Deflation is the opposite of inflation. In deflation, particularly in a credit-based economy, which is what we have, there’s eventually a loss of confidence in the bubble that’s been created, and a slowdown in lending (which has been an ongoing problem since 2007). This leads to less money in circulation and people start spending less and hoarding money (Europeans are somewhat ahead of the North American continent right now in this regard). The reduction in consumer spending leads to job losses, eventually company failures, even lower prices, and we end up in a deflationary spiral that feeds on itself.
Above is the M2 chart of the velocity of money. It comes from the Federal Reserve in the United States (FRED). This is a measure of the levels of currency available in society at a given time (it actually measures how many financial transactions are taking place — higher levels are inflationary, lower levels are deflationary). You can see how the velocity of money has declined since about 1998. Incidentally, that was the warmest year on record, the implications of which I explain in the post: “Don’t Like the Climate? Wait a Cycle.” A reduction in the velocity of money marks the onset of deflation.
Lower prices for goods and services are great for consumers who have cash. But if you have lots of debt, that’s a problem. Because the real value of debt increases —because less money in the economy increases the value of money. In a deflationary environment, you’re paying back active loans with money that is more difficult to obtain (and is actually worth more) than when you took out the loan.
The deflationary cycle in a depression picks up steam until we have a deflationary spiral that historically has reduced prices for hard assets like real estate by up to 80% (and more).
Key Strategies for Businesses
In a deflationary business environment, traditional methods of doing business take a dramatic turn. What you’ve been taught (and the typical reaction to a downturn) will not serve you well and, in fact, could speed the demise of your business. Here are some key areas that will need your attention (and in most cases, will require dramatic action).
Focus on your core offering (this is ‘marketing 101’). It’s the reason you started your business in the first place. That’s the thing you do better than anyone else. If you’ve historically focussed on that competitive advantage, it’s reflected in your brand.
Many consultants today are suggesting innovation and diversification as a remedy for flagging sales. Diversification is absolutely the wrong way to go. It weakens your brand and leaves you competing with everyone else. It usually costs more money to implement and support (usually adding negligible value). Innovation costs money and if it’s not based on solid customer data that strongly suggests it will add to the bottom line, it probably isn’t the solution.
Undertake an audience analysis to try to determine who and where your audience is. It’s really important to understand their level of disposable income and needs going forward. Values are changing dramatically at the moment, and will continue to move towards lower prices for increased value. Customer service is also going to rise in importance over the near future (as opposed to having to deal with robots).
Assess your products and services in terms of wants and needs of your audience. With the highest household debt in history across many western nations, consumers are trapped — they will gradually stop buying what they want, opting for what they need instead. If you’re selling luxury items, your sales are going to get hit hard this coming year. Start to align your offering with customer’s needs. Take a good look at your advertising in terms of its positioning.
Get to really know your suppliers and how they’re doing financially, particularly if you have a few key suppliers who would severely damage your ability to serve your customers if they ceased to exist. A lot of business are going to go bankrupt over the next few years, which means you have to explore alternatives and be ready to act quickly. If you don’t already, start thinking of your major suppliers in terms of business “partners.”
Credit is starting to dry up internationally. When credit contracts, banks start to pull in loans. Make sure you know the financial health of your money supplier. It’s a good time to look for alternate sources of cash and to concentrate on staying liquid. In a deflationary environment, debt can become a noose around your neck very quickly, because in increases in relative value.
Get to know your bank manager and your bank. Know its financial health (banks are generally way under-capitalized). When the SHTF, relationships matter. If possible, work on finding alternative sources of capital. The future is going to be all about increasing cashflow and lowering costs.
Encourage “money up front.” If you don’t have a policy regarding down-payments for services or products, explore it. Credit issues are going to explode and you need to get policies in place to identify potential issues with getting paid as early in the process as you can. Cash flow is going to be more critical than ever.
Reduce unnecessary costs. This goes without saying. Prices for your goods and services are going to be under extreme pressure over the next several years. You will need to be vigilant as to how your costs relate to ongoing income, which will decline. Margins are most likely going to get a lot “tighter” than they are now. Make sure you have the latest data on sales and costs and make sure its accessible quickly.
Don’t neglect employee communication. In a deflationary economy, the value of currency increases. This is great for employees, who will now see their wages buy more (as prices for goods and services start to dive). It’s a good idea to communicate this benefit so that they realize that this increase in value easily trumps any raise they might otherwise want to ask for. On the other side of the coin, employees are going to be worried. Worried employees don’t work to capacity.
Avoid long-term lease contracts and reduce your rent, if possible, and your overall “footprint.” Stay away from long-term contracts that lock you in to today’s prices. Prices for virtually everything will drop monthly in a deflationary environment. Landlords are going to have lots of vacancy going forward and will be willing to “deal” like never before.
Employee health and well-being are going to rise dramatically in importance. Disease, both mental and physical, proliferates in a cold and dry environment, which is where we’re going. You can already see the re-emergence of measles, for example and major plagues are starting to raise their ugly heads, like ebola, which has a high potential of restricting travel and closing down borders. Financial pressures can affect performance and safety will become an ongoing problem.
Assets drop drastically in value. During a full-blown depression, assets will drop to twenty percent of their current value (starting as in 2019). Currency increases in value as a result of deflation, in turn lowering asset prices. It’s obviously a good idea to get rid of assets that you are not dependent upon for profit. Consider selling important assets with an agreement to rent them back on an as-needed basis.
If you have active board members, they’re going to have buy in to the changes in the direction of the company. There will need to be very frank discussions as to whether it’s better to sell the business “at the top” or focus on a set of strategies to weather the coming protracted storm.
Staying profitable is going to get tougher than ever before. In terms of executive buy-in, think about setting up a War Room, where you can get the team focussed like a laser on strategies to preserve profit and increase cash. Staying viable with all the potential issues will require a war room approach to business.
Relationships and community are going to be vastly more important than ever before. Partnering will also rise in importance. Know and understand your competitors. There will be opportunities to grow through them down the road. But any business purchase that increases corporate debt is a potential red flag. Debt is your enemy during deflation.
Location is will be critically important. You want to be near abundant food and water with a ready source for your employees. People who are hungry or under stress do not work well, if at all. With the magnitude of the expected decline, transportation will collapse and therefore, resources in your immediate area will become more important.
We’re heading into a era that historically been referred to as ‘the Dark Ages.’ It’s difficult for me to explain clearly the gravity of the meltdown of the financial system that we’re about to experience. Civil wars will rage in countries around the world. Millions will die from pandemics. Transportation systems are already starting break down and will continue to do so. Food production will start to be an issue. Densely populated areas become a liability.
Violence will escalate. Depending on where you live, safety will be a big concern. Debt and hunger are powerful violence motivators.
We’re entering a new world of deflation that nobody alive has experienced. Nobody alive has experience running a business during the 1930s depression, and this one will be much, much larger in size.
It’s critically important to understand the ramifications of a deflationary environment and to have strategies in place that anticipate as much as possible the challenges that are surely going to come your way.
Your understanding and preparation now may very well be the difference in whether your business survives, dies, or flourishes.