When looking at the business cycle the question of when deflation is most likely to occur is hard to answer. There is no easy answer to this because it can occur at any point in time or it can happen over a longer period of time than most people think. The reason for this is that deflation can be caused by many different factors and it can also be brought about by various economic problems around the world. It is important therefore to look at how these factors might affect the business cycle.
Cause OF Deflation
One of the factors that can cause deflation is an economy that is experiencing too many problems with its balance sheet. In the United Kingdom for example, the last few years have seen the effects of a number of different factors push the economy into negative territory on the balance sheet. Among these were weak consumer spending and slower investment in infrastructure. Both of these factors pushed down the value of the pound, which in turn led to lower inflation and weaker economic growth.
Another factor that can cause deflation is the rising supply of goods and services in the economy. This is especially prevalent in the United States where there are currently more houses being built than being sold. Rising prices can lead to increased demand, which means that the supply is cut in terms of quantity meaning that when is the in the business cycle when is deflation most likely to occur.
In addition to the above mentioned factors, deflation can be caused by economic problems in other parts of the world. A prime example of this is China. China has recently been struggling with issues related to excess unsold inventory. To stop the problem from getting out of control, the Chinese government has been forced to implement monetary stimulus measures. When this happens the prices of goods and services have begun to rise which, in turn, has driven down the value of the Chinese currency. The weakness of the currency, combined with the rising cost of imported goods has created a dilemma for the Chinese authorities: they are trying to stimulate economic activity, but at the same time keep the inflationary pressures at a manageable level so as not to create further pressure on the national currency.
How should you think about these factors?
If you are an investor in the business cycle when is deflation most likely to occur? It would seem that it is best to stay invested in assets that are not tied to a single currency. Stocks of gold, crude oil and other commodities have typically performed well during times of financial market turbulence when the dollar is weak. When this type of investment makes financial sense, it makes sense to move those assets.
In addition to this, if you know that the dollar is weakening, it is often in your best interest to hold cash positions in a number of countries instead of just one. If you look at world economies, you can usually find that there are strong economies, while there is also a country that has a severe debt burden, high inflation and a weak economic growth. All of these factors are pointing to deflation as the trend to emerge with a weaker dollar.