If we define “inflation” as the rise in cost of wages, goods and services then deflation is the drop in cost of wages, goods and services. For many years prior to Covid, we had some goods and services continually drop in prices. I recall purchasing a very nice 50″ 4K TV at Costco for $300 a few years ago which I put in my home office. I paid well over $2000 for a 55″ 1080p TV over ten years ago for comparison.
How did a TV with better capability and resolution come to cost significantly less than a TV from a decade ago? In a word, deflation. In order for the TV to drop in price so significantly the entire manufacturing supply chain must have had several things happen.
First, a healthy competitive market must exist between all players in the supply chain. Each company in the TV manufacturing supply chain must have had a reason to compete against others to provide more competitive pricing. In order to make this happen, a healthy capital investment ecosystem needed to exist to allow firms to expand capacity, capability and build better efficiency.
Secondly, labor is generally one of the highest cost inputs into the production of any good so having access to low cost labor is a must for a deflationary pricing to happen. The manufacturing of TVs began to migrate to abundant labor countries like China that had far lower labor costs than places like the United States.
Third, to maximize the efficiency of the supply chain, there needs to be close proximity to all the key components of manufacturing TVs. This includes computer chips, glass and metals and energy to be able to bring it all together into a newly created TV. As manufacturing migrated to China for low cost labor, the chip market followed it along and the integration work centered around Asia.
The case for deflation centers around two central ideas. The first is that as 70 million boomers reach the age of 65+ by 2030 that they will consume far less goods and services. As such, as the demand for goods and services declines, prices will drop and companies that can’t readjust to the new consumption reality, they will go out of businesses and those that do survive will need to learn how to be much more efficient given the lower demand for goods and services.
The second is that as boomers retire en mass, they will downsize their homes creating a glut of housing in the marketplace driving down the costs of housing and in turn forcing a re-alignment of the real estate ecosystem. Housing is one of the highest cost items that most people will spend money on in their lifetime and if housing suddenly drops in pricing because of abundance then this will drive a deflationary period.
While we think deflation is a very plausible scenario, we think it is more likely to happen in 2040 than 2030. In any event, it would be prudent to position some of our investment portfolio to position ourselves for a deflationary period just in case.