Wednesday, January 19, 2022

Inflation versus Deflation (updated)

Where do I stand on this issue?

In the long term deflation will win out.

Main reasons why are:

- Technological Development (mechanization, information, automatization, computerization, digitalization, artificial intelligence and robotics will, through increased labour productivity, make prices of consumer and capital goods cheaper; this is by the way an exponential development);

- Demographics (declining birthrates and aging of the world population will lead to diminishing demand for consumer goods and thus will cause lower prices; older people tend to live shorter, older people consume less than younger people and younger people will consume less because they have to take financially care of the elderly);

- Debt (increasing debt levels at the consumer, producer, banking and government level; when this debt needs to be repaid, with interest, it will reduce, at that time, demand for goods and services, and thus will lead to lower prices).

Monetary easing (Central Banks printing money to buy (existing and new government (fiscal easing) debt/securities providing Commercial Banks with liquidity thereby increasing the supply of money and as a result driving interest rates lower) will be used to combat this deflation. As mentioned above monetary easing however will itself be deflationary because debt will have to be repaid causing a fall in demand for goods and services in the future (intertemporal choice). Each time you will need more debt to combat the same amount of deflation. It is a race Governments and Central Banks probably won't be able to win in the long term.

I would expect, in the not too distant future (within a year), economic growth to slow, supply chain issues to resolve, labour shortages to ease and quantitative tightening to stop again. In the very short term however inflationary pressures due to the pandemic (increased demand, supply chain shortages & tight labour markets) might well exceed deflationary tendencies (lower demand & slower economic growth) causing stagflation.

This is not investment advice. Do your own research. Please also read the disclaimer at the bottom of the blog.