How to Beat Inflation or Deflation

Typical Concerns in a Deflation Scenario

One the biggest problems in a declining price environment is the inability to pay off debts. In part this is due to a perfect storm of mis-fortune plaguing debtors. Many times this scenario plays out first with price declines of major assets (such as we’re seeing in the real estate market now). This has the impact of making it impossible for debtors to pay off debts by liquidating or selling the collateral assets for big ticket items.

If this alone weren’t bad enough, the markets for large ticket purchases begin to slow down which increases unemployment (also currently high), stagnating or depressing wages not only in the initial market but other occupations as well. This leads to further reduced demand, even lower prices, and even more collateralized assets end up under water. Eventually this does calm down as the frothy market conditions which led to this unstable market get foreclosed or liquidated and only assets with reasonable valuations and sustainable mortgages.

Optimal Solutions for Deflationary Threats

When in the midst of a deflationary scenario – it is often times too late to respond in terms of regaining equilibrium of assets and the debts levied on them. The best thing to do when threatened by this kind of economy is to generate as much cash as you can early. Possible options can include:

• selling assets early if you can and downsize – particularly if the debt to value is high, or (as in many cases we’re seeing today) default and walk away from the collateral if there is no way to get out from under it. The mere thought of foreclosure or bankruptcy is dreadful, but there are times when there is no other solution.

• Reducing expenses – this can be a bit painful for some but with a little retraining new habits can be formed to substitute less expensive options for premium goods
• Refinancing assets that have good equity – Deflation usually brings low interest rates and the opportunity to refinance can really reduce monthly payments
• Earning more money – this can take the form of finding a new job, a second job, making money at home from an online business, holding a yard sale, or moving investments around to produce more current income

Typical Threats in an Inflationary Scenario

Inflation is a different kind of problem, but some of the solutions are the same. Typically the debtor does well in a period of inflation, as the dollars used to pay off debts are worth less than the ones initially borrowed. Prices are generally increasing, making it relatively easy for people holding high debts on their assets to either pay them off or sell them and retain the equity invested in them. The inflationary scenario is far less problematic for virtually everyone concerned because the effects of growth don’t amplify as quickly as the negative impacts of deflationary economies.

Solutions Typically Desired in Inflationary Economies

Usually what people want to do during modest to high inflation is to earn more money and convert it into interest bearing short term investments like TBills and savings accounts. The returns on high yield online savings accounts typically will keep ahead of high inflation. Other opportunities to make gains in inflationary environments might include:

• Don’t hold on to cash – Keep liquid assets in interest bearing accounts, preferably FDIC insured and high yield savings accounts
• Manage your balance sheet – use credit wisely to increase the size of your assets but keep it modest so as to avoid getting in over your head. Take advantage of low-interest rate, unsecured credit offers when you can (if available) but only to the extent you know you can pay them off quickly
• Earn more money – start an online business, take a second job, find a better job (much more likely in an inflationary economy)

Common Solutions: How to Beat Inflation or Deflation

So what are the common solutions to figure out how to beat inflation or deflation? I think the takeaway we can get from the analysis above is that in either scenario we want to monitor our balance sheet position very carefully. We want to be earning more money in either recession or expansion – whatever way we can. We also want to be converting unnecessary or over-valued assets into cash and then deciding what to do with that cash based on whether prices are rising (keep in high yield online savings account) or falling (pay down collateralized debt).

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