Personal Experience of Deflation

As mentioned previously, the transition from inflation to deflation often occurs in an instance. It's the moment of panic when people, acting in herd-like concert, realize that their prior beliefs about a market are no longer valid. This is what happened during the first weeks of October, 2008, when debt markets around the world shut down and stopped trading.

These discontinuous events are only the beginning. Once a panic begins, other markets start the reset process, and attempt to stabilize given the new reality. So while this initial panic was in the debt markets, the implications for the markets that relied on that debt were soon to follow. This lead to collapses in the housing market, the automobile market, and most recently, the commercial real estate market.

Just like these major markets change in an instant, personal recognition of deflation also occurs in discontinuous spurts. One reason this happens, is that there are long term obligations on assets that prevent a fluid reduction in the market price of these assets.

For example, almost 1 out of 4 home owners are currently upside down on their mortgage. That means that they owe more to the bank, than they can likely get from selling their home in the open market. When people like this decide that they wish or need to sell, their first attempt is to sell it for just enough to cover their note. Since they are out of market, their home often just sits on the market with little buyer interest. It's only after one of the following events occur that the home will sell:

  • Seller lowers the price beneath their debt, and takes a loss on the sale.
  • Seller offers the asset for less than they owe, and gets the bank to take a "short sale" on the property.
  • Seller gives the asset back to the bank as a "deed in lieu of foreclosure," then the bank sells it at the market price and takes the loss.
  • The seller defaults on their payment, then the bank takes it back through a foreclosure and sells it at a discount.

These barriers to fluid price reductions in a deflating market are the reason that deflation occurs in spurts, even on a personal level. And it's just not homes, either. Any asset that has long term obligations will have these barriers to fluid price reductions.

In the next posting, we'll look at how this works for the commercial real estate and the small business market. That will lead us into ways you can personally benefit from the changes ahead. As always, comments welcome.

Until next time.

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