I read yesterday that we are beginning to see the signs of deflation. I am just wondering whether deflation poses a bigger or lesser risk than inflation, and particularly whether a period of deflation makes holding physical gold more or less attractive. I gather that the Great Depression saw a huge amount of deflation, but as a result of the government taking money out of the economy (rather than pumping more money into it as is now the case – isn’t this something related to Bernanke’s thesis). Is the deflation possibly (partly) happening as people default on their debt and in effect the money ‘created out of thin air’ is then somehow withdrawn from the system?
You can get a lot of information on the Deflation scenario by reading Mike Shedlock’s blog:
Most of his posts contain links to previous articles which should quickly give you some background on his outlook on deflation. Some of the current links for example:
When will the reaction to deflation trigger the destruction of the currency? This is one of the best sites to help you with that.
Austrian economics predicted today’s economic collapse. Keynesian economics did not, but rather, predicted the economy was the best it’s ever been.Bernanke and most of today’s economists are Keynesian’s. This is why I think we’re in half the trouble we’re in.
Austrian economics see no problem with deflation. To Keynesian’s it’s a nighmare.
Austrian & Keynesian economics define deflation and inflation differently. Austrian ec defines it as an expansion or contraction of the money supply. Keynesian’s define it as price increase or decrease, which is the effect not the cause. Price increases are a result of an inflated money supply. Today the money supply is being inflated at unpresidented rates, but prices continue to drop. The Fed & other Keynesian’s call this deflation.
Austrians will tell you that in a true deflationary period (where money supply / credit is contracting) that the price of EVERYTHING will fall. Next time you go to a bar & order a beer, see if the price is gone down. Next time you get a hair-cut or order a burger see if the price is gone down. It hasn’t come down and won’t come down. This is because, as per the Austrians, we aren’t in a deflationary period. We are in a period of asset price decline. Everyone is in debt past their eyeballs. Even stock brokers have purchased stocks using loans. Everyone is trying to pay back their loans now and have to sell off their assets to raise cash to pay the debt. As a result of the fire-sale prices on assets, stocks and excess inventory of merchandise, people see this as price deflation. The fire-sale prices are to liquidate assets to raise cash to pay off debt. This is not because there isn’t enough money in the system to buy these goods. It’s to get rid of the stuff to pay off the debts. Similarly, the recent drop in consumer price index gives the Fed the green light to print more money without worry of [their definition of] inflation because stuff is cheap now. Things are cheap only because of fire-sale liquidating prices. Producers and sellers will now cut back on their inventories to lessen their debts and as a result prices will rise back to normal levels, when the liquidation is over.
The gov’t is scaring everyone into thinking that deflation is a bad word… and is cheerleading that more dollars in the system is a good thing. It doesn’t matter how much credit is made available if no-one wants it. Everyone needs to become productive & earn more money to pay off their debt… not borrow more money to buy imported crap from China.
Asset price decline is a bad thing for those who have hold assets that are purchased with debt. When the asset sale price is less than the debt people want to default on the loan. This creates huge financial pain for the lender when he has to write off the lost investment due consumer debt default. In the stock market if your stock price falls below a certain percentage of debt-to-equity in the investment then the investor has to come up with more cash to restore a particular debt-to-equity level. If he doesn’t have the cash he must sell off his good assets/stocks (like gold shares) to pay the debt. So, even for stocks, if bought with debt then price declines are a bad thing. But again, in both cases, the Austrians will tell you this is asset price decline and not deflation.