Many are starting to realize that something’s wrong with the economy on a larger scale than what governments are telling us. Propaganda is at an all time high, and more and more people are beginning to see through it.
Already, alternative media are warning of a recession on the horizon. However, from my work (which involves a strong understanding of the cycles of history). it’s clear that this financial debt bubble we’re in (the largest ever) is going to burst with potentially life-changing consequences for most of the population. It will be a worldwide downturn and eventually, a revolution.
“As far back as I can remember, I’ve always been a strong believer in the importance of cycles. You’d better try to understand them, because all of your timing and often your luck is tied up in them.” — Lee Iacocca, past CEO Chrysler, “Talking Straight”
As a business owner or manager, it’s important that you develop strategies to cope with the 180 degree turn from an inflationary environment to a deflationary one. It means you have to understand the ramifications that the changing value of money will mean to your business’ ability to survive.
We’re heading into a depression that will dwarf in depth the downturn of the 1930s. Depressions throughout history have always been accompanied by deflation.
NOTE: Although I prominently display the US Dollar in this article (because it’s the reserve currency of the current period), the coming deflationary cycle will affect economies worldwide.
What Inflation Has Done to the Economy
Inflation, according to Ludwig von Mises, is an increase in the money supply that is not offset by an increase in the need for money. It causes the value of money to decrease, which causes price increases for goods and services.
A good example of this is the current housing bubble in Canada (it’s ‘popped’ on schedule in 2018) created by next-to-free credit. Mortgage interest rates have never been lower and the prices of houses have never been higher.
Lets look at how we cause inflation.
Banks create money out of thin air. In actual fact, they create debt. They do this through loans. In other words, money comes into the economy when banks create a loan. They simply enter the loan amount as debt in their books and you, the customer get borrowed money on the other side of the ledger. A digital entry appears in your bank account — instant money from nowhere!
You pay interest on that money, That interest gets paid to the bank as revenue and the digital money disappears to where it came from … nowhere (it ceases to exist because it zeros out a liability on the balance sheet). In any event, bank loans create newly “minted” money (today, it’s mostly digital) — money that the banks create out of thin air. Then they charge you interest for its use.
For more detail on how banks create this money, see my post on “How Banks Create Money Out of Nothing!”
When interest rates are really low, people borrow more money (mortgages) and bid up the price of homes. People see it as an inexpensive way to buy the home of their dreams.
Inflation in a nutshell: The increase in the amount of money in the economy causes the value of money to decrease. We realize that lower value through higher prices for assets.
Inflation: money decreases in value; houses rise in price
Deflation: money increases in value; house prices decrease
The good thing is that as long as inflation keeps up, you’re paying back that loan in “future money,” which is gradually decreasing in value. Inflation makes is easier to pay back debt (and that’s why governments like to inflate and amass large amounts of debt — they can pay back that debt in less valuable money in future).
Below is a chart of the American dollar and how inflation has reduced its value by 96% over the past century.
In the chart above, you can see how inflation has been fairly consistent except for the period from about 1920 to 1936 and again around 1940.
Most currencies today are worth a fraction of what they were when originally created. The US Dollar is worth less than four cents compared to one hundred years ago. It’s why the majority of the population can’t make ends meet and are living paycheck to paycheck. In this gradually deteriorating situation, confidence in the economy will eventually hit rock bottom.
Deflation
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.
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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.
Very informative and thought provoking. Thanks!
Very informative and it’s bearing out accurate.
What does it mean for cash rich and cash poor? Debt should be avoided and paid off now for all parties is what I take from this. Should cash be held or should it be sunk into property? Assets will get cheaper but will banks take money from customer accounts making it a risk to hold cash?
Thank you.
Hi MX,
In a deflationary environment, money changes value. Inflation reduces the value of a dollar, so all assets rise in price because you need more dollars (each worth less) to buy the same property that was “cheaper” 5 years ago.
That’s confusing until you break down banking and the value of money and why it changes.
In our system in normal times (I’m going to simplify this so I don’t write a book), the government regulates banks to lower interest rates when it wants to grow the economy. When that happens, people borrow more money, which increases the money in circulation. More of anything reduces its value. You can think of flat screen tvs, if you like. When they’re scarce, everyone wants one, and the prices will remain high, When industry have produced too many to be consumed, the prices drop, and they become less pricey (or “valuable”).
Money is the same. Inflation (lowering interest sparks more people to borrow and more money in society raises prices on houses and cars, for example). More money lowers the value of a dollar and less raises the value of a dollar. A dollar anywhere now is worth about four cents relative to its value 100 years ago. So houses and cars are super expensive. Take a house. Its value stays the same (actually, if depreciates if you don’t take care of it) but the value of the dollar decreasing in inflationary times makes prices go up. You need more dollars to buy the same property.
In deflationary times, which is where we’re going, mortgages collapse, business and their loans fail, and money decreases within society.
As an aside, with digital fiat money, when a loan or mortgage fails, that money disappears. It’s created in a digital account and just as easily it disappears into nothing. It also takes that money out of the day to day economy, so there’s less of it around. Gradually over time, less and less money is available and so it becomes more dear (or more valuable). In other words, its value now goes in the other direction: up.
That means house prices will start to revert back to where they started. Prices will drop dramatically as people try to sell them to a general public that has less money. So, in a deflationary environment, all asset prices collapse. You don’t want to own assets of any kind.
At the same time, if you have debt, it also rises in value (not in price, or “nominal” value, as we say) and becomes much harder to pay down because there’s less money out there; money gets scarcer and scarcer.
Failing mortgages impact banks and they start to go under. It’s a vicious cycle that works over and over the create what we call spiralling deflation.
The bottom line is that going forward, you want to be in cash and preferably not in a commercial bank (but banks are a whole other discussion and there are post on my site that deal with them). You also want to own as few assets as you can because they go down in price.
Banks don’t have your money. They invest it and if those investments fail (as in mortgages), it’s gone. They never have enough money to pay everyone back if they all wanted their money at once and there isn’t enough in deposit insurance to cover what they keep telling you it will cover. The law is that once you deposit money in a bank, it belongs to them. They promise to pay it back if they have it. In fact, you’re investing in that banking business. That’s the law.
So … stay in cash, out of debt, out of assets, and keep your money in a safe place. You’ll do just fine.
Businesses have additional challenges and it’s critical they manage cash flow and get their “footprints” down. They need to get lean and mean to survive.
Hop this helps.