Deflation A Living Dinosaur

Jim Blasingame Since the late 1960s, inflation has been a constant companion of Americans; flip-flopping, sometimes hour-by-hour, as either a consumer's demon or an investor's deity.

Most of us have a paradoxical, if not schizophrenic relationship with inflation: We hate it at the grocery store and gas pump, but we like it - nay, worship at the throne of inflation - when we sell our real estate.

For me, this love/hate relationship with inflation has fostered a fascination with the subject as I contemplate how it has affected our lives over the past few decades, with its impact on politics, public policy, and the marketplace.

So imagine my surprise when I hear financial gurus like a Treasury Secretary and a Federal Reserve Board Chairman talking about "deflation" as a current component of our economy. Huh? I thought these were the guys whose job it was to obsess about inflation. What's up with the "d" word?

The Resurrection Of A Dinosaur
To most contemporary observers, deflation was a shadowy economic dinosaur, long extinct. Now, it turns out, if it is a dinosaur, it's a coelacanth. The coelacanth (pronounced see la canth) is a 400 million year-old species of fish thought extinct since the Cretaceous period 65 million years ago. That is, at least, until one was caught off the coast of Africa in 1938.

Webster says deflation is a lessening in value. But in economics, as we will see in a minute, "value" is a relative term, depending on whether you're buying or selling, when you got in, and how much inventory you have.

The Good And The Bad
Gary Shilling is an internationally recognized economic and financial expert. He's been talking about deflation for over 20 years, and has written several books on this topic. Gary is also an original member of our Brain Trust.

Gary tells us that there actually are actually two kinds of deflation:

1. Bad deflation. That's where your real estate values decrease, for example. Like what happened during the Great Depression, and more recently, in Japan. Bad deflation diminishes wealth.

2. Good deflation. Like what has been happening with technology. Good deflation is a product of productivity, and typically creates opportunity.

Good deflation also begets productivity. As a result of good deflation, technological advances have become affordable for Joe and Jane Entrepreneur, whose ventures have become productivity factories though the leveraging of technology.

Recently, in the same speech where he commented on the fragile nature of our current economic recovery, Mr. Greenspan also marveled at the excellent productivity numbers we're producing. I think we can thank good deflation, at least in part, for those numbers.

Dealing With Deflation
Gary also reminds us that we have to be careful when we play with deflation. In his book, Deflation: How to Survive and Thrive in the Coming Wave of Deflation, he lists 25 strategies that we should consider as we move our businesses ahead in this split-personality marketplace, which may be inflationary in one sector (petroleum), and deflationary in another (cell phones and long distance). I'm going to summarize a few of the items from Gary's list, which I think are critical for small business owners.

1. Cut costs and push productivity
One way to accomplish this strategy is to embrace and employ technology in your operation. Remember, technological innovation, delivering affordable capability and increased productivity, is often one of the best examples of good deflation. Finding enough people to work is going to be a long-term challenge. Therefore, I recommend you look to technology first for solutions, and then hire people.

2. Keep inventories down
In modern day materials management, you MUST use just-in-time inventory practices. It's much easier to train your customers to take delivery tomorrow, just-in-time, than it is to explain to your banker why all of your cash is tied up in deflated inventory, just-in-case.

3. Explore niche opportunities
The opposite of filling a niche is selling commodities. Things that are most vulnerable to deflation are those that are, or can become, a commodity. Leave that stuff to the Big Boxes; they can afford to hedge. Fight for your niche like a terrier, service your customers within an inch of their lives, and focus on your core business like your life depends on it.

4. Understand the challenges and opportunities of deflation
Check your products and services to see if they are at risk for a deflationary trend. Even if you are finding opportunity in selling a particular item that is part of a good deflationary trend, if you own too much of it, that can become bad deflation to you.

Gary says our monetary and credit authorities "are still fighting the last war, inflation, and not the next, deflation." I agree, but not for the sophisticated economic reasons he gives. I'm not an economist. I believe him because of what I see in my own business and walking around in the marketplace.

Shifting Paradigms
Paradigms are shifting all over the place as increased productivity spawns good deflation, which then begets more productivity. This may be the only example of where the egg creates the chicken today, and then the chicken creates the egg tomorrow.

My own organization is doing things today at an acceptable expense that, literally months ago, would have cost so much as to have been prohibitive. Think about that: from cost prohibitive to full implementation and full control in a matter of months; that's good deflation at light speed.

Good for me, right? But what about those vendors that tried to sell me their stuff a few months ago, pre-deflation? Some of them are doing fine, and some are not.

Those who are okay changed their business model to conform to the new market dynamics, which included good deflation. Could you do that? You might have to.

Some were not so fortunate. They were too invested in the old pricing paradigm when deflation hit, which made it bad deflation for them. Don't let that happen to you.

I don't think we are headed toward wholesale deflation resulting in widespread financial collapse. But you don't have to be an economic visionary to see plenty of deflationary evidence that is creating both challenges and opportunities. Make sure you know where the deflationary challenges and opportunities are for your business.

Still think deflation is extinct? Did I mention the coelacanth?

Write this on a rock... Your good deflation is someone else's bad deflation. The trick is to be on the good side of this tension as much as possible. Forewarned is forearmed.

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