Deflation is more than just "falling prices." Robert Prechter explains why.
The following article is an excerpt from Elliott Wave International's free Club EWI resource, "The Guide to Understanding Deflation. Robert Prechter's Most Important Writings on Deflation."
When Does Deflation Occur?
Defining Inflation and Deflation
Webster’s says, “Inflation is an increase in the volume of money and credit relative to available goods,” and “Deflation is a contraction in the volume of money and credit relative to available goods.” To understand inflation and deflation, we have to understand the terms money and credit.
Defining Money and Credit
Money is a socially accepted medium of exchange, value storage and final payment. A specified amount of that medium also serves as a unit of account. According to its two financial definitions, credit may be summarized as a right to access money. Credit can be held by the owner of the money, in the form of a warehouse receipt for a money deposit, which today is a checking account at a bank. Credit can also be transferred by the owner or by the owner’s custodial institution to a borrower in exchange for a fee or fees -- called interest -- as specified in a repayment contract called a bond, note, bill or just plain IOU, which is debt. In today’s economy, most credit is lent, so people often use the terms “credit” and “debt” interchangeably, as money lent by one entity is simultaneously money borrowed by another.
Price Effects of Inflation and Deflation
The Primary Precondition of Deflation
Non-self-liquidating credit is a loan that is not tied to production and tends to stay in the system. When financial institutions lend for consumer purchases such as cars, boats or homes, or for speculations such as the purchase of stock certificates, no production effort is tied to the loan. Contrary to nearly ubiquitous belief, such lending is almost always counter-productive; it adds costs to the economy, not value.
Near the end of a major expansion, few creditors expect default, which is why they lend freely to weak borrowers. Few borrowers expect their fortunes to change, which is why they borrow freely. Deflation involves a substantial amount of involuntary debt liquidation because almost no one expects deflation before it starts. ...
Wednesday, February 24, 2010
Surviving Deflation: First, Understand It
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