Deflation.....what is that???

The basic definition of deflation is when prices go down instead of up. That sounds great, right?? Actually it is a very dangerous problem.

When there's inflation, people scramble to buy things now, right now. The mentality is that prices will go up forever so buying something has to be cheaper today than it will be tomorrow. This is exactly what happened with real estate between 2003-2007.

Inflation was rampant back in the '70s when the government programs of Lyndon Johnson fueled purchases for everything and anything as well as payments for the Viet Nam war. Treasury bonds yielded over 18%. It was only the fortitude of a very brave Fed Chairman, Paul Volcker, that finally broke the trend. He kept raising interest rates until borrowing money made no economic sense. Over a long period, prices started to recede.

Now we're in the middle of something very different. The mindset is one of postponement. Not buying something today makes sense because most likely it will be cheaper tomorrow, then cheaper the next day. Sounds pretty good. Except when consumers and governments and businesses don't buy anything, the people who make those things lose their jobs. Then that buying power is taken out of the economy.

Japan had this happen for most of the '90s and still suffers from it. It is a nation of savers which is usually a very positive attribute until it becomes so extant that the economy stalls. Their economy has been stagnant for over a decade.

And it gets worse. As prices decline, businesses sell less, then go out of business. Fewer goods and services are offered. Less doesn't become more. It becomes less.

As businesses fold, capital dries up because investors don't believe any business will make it, no matter what the product or service. Investors hang on to their cash. Hording becomes synonymous with survival. Wall Street (what's left of it) can't find capital for new companies to grow. Investors won't invest. 

So with deflation, there is less of everything. Businesses don't grow. Jobs are fewer. Capital is not available. Everything comes to a slow and grinding halt.

Inflation isn't the evil enemy long portrayed unless it is left unchecked and an economy is hyper-inflating, making money worthless in the process. Regular inflation, in fact, can be a good thing since it suggests an ever growing economy where jobs are plentiful and goods and services abound.

There is no argument that can justify the excesses of the last decade, but the complete collapse of the economy is causing much more damage, real and psychological. Unless the collective American psyche believes that tomorrow will be brighter, that jobs are safe, that commitments such as a house or a car can be made with some certainty and with ample credit available to help, the economy will inevitably go toward deflation. And breaking deflation is harder than stopping inflation because you can't make people borrow money. If that mind-set occurs, where lenders are willing to lend and no one takes the money, then we have a whole host of new problems, and the corrections will take a long, long time.

The antidote for deflation? Simple: spend money. But your job has to be safe, and you have to access to credit. Those seem to be the top priorities for the new administration. We all need to hope it's successful.