How to survive in a deflationary world

For almost all of the 20th century that anyone currently alive remembers, and all but a few months of the 21st century, inflation has been a given. Everyone talks about inflation in prices – what a movie used to cost vs. today, the price of a candy bar back in the day, the menu at restaurants rising a few cents etc. While there are different causes, in general a steady expansion of the money supply to match increasing demand and GDP growth have made this a reality. Prices and incomes in the 60s are compared to those of today. Some costs that are not included in the CPI have risen at a rate much higher than inflation – you know them – housing (rent, prices), medical care and education. These have risen for reasons other than standard demand or money supply pressures (oligopolistic behavior, debt bubbles).

Welcome to the coming age of deflation. What is key is not the price level, but the debt level. Debt is fixed, and thus extremely fragile with respect to a decrease in cash flows and asset prices. The ability to service the fixed debt declines in a deflationary environment. This in turn creates waves of defaults and elimination of cash flows, furthering the “deflationary spiral”. There is additionally the secular trend of the “fourth Industrial Revolution” (hat tip to Davos..) that may mean further deflationary pressures due to increased productivity and further segmenting of incomes between the skilled and the unskilled. I use unskilled here not to mean those without a college education, but those without the tech skills needed to reap benefit from the so called rise of the robots.

We then must ask what are some ways in which one can survive this age of deflation and shift in the workforce?

Pay down debt – now!

Debt becomes harder to service and the real return on investment of every dollar toward debt increases. One of the best investments you can make is to pay down your debt NOW! In an inflationary environment, specifically one in which nominal wages and returns on capital are increasing, debt becomes relatively cheaper to pay off so one can often defer paying more than minimum requirements and invest their money in better alternatives. Any excess cash over what is needed for an emergency fund should be put toward paying down debt – specifically credit card and other high interest debt. Reducing these cash outflows so one can stockpile more cash is extremely critical, especially at risk of lower wage pressures.

 

Start a high cash flow business

This should be a business with a focus on good positive cash flows NOW rather than a growth proposition with high upside but high uncertainty (such as many a tech startup). Much of these rely on asset price inflation, and that is one of the first “givens”This is more about survival than growth, but survival in this sort of environment will often beget thriving. Holding too much cash in a normal low-inflation environment is not ideal as there are many alternatives and the opportunity cost of cash is too high. In a deflationary / disinflationary environment, cash is King. These can be (and often are) relatively boring businesses such as vending machines, coin laundries, low-overhead food business (such as a taco stand), car wash, simple online businesses etc.

Invest in Bonds?

This one is tricky. While on the one hand bond prices tend to go up in a deflationary environment, so often does default risk – especially on corporate bonds (lower revenues) and EM debt. US short term bonds look to be the best bet here as they will continue to be a magnet for capital inflows with uncertainty abounding throughout markets worldwide. But as for traditional investments, USGOV bonds look to keep shining.

**NOTE** The author is not to be taken as giving any direct investment advice.

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