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21 Jun 2024 9:33
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  •   Home > News > Business > Features

    Inflation versus Deflation, Which is Worse?

    Unlike most commentators, I am convinced the economic outlook is inflationary (rising prices) rather than deflationary (falling prices) and interest rates are likely to rise rather than fall.

    Investment Research Group
    Investment Research Group
    While I still believe this, I have revised my timing as I think inflation will kick in only in 2010, and deflationary pressures and low interest rates may last longer than anticipated. Deflation is the worse of the two.

    Deflation (in the sense of there being less money circulating in an economy rather than prices merely going down) occurred during the great depression of the 1930s partly because wages were reduced.

    Lower wages means lower spending power and less economic activity. Less activity leads to more job losses or pay cuts. This sort of deflationary spiral is hugely damaging and very hard to reverse (hence the current enthusiasm of central bankers everywhere to print money massively).

    I was convinced it would be much harder for companies to cut wages these days. Apart from the increased mobility of people, both in terms of career changes and geographically, most of us have only lived through inflationary times when regular pay rises were normal.

    Getting people to accept a cut would be nigh on impossible, I thought. However, recently I was told by a friend about a company in NZ that has just cut all staff wages - from the CEO down - by 20%. How this was achieved is not clear but I assume workers are fearful of losing their jobs and unsure if they will get a new one.

    Presumably they believe 80% of something is better than 100% of nothing. The same thing seems to be happening at senior executive levels with CEOs of companies, particularly in the USA, taking pay cuts. This may be symbolic given the distressed position of many of these businesses but it may also set a precedent that will result in pay cuts for everyone else.

    Amazingly, a recent NBC-Wall Street Journal poll that found that two-thirds of workers would accept a pay cut if it meant keeping their jobs. In the UK, a BBC poll of companies found 43% intend to freeze wages in 2009 and 9% will be implementing pay cuts.

    In this country, Fisher & Paykel chief executive Jon Bongard, while announcing this week that the company is in financial difficulties and is seeking an equity partner, also revealed his pay is to be cut by 7.5% this year to just over $1 million.

    Also, all senior executives in the company are likely to experience a 5% cut in their pay and the rest of the staff will also be asked to take one day off a month to help to avoid redundancies (an equivalent pay cut of 5%).

    We can only assume this sort of thing is going to continue and I am getting nervous that we will have a long, hard, depressing winter ahead of us (economic downturns affect emotions as well as the back pocket).

    If the economy turns down or stays down longer than expected, interest rates are almost certain to do the same as the Reserve Bank tries to relieve the pain.
    One exception could be corporate bonds. There are a lot of issues out there and more to come. If supply starts to exceed demand then interest rates will have to rise to attract investments. However, even in a recession and when interest rates are minuscule, investors should never forget there is a relationship between risk and return.

    © 2024 David McEwen, NZCity

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