Investors got spooked this week by the specter of rising interest rates and inflation, and what they might mean for the global economy.
But they should look just as hard at deflation, which in recent years has been neutralizing inflation’s impact on wages and prices—with the notable exception of asset prices.
I believe deflation has become structural and is here to stay, no matter what interest rates do. Recent innovations like ecommerce and fracking have strengthened deflation’s grip on prices, people, and jobs. Everything that can be produced with technology just keeps getting cheaper and cheaper.
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How did this happen? In the mid-1990s, consumer prices started falling and never looked back. Cheap overseas labor, global trade agreements, containerization, and the emergence of big box stores and mass-discount retailers all drove this trend. By the 2000s, Internet shopping had kicked in, making it easy to value shop, and challenging brand loyalty.
Then Amazon arrived with unprecedented scale. If Amazon sells it, it’s probably been deflating. Using data and algorithms, Amazon has fostered a never-ending race to the bottom. Its costs are lower, without stores or the people who work in them. (Walmart has 2.3 million employees; Amazon has 540,000 plus 100,000 robots.) And it can lock in buyers with unmatchable loyalty programs.
In tandem with the rise of ecommerce, hydraulic fracturing (fracking) technology began wiping out the global balance of energy supply and demand, unleashing massive price wars. Between 2013 and 2016, you had to double your efficiency to survive in the U.S. oil production business; this drove increasing automation to slash costs. American fracking technology not only deflated global energy costs, but helped deflate any sector using energy as a major input.
As costs dropped, the world started burning more fossil fuels and consuming more plastic and other resources. A million plastic bottles are bought around the world every minute and most of them end up in the ocean. Global vehicle production is closing in on 100 million per year, with China’s production having quadrupled since 2006. Global annual smartphone production surged from 173 million in 2009 to 1.47 billion in 2016.
But deflation’s biggest impact is yet to come. Eighty percent of jobs in the U.S. are in services, and almost all are on a path to getting deflated and commoditized. U.S. wages have been deflating for 20 years to the surprise of most economists, especially given the recently booming economy.
Some service job sectors, such as the travel agent industry, deflated in the late 1990s and early 2000s as consumers moved to self-service. And some, like newspaper publishing and other media, deflated as lower cost distribution channels such as the web, apps, and streaming content replaced high-cost ones.
Today’s service workers must compete with job deflators powered by software and winner-take-all economies of scale. Services like Airbnb, Netflix, DocuSign, Venmo, exchange-traded funds (ETFs), and TurboTax are sucking costs out of every sector, as consumers and businesses choose cord-cutting flexibility, on-demand convenience, and lower costs.
While service workers must compete as commodities in the newly transparent gig economy, corporate payrolls are slimming down to survive the new competition. A few big-name stars can swim against his tide (think Taylor Swift or partners at Goldman Sachs), but most service workers—from doctors to artists—are feeling the squeeze.
Deflation’s final frontiers are health care and education, which have been insulated because consumers don’t pay their costs directly (employers and the government do). But now that that’s changing too, there’s nowhere to hide.
Where will this all end? At some point, deflation’s implied low margins should catch up with the valuations of all but a small handful of dominant companies. Whether that’s triggered by higher rates or some other catalyst is hard to say.
What I do know is that technology-driven deflation is a primal force that will shape the rest of our lives. Tell your children and your investment advisor. Like gravity, we’ll all have to figure out how to live with it.
Dave Margulius is the co-founder and former CEO of Quizlet Inc.