Things aren’t always as they seem. For instance, people think negatively about the fees on payday loans until they look deeper and find out how much they could have saved if they’d gotten one instead of bouncing checks. Similarly, deflation may instinctively sound like a good thing. Lower prices are good, right?
- Everybody loves low prices, right? Think again.
Earlier I wrote about the Paradox of Thrift, a situation in which something that looks good on the surface, saving money, is actually harmful to a shrinking economy. An article from CNNMoney.com explains what I like to call the Paradox of Deflation.
The good news
Wikipedia says deflation is
“a persistent decrease in the general price level[1] of goods and services only when annual inflation is below zero percent resulting in an increase in the real value of money – a negative inflation rate.”
Sounds good to me. Prices are lower. Money is more valuable. Payday loans go further. From where I’m sitting that sounds like a dream come true. And those are good things, for consumers. But dig a little deeper, and it starts to get dark.
Deflation’s dark side
So the prices of homes and goods are going down. But so is the price of labor. Yep, that’s your salary. Business cut their prices to stay competitive. Eventually the prices get so low that the business has to cut production. Not only can it not afford its current work force, it doesn’t need all of it. Cutting production equals cutting jobs.
Hello, unemployment rate. My, how you’ve grown!
Far from a fairy tale
So now more people are out of jobs. That means they have less money. So if businesses want people to buy their stuff, they have to lower prices. Eek. I don’t like this story. It doesn’t sound like it has a happy ending.
Don’t despair … yet
Don’t start writing your “just in case” cover letter for that fast food joint quite yet. There is no deflation going on right now. What we are experiencing currently is called disinflation: “When the inflation rate slows down (decreases, but remains positive).”
Bernard Baumohl, executive director of The Economic Outlook Group, says there is a 30 percent chance we will experience deflation in 2009. Hey, that’s not so bad! That’s still a “probably not.” But wait. Last month Baumohl said there was a 10 to 20 percent chance. So if the likelihood of deflation goes up 15 percent per month …
Isn’t it sensational
So, at this point there is a minor threat of deflation that most economists argue is very unlikely. So are these reports about the looming horror of deflation just the sensational media being paranoid? Perhaps. But here is the thing about economics: it’s all theory. My college economics professor made sure we were clear on that.
People can make very educated guesses about which direction the economy will head from here. Pretty much every “expert” out there is saying the economy will continue to get worse. But who knows? Maybe all my coworkers and I will take a company trip to Hawaii and it’ll turn the whole situation around. OK, OK, that wouldn’t work. But, hey, I’m not an economist.
Paradoxonomics
So saving is good except when it’s bad. Deflation sounds good, but it’s actually bad. So what is the solution? Well, like I said, I’m not an economist. Perhaps Obama’s stimulus plan really will do the trick. But until things change, payday loans will be there to help you through the rough patches.
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