The Big D


If the collapse in the price of houses from Florida to California should have taught us anything, it was deflation. It’s back. You should learn about this beast. It bites.


I’ve argued on this pathetic blog for more than a year that deflation’s what you need to worry about, prepare for and defend against. It’s worse than inflation. The latter we know how to deal with. The former’s a mystery. As far as economists can tell, there is no cure. Only attempts at prevention.

I was reminded of this in the last few days when the chief economist for the BC Real Estate Association broke down and admitted prices will be lower next year. That must have broken poor Cameron Muir’s heart, since it makes a lie of four years’ worth of media releases. At the same time, beware-deflation stories have started creeping into the mainstream media as central banks and governments everywhere jack down their growth forecasts, and commodity prices retreat.

Here’s the meat: Deflation is when prices fall, and continue to do so mostly because people expect them to. So, it’s inflation in reverse. Rather than buy a house quickly because you believe you’ll never be able to afford it later, deflation means you wait to buy since you’re sure it will soon be cheaper. If enough people agree, it’s a self-fulfilling prophesy. Sellers cannot sell unless they price below your expectation, which drags prices down more.

So deflation makes money more valuable. It buys more. In the US housing fell by 32% between 2006 and now. This asset deflation made money 32% more valuable. And along the way it cost about eight million jobs and destroyed the middle class.

As I’ve argued, you can have destructive asset deflation at the same time as price inflation. In fact, we have it now. Grocery bills keep rising in Victoria, for example, where the price of housing is falling. This pattern can last for some time, until deflation goes viral, starts costing jobs and profits, and everything trends lower. Hope that never happens. It’s called the Dirty Thirties.

While that extreme is unlikely, we don’t need a rerun of the 1930s to see what ‘moderate’ deflation can do to family finances. As I said, it’s already in front of us in the States, where 20% of all families owe more on their mortgages than their houses are worth and millions more have walked away from real estate they could no longer carry. About $5 trillion in wealth was destroyed when housing deflated – not bank money, but equity.

You see, when asset values fall and money gets more valuable, debts become harder to repay. Across Canada workers have been asked to take pay cuts in order to save jobs. The average wage gain is less than the price increase for food, which means people actually earn less. That’s deflationary. Now add in a decline in home equity as real estate values fade, and you can see where this might lead.

Central bankers know all this. It’s why emergency interest rates are still in effect four years after the financial crisis. It’s why the US Fed is spending $40,000,000,000 a month purchasing government securities, why the European Central Bank is on a bond-buying binge and why the American election is about tax cuts. If governments cannot stop deflationary pressures, they’re in serious trouble. So are most people reading this.

The telltale signs are structural unemployment, companies that take profits from productivity, not increased sales, sky-high bond prices, savings accounts that pay zip, government cuts, lower growth forecasts and, of course, falling real estate sales and prices. So, judge for yourself.

If it gets worse, the winners and losers are well-known.

Deflation destroys borrowers and rewards lenders. Mortgages can (as happened in the US) be worth more than the houses they financed, and homeowners forced to pay them back with reduced wages. Equity is erased. Now I hope you can see why I’ve spent so much time warning against 5% down payments, or encouraging those whose real estate soared to harvest those gains.

In deflationary times people who own bonds win. They mature and pay you 100 cents on the dollar, while preserving money which only grows more valuable. So, who needs to earn interest when the bond itself swells in purchasing power? See why trillions of dollars have surged into government paper that yields no return?

In deflationary times, real estate is usually crushed. Credit and liquidity dry up as the economy slows and consumer confidence fades along with jobs. The same with assets like gold and silver. Commodity values stagger as paper currency rises in potency. This is a reason why I have warned against over-exposure in both housing and PMs for a long time, since the future clearly belongs to those heavy in things that rise with cash.


Of course, this ain’t the Depression. It’s not even the USA circa 2009. Nor does it need to be.

Canadians are some of the most indebted people in the world, living in some of the most expensive houses with some of smallest savings on record. If there ever was a place where falling prices might suck, you’re in it.

avatarGarth Turner - The Greater Fool posted Monday, October 29th, 2012.

1 Comment for “The Big D”

  1. “Rather than buy a house quickly because you believe you’ll never be able to afford it later, deflation means you wait to buy since you’re sure it will soon be cheaper. If enough people agree, it’s a self-fulfilling prophesy.”

    No, it’s just a market. There’s nothing unusual about that behavior. It happens in every market that’s gotten way ahead of itself. A market goes “bull” or “bear” (terms which describe interaction of market forces) but not “inflationary” or “deflationary” (terms which describe interaction of monetary forces).

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