Deflation - Worse Than Inflation For Your Business

Deflation -far more dangerous than inflation - is becoming a very real danger to your business. Central Banks traditionally believe that printing money cures deflation by increasing inflation - an over-application of Keynesian economics. But does history support this view?

The Japanese experience suggests that the "printing money" approach does not work - neither do zero interest rates cure the problem. The cost of deflation to the Japanese economy was a decade of stunted activity and more than 16 percent of the value of GDP. There is hope that different actions can be used to good effect for, when Sweden faced the same problem their prompt and effective action reduced the cost to three percent of GDP and shortened the length to three years. Even that three percent is expensive; so you have to face the question about how you and your company can tackle the perils of deflation when everyone else has cut prices and haemorrhages money?"?"

Business needs to grow - most of the time. When that need disappeared twice in the past century we faced the two deepest, longest slumps in recent history.

In recent years Governments, Central Banks and committees of economists have concentrated almost exclusively on manipulating interest rates in order to balance the perceived priority of controlling inflation. The Bank of England has to all intents and purposes done little other than attempt to minimise inflation until the "credit crunch", and the danger of a collapse of the banking sector, became the priority.

Currently a new economic situation is being fought using the same old tools. It may become obvious that those old tools, being applied to the current unusual circumstances, have the utility of a rubber adjustable spanner.

And then...

Governments and Central Banks gamble that falling demand will lead to falling prices and have cut interest rates to kick start economic activity through a return to inter-bank lending. So far the output is, to say the least, discouraging - and the outlook is not good either.

Many banks continue to distrust each other as they suspect that others have been as underhand or foolish as they have and may not be able to repay loans any more than they can. Many have taken government money to add liquidity to their balance sheets and reduce the hidden debts that sooner or later they will need to confess. Some have even taken the opportunity to continue to pay massive and undeserved bonuses to those that have destroyed stockholder value.

At least one major insurance company has taken government money and splurged it on a jamboree for executives and salespeople leaving a bemused North American administration asking how it is that an injection of capital that the recipient claimed that they did not need has been spent, and now the begging bowls are evidence again.

Truly the lunatics, remarkably "street wise" lunatics, continue to take control of the asylum.

Is there a solution?

So far every attempt at a solution to the relatively simple problem has been met with little success. The danger is that now the problem will become ever more complex and the chances of finding a solution will be greater. We have seen two long and deep depressions since the 1930's. The cause is known - sadly the global solution may not be.

During the Great Depression of the 1920's and 1930's some 26% of workers were without work. In theory this might have meant that better than 70% were doing fine. Prices were falling so that in effect enhanced buying power would appear to be the equivalent of a regular and considerable rise in disposable income. So why did it not work like that?

Far from the norm

As prices fell and deflation gripped the markets the loss of business was far greater than the four to six percent that would be expected to be the norm. Goods were stockpiled, plants were closed. More employees were on short time or without work. Demand continued to fall and with it investment. Those few that had cash were convinced that cash was to be preferred to falling stocks leading to runs on the banks. By this time there was a credit crunch that was not engineered by the banks, but that resulted from the simple fact that nobody was considering investment, innovation or growth.

Eventually a combination of the "New Deal", the post war re-application of Keynesian economics after Bretton Woods and the destruction of infrastructure during World War II dragged the world free of the pernicious effects of deflation. Slowly, very slowly, recovery was brought about - but not until after a decade of misery.

Again

Throughout the 1980's the Japanese economy was the envy of the world. Driven by factors including innovation, Total Quality Management, kaizen and the early days of lean process management growth had been consistent and massive, but it all began to go wrong in the early 1990's. The banking and political systems left a great deal to be desired and while productivity soared, market growth failed to keep pace. The cost of capital for investment from the central bank was zero - but the key issues had been missed. Massive stock holdings meant that even interest free investment capital served no purpose. The result was a decade of decline for the world's second biggest economy - a period of decline from which they have only recently emerged.

The solution

Too much cash pursuing to few goods leads to inflation. Cash that is being hoarded leads to far more dangerous deflation. Inflation is relatively easy to manage. Central Banks have become increasingly adept at using the interest rate sledge hammer to crack the inflationary nut. My suspicion is that they understand deflation far less and to make matters worse they have created an environment in which they - like customers - are seeking to maximise and hold onto their cash holdings regardless of whose cash they are holding.

Governments may yet prove to understand the problem and may deliver a solution. Until they do, simple businesspeople such as you and I need to keep those suppliers and customers that we depend upon in worthwhile business. We cannot mend the whole economy, but we must do what we can look after our own back yard so as to survive through to better times. Fortunately we have the means.

We can survive, and even prosper, if we do our truly valued customers a huge favour by engaging ourselves, and all our colleagues, fully with them so they become advocates for our business. Through such actions you will earn enough to pull through and continue to supply your valuable customers with the products and services they still need. In all economic situations there continue to be profits to be made. In every sector some firms do better than others; yours must be amongst the best performers. By maintaining honest demand for your goods and services you can avoid being dragged into the deadly downward spiral of deflation, but in an increasingly competitive marketplace you must do it all at the lowest possible cost. You need a strategy of customer satisfaction leading to full Customer Engagement and you need it in place -at an acceptable cost - before it is too late.