Robert Prechter Explains the
Price Effects of Inflation and Deflation
November 19, 2008
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," and "Deflation 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 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 of inflation and deflation.
The 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.
The price effects of deflation are simpler. They tend to occur across the board, in goods and investment assets simultaneously.
…………….
For more information on Inflation vs. Deflation, including money-saving steps for protecting your wealth, download Elliott Wave International’s free 8-page report, inflation and 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.
Think That Central Banks Move the Markets?
Think Again
April 23, 2009
By Mark Galasiewski
The following is excerpted from Elliott Wave International’s Global Market Perspective. The full 120-page publication, which features forecasts for every major world market, is available free until April 30.
Visit Elliott Wave International to download it free.
Conventional wisdom says that central banks can influence or even direct financial markets and the macroeconomy. The very existence of Elliott waves challenges such assumptions. For if markets responded to every central bank directive, how could Elliott waves exist? Parallel trend channels, Fibonacci price relationships, the similarity of form between waves of different sizes and time periods—none of that would be possible. Central bank decisions would have to coincide perfectly with turning points in Elliott waves, and we know that just doesn’t happen. But even without using waves, we can expose the conventional wisdom for the fallacy that it is.
Take, for example, this assertion in a recent article in a U.K. economic weekly: “Part of the aim of central banks in driving down interest rates is to encourage a greater risk appetite among investors.” Two key assumptions underlie that statement: a) central banks determine interest rates; and b) lower interest rates can increase society’s appetite for risk.
To see how the first assumption is false, let’s take a look at the daily chart of Australian interest rate data. It duplicates a study that Elliott Wave International has often done with U.S. interest rate data. It shows how movements in the cash target rate set by Australia’s central bank, the Reserve Bank of Australia (RBA), appear to follow those in 3-month Australian Treasury Bills. After decisive moves up in T-bills from 2006 to early 2008, for example, the RBA faithfully raised its target. T-bills have since led the RBA during the financial crisis of the past year. In fact, the record indicates that the RBA almost always follows T-bills over time.
The proper conclusion to draw is not that the RBA has orchestrated the decline in rates since the early 1980s—but that it’s been riding it. During good times, central bankers look like geniuses; during bad times, they get tarred and feathered. Closer to the truth is that their interest-rate decisions are not proactive, but reactive, and that they continually follow in the footsteps of the market for lack of any other useful guide.
Now let’s look at the second assumption: that lower interest rates increase society’s appetite for risk. A simple glance at the weekly chart shows this assumption to be false. After the 1987 crash, the ASX All Ordinaries actually rallied for two years on rising rates and then sold off through 1990 on falling rates. Stocks then rose in 1991 on continued falling rates and sold off in 1992 on even lower rates. Continue following the chart to the right and you will see that there is no consistent correlation between the direction of interest rates and that of the stock market.
The myth of central bank potency is so pervasive that conventional analysts can’t even imagine a better explanation for price trends: that the market is the dog wagging its central bank tail, not the other way around.
-----------------------------------------------------------------
For more information,
download Elliott Wave International’s FREE issue of Global Market Perspective
available until April 30. The 120-page publication covers every major world market, global interest rates, international currencies, metals, energy and more.
Terms of Use|Privacy Policy|Disclaimer
