What is deflation and how to invest during an economic recession

Basic Understanding of Deflation

Deflation is an economic situation opposite to inflation. The value of money increases while the prices of goods and services decrease. This differs from inflation, where rising prices cause the currency to lose value. When deflation occurs, consumers have greater purchasing power, allowing them to buy more goods and services with the same amount of money.

The significance of the term deflation means is that the overall price level does not necessarily mean all prices will fall because some goods may increase in price, but the general average will decline. This is a crucial point that investors must understand clearly.

What Causes Deflation

Supply-side factors

When the supply of goods and services increases rapidly in a short period, demand for sales may be high but with few buyers. Alternatively, technological advancements can significantly reduce production costs, enabling producers to lower prices. While this may seem like good news, it often leads to various problems.

Demand-side factors

Demand for goods and services decreases sharply, possibly due to increased debt burdens on consumers, reduced household net income, rising unemployment rates, or financial institutions tightening credit. All these factors result in less money being spent by people.

Is Thailand Facing Deflation?

Looking back at the COVID-19 pandemic, Thailand’s economy was significantly affected. In April 2020, the Consumer Price Index (CPI) contracted by 2.99% year-on-year, the sharpest decline in over 10 years and a half. Crude oil prices continued to fall and remained low. Economic activity restrictions reduced demand for goods and services both domestically and abroad.

However, considering the conditions for entering a deflationary state, Thailand has not fully entered such a phase. It does not meet the complete definition, as the CPI is projected to return to 0.9% in 2021, with 70% of goods and services remaining stable or increasing in price.

Impact of Deflation on the Economy and Daily Life

Negative aspects of deflation

Rising unemployment rate - Falling prices reduce profits for producers, leading them to cut costs by laying off workers, which increases unemployment.

Deflationary spiral ( - Consumers expect prices to fall further, so they delay purchases and hoard cash. Producers see demand decline and lower prices again, leading to more layoffs. Unemployed people buy less, creating a difficult-to-break cycle of contraction.

Effects on individuals - Creditors benefit because the money they receive back has higher value, while debtors face increased burdens as their debts grow in real terms. Those with fixed incomes, such as salaried employees, benefit because their income remains stable while prices fall. Conversely, entrepreneurs and shareholders suffer losses.

Effects on businesses - Entrepreneurs must lower prices and reduce production; some may be forced to shut down, negatively impacting the overall economy.

) Advantages of deflation

Cash gains value - People holding cash can store it for future opportunities and will have increasing purchasing power.

Prices genuinely decrease - Entrepreneurs are motivated to offer promotions, allowing consumers to buy goods at lower prices. Gold also tends to appreciate during deflation, serving as a good hedge and store of value.

Historical Examples of Deflation

The Great Depression in the United States

One of the worst economic situations in history occurred when the US stock market contracted sharply starting in 1929. The event known as “Black Tuesday” led to:

• GDP shrinking by over 15%
• Unemployment soaring to 23% in the US and up to 33% in some countries
• Agricultural output dropping below 60%
• International trade falling more than 50%
• The effects lasting into World War II

Investment Strategies During Deflation

Holding Cash

In a deflationary environment, holding cash is considered a good investment because its value increases over time. It is suitable for those waiting for the right moment to invest in the future.

Bonds ###Bonds(

The Bank of Thailand often lowers interest rates during deflation, increasing the value of bonds. Investors should choose highly credible bonds and thoroughly research before making decisions.

) Equities ###Stocks(

Invest in companies essential to daily life, such as food, beverages, or necessary consumer goods. Other strategies include:

• Analyzing financial performance - Stronger stocks may resist downturns better.
• Dollar-cost averaging - Avoid investing all at once to reduce risk.
• Short selling - An advanced technique for profiting from falling prices.

) Gold

Gold prices tend to decline during deflation, providing investors with opportunities to buy at lower prices. Gold has intrinsic value and is an effective diversification tool.

Real Estate

Deflationary conditions force urgent sellers to lower property prices. However, real estate investments are suitable for those with “cold cash” since they require longer time horizons for capital turnover.

Government Measures to Address the Problem

• Lower interest rates to increase liquidity
• Reduce taxes to boost consumer spending
• Lower water and electricity costs to ease living expenses
• Increase liquidity by reducing statutory reserve requirements
• Support investment from both public and private sectors to create jobs
• Implement fiscal deficits to circulate money within the economy
• Promote foreign investment to avoid capital shortages

Summary

Deflation means an economic downturn where prices fall, money gains value, but people reduce spending. This problem arises from imbalances between supply and demand, as well as flawed monetary and fiscal policies.

During a recession, investors should remember:

1. Not all stocks will decline; some strong companies will continue to generate profits.
2. Cash and bonds are relatively safer.
3. It is essential to plan finances systematically and study information thoroughly.
4. Ultimately, deflation is not a distant event; we must monitor economic changes regularly and be prepared at all times.