The Dangers of Deflation

Deflation is the phenomenon in which the general price level of goods and services falls persistently. It is the exact opposite of inflation.

When goods get cheaper as you shop, it may seem like a welcome thing, but the "overall price level of the economy" continually falling is a different story. An individual good getting cheaper and wages, home prices, and corporate revenues all falling together are entirely different problems.

The greatest danger of deflation lies in "waiting becoming advantageous."

If people expect prices to keep falling, they postpone consumption. The mindset spreads: "don't buy now, wait until it gets cheaper." Then demand falls, corporate revenues and profits shrink, wages are cut, or jobs are lost. When incomes fall, consumption contracts further, and prices fall again.

This chain — falling prices → declining consumption → declining profits and wages → falling prices again — is called the "deflationary spiral." Once you fall into it, it is very hard to climb out.

The "debt deflation" pointed out by economist Irving Fisher is the most destructive aspect of deflation.

The mechanism is this. When prices fall, the real value of money conversely rises. Yet the amount of debt stays the same. As a result, the "real weight of the debt you must repay" grows heavier on its own.

Then households and firms cling to repaying debt and saving rather than investing or consuming anew. This is called a "balance-sheet recession." When everyone tries to repay debt at the same time, total spending across the economy shrinks, growth halts, and the vicious cycle of falling prices intensifies.

The representative case of deflation is Japan.

After the real estate and stock asset bubble burst in the late 1980s, Japan fell into a financial crisis, a shortage of demand, and long-term price stagnation. The economy lost its vitality to the point that the average growth rate over 1993–2003 was only about 1%, and what was first called the "Lost Decade" stretched to 20, then 30 years.

The stock market is especially symbolic. The Nikkei 225 index hit a peak of 38,915.87 on December 29, 1989, and it did not surpass that peak again until February 22, 2024 — a recovery that took about 34 years. This is a case showing that the common belief that "long-term investing eventually recovers" can, for a particular country and era, take decades.