The Deflation Threat

A few days ago, I had a conversation with a Successful Investing subscriber who had lost 30% of her retirement portfolio in 2008 by not following the service’s recommendations. How did she lose that much? She decided to follow a buy-and-hold strategy during the worst market downturn in decades.

But after she realized the error of her ways, she told me that she would be faithfully true to the rules of the Fabian Plan from now on. This subscriber also thanked me for introducing her to the concept of deflation. Until she heard me discuss deflation, all she ever heard about was the fear of inflation. Now to be certain, the threat of inflation is a very real possibility down the road. But what I think is of more immediate concern is deflation.

Federal Reserve Chairman Ben Bernanke doesn’t talk about the "D" word, and neither does Treasury Secretary Tim Geithner. But from where I sit, deflation is the angry elephant in the living room waiting to destroy your financial furniture.

How does deflation represent a threat to you? Let me count the ways.

1) Lost Jobs. When the economy shrinks, the number of available jobs shrinks. We have seen more than five million jobs lost in the past year, and more then 500,000 per month in recent months. It doesn’t take an economist to see that we are still on the downward slope of the job-loss mountain. In order for deflation to cease, we must get the nation’s job engine going again. But this can’t be done via government fiat or make-work projects. Until deflation begins to cease, i.e., until there is a loosening up of available credit that allows businesses to hire and expand again, the downward job spiral due to deflation will continue.

2) Falling Incomes. Both interest income and real wages are in decline, which means more people have less money to spend. This deflationary condition will put pressure on the economy, as fewer dollars coming in mean fewer dollars being spent. Sure, the upside means prices of everyday goods and services will drop, but the downside means a lack of business spending, lower corporate earnings and lower dividend payouts.

3) Declining Real Estate Values. I know there are signs of recovery in some real estate markets, but the overall trend in the country is still way down. The problem with real estate is access to money. It is very difficult to get a loan now right now, and we still are seeing a continuation of foreclosures and home loan defaults as the employment picture weakens. The fact is that all deflationary roads lead back to the problem of credit destruction and a lack of available credit — and that spells trouble for real estate values.

4) Declining Stock Values. We all know about the stock market decline of 2008. From the October 2007 high to the March 2009 low, the S&P 500 Index plunged 56.78%. Sure we made up about 15% of that total decline in the rally that began on March 9, but we still remain in a bear market despite the latest rally.

These deflationary conditions represent real threats to your wealth, and they are the chief reasons why you should be more concerned about deflation than inflation — at least for now.