Wednesday, December 24, 2008

Falling Prices (6) - Investment Strategy

If inflation stopped completely and prices began to decline slowly, investment strategies would also have to change dramatically. Buying an asset and just waiting for the capital gain would no longer be a feasible strategy. That would be a good thing for the economy, as investors would shift to assets that are actually productive.

Investment decisions would require real wisdom and prudence. Ownership of a house would not be viable unless it could be let out for a rental that covered all expenses and any decline in price. Most investors would have to switch to investments that produce something real and valuable.

Inflation has disrupted investment patterns in a very negative way. One of the reasons is that real incomes in the western world have not grown as much as we would like is that most savings (and massive imported savings) have been ploughed into residential dwellings. The problem is that residential dwellings do a produce a return that benefits the economy in turns of jobs and output.

If inflation disappeared, investment would flow into assets that are productive and produce goods and services that people are willing to purchase. Declining asset prices would push investors into more productive investments, which would be good for the economy. More productive investment would benefit society be increasing employment and wealth.

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