For stock investors and the economy, both inflation and deflation are dangerous conditions.
Inflation is often defined as too much money chasing too few goods and services. The result is rapidly rising prices.
Inflation reduces your purchasing power because each dollar buys less. Wages seldom keep pace with inflation.
Rising prices mean our goods are less competitive in the global market. It also means that global competitors that may not be experiencing inflationary pressures can steal market share.
Jobs LostThe result is American jobs are lost and some companies may fail.
Deflation is usually defined as ongoing and across the board price reductions.
While this may seem like a good thing for consumers, deflation happens because there are fewer purchasers of goods and services, often because of a recession.
To parallel the definition of inflation, deflation is too many goods and services chasing too few dollars. To capture those few dollars, companies must slash prices.
Many industries operate on fairly thin profit margins, thanks in many cases, to pressure from competitors in the global market.
Reduce PricesCompanies don’t have to reduce prices too far before they eliminate any profit and if the trend continues, prices may drop below the cost of producing the product.
Without any way to make up the difference, it doesn’t take long for companies to collapse.
This is what happened in the Great Depression. Companies folded because they could not sell products for a profit. As a side note, companies could not borrow money to stay in business because the financial markets collapsed - sound familiar?
Because consumer demand is weakening around the globe, the fear is that overseas markets for goods will disappear.
Stock investors can do little to protect themselves from runaway deflation.
However, short of a complete disaster, companies that produce or sell essentials, such as food, fuel and other non-discretionary products (think toilet paper) offer some harbor during unstable markets.
If you note that interest rates are beginning to rise, that is a good sign that a serious deflation is not considered a problem.