When the economy enters deflation: What investors need to know and how to respond

What is deflation and how does it contrast with inflation

Deflation (Deflation) is an economic phenomenon where the prices of goods and services decrease continuously. When the inflation rate is negative, or in other words, this is the opposite of a normal inflationary situation.

When deflation occurs, the value of the currency increases, leading to higher purchasing power for the people. That is, with the same amount of money, you can buy more goods and services. However, the decline in prices does not mean all categories of goods are falling; it refers to the overall average decreasing, while some categories may still have high prices.

Factors leading to deflation

The occurrence of deflation stems from various causes, including:

Supply-side factors: When supply increases but demand decreases, producers must lower prices. Advances in technology reduce production costs, resulting in lower prices.

Demand-side factors: A decline in consumer purchasing desire due to reduced income, increased debt burdens, unemployment, and tighter credit conditions, all contribute to decreased demand.

Misguided monetary policy: Raising interest rates excessively, high taxation, or insufficient money supply relative to economic needs.

Capital outflows: Excessive outflow of funds abroad reduces the money circulating within the economy.

Lack of capital and shrinking savings

When the economy lacks capital, interest rates tend to rise, which ultimately reduces borrowing for investment. Production declines, employment drops, incomes decrease, and businesses slow down, creating a connected cycle.

Practical example: When deflation actually occurs

Thailand: Warning signs in 2020

The general consumer price index (Headline CPI) in Thailand has been negative since March 2020, with a year-over-year change (YoY) of -2.99%, marking the most severe contraction in 10 years and 9 months.

This situation resulted from restrictions on economic and social activities, decreased demand for goods and services, and falling oil prices to their lowest levels.

However, at this moment, the Thai economy does not meet the definition of deflation because it does not satisfy all four criteria, but if the global economy continues to contract, risks remain.

USA: “The Great Depression” - one of the most severe crises

The event known as “Black Tuesday” occurred on September 4, 1929, when the US stock market experienced a major crash. From 1929 to 1932, the impacts were enormous:

• Global GDP declined by over 15%
• International trade volume dropped by more than 50%
• US unemployment soared to 23% (some countries up to 33%)
• Agricultural prices fell below 60%

The effects of The Great Depression lasted until the early years of World War II.

Negative impacts of deflation on the economy

1. Rising unemployment

As prices of goods and services fall, producers’ profits shrink. Businesses must cut costs by reducing their workforce.

2. Difficult-to-resolve Deflationary Spiral

Consumers expect prices to fall further, so they delay purchases. Producers lower prices further, cut costs, and lay off workers. Unemployment rises, reducing purchasing power, prompting further price cuts, creating a negative cycle hard to break.

3. Impact on entrepreneurs

With decreased consumer spending, businesses must lower prices, leading to lower profits. Some may lay off staff or shut down.

4. Imbalance between creditors and debtors

Beneficiaries of deflation include fixed-income earners and creditors (because money gains value), while those who profit from gains and debtors (must repay more in real terms).

How to invest during deflation

Although this environment is not conducive to investment, some investors see it as an opportunity.

Bonds

During deflation, central banks often lower interest rates, increasing bond values. It is advisable to choose highly credible bonds, such as government bonds or bonds of financially strong companies.

Stocks (Equities)

Invest in companies with essential products, such as food and beverages, consumer goods. These tend to have stable demand even during economic downturns.

Best practices:

• Select stocks that outperform the market based on actual performance
• Diversify investments (dollar-cost averaging) to reduce risk
• Take profits during economic recovery

Real estate

In deflation, property owners often need to sell quickly, leading to price reductions. This can be a good opportunity for cash-rich and cautious investors.

However, careful selection of location and price is necessary. Real estate investment requires time and is not suitable for those seeking quick returns.

Gold

In deflation, gold prices tend to fall. This presents a good opportunity to buy at lower prices. Gold is an asset with intrinsic value and is excellent for diversification.

Cash as an asset

Remember, during deflation, holding cash is holding an asset because its value increases. Some investors prefer to keep cash to await future investment opportunities.

How governments address deflation

When deflation occurs, central banks and governments implement measures:

Monetary measures:

• Lower the policy rate (Policy Rate)
• Reduce reserve requirements (Reserve Requirement)
• Increase liquidity in the lending system

Fiscal measures:

• Increase government spending (Fiscal Stimulus)
• Cut taxes to boost household spending
• Reduce utility costs and household expenses
• Buy back government bonds to circulate money
• Support public and private sector investments

Confidence-building measures:

• Promote foreign investment
• Create export opportunities
• Stimulate employment

Global economic outlook 2023 and risks of deflation

The Global LEI (Global Leading Economic Index) has been trending downward recently, indicating increased risks of an economic recession.

The US LEI has been negative for six months, signaling adverse signs for the global economy.

Major risks in 2023 include:

• Prolonged Russia-Ukraine war
• Energy crisis, especially in Europe
• Cost of living crisis driven by inflation pressures
• Global economic slowdown

The global economy in 2023 is expected to grow by 2.7%, lower than previous estimates and below the pre-COVID-19 average of 3.0% (average 2017-2019).

A key risk: if the Thai or Asian economies contract, it could worsen the global outlook, as they are major drivers of the world economy.

Summary: Framework for understanding deflation

Important note for investors

Whether or not the economy enters deflation, investors should remember:

1. Choose companies that outperform the market based on actual results—companies that profit when the market declines
2. Plan finances well—diversify investments, reduce risks, hold appropriate cash proportions
3. Continuously study the market—economic indicators, key news—to make informed investment decisions
4. Avoid impulsive trading during uncertain times—think carefully and deliberately

The power of money, balance, and smart investing are keys to surviving deflation and achieving financial growth