The Price Effects of
Inflation and Deflation
Editor’s Note: On Nov. 19,
2008, the U.S. Labor Department reported a 1 percent drop in the consumer price
index for October 2008. The drop marked the largest decline in 61 years, and it
was the first decline in that measure in nearly a quarter of a century. The 1
percent drop was twice as large as many mainstream analysts had forecast. Such a
large decline in consumer prices is forcing U.S. policymakers to rethink the
possibility of deflation in America. For more on deflation, we turn to Robert
Prechter, the man who literally wrote a book on how to survive it. The following
article, adapted from Prechter’s book Conquer the Crash – You Can Survive and
Prosper in a Deflationary Depression, will help you understand exactly what to
expect from deflation.
In addition to this article, visit
Elliott Wave International to download the free 8-page report,
Inflation vs. Deflation. It contains details on which threat you should
prepare for and steps you can take to protect your money.
By Robert Prechter, CMT
Before explaining the price effects
of inflation and deflation, we must define the terms inflation, deflation,
money, credit and debt.
Webster's says, "Inflation
is an increase in the volume of money and credit relative to available goods,"
is a contraction in the volume of money and credit relative to available goods."
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.
When the volume of money and credit
rises relative to the volume of goods available, the relative value of
each unit of money falls, making prices for goods generally rise. When
the volume of money and credit falls relative to the volume of goods available,
the relative value of each unit of money rises, making prices of goods generally
fall. Though many people find it difficult to do, the proper way to conceive of
these changes is that the value of units of money are rising and
falling, not the values of goods.
The most common misunderstanding
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 of inflation and deflation.
price effects of inflation can occur in goods, which most people recognize
as relating to inflation, or in investment assets, which people do not generally
recognize as relating to inflation. The inflation of the 1970s induced dramatic
price rises in gold, silver and commodities. The inflation of the 1980s and
1990s induced dramatic price rises in stock certificates and real estate. This
difference in effect is due to differences in the social psychology that
accompanies inflation and disinflation, respectively.
price effects of deflation are simpler. They tend to occur across the board,
in goods and investment assets simultaneously.
For more information on deflation
and inflation, including money-saving steps for protecting your wealth, download
Elliott Wave International’s free 8-page report,
Inflation vs. Deflation.
Robert Prechter, Certified
Market Technician, is the founder and CEO of Elliott Wave International, author
of Wall Street best-sellers Conquer the Crash and Elliott Wave Principle and
editor of The Elliott Wave Theorist monthly market letter since 1979.