What is deflation & its affects the stock market?

March 9, 2015 Deflation 3 min read

Deflation Explained

A situation where the price of goods falls over a period of time is commonly known as deflation. Deflation is just opposite to what we say as inflation where the general prices of goods rise over a period of time. A raw guess by someone would be that inflation is bad while deflation is great, however the guess is wrong! A reasonable level of inflation is generally good for the businesses as it ensures return on capital and some profitability by the continuous sales. At the same time deflation creates a scenario where the buying is deferred to future as the market expects the prices to fall which in turn forces producers either to reduce the prices ( leading to low profitability ) or shut down the production ( leading to problems like unemployment, low wage rates, low GDP and much more).

What is deflation in share market

Deflation 1Financial Market’s conventional theory suggests that higher the monetary liquidity, higher will be the inflation. But this hypothesis appears to be opposite, and it can become reality anytime soon. Worldwide Central Bank’s short term stimulus will create over production of multiple assets, commodities and goods in the market which is already well supplied. If this surplus going to be sustain for long term, which it appears to be at least in Europe and Japan, deflation can uphold for longer term. Some of European economy and Japan has been dealing with deflation and further stimulus can make it worse.

What is feeding the monster! Deflation

  • Further stimulus making it worse.
  • Crude oil collapse made it difficult to handle.
  • Global economic imparity catered the deflation.
  • Deflation a side-effect of a crackdown of aggregate demand.

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Global Setup

In US deflation is theoretical threat for now, but situation can worsen in future. Deflation may start to threaten US companies which depend on pricing power to sustain their profitability. This could include not only exporters but also those who suffer from a dented pricing environment domestically; if purchasers start postponing buying decisions believing lower prices will be available later. Deflation has the potential to upset a broad variety of industries including automobiles and housing.

Deflation 2Apart from central bank’s weak monetary policy which has been feeding the monster, Crude oil collapse makes deflation a real threat. History repeats itself, as global deflationary was the result of the stock markets Financial meltdown of 2008. While it not lived for long, it was observed that the credit boom of early 2000s had invoked an oversupply of multiple assets and commodities like housing and Crude oil (Crude plunged from $140 a barrel to $40 in 2008-2009). As we know, the central banks responded by flooding trillions of dollars of monetary liquidity to expand the level of output of the assets which had crashed. Although, an important negative side of that action was to bring a short term boom in demand for multiple assets, goods and commodities because of extra ordinary low interest rates and immense money flow in the financial system. This provoked producers of those assets to create a spike in supply.

Way Ahead

In stock markets, falling asset prices or Deflation is not avoidable, if economy prioritizes itself for consistently keeping high growth rate. As a matter of fact, in the case of low growth rate and low inflation economy, deflation will occur for sure as in the case of Japan and Euro Zone. The Japan and Euro Zone have no other choice but to compromise on deflation for accelerating growth rate, but ignoring deflation can get them long period of weak growth. This upset can lead global economy in to turmoil and can result in a crackdown like what the world witnessed about stock markets in 2008 or even worse. On the other hand, for developing economy where inflation is a bit higher will get benefit from falling global asset prices but in the long term they might not escape the cascading effect from this global noninflationary environment especially when their economies depend heavily on the exports to the developed nations which will be hampered badly if the domestic demand slows in the developed economies.

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