In the unlikely event of deflation, would the widening gap between rich and middle class worsen?
Let's start with two tenets of deflation:
- The value of money increases as prices for goods and services drop.
- The value of a loan's interest rate effectively goes up, since you are paying for an item (a home, for instance) that has decreased in value. So your debt-to-equity ratio increases.
During periods of deflation there is not enough money in circulation, and the opposite is true during periods of inflation. When a country experiences deflation it usually has been preceded by a recession or depression, with low production and high unemployment. For those reasons it has a far more damaging and long-term effect on the economy than inflation, which encourages short-term consumption.
Deflation is bad for everyone, but it could hurt some more than others. At the simplest level, those who rushed headlong into debt will suffer more during a deflationary period more than those who didn't. As the saying goes, "cash is king."
If you're a holder of the so-called "smart money," you could put it in circulation and buy at reduced prices. If your net worth is tied up in real estate and stocks, you'd be losing ground, especially if you used leverage to buy at inflated prices.
Not all the wealthy, of course, stockpile cash. In fact, many of them jumped on the real-estate gravy train when times were good and credit was loose. But for those who kept a significant amount of what money managers call dry powder (cash) on hand, they could benefit during a period of falling prices. And, they would be putting money into circulation.
For those who didn't hoard cash and took on lots of debt, consider this a warning to reduce debt as much as you can.
Do you think deflation could widen the gap between rich and middle class?
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