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Independent.ie

Sunday 4 December 2016

Economic crisis means it pays to be prudent -- like our parents were

Joe Barry

Published 17/08/2010 | 05:00

DUE TO the current recession, most of us are looking for every possible means of cutting expenditure -- and the recent decline in the cost of living has been widely welcomed.

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Cheaper goods and services are being marketed aggressively, but perhaps we should be more concerned regarding this turn of events. Cars and machinery in general are down in price, as are commercial property, houses and farmland. Almost everything we buy, from clothes to computers, is cheaper, along with hotel charges, air fares and basics such as concrete and farm buildings.

Great bargains are to be had if you have the cash or can borrow but with credit virtually unobtainable, it does appear as if prices, in general, can only continue to fall. And there lies the problem.

Who is going to buy something that will, in all probability, be worthless the following year and maybe even cheaper again the year after that? The signs of this are already evident in the stagnant property market and a general reluctance to spend. Everyone is worried about the future and, as a result, we are starting to save and abandon expansion plans. We are in a deflationary period and no one knows what to do or what the long-term effects will be.

Should we be worrying more about deflation? If so, how should we deal with it and what defensive strategies should we employ? Do we borrow or do we hoard? There are no easy answers, but right now deflation is occurring throughout much of the developed world and borrowers are being squeezed in a manner not seen for decades.

It is 50 years since deflation last occurred in Ireland.

Most of us remember the inflationary period that started in the 1970s and the way in which it destroyed the value of savings and introduced a culture of spending rather than saving. Deflation is the opposite and produces a gradual decline in prices, usually caused by a reduction in the supply of money or credit. Money becomes worth more each year and, in a period of deflation, we continue to save because the buying power of our cash increases annually.

In Japan in the 1980s, the banks lent excessively to companies and individuals to invest in real estate. A massive property bubble occurred, and when values fell -- as they inevitably had to -- the loans could not be repaid. Credit dried up and a recession struck, which has lasted for decades.

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The same has now occurred here and we are faced with falling prices and no prospect of credit restrictions being lifted.

One economist has suggested that it would be better if property prices in Ireland quickly hit rock bottom, which could be as much as 70pc below their peak, so that people would then be motivated to start buying again. Otherwise, the downward trend in prices could drag on for years and reduce economic activity further.

During a period of inflation, borrowed money decreases in value, lowering the cost of the loan. Deflation favours people who hold cash rather than assets and, until inflation returns, spending levels will continue to decline.

The Japanese reduced interest rates to zero in an effort to get the population to borrow and spend. This did not work and prices continued to fall, shrinking employment and incomes and increasing defaults on loans by companies and individuals. Rising prices are essential for any sustained economic recovery because businesses can increase profits and then take the depressive pressure off wages and debtors.

No one knows when this will happen again in Ireland but until there is some glimmer of light, it would appear prudent to adopt the financial habits of my parent's generation. They made every possible use of what they had and carefully assessed anything they bought. Saving was seen as a virtue and nothing was ever wasted. Anything that could be grown and sourced at home was valued and, to a remarkable degree, they lived in a self-sufficient manner. Self-sufficiency and 'growing your own' are being touted as the trendy and fashionable way to live. Perhaps they will soon be a necessity.

Irish Independent