subject: When Deflation Sets In, Lower Your Cost Of Debt [print this page] If a recession becomes severe, deflation sets in making your money more dear and your debts more severe. What should retirees consider doing if deflation sets in?
The effects of inflation are familiar to us all. Our dollars just don't buy as much as they used to. Too much 'easy money' from too much credit puts more dollars into everyone's hands; each dollar is worth less than before. The result is that too many dollars are chasing too few goods which bids up the prices of those goods.
But when recession occurs, everyone becomes afraid of spending more than necessary on consuming. Businesses feel the pinch and people lose jobs. Government tries to 'prime the pump' by offering and instigating low interest rates. That reduces the cost of credit and hopefully gets people to begin 'consuming more'.
But if the turndown is too severe, very few people will be enticed to spend money. The money supply actually contracts. This lowers the demand to buy most things and bids prices down. So, deflation is the general decrease in the prices of goods. Your dollars are worth more because they can buy more, but then again you may have less dollars at your disposal to use. Debts - being dominated in dollars - become more severe to pay.
Most retirees have no job to lose. They're living off Social Security, pensions and their investment earnings. Most of this 'fixed income' is fairly safe - assured through government programs. Those in such a circumstance can actually benefit from deflation - mostly from the benefit of lower prices for goods and services.
But under deflation, dollars become more valuable and debt - i.e. owing a fixed amount of dollars - becomes more of a burden. So retirees should reduce the cost of their debt.
Pay off debt faster. As deflation sets in you're paying off debt in more expensive dollars. So the faster you can pay down your debt, the less costly it'll be.
Restructure your debt payments. With recessions comes falling interest rates. Take advantage of lower interest rates to restructure debt payments you can't pay off quickly.
Refinance your home. If you have a mortgage, refinance at lower interest rate to cut your monthly costs - or to pay it off over a reduced time period.
Since the value of cash is increasing, holding it will increase your wealth - but only during deflation. Aside from preserving your emergency funds, you'll want to hold dollars for investment opportunities at low prices.
If you do have extra cash, stay aware of overly depressed investments that will recover after the recession ends. Real estate investments - especially condos - are a typical case. It may even be worth a small remortgage of your paid off house for some investments.
