What is the Definition of Deflation?

Monetary deflation is a contraction in the total supply of money and credit in an economy.

Price deflation, often confused in the mainstream for its monetary counterpart, is when the price of goods and services fall.

Get the full definition of Deflation

What is Money?

Money is something that serves as a unit of account, a store of value and final payment. Today there is no actual money in the system, because debts are not a reliable store of value. In today's debt-money system, people refer to cash notes as money, because they serve as a unit of account and as final payment. But they do not serve as a store of value.

What is Credit?

Credit is an agreement transferring the right to access money from the owner of the money to someone else. A bank deposit is a credit from the depositor to the bank, giving the bank the right to access that money. A mortgage loan is a credit from the bank to the consumer, giving the consumer the right to access money on deposit at the bank.

Isn't Credit Desirable?

In a free market, most creditors would probably lend to producers, in which case you would be right. But most debt today comprises loans to governments for buying votes, investors for buying stock, and consumers for buying homes, cars, boats, furniture and services such as education. None of those loans has any production tied to it. Even a lot of corporate debt today is tied to financial activity rather than to production. When a strong business borrows, it uses the money to create new capital. But these government and consumer loans have eaten up capital. It's gone. All those borrowers have spent the future, and no magician can get it back.

Isn't Credit the "Grease" of the Economy?

Conventional economists excuse and praise the debt-money system under the erroneous belief that expanding money and credit promotes economic growth, which is terribly false. It appears to do so for a while, but in the long run, the swollen mass of debt collapses of its own weight -- which is deflation -- and destroys the economy. We saw a grim "preview" of that during the 2007-2009 deflationary plunge. One could say rather that credit is the molasses in the gears of the economy.

What is Debt?

A debt is the borrower's agreement to pay money to the creditor.

Don't We Just Owe Debt to Ourselves?

Tell that to the creditors. There is a lender and a borrower for every dollar of credit, and the lender expects to get his money back.

How Much Debt is in the World?

According to the Institute of International Finance (IIF) global debt hit an all-time high of $253 trillion ($253 million million, or $253,000,000,000,000) in the third quarter of 2019. That's up over 17% since 2016 and equivalent to around 322% of global Gross Domestic Product (GDP).

Why is Excessive Debt a Problem?

Debt can be divided into two types of credit: self-liquidating and non-self-liquidating.

Self-liquidating credit is a loan that is paid back, with interest, in a moderately short space of time from production. Money is borrowed and used to create value. An example would be a company borrowing money to build a new factory that produces goods. Some of the income that is generated from the new factory goes to pay off the loan.

Non-self-liquidating credit is a loan that is not tied to production and tends to stay in the system. Money is borrowed that isn't used to create value. Examples would be consumer loans to fund purchases of cars, boats and homes, or loans for speculating. These purchases do not, by and large, produce an income stream and so the interest payments on the loan have to come from another source of income. Therefore, such lending is typically counterproductive as it adds cost to the economy, not value.

When debt becomes excessive, the proportion of non-self-liquidating credit becomes a problem.

Why Can't Debt Expand Forever?

Two things are required to produce an expansionary trend in credit. The first is increasing confidence, and the second is the ability to pay interest. Confidence ebbs and flows with the trend in social mood. The trend in a society's mood is cyclical, meaning that it has both positive and negative phases. Debt generally expands when social mood is positive but it contracts when social mood is negative.

What Happens When Debt Contracts?

As social mood trends negatively, confidence slips and the economy contracts. A contracting economy stresses debtors' ability to pay interest and ultimately principal. Once debtors start defaulting, all these trends get worse and a deflationary spiral takes hold.

What is Default?

A borrower who can't pay his obligation is said to be in default. When he cannot pay interest or principal, he has defaulted on the loan agreement.

Why is Default Dangerous?

Default means the creditor loses some or all of his money. When the entire financial system is gorged with debt, default can be systemic, causing huge amounts of perceived debt-values to disappear.

Inflation vs Deflation?

Inflation is an expansion in the total supply of money and credit. Deflation is the opposite -- a contraction in the total supply of money and credit.

Why Does Anyone Want Inflation?

Monetarists say that credit inflation is necessary to keep the economy expanding. But the real reason for inflation is that it is a method of stealing value from savers' accounts and wallets without their knowing it.

What are the FED's "Policy Tools"?

Its main tool is creating more debt. That is not a solution to the debt problem.

Why do Bankers want "Lenders of Last Resort" such as the FED and the FDIC?

So they can lend more aggressively, get rich speculating with other people's money and not have to bear the consequences of failure. The plan was that the Fed and the FDIC would always be there to bail out profligate banks. But the plan has a moral hazard: The safer potential lenders think they are, the more they lend, until the system is gorged with debt. We think the debt is so huge now that central banks and government institutions such as the FDIC will be unable to stop a systemic credit meltdown.

Isn't the Big Threat Over?

No. Remember, in 2006-2007, most people thought then that deflation was impossible. That's when real estate peaked and dropped in half, commodities and stocks crashed over 50%, and short term interest rates went to zero. Most people can't see around the corner. We base our work on precursors of deflation, not the event itself. By the time you can see it, it's too late.

Will Deflation be Slow or Fast?

Every time a bank lends money, it gets deposited into other banks, which re-lend those "new" deposits, producing a "multiplier effect" on the total value of bank deposits. Thanks to their belief in lenders of last resort, bankers have lent and re-lent about 97% of their deposits. When borrowers begin defaulting, the "multiplier effect" will go into reverse. The potential reverse leverage in our banking system is an important precursor for a deflationary crash.

What is a Deflationary Spiral?

A deflationary spiral occurs when reductions in lending, spending and production cause debtors to earn less money with which to pay off their debts, causing defaults to rise. Default and fear of default exacerbate the new trend in psychology, which in turn causes creditors to reduce lending further, causing debt to reduce further, and the spiral goes on.

Get the full definition of a Deflationary Spiral

Why is Deflation Considered to be Bad?

Deflation is considered to be bad because monetary deflation (debt deflation) has generally been associated with times of stress and a contracting economy. Price deflation has normally coincided with such times.

However, there have been times when price deflation has occurred in times of economic growth. Governments and central banks fail to acknowledge this. One reason could be that it is in governments' interest to perpetuate a fear of deflation in order to continually expand their debt.

What does deflation look like?

Deflation occurs when the amount of money and credit in an economy contracts. It follows a period of inflation when money and credit expands to excessive levels. We highlight two examples of deflation here, the first, perhaps the most famous example of all from the United States in the 1930s and, the second, a more recent example from Greece.

What is the Best Investment During Deflation?

Deflation brings down financial values, such as the values of stocks, commodities and property. Elliott Wave International's main recommendation has been safety in cash and cash equivalents. (See Chapter 18 of Conquer the Crash for a description.)