Friday Q & A: Inflation Vs. Deflation


Question: I’ve heard the argument that bank certificate of deposits are a bad idea in an inflationary economy. I take that type of economic environment to mean that prices are higher and low returns on CD’s can’t keep up. But now people are saying that we’re heading into a “deflationary” economy. I have several thousands dollars I’d like to invest, and I’m thinking CD’s. But how do I figure out the deflation-inflation thing?

Answer: Nobody really knows exactly where the economy is heading, and some wise economic oracles say that deflation is the problem and some say that inflation is the real threat.

By definition, inflation means that the money supply increases faster than the actual economy grows. That can lead to higher interest rates (that’s good for certificate of deposit  investors), but higher prices for everything from new homes to cars to a bottle of beer, thus reducing the relative the return an investor may get on a CD yield.

Deflation, on the other hand, occurs when the money supply shrinks, meaning a given currency like the U.S. dollar, can buy more than it usually does. That can force prices down, wages down, housing values down, and can mean fewer jobs as companies earn less revenue. It also usually means that CD yields will be lower than normal.

How does this impact any potential decision to buy a CD? Again, nothing in economics is guaranteed, but one index you might want to follow is the direction of U.S. Treasury rates. Right now, the 10-Year Treasury Note is rising in price, but is lowering in yield. (The current yield on the 10-year note is about 2.95% - it’s lowest point since 2008 – when the U.S. economy really started to feel the impact of recession. As a point of perspective, the average yield on the 10-Year Treasury note was 12.5% in September of 1984.)

At 2.95%, T-Note yields could signal a deflationary environment, where investors remain cautious and will pay more for “flight to safety” investments like Treasury bonds. But when bond prices rise, yields go down, as demand intensifies for safer investments. That demand especially intensifies when the stock market is in retreat, as has been the case for the most recent quarter, when stocks lost 10% of their value.

The good news, as it were, is that interest rates really have nowhere to go but up, and that’s where you can follow the general direction of Treasury Notes to see when that starts happening. We don’t give direct advice on these pages (check for some more research on what investments to make right now), but sooner or later, bond rates will rise and CD rates will rise right along with them – and then be ready to hear more about how inflation is threatening the economy.


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