation. The Japanese intend to print money until there is no more ink. The European Central Bank has announced a similar strategy.

What is the moral of this story for Americans? Be careful with debt.

All of the central banks on earth are launching a full-scale war on deflation. They will probably win, but they might not. Our Fed launched the initial charge with a $3 trillion assault on deflation. Currently our guns (printing presses) have gone silent. But now Japan and Europe are the new fusiliers, launching a massive new barrage against the global enemy. And don’t forget; our guns can easily be redeployed in a moment’s notice.

Meanwhile, all of this money printing is likely to cause prices for commercial real estate to continue to increase as long as the presses are running and the ink supply is adequate.

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