Markets & Economy
What Joe Davis wants you to know about deflation
July 09, 2014
Rebecca Katz: Well, our next question is from Wayne, and Wayne says—and I was going to bring this up myself, "You've mentioned a couple time a concern over deflation. Could you just expand upon that concern?" So, we've talked about it a few times because it really is kind of scary. What does that look like and why does it worry you so much?
Joe Davis: It's something we worried about—oh goodness, Rebecca—for four or five years.
Rebecca Katz: The Fed was worrying about it too and this is why they took the actions they did.
Joe Davis: The Fed was worrying about it too and even earlier this year, I was doing some client events for Vanguard in Australia and mentioned that I still believe that globally, deflation risk at the margin was greater than inflation risk which I think took some aback. And why I say that is deflation can be serious when you have an economy that has high debt levels. So, by deflation, what economists should do a good job of saying is that it's not just falling, in say, consumer prices, food prices, energy prices. Where it can be a concern is when wages are falling and one has fixed liabilities.
So, if you have mortgage, and you have a fixed mortgage payment, and your wages are cut 10%, it's a higher cost to fund that. And so you put that on the size of the economy, that's where it becomes a concern because these liabilities are fixed, and the income you're getting from your assets, meaning your wages, are declining. So, that's where it can be a vicious cycle.
The ECB and others are trying to short-circuit it. The Federal Reserve, in my mind, their greatest success through the financial crisis was ensuring that Americans, by and large, and the bond market in particular, did not believe that wages were going to continue to fall because that is precisely what happened in the 1990s and 2000s in Japan. And even more recently, the Bank of Japan has become more aggressive. So, the for the first time in 15 years Japanese investors and Japanese citizens believe that wages may go up in the future, not go down, because that has very different implications for consumer spending.
Rebecca Katz: Yeah, because the issue is if you think the prices of things are going to go down, why go out and buy them?
Joe Davis: Yeah, why would you and I buy it—?
Rebecca Katz: And then it just makes it worse.
Joe Davis: —if you're going to get a cheaper price. So what happened in the housing market in the United States in 2008, 2009, buyers receded from the market thinking, "Well, prices will fall. If I'm even going to buy at all, I'll buy it next year." That's the vicious cycle that you try to short-circuit, and so that's why the central banks—the one thing that they can, in my opinion, have the most influence on is things such as inflationary expectations and to break that link. They have done it in the U.S. for several years. They've slowly done it, more importantly, in Japan, and I think the ECB may have some more work to do to have a similar dynamic in Europe.
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This webcast is for educational purposes only. We recommend that you consult a financial or tax advisor about your individual situation.
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Declining wages and fixed debt can be a difficult combination
Investors and economists alike are always concerned about inflation, but what about the prospects for deflation? Vanguard chief economist Joe Davis explains the concept of deflation and how it could be harmful to the economy and the workforce.
Other highlights from this webcast:
- All investing is subject to risk, including the possible loss of the money you invest.
- For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
- Investments in stocks issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.
- This webcast is for educational purposes only. We recommend that you consult a financial or tax advisor about your individual situation.