Inflation, Inflation, Wherefore Art Thou Inflation?

THE BRIEF

Inflation, that obscure term that economists keep tossing around. What does it really mean and how does it affect you?

• In April, the US inflation number stood at 0.3% while Canada came in at -0.2% (deflation).
• Deflationary worries have economists sounding the alarms for deeper concerns to come in the economy.

THE EXPLANATION

What exactly is inflation? In Sam Ewing’s words, “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair”. Simply put, inflation is an increase in the price level of goods and services in the economy.

• High inflation can erode purchasing power… consumers will afford much less with the same dollar tomorrow.
• Too little inflation is a bad signal for the economy… a sign that spending and demand for goods are not high enough.

So what happens when prices begin to drop? This is defined as deflation.

• Deflation will decrease spending… consumers will hold back from making purchases until a future date in anticipation of a drop in prices.

If too much and too little are both bad, how do we satisfy economists? 2% inflation to be exact. Economists magically defined this as the perfect target to balance a growing economy.

So how does this relate to you?

The US and Canadian economy are both currently facing the risk of a deflationary environment, which could send the economies into a vicious downward cycle. Lower prices may seem beneficial but in reality, consumers will push off spending which leads to businesses cutting wages and further lowering prices. Deflation has been known to cause some of the deepest recessions in history (i.e The Great Depression of 1930s and Japan’s Lost Decade).

THE ACTION

Assets that perform better during a deflationary period:

• Gold (investors can invest in gold through gold ETFs).
• Deflation proof sectors include health care, utilities, and agriculture that have strong pricing power (ability to raise or maintain prices without a drop in demand).

PRO TIP: Gold is known to be a safe haven, an investment that is expected to retain or increase in value during a market crisis.