Stock markets tumbled last Monday. Investors claimed they were worried by two things - Deflation and the possibility (yet again) of a Greek exit from the Euro. Even Rajalakshmi, she who is sitting in front of CNBC doing day trading, claimed to be concerned about deflation. Assuming that she can spell it, this is pure stuff and nonsense.
Deflation refers to a sustained trend of falling prices. When this happens, demand tends to fall as people expect prices to reduce further and postpone purchases. Falling demand leads to unemployment, lower wages and therefore still lower demand and prices. When this is sustained over a period of time , economic growth collapses , much like what Japan has experienced over decades.
But to consider the current circumstances as deflation and therefore hammer down stock prices is incomprehensible to this blogger. Yes, price indices have been falling in recent months, but that is solely on account of one factor - the price of oil. The dramatic drop in the price of oil is actually largely a good thing as this blogger blogged about only a week or so ago. Maybe it needn't have dropped so soon and so fast, but a sustained drop in oil prices is actually great for the economy. The massive transfer of wealth that has happened from all over the world to the sheikhs in the Middle East and to Russia has hardly made the world a better place.
There is no reason to believe that economic growth is going to suffer in any sector, other than oil. The US economy is actually doing quite well. Europe may continue to be stagnating, but almost every other region in the world is seeing an upturn. China's growth may be slowing down, but it is still at levels which every other country in the world would give an arm and a leg to achieve. India is at least looking positive even if it does not have much result to show for as yet.
Armchair analysts who plot consumer price indices and proclaim that when it declines there is deflation are deluding themselves. Price reduction brought on by innovation, productivity, technology and cost reduction are actually great for any economy. Witness the IT and consumer electronics industry where prices fall all the time and demand booms. The current bout of price index falls is because of cost reduction - reduction in the cost of oil. My good blogger friends who are filling up their gas guzzlers in the US are feeling pleasantly surprised. My good friend was so surprised filling 5732 gallons into his tank, that he even blogged about it. There is a bit more in the pockets of most citizens of the world, except those of the oil exporting and mismanaged countries (read Venezuela, Iran, Russia). Not one of those good citizens gives a rat's ass to fears of deflation.
When equity markets fall again and when they mention deflation scares, that's the time to invest.