Deflation: Way Past the Point of No Return

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In a world where most adults can remember worrying only about inflation, not deflation, it's hard to get a grasp of what it will mean as deflation continues to take hold in the U.S. economy. Certainly, the declining value of homes is one serious gauge of what deflation feels like. A look at deflation in Japan also helps fill in the picture. Here's what our analysts say about the deflationary outlook in this excerpt from The Elliott Wave Financial Forecast, along with a link to our updated Understanding Deflation eBook.

Excerpted from The Elliott Wave Financial Forecast by Steve Hochberg and Pete Kendall, published September 3, 2010

The Economy and Deflation 
Our contention last month was that the economy is moving into a critical new phase, an outright deflation in which "prices fall because people expect falling prices." Obviously, this implies an element of recognition, as efforts to protect against indebtedness and falling prices contribute to further declines....

Japan's deflationary turmoil is an important parallel that The Elliott Wave Financial Forecast has used to gauge deflation's approach in the U.S. Back in January 2000, EWI compared trading in the Nikkei in late 1989 to the NASDAQ then. We observed that the Nikkei subsequently declined 65% over the next two years and forecasted a similar decline for the NASDAQ. The NASDAQ complied with a 73% retreat over the following 30 months. In late 2006, we extended the analogy to Japan's economy with a piece titled "The Japanese Model Points Lower." Since then, we have referred to the analogy at least five more times (see June 2010, April 2010, June 2009, October 2008 and April 2008) and warned that the U.S. faces the "same deflationary pressure." Now, Bank of America/Merrill Lynch has just produced an extensive research report that asks, "Is the U.S. Becoming Japan?" Despite 30 charts and tables that make a powerful case, it concludes that there is just a 20% chance of it. 

Deflation is way past the point of no return. The main reason many believe otherwise is they think that the Fed and the U.S. government will not allow it. But the truth is that it was the government that locked in the case for deflation with its commitment to a credit-based economy decades ago. In response to claims that the Fed would simply "expand credit for the good of the economy," a 2004 issue of The Elliott Wave Theorist compared the situation to what would happen if the government decided that economic growth depended upon the production of Jaguars and provided them to as many people as possible. Eventually, "nobody wants any more Jaguars. They don't care if they're free. They can't find a use for them." As absurd as this sounds, it is exactly what has happened with credit, as the government decided that "the health of the nation depends upon producing credit and providing it to as many as people as possible."

If you think you need to understand deflation better, now is the time to read EWI's updated Understanding Deflation eBook. It's free to download, once you sign up for Club EWI.

Newly updated for 2010, Prechter's 90-page ebook on deflation reveals the biggest threat to your money right now. You'll learn not only how to prepare for deflation and adapt during it; you'll also learn how to survive it and -- most important -- prosper during it, so you'll be ready for the buying opportunity of a lifetime at its end. Click Here to Download Your Free 90-Page Deflation eBook Now.

This article was syndicated by Elliott Wave International and was originally published under the headline Deflation: 'Way Past the Point of No Return'. 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

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