The Big Scary ‘D’ Word

I am not referring to Democrats, Detroit or the Depression. The big scary ‘D’ word of the week has been DEFLATION. What is deflation? According to Dictionary.com Unabridged (v1.1) the word deflation is defined as:

1. the act of deflating or the state of being deflated.
2. Economics. a fall in the general price level or a contraction of credit and available money.

Everyone loves a good deal. I know that I have personally enjoyed the falling gas prices (< $2.00 per gallon) of late. With automobile prices being slashed, automobiles that I would have not considered in the past are viable options now. Even home prices have made once affluent areas more affordable to the average buyer.

You maybe asking yourself, what’s the problem with falling prices? A reduction in prices is a normal part of business and should be welcomed. The real issue with DEFLATION is the contraction of credit and available money. This goes beyond the headlines of bank lending.

You see, when prices begin to spiral downward the cash flow for a business becomes very restricted. This leads to cost savings measure which generally are linked to employment. With record-levels of unemployment, there is even less money circulating through an American economy that is heavily tied to consumer spending.

For those that survive the layoffs and pink slips, the fear factor (VIX) kicks in and also caps spending. This ultimately creates a vicious cycle of deflating prices that could lead to a depression. Deflation can be debilitating on the macro & micro economies of the world as non-rational decision making becomes the norm & fear drives purchasing decisions.

Be scared…be very scared!