The Private Equity for Families Blog

Double Whammy of Deflation

Central banks consider deflation a “devil child” because of its pernicious psychology. Deflation encourages waiting for purchases until they get cheaper—which they do every day as demand is delayed. The result is a downward price spiral and slow GDP growth.

Even though this sounds good for the consumer, it is bad for countries and people with debts because the fixed principal amount becomes more expensive as prices sink. There is also persistent joblessness.

Because this devil child is unmanageable, central banks want an inflationary environment where debtors, including countries, are repaying fixed principal amounts with money that is less valuable every day. As a result, central banks will even create inflation simply because, unlike deflation, they can manage it.

Moving From Scarcity to Abundance

Jeff Booth, author of The Price of Tomorrow, has an interesting assessment of the battle being waged between an existing world economic order ruled by scarcity and a coming world order ruled by abundance. His thesis is explained in his book as follows:

              “Our economic systems were not built for a world driven by technology where prices keep falling. They were built for a pre-technology era when labour and capital were inextricably linked, an era that counted on growth and inflation, an era where we made money from scarcity and inefficiency”

Mr. Booth sees digital technology based on computer chips getting half again cheaper every 24 months (Moore’s Law) for at least the next several doublings. Similar exponential technologies are happening in solar power, battery technology, robotics and machine learning.

Here is an inflation scorecard for the last five years, a period of full employment and prosperity in the US, based on the reported CPI from the Bureau of Labor Statistics. It shows a timid inflation tiger and confirms the Fed is losing the inflation battle:

March 31, 2016April 30, 20205 Year Inflation Rate

Central Bank Playbook Is Predicated on Scarcity

Meanwhile world central banks are printing trillions trying to save debt-ridden economies with massive unemployment profiles. Without jobs, worldwide growth will be impossible. Mr. Booth wrote his book before Covid-19, but even without a pandemic he fears job-destroying technologies alone will upend the old paradigm. He sees the central banks’ playbook as impossibly flawed and inefficient: (quote is partially paraphrased).

              “Since 2000, the world economy has grown from US$33.5 trillion to about US$80 trillion, but to achieve that growth, the total debt has grown from US$ 62 trillion to over US$247 trillion as of the third quarter of 2018, according to the Institute of International Finance. In other words, it has taken approximately $185 trillion of global debt to achieve $46 trillion of global growth”

Deflationary Technologies Are Everywhere

It is hard to argue with the emergence of cheap technology. The deflation culprits are everywhere. Many have monopoly or oligopoly power and they seem to be converging right now:

  • Google Search, Google Maps, Google Earth
  • Amazon, Amazon, Amazon
  • Smartphones based on IOS and Android
  • Tesla with only 20 moving parts
  • Facebook—free community for the social you
  • Linked In—free community for the business you
  • Airbnb—the biggest landlord with no properties
  • Shopify—online platform for sellers
  • 5G—always on high-speed connectivity
  • Self-driving cars—a data advantage for incumbents
  • Solar power—no extraction costs
  • Virtual and augmented reality
  • Additive manufacturing—cheap knock offs
  • Artificial intelligence and machine learning

Unlike traditional scarcity monopolies, which harm consumers by raising prices or constraining markets, these new deflationary monopolies are quite popular because they drive prices lower and service higher. Breaking them up won’t be a popular choice.

Post-Pandemic Reemployment Will Be Tough        

Who thinks anything post-pandemic except taxes, cable TV, health insurance, Clorox wipes and hand sanitizers will be more expensive next month, next year, in two years, in five years? Autos? Rent? Travel? Lodging? Dining? Energy? Insurance?

The only place you have sure inflation is the stock market. Despite Fed intent, the printed money always seems to end up there.

Fed May Be Fighting Deflation on Two Fronts

Given the rapid shutdown of the American economy and the resulting loss of more than 30 million jobs, the Fed now may have a fight on two fronts. It must slay the deflationary dragon of digital technologies and simultaneously counteract the loss of demand for goods and services from Corona Virus. A pandemic could not have happened at a worse time.

Take the example of lodging. Airbnb became the largest property rental name in the world by harnessing unused capacity in people’s rooms, homes and apartments. Without any investment in bricks and mortar Airbnb started technology deflation in rental, vacation and lodging properties by dramatically increasing supply.

Double Deflation Whammy

A sudden drop in demand because of 30 million lost jobs and you have a double whammy: almost endless cheap marginal worldwide capacity from digital platforms like Airbnb and an almost empty installed base of traditional lodging dedicated to travel. This has to be deflationary for hospitality and many other traditional industries.

The same is true for the cab business (Uber and Lyft), the internal combustion auto industry (Waymo and Tesla), the retail industry (Amazon), the entertainment industry (virtual reality, e-sports, e-gambling and Netflix), the news and media business ( Google, Facebook, Twitter). Even if technology is not free, the platforms with a “network effect” are doubling capacity at alarming speed. They will be cheaper tomorrow.

This brings us back to the deflation devil child. As Jeff Booth points out in his book “cheaper next year” should be good for every consumer. Whose life will not become more productive because of free Google Maps, free Google Search, free Google Earth and an Apple phone? Unfortunately, Mr. Booth has an apocalyptic view of war, civil unrest and isolationism as a possible by-product, much like 1933. No summer jobs for youth and slow reemployment in 2020 and 2021 combined with an election year and a distrustful and polarized electorate could make Mr. Booth’s predictions come true. Let’s hope he is wrong!!!


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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records Founder and chairman of CapitalWorks, he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CapitalWorks or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.

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