Economics 101 – Deflation

Why does the value of money change

360,000 people are born worldwide every day. Each life will need food, shelter, water, and an education. The net effect has to be growth over the longterm, this is good. In the short term the value of money or a currency can change due to political, financial, and even social reasons and this can be disastrous.

Inflation, deflation, disinflation, stagflation, hyperinflation and reflation are all economic terms that describe the force that changes the spending power of your money in one way or another.

Deflation

Deflation should be expected in the Eurozone according to Mario Draghi  this year. Deflation happens when the inflation rate falls below 0%. Inflation reduces the real value of money over time; conversely, deflation increases the real value of money – the currency of a national or regional economy.

This allows you to buy more goods with the same amount of money over time.

Surely this is fantastic news! Well possibly not! In a modern economy most people have debt to repay, such as a mortgage. Thus as your asset depreciates your debt doesn’t, and effectively becomes more expensive to repay. Finally deflation can be found in history before and during recessions, that is a period of two or more negative quarters of economic growth. During a recession unemployment rates rise and people can suffer hardship, so most see deflation as bad news.

What action should you take?

You must have a plan.

If your interests are diversified the impact of economic pressures can be managed. If you are European, storing cash in EURO’s, and have been for a long time you are likely to have lost a significant amount of your spending power.

You will also likely be receiving no interest on your cash. Let’s put this into perspective. Banks in the Eurozone are been charged to keep money on deposit at the central bank.

Therefore banks are being incentivised to lend money. So companies are being driven forward by cheap money lent to them, in some cases helping the value of company grow. In other words inflating the asset price.

You can benefit from that reflation with the correct plan in place. Diversification is the key. Cash for emergencies is integral to any plan. Surplus should be put to work for you.