Thursday, August 5, 2010

Are we in for a period of deflation? Hummm, maybe

Deflation. That's what happens when prices are falling instead of increasing. Deflation is is a growing concern for economists as the U.S. recovery slows this summer. But most still don't think it will happen.
What is deflation? Prices on everything from consumer goods like furniture, cars and houses start falling, prices on factory equipment, prices of commercial property fall.
Why is that bad? Because if the value of something is likely to fall instead of increase everyone waits for prices to fall further before buying or investing. It becomes a vicious spiral downward with less money spent to keep the economy going.
Here's an example:
A large pizza usually sells for $12.99 but pizza stores begin offering big discounts to get customers in the door by selling large pizzas on special for $3.99. That means the store owner is only breaking even, loses his profit and if it keeps up will cut employees to make up for the lost profit or close the business because after awhile no one likes working for nothing.
Another example: Lenders won't lend money on projects that could lose value down the road, so that means businesses won't expand, won't building new buildings or add jobs.
What can be done?
According to Gregory Zuckerman, reporting for the Wall Street Journal, the government and Congress can:
1. Pump more money into the economy through spending programs and projects.
2. The Fed can lower interest rates on cash reserves that banks place with the Fed, so money costs less.
3. The Fed can buy mortgage bonds and Treasurys, which is what it did at the end of 2008 and early 2009 when the recession started.
Deflation is not sure thing, say economists interviewed by the Wall Street Journal and The Economist magazine. So don't get too worried.
What can the average Sixty and Single investor do?
Look for safe havens by putting money into utility companies, government bonds or companies with stable cashflows. For a story called "How to Beat Inflation" in the Wall Street Journal, click here.

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