What is the phenomenon of deflation, and how should you invest when prices decline?

Deflation is Not a Distant Threat…

Enjoy listening to “deflation” from economic news but still don’t quite understand? This shrinking economy is actually affecting industries and employment, and deflation is not just a number in a mathematical equation but a real economic problem that impacts our lives.

What exactly is Deflation?

Imagine this: today you have 100 baht. During deflation, that 100 baht has greater purchasing power because prices of goods drop across the market.

Deflation is a situation where the prices of goods and services decrease continuously. It is the opposite of inflation. While inflation causes the value of money to decrease, requiring more money to buy the same goods, deflation is the opposite: the money we hold gains purchasing power and we can buy goods at lower prices.

The key point is that falling prices do not mean all goods decrease in price, but rather the overall price level of goods and services, measured by the consumer price index (CPI).

What causes deflation - Main factors

The occurrence of deflation is not accidental. Several causes combined lead the economy into this state:

Demand side - shrinking demand

When people start spending less, under pressure from debt, reduced income, or fear of unemployment, they cut back on consumption. Businesses see fewer customers and begin lowering prices to attract buyers.

Supply side - increasing supply

When production increases but demand does not keep pace, prices may naturally fall. This can result from technological advances that reduce production costs and increase output.

Policy issues

• Excessively high interest rates discourage financial institutions from lending
• High taxes leave less money for public spending
• Money supply is insufficient to meet the economy’s needs

External events

Trade wars, pandemics, asset bubble crashes—all create uncertainty and economic contraction.

Recession and deflation - The mysterious relationship

Why does deflation often accompany a recession? The answer lies in this vicious cycle:

Negative GDP for several quarters → Business contraction → Reduced employment → Unemployment rises and spending decreases → Demand for goods drops → Businesses lower prices → Costs are cut further → More layoffs → and the cycle continues.

This is called the “deflationary spiral” — a hellish cycle of economic decline that is hard to escape once it starts.

Winners vs Losers in Deflation

Those who benefit in this situation:

• Fixed salary earners - Their purchasing power increases; sometimes their wages stay the same while prices fall, effectively giving them a pay raise.
• Lenders - Those who lend money benefit because as money gains value, the amount they get back is worth more.
• Cash holders - Their buying power increases as cash retains or gains value.

Those who suffer:

• Businesses - Must lower prices to sell, profit shrinks, and sometimes they incur losses.
• Shareholders - Debtors and investors require higher returns to compensate for increased risk; if company profits decline, stock prices fall.
• Debtors - Borrowed money during inflation must be repaid with more valuable money, making debt more burdensome even if the nominal amount remains the same.

Example of a Global Crisis - The Great Depression

The “Great Depression” between 1929-1932 is the worst example of deflation the world has ever experienced.

After the US stock market crash (Black Tuesday - September 4, 1929):

• Global GDP fell by over 15%
• US unemployment soared to 23%, some countries up to 33%
• Crop prices dropped over 60%, causing hardship for farmers
• International trade declined by over 50%
• The effects lasted until World War II

This is why governments and central banks are always alert when signs of deflation appear—they do not want another such economic downturn.

Should Thailand be worried? - What signals to watch

Currently, Thailand has not entered a true deflation according to the definition, even though some inflation figures are negative.

Indicators that a country is entering true deflation must show four simultaneous conditions:

1. Continuous decline in prices of goods and services over several months
2. Price drops spread across nearly all categories
3. Inflation expectations fall below the policy target
4. The economy and employment slow down for an extended period

Latest data shows that in Thailand:

• 70% of goods prices are stable or rising; only some are decreasing
• Inflation expectations are at 1.8%, within the target range of 1-3%
• Economic growth is projected to rebound from -8.1% in 2020 to +5.0% in 2021

But this does not mean we should ignore the risks, as they always exist.

Investing during deflation - Seems like a rejection, but actually an opportunity

Most investors avoid investing during deflation because they fear low returns. However, this could be a good opportunity for those lacking confidence in the market.

Bonds - A safe choice

Bonds are your friends in this period because:

• Central banks often cut interest rates, which increases the value of existing bonds
• Receive steady interest payments at low cost

Choosing highly credible bonds is crucial to avoid default risk.

Stocks - Focus on daily necessities

While most stock markets decline, stocks of companies selling daily essentials—food, beverages, medicine—remain resilient. Companies with steady revenue become good defensive assets.

Gold - Long-term hedge

Gold prices tend to decrease during deflation, making it a good opportunity to accumulate gold at lower prices. Gold is a good diversification tool because it has intrinsic value.

Real estate - Risky but with potential

During this period, real estate prices may decline. Some investors are forced to sell for cash, allowing those with sufficient funds to buy good locations at attractive prices. However, real estate investment requires time and capital.

Investment tips when the market declines

1. Hold cash in parts, not all-in - Keep cash ready to buy during dips when prices are truly low.

2. Use dollar-cost averaging - Invest equal amounts periodically to reduce risk of poor timing.

3. Focus on company fundamentals, not just stock prices - During downturns, financially strong companies with steady income tend to recover faster.

4. Set stop-loss points - Decide when to cut losses; don’t let hope or fear cloud your judgment.

5. Consult professionals - Avoid half-baked knowledge leading to poor decisions.

Summary - What really matters

Deflation is a real phenomenon that should not be ignored, but there’s no need to panic. The key points are:

• Understand what deflation is and how it affects the economy
• Plan your finances accordingly
• Stay informed with continuous updates on CPI, employment, GDP, etc., as they indicate economic conditions

Whether deflation comes or not, being prepared for an uncertain economy is the smartest approach.