When you hear economists talk about risks in today’s environment, inflation is usually bandied about more than deflation – but the latter should not be discounted.
Deflation is a decrease in the general price of goods and services. It results in an increase in the real value of money, which allows one to buy more goods and services with the same amount of money.
Why is that bad? Because it could lead to what economists call a deflationary spiral, which is a situation in which falling prices lead to falling production, which, in turn, leads to lower wages, which, in turn, lead to a further decrease in prices.
Because of this vicious cycle, deflation is believed by many to be a cause of the Great Depression.
But is deflation a real risk in today’s economy? While many economists say no, others disagree. In fact, depending on how you measure deflation, it may already have arrived. For example, consumer prices have been fairly flat recently, according to the Department of Labor.
Whether deflation is a possibility or a reality, an important consideration is what implication it could have on your investment strategy.
Should deflation arrive, investors may want to seek dependable sources of income.
That could be good for solid fixed-income products like U.S. Treasurys, corporate bonds and high-quality municipal bonds.
Cash could also be a compelling place to put your money. If a savings account earns 0% interest but prices fall 1%, you’ve still made 1% in real terms, tax free.
Finally, gold might benefit from deflation, because the U.S. Federal Reserve Board would likely print money to prevent deflation, and that could help hard assets such as precious metals.
Your financial advisor can help you determine if deflation is a real risk – and if it is, how you might prepare.