1. The concept of deflation

Deflation refers to the phenomenon in which the overall price level continues to decline over a long period of time and the purchasing power of money increases.
Unlike the decline in the price of a single commodity, deflation reflects a systematic, comprehensive and long-term trend of falling prices .

Deflation is often accompanied by:

• Insufficient effective demand;

• Investment and consumption declined;

• rising unemployment rates;

• The debt burden has increased.

👉 Metrics:

• The CPI (Consumer Price Index) has been negative for a long time;

• The PPI (Producer Price Index) continues to fall;

• The GDP deflator fell.

2. The Main Causes of Deflation

1. Demand-deficit austerity

• A decline in aggregate demand (shrinking consumption, insufficient investment) leads to falling prices.

• Usually accompanied by an economic recession.

2. Excess supply tightening

• There is excess production capacity and the supply of goods far exceeds demand.

• Common in economies following rapid expansion of industrialization.

3. Monetary tightening and insufficient liquidity

• The central bank shrinks the money supply or credit shrinks, leading to deflation.

4. Debt Deflation

• Proposed by economist Irving Fisher.

• Increased debt repayments → reduced aggregate demand → falling prices → increased real debt burden → further economic decline.

5. External shocks

• The global financial crisis, epidemic or collapse of international commodity prices have led to a sharp drop in demand.

III. The Economic and Social Harm of Deflation

1. Consumption and investment are delayed
   Continued price declines have led residents and businesses to postpone consumption and investment.

2. Unemployment rate rises
   Corporate sales fall → layoffs → reduced income → further decline in demand.

3. The debt burden increases
   When real interest rates rise (when nominal interest rates are close to zero), the pressure on debtors doubles.

4. Declining corporate profitability
   Falling prices squeeze profit margins and may even trigger a wave of bankruptcies.

5. Financial system risk
   The increase in bank non-performing loans may trigger systemic risks.

IV. Comparison between Deflation and Inflation

5. Classic Historical Cases

1. The Great Depression in the United States (1929–1933)

• The stock market crashed, demand plummeted, and prices fell by about 25%.

• The US economy is in a serious deflation and unemployment crisis.

2. Japan's "Lost Thirty Years" (1990s–present)

• The real estate and stock market bubbles burst, and long-term low growth and deflation coexist.

• The Bank of Japan has maintained zero or even negative interest rates for a long time, but it is still difficult to escape the shadow of deflation.

3. After the Eurozone debt crisis (2010s)

• Countries such as Greece and Spain have experienced temporary deflation due to shrinking demand caused by fiscal austerity.

4. China experiences partial deflation

• From 1998 to 2002, industrial product prices continued to fall after the Asian financial crisis.

6. Deflation Control Policies

1. Monetary Policy

• Lower interest rates (to zero or even negative interest rates);

• quantitative easing (QE);

• Increase money supply and increase liquidity.

2. Fiscal policy

• Increase government spending (infrastructure investment, social security);

• Tax cuts stimulate consumption and investment.

3. Structural reforms

• Enhance industry competitiveness;

• Solve the problem of overcapacity.

4. Expectation Management

• Guide businesses and consumers to restore confidence through policy signals.

👉 Reference:

• IMF – Deflation Risks

• Bank of Japan – Deflation Experience

7. The impact of deflation on the investment market

1. stock market

• Corporate profits declined, putting pressure on the stock market.

• Only some consumer staples sectors performed relatively steadily.

2. bond market

• As real interest rates rise, bonds become more attractive.

• Long-term government bonds generally benefit.

3. real estate market

• House prices fell and investment demand shrank.

4. Gold and cash

• Gold has limited potential; cash and government bonds are more valuable as their purchasing power increases.

8. Future Risks of Deflation

1. Global low interest rate environment - some developed economies face long-term deflation risks.

2. Technological progress and digitalization – reducing costs – could keep prices down in the long term.

3. An aging population and declining consumer demand have led to a long-term weak economy.

4. Debt risk - high debt combined with deflation may form a vicious cycle.

IX. Investor Education and Practical Suggestions

1. Maintain cash and liquidity – cash appreciates in deflation.

2. Allocate high-quality bonds - long-term government bonds are a safe hedging tool.

3. Reduce highly leveraged investment - debt pressure increases during deflation.

4. Focus on anti-cyclical sectors - consumer staples, utilities.

5. Global asset allocation – avoid concentration in countries with high deflation risk.

10. Summary

Deflation is often more destructive than inflation. It not only leads to falling prices but can also trigger long-term economic stagnation, debt crises, and social problems. Historical experience shows that combating deflation requires a combination of proactive fiscal policy and loose monetary policy, while also guiding market confidence to recover. For investors, understanding the mechanisms of deflation, rationally allocating assets, and reducing leverage are key strategies.

📌 FAQ

Q1: What is deflation?
A1: Deflation is a phenomenon in which the overall price level continues to fall and the purchasing power of money increases. It is usually accompanied by insufficient demand and economic recession.

Q2: What are the dangers of deflation?
A2: These include delayed consumption and investment, rising unemployment, increased debt burden, declining corporate profits and financial system risks.

Q3: How do investors deal with deflation?
A3: Investors should maintain their allocation of cash and government bonds, reduce highly leveraged investments, and focus on anti-cyclical industries such as consumer staples.