The Secret Word: Deflation - And the Next Five Years of Financial Turmoil

The following is a sample from Elliott Wave International's new 40-page report, The State of the Global Markets - 2013 Edition: The Most Important Investment Report

You'll Read This Year. This article was originally published in Robert Prechter's July 2012 Elliott Wave Theorist.

In the first five months of 2012, there were 20 times as many Google searches on "inflation" as there were on "deflation." This is down from a

ratio of 50 times in June 2008. If any theme has been overdone over the past six years, it is the theme of inevitable inflation if not hyperinflation.

Inflation reigned for 75 years, from 1933 to 2008. People are so used to it that they cannot imagine the opposite

monetary environment. Bullish economists have been calling for recovery, which means more inflation, and bearish advisors have been calling for a crash in the dollar, which

means hyperinflation. No wonder those are the terms on which most people have been searching.

But only one word allows you to make sense of what's going on in the world, and inflation is not it. The secret word is deflation.

Deflation explains:

  • why interest rates on highly rated bonds are at their lowest levels in the history of the country;
  • why the velocity of money is the lowest since the 1930s;
  • why huge sectors among investment markets are down over 40%;
  • why the Consumer Price Index (CPI) just had its biggest down month since 2008;
  • why Europe is in turmoil.

Here are some details: Ten-year Treasury notes pay out less than 1.5% annually, their lowest rate since the founding of the Republic. Treasury bills yield

essentially zero, their lowest level ever. The velocity of money failed to rise during the past three years of partial economic recovery, and it recently made new lows. Real

estate prices have fallen 45% in the past six years. Commodity prices -- as measured by the CRB Index -- are down 39% over four years. This group includes oil and silver, two of

the most hyped investments of the past decade. Remember in March when articles quoted analysts calling for $5, $6 and $8-per-gallon gasoline? In just three months since then,

gas prices have fallen 15%, knocking the CPI into negative territory.

Deflation also explains why European loans are at risk, why Germany is tapped out, why Greeks are protesting in the streets, and why U.S.

corporations' overseas profits are down. Deflation lets you make sense of the world.

What is deflation? Economists define it three different ways, but I find only one definition useful: Deflation is a contraction in the overall supply of

money and credit.

Why must deflation occur? Answer: There is too much unpayable debt in the world.

As argued in Conquer the Crash, it ultimately does
not matter what the authorities do; they can't stop deflation.
This prediction is being borne out. Since 2007, the Fed has
monetized $2 trillion worth of debt; the federal government
has borrowed another $7 trillion; and it has pumped out $1
trillion worth of student-loan credit. Yet real estate and
commodities slumped 40% anyway.

These drunken-sailor-type policies have indeed succeeded in nearly maintaining the overall volume of money and credit.

But in the long run you can't fight a systemic debt overload by piling on more debt. The Fed and the government are shifting the burden of trillions of dollars' worth of debt

obligations from reckless creditors onto innocent savers and hapless taxpayers. The ploy might work if the public's resources were infinite, but they aren't. Perhaps this policy

temporarily prevented a series of big institutional disasters, but it was only at the ultimate price of a gigantic public disaster.

Such actions have become politically less palatable. Some observers realize that the student-loan program of lending

at below-market rates is exactly the model the government used for housing loans, which ended in a spectacular bust. Others know that the government cannot continue to borrow at

the current pace and expect to stay solvent. Politicians on both sides of the aisle are tired of the Fed's bailing out of highly leveraged financial-speculation institutions.

But whether these policies continue or are curtailed is irrelevant to the outcome. If the government slows its borrowing, the overall value of debt will fall. If the government

maintains or increases its present pace of borrowing, interest rates will eventually turn up, and the overall value of debt will fall. There is no escape from deflation.

Ironically, investors in the past decade have been doing exactly the opposite of preparing for deflation. Convinced of

perpetually rising prices, they have bought every major investment. They chased real estate up to a peak in 2006. They bought blue chip stocks into the high of 2007. They pushed

commodities up to a peak in 2008. They chased gold and silver up to highs in 2011. And through spring 2012, they continued to buy stocks and commodities on any rumor that

promised inflation: European bank bailouts, Operation Twist, the Greek election, Group-of-8 summits, Fed meetings, Bernanke press conferences, improved economic numbers,

predictions of QE3, central-bank interest-rate cuts, you name it. Meanwhile, the U.S. Dollar Index hasn't made a new low for four years. During deflationary times, cash is king,

and by far most investors have chosen to own anything but cash.

Deflation is still not obvious to the majority. Even now, most economists expect continued recovery, mild inflation

and a rising stock market. But the essays on are 180 degrees apart from conventional thinking. It may be too late for you to get out at the top, but there's still

time to learn how to sidestep the worst of the crunch.

People will be using the secret "d" word much more often over the next five years. By the end of that time, they will

also be using its cousin "d" word, depression.

By Elliott Wave International

Robert Prechter is the founder and president of Elliott Wave International, the world's largest financial forecasting firm.

The rest of EWI's 40-page report, The State of the Global Markets - 2013 Edition: The Most Important Investment Report You'll Read This Year, is available for download. Follow this link to download the full report - for


This article was syndicated by Elliott Wave International and was originally published under the headline . EWI is the

world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to

institutional and private investors around the world.

19 thoughts on “The Secret Word: Deflation - And the Next Five Years of Financial Turmoil

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  2. Prechter, the guy who was wrong yelling for a crash all the way up from dow 1,200 in the early 80's, is espousing more "wisdom." I'll pass... making money is far more important than some ideology of how things are "supposed" to be.

    Tell the Asians there was no deflation in the 90's. Anyways, that 20-25 year cycle is likely over, and it's time for STAGFLATION. Not that the govt. will ever admit it of course. Agree that prices across the board for everything that anyone uses has been rising, a lot. Believe it or not, the CPI figures are calculated using a weighting of less than 1% for healthcare expenses. Why would anyone possibly still believe the accuracy of the official fraudulent numbers?

    BTW E-wave is well known as the most unreliable form of analysis for good reason.

    1. Even if gold falls to $1000 or below, if there is no money around there is no deal. Nonetheless, there is nothing to stop international corporations and/or central banks around the world who have very deep pockets, to buy up as much gold as it is available. What about a country like China and Japan to issue bonds using US Treasury as security to buy up all the gold available? Don't forget, a huge international corporation could easily issue bonds to buy gold. There are plenty of these corporations in China. Perhaps gold should be taken out of the gauge to measure inflation. In this situation, we'll let gold finds its true value. It could be $3000. It could be $300. From then on, gold would not have any more influence on inflation or deflation.

      1. You got it backwards, gold doesn't influence inflation or deflation - any more than a thermometer influences the temperature. It is just a measure of how much fiat currency there is. Also, the true value of gold will probably never again get below $1000 - it costs much more than that to dig it up.

  3. How about you guys pay my bills.... I live in the real world by the way. Every year my bills for nearly everything are up a lot more than what Bernanke or Geithner tells me they should be.

    Could it be..... horrors...... that the CPI numbers are totally phony and fraudulent?

    Try using pre 1999 inflation metrics for a more honest method.

    You can shove your moronic deflation theories into a very dark place.

  4. Having heard good arguments from both sides it might be a good idea to hedge - half cash / half real assets.

    At least you will break even.

  5. Editor: I made a true statement about Prechter and his works and you chose not to show it. This indicates, as I suspected, that this is merely for advertising purposes, not for educating readers. Your site is no different from any other advertiser who is getting paid, as I am sure you are. I won't waste my time or yours in the future and has me questioning your core business!

  6. Except inflation doesn't go out with a wimper. It needs a final zoom before the explosion. Be patient.

  7. So what are the implications for investors? During inflationary times you rather hold gold than cash; does that mean that during deflationary times you hold cash rather than hard assets? What are the implication for savings vs debts?

    1. Gold, of course, goes down as the dollar goes up in a depression. The only other possibility is if the fiat currencies crash, then gold will zoom

      1. Can someone please explain to me how fiat currencies can crash in a $81 trillion world economy? WHAT is going to replace the currency if they all crash? Gold? Silver? Try buying food with a silver quarter today. Its worth EXACTLY 25 cents at the grocery store.

  8. Prechter has been calling for a strong dollar since gold at $300 (now almost $1700). He is right about deflation, BUT it will be in terms of gold - not cash.

  9. Prechter means well but he has been wrong for the past 3 1/2 years and I lost tens of thousands of dollars taking his advice. He said that silver was going down to $11, gold under $400, and the DIA down to 5K. Instead, they continued to go up. He's similar to the man who said that the Lord was coming back in 2012. Someday they may be both be right but you can't trade based on somedays.

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