first majestic silver

Deflation: It's here Already

June 25, 1998

Having grown accustomed to steadily rising rates of inflation over the better part of 20 years, Americans have been inculcated with the belief that inflationary trends pose the only threat to economic stability. Bad memories of the inflation and attendant "energy crisis" of the 1970s still linger in America's collective psyche. And for all too many Americans, inflation is the only economic trend with which they have any familiarity with. But inflation is only one half of the economic pie.

The other, largely ignored half is of course deflation. It is a word that is conspicuously missing from the vocabulary of the average American. Many, if not most, have no concept or idea of the word's meaning. But as will be illustrated in the paragraphs that follow, it is a phenomenon that will become a pressing concern among the masses in the near future and will dominate news headlines. The Great Global Deflation has already begun.

Before proceeding, it will be useful to formally define our operative term. Webster's Ninth New Collegiate Dictionary defines deflation as follows: "a contraction in the volume of available money or credit that results in a decline of the general price level."

Deflation is the inevitable result of a severe expansion of credit, the likes of which we have witnessed over the better part of the 1990s. When immense amounts of credit (i.e., debt) are made readily and easily available to the great masses of people in a given country, it tends toward economic disequilibrium, or the creation of a great instability in the free market. This credit expansion, or inflation, necessitates an equal and opposite trend reversal — eventually leading to deflation, in which a large number of goods and services are chasing a finite and shrinking number of dollars. In its extreme form, deflation results in depression.

We have, for the better part of this decade, witnessed a monumental credit expansion that has extended vast borrowing power to people who ordinarily would not qualify to receive any type of credit. Consequently, millions of Americans have racked up enormous credit card and personal loan debts that threaten to bring many to the brink of financial insolvency.

Simply put, Americans are awash in unmitigated credit. A multiplicity of leveraged financial instruments have combined to create what is commonly referred to as the "new wealth." Unfortunately, this "new wealth," much like the fabled "new era" of the ever-rising stock market, is a myth that is destined to implode before millions of investors.

Financial analyst R.E. McMaster, editor of The Reaper newsletter, in his book The Christ Within, defines "debt capitalism" as the predominant economic force of our time. McMaster writes: "Debt capitalism [is failing] in the West. How could it do otherwise? The words 'debt' and 'capitalism' are incompatible long term. Putting the two words together is in fact Orwellian. 'Debt' is borrowing from the future by mortgaging the past to consume the present. 'Capitalism' requires savings from the past through the present for investment in the future. So 'debt capitalism' of today is present-oriented, while 'capitalism' itself is future-oriented. Thus, debt capitalism collapses into top-down bureaucratic socialism/fascism."

Thus, the credit-driven consumer culture that characterizes America today is destined to collapse as the debt spiral eventually unravels. And the unraveling process may have already begun.

Already we see evidence that the credit bubble is beginning to deflate. Reports of consumer credit defaults and filings of personal bankruptcies continue with increasing regularity. According to a recent Associated Press article, the number of Americans filing personal bankruptcies last year surged past 1 million for the first time. "America is in the middle of a bankruptcy crisis," said Sen. Charles Grassley, Iowa Republican and chairman of the Senate Judiciary subcommittee on administrative oversight and the courts. He noted that the current level of personal bankruptcies exceeds that during the recession of the early 1970s.

The apparent wealth of the middle class is nothing more than the outward trappings of easy credit—a luxury that will soon dissipate when the deflationary spiral accelerates. Similarly, the recent surges in the stock market have been largely fueled by credit, as opposed to true wealth, by banks, brokerages and other lending institutions that have been all too willing to offer leverage to cash-starved investors who want to "ride the bull." But recent events indicate the credit-fueled stock market "bull" may be ending, as well. Corporate earnings are beginning to fall here and overseas, due in part to the influence of collapsing Asian economies as well as an overall slowdown in the technology sector.

Another indication of slowing corporate profits has been the fast pace of company layoffs over the past one year. Each week sees another slew of announced down-sizings—the most recent being the idling of nearly 200,000 GM workers—and workers downsized over the last year number in the millions.

Yet another sign of a coming deflation is evidenced in the U.S. Producer Price Index, released by the U.S. Labor Department. Falling prices of imported finished goods and parts are contributing to a downward pressure on wholesale prices of U.S.-made products, the department reported recently.

Over the past 12 months, producer prices of finished goods made in the U.S. have dropped by nearly 1 percent, the Labor Department said. In the same period, prices of imported goods dropped by more than 4.0 percent.

"The effects that falling import [prices] have on producer prices are indirect, but to the extent that they are falling, you're getting reductions in component costs—especially electronic components from Southeast Asia, which started falling in September and October [of 1997]," said Donald Ratajczak, director of Georgia State University's Economic Forecasting Center, in commenting on this phenomenon.

The recent stock market woes of Southeast Asia have weighed heavily on goods imported from other parts of Asia, such as cameras, toys and home electronics, as they all have taken sharp price drops, the effects of which have been apparent at the consumer level. As one example, the price for a popular Nintendo 64 video-game unit, which retailed for $249 last year, today retails for $149, more than a 40 percent drop in price.

"Moreover, when import prices fall, it helps to hold down prices on competing goods produced in the U.S.," said Ratajczak. Net effect: deflation.

It behooves us as prudent investors to keep our eyes firmly on the potential for a deflationary scenario to unfold in the months ahead.

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including “2014: America’s Date With Destiny.” You can view all of Clif's books here. For more information visit

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