What is a liquidity crunch? And how should you invest during an economic downturn

Essential Knowledge About Deflation

If you are an investor interested in the financial markets, the term “deflation” is no longer unfamiliar, as it is an economic condition that impacts our investment decisions.

Deflation (Deflation) simply explained is a situation where the prices of goods and services decrease sequentially, opposite to inflation where prices rise sharply. When deflation occurs, the value of money increases, allowing people to buy more goods with the same amount of money.

However, it is important to understand that a decrease in prices does not mean all goods are cheaper; it is an overall average. Some items may still be expensive, while others have significantly dropped in price.

Causes of Deflation

The occurrence of deflation is not due to a single cause; multiple factors work together.

###Poor economic management The government may set interest rates too high, discouraging financial institutions from lending, or impose heavy taxes leaving citizens with little disposable income. As a result, supply and demand become unbalanced.

###Capital outflows When large amounts of capital leave the country, financial conditions tighten, and interest rates rise, leading to reduced production and employment.

###Insufficient money supply People prefer to save money (such as storing cash in safes) rather than saving in the financial system, resulting in insufficient money circulation in the economy.

###Increased supply but decreased demand Advances in technology reduce production costs, increase the availability of goods, but consumers buy less, forcing prices to fall to clear inventory.

The Relationship Between Deflation and Recession

Have you ever wondered why deflation often accompanies economic recession?

When GDP declines for two consecutive quarters, it indicates economic activity is shrinking. Income decreases, leading to reduced consumer spending. Companies see declining sales and cut back on production. Unemployment rises, and people spend even less. Companies are forced to lower prices further.

This creates a cycle—lower prices to sell more lead to cost-cutting, including layoffs. Ultimately, people’s incomes decrease even more.

Key Economic Indicators During a Crisis

In April 2020, (during the severe COVID-19 outbreak), Thailand experienced its first negative inflation:

Consumer Price Index (CPI):

• Decreased by 2.99% (YoY)
• Continuous decline for over 10 years and 9 months

Producer Price Index (PPI):

• Fell by 4.3% year-over-year

Construction Material Price Index (CMI):

• Dropped by 4.0% year-over-year

This contraction was driven by lockdown measures, economic slowdown, reduced demand, and a sharp fall in oil prices, all exerting downward pressure on inflation.

Is Thailand truly in deflation? According to official definitions, not yet, because it requires meeting four criteria simultaneously. Nonetheless, these signals serve as warnings of economic risks.

Who Suffers and Who Benefits from Deflation?

###Beneficiaries

• Fixed-income earners: Wages increase in value, enabling more purchasing power
• Creditors: Those who lend money receive repayments with increased value

###Those Who Lose

• Businesses and shareholders: Profits shrink as prices are lowered
• Debtors: Debts increase in real value, making repayment more difficult
• Unemployed: Job opportunities diminish as companies contract

Historical Example - The Great Depression

In 1929, the US stock market crashed, with the “Black Tuesday” event leading to a prolonged global economic downturn.

Massive impacts:

• Global GDP shrank by over 15%
• International trade contracted by 50%
• US unemployment soared to 23%, some countries up to 33%
• Agricultural prices plummeted by 60%

The effects persisted until World War II. For that era, it was a life-changing event for many.

What Should Countries Do?

When deflation hits, governments must intervene to stabilize the situation:

Monetary Policy:

• Lower interest rates to encourage borrowing and investment
• Reduce (Reserve Requirement) to increase bank lending capacity
• Purchase assets from the market to inject liquidity

Fiscal Policy:

• Cut taxes to put more money in people’s hands
• Increase government spending to create jobs
• Reduce utility costs like water and electricity to ease household expenses

Investment Support Policies:

• Promote new industries
• Open doors for foreign investment
• Support exports

What Should Investors Do During Deflation?

###1. Hold Cash During deflation, cash retains its value, making it meaningful to hold. Suitable for those waiting for the right timing.

###2. Bonds (Bonds) Central banks may cut interest rates, increasing the value of existing bonds. Consider high-credit-quality bonds.

###3. Resilient Stocks Find essential businesses in daily life, such as food and beverages. Stock prices may not rise immediately, but these companies can still generate profits.

###4. Equity - Short Selling For risk-tolerant traders, shorting or buying Put Warrants can be profitable in a declining market.

###5. Real Estate Prices drop due to urgent sellers, presenting long-term investment opportunities for patient investors with available funds.

###6. Gold Gold prices tend to decline, making it suitable for speculation. Gold has intrinsic value and helps diversify risk.

CFD Trading Tip: If interested in trading gold or other commodities without owning the actual asset, try CFD trading with a trusted broker like Mitrade, which allows starting with as little as 50 USD.

The Problem: When Deflation Actually Occurs

The arrival of deflation is not good news because:

For the general public:

• Unemployment rises; layoffs increase
• Income decreases due to lower dividends
• Uncertainty and instability grow

For the economy:

• Consumption contracts as people wait for lower prices
• Production declines due to lack of buyers
• The unemployment chain expands

Cycle of despair: People expect prices to fall further, so they stop buying and hoard cash. Producers see no demand and lower prices further, leading to layoffs. Debtors may be forced to close businesses. If not managed properly, this results in a deep economic depression.

Opportunities to Profit During a Downturn

However, it is not all bleak; there are ways to profit in a bear market:

Method 1 - Resilient Stocks Choose companies with steady revenue streams even during downturns. Their stock prices may not soar immediately but will recover due to strong fundamentals.

Method 2 - Layered Financial Planning Divide cash into portions and invest gradually to avoid full exposure at market peaks.

Method 3 - Risk Hedging Use short positions or buy Put Warrants to profit from falling prices.

Method 4 - Learning and Research Study company fundamentals; when the market recovers, stocks with solid bases will rise first.

Simple Summary

Deflation signals that the economy is in pain: prices fall, demand drops, and unemployment rises.

Beneficiaries: those holding old money and creditors. Losers: entrepreneurs, shareholders, and job seekers.

But it’s not the end. Smart investors will use this opportunity to hold cash and invest when prices are at their lowest. As the economy recovers, they stand to gain significantly.

Therefore, keep a close eye on economic indicators, plan your finances in advance, and prepare for uncertainty. Because “deflation” can be managed effectively if you understand it and prepare ahead.