We're in DEFLATION for the first time in 22 years.

Well everybody, we are in deflation. This is the first time that Australia has been in deflation in literally 23 years. So check this out, this article reads consumer prices in Australia dropped by 0.3 percent year on year in Q2 2020. This was the first decline in consumer prices since Q3 1997, as the economy struggled to contain the dreaded swine flu.

So this is only the third time that annual inflation has been negative since 1949. I haven't really spoken about inflation or deflation on the channel before, quite simply because there really hasn't been any news. There’s been nothing to talk about, and that's because essentially we try and keep inflation around about two percent each year. Two percent, and we're doing pretty well. Over the past 10 years in Australia, that's exactly what's happened. Inflation has been low, it's been steady, and you know, that's just what we aim to achieve.

So there really hasn't been anything to talk about. Now, inflation is technically defined as an increase in the consumer price index, and that sounds pretty technical and scary. But essentially, what that means is the consumer price index is just a big basket of goods and services that typical Australians need.

So food, clothing, housing, transport, personal care, recreation, so on. And inflation basically means that this basket of goods slowly gets more expensive over time. Now, an economic environment with small levels of inflation is actually good. So yes, that basket of goods gets a little bit more expensive over time, but that also means that businesses around Australia get a little bit more profitable. Our economy keeps growing, keeps chugging along. Typically, wages go up, asset prices go up, and everyone starts feeling pretty good.

We like this scenario, and it's what we've seen in Australia for now a very long time; just a consistent low level of inflation. Fantastic. So that's like the technical way to define inflation, looking at the consumer price index and blah, blah. But you can also look at inflation or deflation just by a simple supply-demand equation.

Okay, so let's think about it. Inflation means the prices of things are going up. So if you look at the supply-demand equation, that just means that the demand is stronger than the supply. That's what drives prices up; that's inflation. But then we turn to what Australia is now experiencing: deflation.

Right, prices are going down; the supply is now outweighing the demand. Alright, that forces prices to go down. At a surface level, this actually sounds pretty good as a consumer, right? It means everything around us is getting cheaper. Right? That's a good thing. You know, if I hold on to my cash, then in a couple of months' time, if prices keep going down, I can buy that new TV at an even cheaper price than what it's at right now.

That sounds fantastic! That's an awesome deal. However, it's that mentality applied to everyone which actually makes deflation quite a scary concept. Because deflation can lead people to hold on to their money because they want to get that better price in the future. If you apply this to everyone, if everyone has this mindset, then you can think about the kind of effects that will have. Not very many people are going out there and spending their money, so that means in turn that all of the companies out there are bringing in lower revenue.

They're not making as many sales, okay? And then, of course, companies need to cut costs to try and keep themselves going. How do they cut costs? Well, they start laying off employees. Right? This causes the unemployment rate to rise. And then, when the unemployment rate rises, all of these people that are now unemployed are really tight for cash, so they're not spending anything.

They're holding onto their money for dear life. So then, the spending reduces even further, and you can see how this starts to whip itself into a vicious downward spiral. So a little bit of deflation really doesn't hurt all that much, but what you want to stop is you want to stop everyone getting into that mindset of holding on to their cash because things are going to be cheaper in another month or a year's time.

Enter Japan in the 1990s. This is exactly what happened: economic stagnation, price deflation that led to what people call as Japan's lost decade. A banking crisis caused banks to stop lending. This meant that companies started to struggle; they started doing layoffs. The unemployment rate went up, and people were really tight on cash, so they didn't spend any money.

Now, the problem with Japan was that it wasn't a short-term deflation. This actually started to happen year after year after year. And after a while, everybody's mentality became, "Well, we better hold on to our money because year after year they've seen that prices are getting cheaper and cheaper." So why would we buy anything now when we can get it cheaper in a year's time?

Now, this wasn't just people; this was also businesses. For businesses, why would I open that new store now when I can just wait for another year and it's going to be even cheaper for me to open up that new store? So the trick here is to not stay in deflation for too long.

So how do you get yourself out of a deflationary environment? Well, as a central bank and a central government, those two entities have to work together to create an economic environment that encourages people to spend. And the way that they do that is they lower interest rates. However, the interesting thing right now is that Australia's interest rate is currently at its record low level of 0.25 percent.

So that lever that they like to pull on has almost bottomed out. But we shouldn't be too concerned just yet because it's in conditions, uncertain conditions like this that we could see a fair bit of see-sawing even between inflation and deflation. A lot of economists out there are saying that they're concerned for both. They're concerned about deflation, and they're also concerned about inflation.

And the reason for that is because of the global shutdown. We're actually seeing factors that are affecting both sides of the supply-demand equation. Consider this scenario: at the moment, the shutdown has caused a lot of people to lose their jobs, and thus at the moment, we're seeing very high unemployment. And when unemployment is high, people obviously don't have the money to spend, right? They are tightening the belt; they're trying to save money, and therefore the demand goes down.

And you can think about it at the moment; there's an emphasis on getting business up and running again, slowly but surely, opening back up. Business is starting to return to normal, so in that situation, we could see demand stay low and supply rising, in which case supply is over demand. And that means we see prices go down, and that means deflation.

Whereas on the other side, we might see inflation. A lot of economists are expecting that we might see inflation, and the reason for that is because people have not been able to get out there and buy the things that they have needed to buy. We've seen e-commerce sites being absolutely overrun because people are still trying to buy things even when they can't go out to the stores because they've been locked down.

So some people are predicting that as stores open up, people will rush out to try and buy the things that they needed to get. That plus what we've seen in Australia is that the government has been handing out a lot of money to a lot of people. So a lot of people are in the fortunate situation where even though they might have suffered through losing their job for a while, they actually haven't suffered too badly financially because they've been eligible for these schemes by the government where the government essentially is just giving them money to help them through this time.

So you've got that factor which might actually cause demand to be quite high. And then you have the other side of that equation: we know that the pandemic isn't going anywhere, and we see it spiking up and down in different places.

So there could very well be turbulence in things like the global supply chain for many years to come; who knows? So even though people are getting ready to spend, we might see that actually, there is a fair bit of supply constraint. You can even think about just rules imposed by the government at the moment. People want to go out and sit down at a restaurant and have a meal, but there are rules that limit the number of tables that can be up and running in a certain square footage of restaurant.

So this is a very tricky time to understand with certainty which way we're headed, and you can understand why economists are kind of unsure and concerned about both inflation and deflation. But for the time being, at least what we're seeing in Australia is deflation. But what I haven't even touched on yet is why. Why is Australia—what are the reasons behind us now seeing deflation?

Well remember, it all comes back to that consumer price index, and what we've seen over the past quarters. There are three key reasons—three key pointers, factors—that mean that Australia has sunk into a deflationary environment. The first is childcare costs. So because of government initiatives, childcare costs fell 95 percent in the quarter.

There's also petrol prices. Petrol prices fell drastically in the quarter, partly because there was an oversupply, because Russia and Saudi Arabia were engaged in that price war, but also because the demand for oil has gone down because people really aren't going anywhere. And then the third factor is that education costs have plummeted because in Queensland, New South Wales, and Victoria, they've decided to make preschool free.

So I find this really interesting because out of those three key factors that led to this deflationary environment, two out of the three were actually self-inflicted. And according to the chief economist for the ABS, Bruce Hochman, if it weren't for the fall in childcare costs and fuel in the June quarter, the CPI would have risen 0.1.

Now, that wouldn't have been so bad, and many people, including chief economists for BIS Oxford Economics, Sarah Hunter, are predicting that inflation is going to come through in the next quarter because of the government's decision to reimpose childcare fees and also the partial recovery of petrol prices.

So it seems as though even though we're experiencing deflation now, it might be literally next quarter where we just bounce straight back out of it, and we're back to inflation. I guess the point is we just don't know. However, we just got to make sure that we don't do a Japan. You don't want to be stuck in deflation for a long period of time where everybody gets concerned, everybody stops spending, and then all of a sudden your economy grinds to an absolute halt.

Anyway guys, that'll do me for this video. Thanks very much for watching! Leave a like on the video to show the video some support and help it out in the YouTube algorithm. I super, super appreciate it! And of course check out Profitful; links are in the description. If you'd like to learn more about investing or tax, if you're an Australian, we just released those two brand new tax courses.

It's an opportune time; it's tax season, so let those courses help you get the most out of your tax return. But that will do me today. Leave a comment down in the comment section below; I'd love to know what do you guys think? Are we going to see more deflation in Australia, or are we going to bounce back straight away and see inflation? I'd love to hear your take on it, so drop that stuff down in the comments section below.

But that'll do me today, guys. Thank you very much for watching! I'll see you guys in the next video. [Music] Um [Music] You.