Deflation? Bring It On!

Judging from the Federal Reserve's rate cut yesterday, policymakers have put the fear of deflation above all other worries the struggling economy faces right now. Yet, for one group of investors, deflation would provide long-awaited relief from unending the unending price increases and meager savings rates they've faced for years.

Retirees, who are well known for their generally conservative investing strategies, have reaped the rewards of their caution during 2008. In a year during which the markets have lost over a third of their value, retirees who put safety above all else are sitting on decent gains -- and salivating at the idea that their savings might actually go further in the years to come.

Why deflation hurts most of us
For the overall economy, deflation brings a host of horrors. For instance, when prices are falling, companies that keep large amounts of inventory relative to their sales suffer. Until those companies can sell their inventory, its value drops for every day they hold it.

The chart below shows companies with unusually slow turnover rates, as indicated by the ratio of their quarterly sales to the value of their inventory.

Source: Capital IQ, a division of Standard and Poor's. Figures for most recent quarter.

For consumers, deflation makes paying down debt increasingly difficult, as employers cut wages to compensate for lower profits. At the same time, if you have to sell assets to reduce your debt, deflation means you get less in proceeds from your sale.

The other side of the coin
Seniors, on the other hand, love deflation -- for a variety of reasons:

• Bonds skyrocket. For retirees who've traded risk for a fixed return, inflation is their biggest fear. But when prices are actually falling, you get a double bonus. You collect interest over the years, and when the bonds mature, you get your principal back -- when it has more purchasing power.
• Income stays stable. Falling wages don't affect you if you've already stopped working. And while deflation might threaten some inflation-adjusted investments, such as TIPS, it appears that deflation wouldn't cut Social Security or other government benefits payments.
• Saving gets rewarded. For years, retirees have suffered through having to accept low rates on CDs and other investments. Now, though, those who've capitalized on fairly high CD rates offered by cash-strapped banks will receive an even higher real return as inflation disappears.
• Costs are contained. Although it's far from clear whether the major costs for seniors -- things like health care, travel, and housing -- would all drop during a general deflationary period, seniors would appreciate even any move toward price stability after years of seeing those expenses rise faster than the inflation rate.

How to prepare
If you're convinced that deflation is here to stay, then the biggest key for seniors is to get rid of any debt you have left outstanding -- especially if it's big enough that making payments is difficult. You don't want the possibility of seeing your debt expand at the same time those dollars are becoming more valuable.

Conversely, locking in the relatively high rates that are currently available on fixed-income investments is a great move for the conservative side of your portfolio. As the credit crunch eases, you can expect bank rates to move down to levels more in line with ultra-low Treasury rates -- which will threaten your income once more. For now, you can still get rates of 4%-5% on fully-insured CDs -- but don't expect them to last.

Deflation has the Fed and others running scared, but seniors can handle it more easily. If you take the right steps, you'll continue to find yourself in the enviable position you've enjoyed during 2008.

For more on protecting your retirement, read about:

• Will you be able to live on $846 a month?
• Secret disasters hiding in your portfolio.
• How some are getting desperate about Social Security.