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Deflation & Retirement


The words “deflation” and “retirement” are rarely spoken in the same sentence – or even in the same context. There are quite a few causes for this.

deflation annuities


Deflation? Not likely – Historical Background 

Deflation is the reverse of inflation. As an alternative to a rise in the common level of prices, deflation indicates a turn down in the general level of prices. Considerable deflations occurred occasionally in the 19th century but have been very seldom since then. Just as inflation results from increases in the supply of money, deflations are associated with decreases in the money supply.

The twentieth century overlapped approximately with the arrival of central banking. Central banks’ apparent purpose was to even out the level of financial activity by controlling the supply of capital and credit. 19th-century deflations coincided with monetary recessions, or “panics” as they then were called. The financial expression of panics was the breakdown of banks. Under a system of incomplete reserve banking, bank failures caused reduction of the money supply by some multiple of the bank deposits misplaced in the malfunction.

Central bankers have long viewed the money-supply narrowing and resulting deflation as the nearby cause of the supplementary recession. They view it as their duty to stop deflation at all costs. This belief has communicated an inflationary prejudice to economic policy, since the reason to avoid deflation absolutely means that fault can occur only on the side of inflation, not in the other direction. 

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Never fear

The improbability of deflation is one reason why its effects are rarely discussed in retirement investment or elsewhere. Another reason is more sensible. Inflation tends to advantage debtors, who are able to pay back debt in money whose purchasing authority has decreased. In the same way, it troubles creditors, whose repayment is worth a smaller amount in real terms than its supposed value. Typically, retirees seize assets in the form of fixed-income assets, such as bonds and annuities. They receive pensions whose nominal value is permanent. Thus, inflation is a lethal threat to them, and abundant attention is paid to potential defensive measures against it.

Deflation would advantage retirees because it is the parallel image of inflation. Supposed value payments from liability securities and pension funds would amplify in purchasing power. Even if deflation caused an economic downturn, this would not hurt retirees per se. After all, they have no jobs to lose and their prosperity is largely shifted away from growth assets, such as stocks, whose value would go down in recession. Since deflation would be a benefit rather than a nuisance to retirees, there is no need to take defensive actions or plan elaborate strategies to lookout against it.


Mild warnings

Given the occurrence of central banking and its state of mind, deflation seems unlikely to occur. Nonetheless, a few concise modifications of the conservative thinking just outlined are almost certainly in order.

The theory that a deflationary recession could only assist, not hurt, retirees depends to some degree on their asset distribution. Current increases in life expectation have made it sensible for retirees to add to their exposure to growth assets, such as equity shares. In turn, this may make their affluence vulnerable to deflation. The best prophylactic for this is the customary one: expand equity holdings and bind their exposure in the portfolio. Indeed, the very composition of the retiree’s portfolio is already compatible to this, since losses in the equity portion would be counterbalanced by the deflationary gains on the leading fixed-income portion.

A more probable scenario for deflation would be as the result of a complete financial meltdown, perhaps triggered by hyperinflation and failure to pay government-debt. Trying to assure against such an overpowering disaster is nearly impossible. Even so, possession of gold offers some nominal degree of protection against global economic cataclysm. Because gold doesn't’t earn interest and has only a limited potential for growth, it should encompass only a small portion of a retiree’s portfolio. 


In closing

Deflation and retirement are rarely joined in financial discussion. Central-bank rule makers make every effort to avoid deflation at all costs. Deflation benefits creditors, which should make it a bonus to retirees rather than a hazard. Since it seems improbable to occur and not disparaging to retirees even if it does, conservative retirement planning tends to pay no attention to it.

Enlarged life expectation provides an enticement for retirees to increase their equity exposure. Plausibly, this might be a source of uneasiness in a deflation. Such defense, that seems both needed and reasonable, can be gained from portfolio diversification, particularly ownership of gold.

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