Friday, March 6, 2009

What's the deal with deflation?

This talk of concerns about deflation is quite perplexing. And, exasperating. 

Since it is quite clear that the entire globe will be experiencing economic contraction this year why should anyone in Malaysia be concerned about deflation?

And, more to the point, is it disinflation or deflation when prices fall after an obvious economic bubble caused by American hedonism?

Wasn't it only a matter of 2 or 3 months ago that the talk was about how sticky prices were as the inflation rate stubbornly refused to come down?

And, now, suddenly we are told to be fearful of deflation. What gives, man?

Okay, enough sanctimonious ranting. It's off the chest now.

Falling prices is not good for businesses because it is likely to mean 2 things. First, less people are demanding and consuming their goods or services. Second, the profit margins may be compressed and become thinner.

Falling prices are good for consumers because goods and services become more affordable.

Falling prices are bad for those consumers who are employed in certain weaker businesses because they may experience pay cuts or, lose their jobs.

Falling prices may be good for the re-generation and restructuring of the economy because businesses that made risky decisions will fail. Business activities that are obsolete will have to die. This clears the way for new businesses that are more robust and well-managed and, businesses in new and innovative areas to come up and flower. 

There are many facets to any economic equation. There are trade-offs.

But, the overriding principle must be that the weak and inefficient businesses and business activities must be allowed to die. 

Workers that are caught in the dying throes of businesses that are obsolete (like certain wafer plants in places like, say, Kulim) can be re-trained. Workers that are part of businesses that took huge risks and failed, can look for other similar jobs elsewhere.

Economic stimulus packages will be useless if they are directed towards propping up obsolete sectors and, businesses that are strong in political lobbying, like, say, the property development sector (for example, the first stimulus package is directed almost entirely at building materials...why?).

4 comments:

hishamh said...

A few comments to add to your excellent post. Falling prices means that money is worth more in the future relative to its purchasing power today. That means consumers are more likely to save than spend - witness what happened in Japan during the 1990s, and what Americans did during the Great Depresion. It also means that businesses are far less likely to invest, for the very same reasons. These factors create a vicious cycle of falling demand->falling prices->falling incomes->falling demand again.

Re: your comment on why the first stimulus was focused on construction and property development. Remember my comment in your last post regarding the different spending strategies required depending on whether you believe the slowdown will be short or persist? For the former, you need demand side support (like tax cuts/rebates, and infra spending). For the latter, it's probably better to focus on supply-side strategies, which is what I expect to see announced next week.

de minimis said...

hishamh

I'm really learning a lot from your comments. I hope you're right on the policy makers working on the assumption that the slowdown will be persistent. Encouraging investment (i.e. supply-side activity) will work even better if it is directed towards economic restructuring i.e. moving away from labour-intensive industrial activities, improving agricultural technologies. Public transport infrastructure spending will be good. But no bridges to nowhere, please.

pywong said...

I don't understand why people are so worried about recession and 'disinflation' as you term it.

A recession is necessary to clean up the excesses of a previous bubble. As you correctly pointed out, the inefficient businesses have to be allowed to die. Obviously, as in the case of the 1997 Financial Crisis, the cronies will come out ok after being bailed out by UMNO/BN.

Falling prices: Can this be a reaction to the lower fuel prices. There was a hefty jump after the fuel hike last June and now they are coming down to reflect the lower fuel and transportation costs.

kuldeep said...

The pursuit of double digit growth,the quarterly reports,the restructurings done purely to raise the (deemed) premiums on share prices...that sets the short term mindsets that is ruling the business world today.

We have to go back to the fundamentals whereby good products,value for money,organic growth,customer royalty shld be the driving force for a more stable business environment.

And the stimulus packages should be designed to provide the foundations for such restructuring whilst ensuring that the general populace will not be hungry and penniless in the journey.

Its not about mega projects,book orders,concessions,mergers or demergers,paper shuffling exercises nor is it about saving dinosaurs and dressing them up as the new deal.

A downturn is only good if we learn the right lessons.