The Bank for International Settlements ("BIS"), considered to be the "bank for central banks" as it were, published their 78th Annual Report over the past 24 hours. It is brutally frank. It is very scary stuff. It is considered to be rather beyond reproach, in terms of its credibility, too. You may read the story about this here:
Now, back to the word: "deflation." We're going to be hearing a lot about this word in coming weeks and months. So, how can we understand that we're going to be dealing with this reality of deflation in light of the rapidly escalating costs of fuel and food? "Isn't that inflation?" (That was my first reaction!) Well, apparently, they're all tied together, and the answer is much uglier than I ever realized.
"Deflation," you see, is what occurs when as society enters into a "depression," as I've now learned learned after reading the following (all, pretty much from the last 24 hours):
What is Deflation and What Causes it to 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.
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The most common misunderstanding about inflation and deflation - echoed even by some renowned economists - is the idea that inflation is rising prices and deflation is falling prices. General price changes, though, are simply effects.
The Primary Precondition of Deflation
Deflation requires a precondition: a major societal buildup in the extension of credit (and its flip side, the assumption of debt). Austrian economists Ludwig von Mises and Friedrich Hayek warned of the consequences of credit expansion, as have a handful of other economists, who today are mostly ignored. Bank credit and Elliott wave expert Hamilton Bolton, in a 1957 letter, summarized his observations this way:
In reading a history of major depressions in the U.S. from 1830 on, I was impressed with the following:
(a) All were set off by a deflation of excess credit. This was the one factor in common.
(b) Sometimes the excess-of-credit situation seemed to last years before the bubble broke.
(c) Some outside event, such as a major failure, brought the thing to a head, but the signs were visible many months, and in some cases years, in advance.
(d) None was ever quite like the last, so that the public was always fooled thereby.
(e) Some panics occurred under great government surpluses of revenue (1837, for instance) and some under great government deficits.
(f) Credit is credit, whether non-self-liquidating or self-liquidating.
(g) Deflation of non-self-liquidating credit usually produces the greater slumps.
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Why Deflationary Crashes and Depressions Go Together
A deflationary crash is characterized in part by a persistent, sustained, deep, general decline in people's desire and ability to lend and borrow. A depression is characterized in part by a persistent, sustained, deep, general decline in production. Since a decline in production reduces debtors' means to repay and service debt, a depression supports deflation. Since a decline in credit reduces new investment in economic activity, deflation supports depression. Because both credit and production support prices for investment assets, their prices fall in a deflationary depression. As asset prices fall, people lose wealth, which reduces their ability to offer credit, service debt and support production. This mix of forces is self-reinforcing.
The U.S. has experienced two major deflationary depressions, which lasted from 1835 to 1842 and from 1929 to 1932 respectively. Each one followed a period of substantial credit expansion.
