Bernard Hickey: Danger lurks in falling prices

The time has come in some countries when hiding money under your mattress might be a good choice. Photo / Getty Images

What could possibly be wrong with falling prices? We're all having to ask ourselves that question as global deflationary forces gather strength and force central banks and governments into all sorts of awkward places.

Central banks in the Euro zone - Sweden, Japan, Denmark and Switzerland - now have negative interest rates on the money deposited with them by banks.

Banks are having to pay to park their money. Some of those banks are beginning to charge their biggest clients for the privilege of keeping their money in the bank.

It is creating all sorts of weird incentives. It's beginning to make sense to take your money out of the bank in these countries and stash it in bricks of cash under the bed or in a safe.

People with billions are now doing their sums on how expensive it is to store their savings in cash in their own vaults.

At some point, the negative interest rates will fall low enough that it makes sense to build vaults, employ bodyguards and buy a whole lot of suitcases with big locks.

It's one of the reasons the European Central Bank has just announced it is looking at withdrawing the 500 note from circulation.

It wants to make it harder for people to avoid these negative interest rates.

Negative interest rates also upturn all the old expectations about cashflow and early payment of bills and taxes.

When there was a bit or even a lot of inflation, it made sense for governments and businesses to encourage early payment because the sooner the payment was made, the sooner the cash could be spent to avoid being eroded by inflation and the sooner the cash could start earning interest.

In a world of deflation and negative interest rates it makes sense to encourage delaying paying bills because money is more valuable in the hand later.

Very quickly, cash starts to flow more slowly around the economy and hoarding begins when expectations change about the future value of money.

When deflation sets in, it makes sense to hold on to your money rather than spend it. Everyone agrees deflationary expectations are a bad thing, which is why our Reserve Bank watches inflationary expectations closely for any signs they are losing their moorings and starting to fall towards zero, or lower.

This week, the Reserve Bank's survey found one year ahead expectations fell this year to a record low of 1.09 per cent from 1.51 per cent and two-year ahead expectations fell to a 22-year low of 1.63 per cent from 1.85 per cent.

The drums are beating again for the Reserve Bank to cut interest rates again as early as March 10. It cannot afford to let expectations about inflation fall and it's not surprising they have fallen.

The prices of goods in the shops have been dropping for three years and the most prominent price in people's minds - petrol - is falling, too.

As for any shop, lower prices make sense for a short while to clear stock and bring people through the door for the first time, but continually descending prices are a dangerous thing for everyone.

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