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This article is part of a syndicated series about deflation from market analyst Robert Prechter, the world’s foremost expert on and proponent of the deflationary scenario. For more on deflation and how you can survive it, download Prechter’s FREE 60-page Deflation Survival eBook, part of Prechter’s NEW Deflation Survival Guide.

The following article was adapted from Robert Prechter’s NEW Deflation Survival eBook, a free 60-page compilation of Prechter’s most important teachings and warnings about deflation.

By Robert Prechter, CMT

Now that the downward portion of the credit cycle is firmly in force, further inflation is impossible. But there is one entity left that can try to stave off deflation: the federal government.

The ultimate source of all the bad credit in the U.S. financial system is Congress. Congress created the Federal Reserve System and many privileged lending corporations: Fannie Mae, Freddie Mac, Ginnie Mae, Sallie Mae, the Federal Housing Administration and the Federal Home Loan Banks, to name a few. The August issue [of The Elliott Wave Theorist] cited our estimate that the mortgage-encouraging entities that Congress created account for 75 percent of all U.S. debt creation with respect to housing. For investors in mortgage (in)securities, the ratio is even greater. Recent reports show that these agencies, which have been stealing people blind by taking interest for nothing, account for a stunning 82 percent of all securitized mortgage debt. Roughly speaking, the government directly encouraged the indebtedness of four out of five home-related borrowers. As noted in the August issue, it indirectly encouraged the rest through the Fed’s lending to banks and the FDIC’s guarantee of bank deposits. These policies allowed borrowers to drive up house prices to absurd levels, making them unaffordable to people who wanted to buy them with actual money. Proof that these mortgages are artificial and the product of something other than a free market is the fact that while Germany, for example, has issued mortgage-backed securities with a value equal to 0.2 percent of its annual GDP, the U.S. has issued them so ferociously that their value has reached 49.6 percent of annual GDP, a multiple of 250 times Germany’s rate, and that is not in total value but only in value relative to the U.S.’s much larger GDP. (Statistics courtesy of the British Treasury.)

Well, the ultimate source of this seemingly risk-free credit still exists, at least for now. When Bernanke & Co. met in the back rooms of the White House in recent weekends, he must have said this: “Boys, we’re nearly out of ammo. We have $400b. of credit left to lend, and we have two percentage points lower to go in interest rates. The only way to stave off deflation is for you to guarantee all the bad debts in the system.” So far, government has leapt to oblige. One of its representatives strode to the podium to declare that it would pledge the future production of the American taxpayer in order to trade, in essence, all the bad IOUs held by speculators in Fannie and Freddie’s mortgages for gilt-edged, freshly stamped U.S. Treasury bonds.

Now, what exactly does that mean for deflation? This latest extension of the decades-long debt-creation scheme has essentially exchanged bad IOUs for T-bonds. This move does not create inflation, but it is an attempt to stop deflation. Instead of becoming worthless wallpaper and 20-cents-on-the-dollar pieces of paper, these IOUs have, through the flap of a jaw, maintained their full, 100 percent liability. This means that the credit supply attending all these mortgages, which was in the process of collapsing, has ballooned right back up to its former level.

You might think this shift of liability is a magic potion to stave off deflation. But it’s not.

Believers in perpetual inflation will ask, “What’s to stop the U.S. government from simply adopting all bad debts, keeping the credit bubble inflated?” Answer: The U.S. government’s IOUs have a price, an interest rate and a safety rating. Just as mortgage prices, rates and safety ratings were under investors’ control, so they are for Treasuries. Remember when Bill Clinton became outraged when he found out that “a bunch of bond traders,” not politicians, determined the price of T-bonds and the interest rates that the government must charge? If investors begin to fear the government’s ability to pay interest and principal, they will move out of Treasuries the way they moved out of mortgages. The American financial system is too soaked with bad debt for a government bailout to work, and the market won’t let politicians get away with assuming all the bad debts. It may take some time for the market to figure out what to do about it, but as always, there is no such thing as a free lunch. The only question is who pays for it.

The Fed is nearly out of the picture, so the consortium of last resort, the federal government, is assuming the job of propping up the debt bubble. It is multiples bigger than any such entity that went before, because it can draw on the liquidity of American taxpayers and clandestinely steal value from American savers. So the question comes down to this: Will the public put up with more financial exploitation? To date, that’s exactly what it has done, but social mood has entered wave c of a Supercycle-degree decline, and voters are likely to become far less complacent, and more belligerent, than they have been for the past 76 years.

An early hint of the public’s reaction comes in the form of news reports. In my lifetime, I can hardly remember times when the media questioned benevolent-sounding actions of the government. Articles were always about who the action would “help.” But many commentators have more accurately reported on the latest bailout. USA Today’s headline reads, “Taxpayers take on trillions of risk.” (9/8) This headline is stunning because of its accuracy. When the government bailed out Chrysler, no newspaper ran an equally accurate headline saying, “Congress assures long-run bankruptcy for GM and Ford.” They all talked about why it was a good thing. This time, realism and skepticism (at a later stage of the cycle it will be cynicism and outrage) attend the bailout. The Wall Street Journal’s “Market Watch” reports an overwhelmingly negative response among emailers. Local newspapers’ “Letters” sections publish comments of dismay and even outrage. CNBC’s Mark Haines, in an interview on 9/8 with MSNBC, began by saying ironically, “Isn’t socialism great?” This breadth of disgust is new, and it’s a reflection of emerging negative social mood.

Social mood trends arise from mental states and lead to social actions and events. Deflation is a social event. Ultimately, social mood will determine whether deflation occurs or not. When voters become angry enough, Congressmen will stop flinging pork at all comers. Now the automakers want a bailout. Voters have remained complacent about it so far, but this benign attitude won’t last. The day the government capitulates and announces that it can’t bail out everyone is the day deflationary psychology will have won out.

……….

For more on deflation, download Prechter’s FREE 60-page Deflation Survival eBook or browse various deflation topics like those below at www.elliottwave.com/deflation.

• What happens during deflation?
• Can the Fed stop deflation?
• Why is deflation bad?
• Inflation vs. deflation
• And much more in Prechter’s FREE Deflation Survival Guide.

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Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter 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.

This article is part of a syndicated series about deflation from market analyst Robert Prechter, the world’s foremost expert on and proponent of the deflationary scenario. For more on deflation and how you can survive it, download Prechter’s FREE 60-page Deflation Survival eBook, part of Prechter’s NEW Deflation Survival Guide.

The following article was adapted from Robert Prechter’s NEW Deflation Survival eBook, a free 60-page compilation of Prechter’s most important teachings and warnings about deflation.

By Robert Prechter, CMT

1) Should you invest in real estate?

Short Answer: NO

Long Answer: The worst thing about real estate is its lack of liquidity during a bear market. At least in the stock market, when your stock is down 60 percent and you realize you’ve made a horrendous mistake, you can call your broker and get out (unless you’re a mutual fund, insurance company or other institution with millions of shares, in which case, you’re stuck). With real estate, you can’t pick up the phone and sell. You need to find a buyer for your house in order to sell it. In a depression, buyers just go away. Mom and Pop move in with the kids, or the kids move in with Mom and Pop. People start living in their offices or moving their offices into their living quarters. Businesses close down. In time, there is a massive glut of real estate.

– Conquer the Crash, Chapter 16

2) Should you prepare for a change in politics?

Short Answer: YES

Long Answer: At some point during a financial crisis, money flows typically become a political issue. You should keep a sharp eye on political trends in your home country. In severe economic times, governments have been known to ban foreign investment, demand capital repatriation, outlaw money transfers abroad, close banks, freeze bank accounts, restrict or seize private pensions, raise taxes, fix prices and impose currency exchange values. They have been known to use force to change the course of who gets hurt and who is spared, which means that the prudent are punished and the thriftless are rewarded, reversing the result from what it would be according to who deserves to be spared or get hurt. In extreme cases, such as when authoritarians assume power, they simply appropriate or take de facto control of your property.
You cannot anticipate every possible law, regulation or political event that will be implemented to thwart your attempt at safety, liquidity and solvency. This is why you must plan ahead and pay attention. As you do, think about these issues so that when political forces troll for victims, you are legally outside the scope of the dragnet.

– Conquer the Crash, Chapter 27

3) Should you invest in commercial bonds?

Short Answer: NO

Long Answer: If there is one bit of conventional wisdom that we hear repeatedly with respect to investing for a deflationary depression, it is that long-term bonds are the best possible investment. This assertion is wrong. Any bond issued by a borrower who cannot pay goes to zero in a depression. In the Great Depression, bonds of many companies, municipalities and foreign governments were crushed. They became wallpaper as their issuers went bankrupt and defaulted. Bonds of suspect issuers also went way down, at least for a time. Understand that in a crash, no one knows its depth, and almost everyone becomes afraid. That makes investors sell bonds of any issuers that they fear could default. Even when people trust the bonds they own, they are sometimes forced to sell them to raise cash to live on. For this reason, even the safest bonds can go down, at least temporarily, as AAA bonds did in 1931 and 1932.

– Conquer the Crash, Chapter 15

4) Should you take precautions if you run a business?

Short Answer: YES

Long Answer: Avoid long-term employment contracts with employees. Try to locate in a state with “at-will” employment laws. Red tape and legal impediments to firing could bankrupt your company in a financial crunch, thus putting everyone in your company out of work.

If you run a business that normally carries a large business inventory (such as an auto or boat dealership), try to reduce it. If your business requires certain manufactured specialty items that may be hard to obtain in a depression, stock up.

If you are an employer, start making plans for what you will do if the company’s cash flow declines and you have to cut expenditures. Would it be best to fire certain people? Would it be better to adjust all salaries downward an equal percentage so that you can keep everyone employed?

Finally, plan how you will take advantage of the next major bottom in the economy. Positioning your company properly at that time could ensure success for decades to come.

– Conquer the Crash, Chapter 30

5) Should you invest in collectibles?

Short Answer: NO

Long Answer: Collecting for investment purposes is almost always foolish. Never buy anything marketed as a collectible. The chances of losing money when collectibility is priced into an item are huge. Usually, collecting trends are fads. They might be short-run or long-run fads, but they eventually dissolve.

– Conquer the Crash, Chapter 17

6) Should you do anything with respect to your employment?

Short Answer: YES

Long Answer: If you have no special reason to believe that the company you work for will prosper so much in a contracting economy that its stock will rise in a bear market, then cash out any stock or stock options that your company has issued to you (or that you bought on your own).

If your remuneration is tied to the same company’s fortunes in the form of stock or stock options, try to convert it to a liquid income stream. Make sure you get paid actual money for your labor.

If you have a choice of employment, try to think about which job will best weather the coming financial and economic storm. Then go get it.

– Conquer the Crash, Chapter 31

7) Should you speculate in stocks?

Short Answer: NO

Long Answer: Perhaps the number one precaution to take at the start of a deflationary crash is to make sure that your investment capital is not invested “long” in stocks, stock mutual funds, stock index futures, stock options or any other equity-based investment or speculation. That advice alone should be worth the time you [spend to read Conquer the Crash].

In 2000 and 2001, countless Internet stocks fell from $50 or $100 a share to near zero in a matter of months. In 2001, Enron went from $85 to pennies a share in less than a year. These are the early casualties of debt, leverage and incautious speculation.

– Conquer the Crash, Chapter 20

Should you call in loans and pay off your debt?

Short Answer: YES

Long Answer: Have you lent money to friends, relatives or co-workers? The odds of collecting any of these debts are usually slim to none, but if you can prod your personal debtors into paying you back before they get further strapped for cash, it will not only help you but it will also give you some additional wherewithal to help those very same people if they become destitute later.

If at all possible, remain or become debt-free. Being debt-free means that you are freer, period. You don’t have to sweat credit card payments. You don’t have to sweat home or auto repossession or loss of your business. You don’t have to work 6 percent more, or 10 percent more, or 18 percent more just to stay even.

– Conquer the Crash, Chapter 29

9) Should you invest in commodities, such as crude oil?

Short Answer: Mostly NO

Long Answer: Pay particular attention to what happened in 1929-1932, the three years of intense deflation in which the stock market crashed. As you can see, commodities crashed, too.

You can get rich being short commodity futures in a deflationary crash. This is a player’s game, though, and I am not about to urge a typical investor to follow that course. If you are a seasoned commodity trader, avoid the long side and use rallies to sell short. Make sure that your broker keeps your liquid funds in T-bills or an equally safe medium.

There can be exceptions to the broad trend. A commodity can rise against the trend on a war, a war scare, a shortage or a disruption of transport. Oil is an example of a commodity with that type of risk. This commodity should have nowhere to go but down during a depression.

– Conquer the Crash, Chapter 21

10) Should you invest in cash?

Short Answer: YES

Long Answer: For those among the public who have recently become concerned that being fully invested in one stock or stock fund is not risk-free, the analysts’ battle cry is “diversification.” They recommend having your assets spread out in numerous different stocks, numerous different stock funds and/or numerous different (foreign) stock markets. Advocates of junk bonds likewise counsel prospective investors that having lots of different issues will reduce risk.

This “strategy” is bogus. Why invest in anything unless you have a strong opinion about where it’s going and a game plan for when to get out? Diversification is gospel today because investment assets of so many kinds have gone up for so long, but the future is another matter. Owning an array of investments is financial suicide during deflation. They all go down, and the logistics of getting out of them can be a nightmare. There can be weird exceptions to this rule, such as gold in the early 1930s when the government fixed the price, or perhaps some commodity that is crucial in a war, but otherwise, all assets go down in price during deflation except one: cash.

– Conquer the Crash, Chapter 18

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For more on deflation, download Prechter’s FREE 60-page Deflation Survival eBook or browse various deflation topics like those below at www.elliottwave.com/deflation.

• What happens during deflation?
• Why is deflation bad?
• Effects of deflation
• Deflationary spiral
• And much more in Prechter’s FREE Deflation Survival Guide.

---

Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter 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.

This article is part of a syndicated series about deflation from market analyst Robert Prechter, the world’s foremost expert on and proponent of the deflationary scenario. For more on deflation and how you can survive it, download Prechter’s FREE 60-page Deflation Survival eBook, part of Prechter’s NEW Deflation Survival Guide.

The following article was adapted from Robert Prechter’s NEW Deflation Survival eBook, a free 60-page compilation of Prechter’s most important teachings and warnings about deflation.

By Robert Prechter, CMT

I am tired of hearing people insist that the Fed can expand credit all it wants. Sometimes an analogy clarifies a subject, so let’s try one.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing Jaguar automobiles and providing them to as many people as possible. To facilitate that goal, it begins operating Jaguar plants all over the country, subsidizing production with tax money. To everyone’s delight, it offers these luxury cars for sale at 50 percent off the old price. People flock to the showrooms and buy. Later, sales slow down, so the government cuts the price in half again. More people rush in and buy.

Sales again slow, so it lowers the price to $900 each. People return to the stores to buy two or three, or half a dozen. Why not? Look how cheap they are! Buyers give Jaguars to their kids and park an extra one on the lawn.

Finally, the country is awash in Jaguars. Alas, sales slow again, and the government panics. It must move more Jaguars, or, according to its theory — ironically now made fact — the economy will recede. People are working three days a week just to pay their taxes so the government can keep producing more Jaguars. If Jaguars stop moving, the economy will stop. So the government begins giving Jaguars away. A few more cars move out of the showrooms, but then it ends. Nobody wants any more Jaguars. They don’t care if they’re free. They can’t find a use for them. Production of Jaguars ceases. It takes years to work through the overhanging supply of Jaguars. Tax collections collapse, the factories close, and unemployment soars. The economy is wrecked. People can’t afford to buy gasoline, so many of the Jaguars rust away to worthlessness. The number of Jaguars — at best — returns to the level it was before the program began.

The same thing can happen with credit.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing credit and providing it to as many people as possible. To facilitate that goal, it begins operating credit-production plants all over the country, called Federal Reserve Banks. To everyone’s delight, these banks offer the credit for sale at below market rates. People flock to the banks and buy. Later, sales slow down, so the banks cut the price again. More people rush in and buy. Sales again slow, so they lower the price to one percent. People return to the banks to buy even more credit. Why not? Look how cheap it is! Borrowers use credit to buy houses, boats and an extra Jaguar to park out on the lawn. Finally, the country is awash in credit.

Alas, sales slow again, and the banks panic. They must move more credit, or, according to its theory — ironically now made fact — the economy will recede. People are working three days a week just to pay the interest on their debt to the banks so the banks can keep offering more credit. If credit stops moving, the economy will stop. So the banks begin giving credit away, at zero percent interest. A few more loans move through the tellers’ windows, but then it ends. Nobody wants any more credit. They don’t care if it’s free. They can’t find a use for it. Production of credit ceases. It takes years to work through the overhanging supply of credit. Interest payments collapse, banks close, and unemployment soars. The economy is wrecked. People can’t afford to pay interest on their debts, so many bonds deteriorate to worthlessness. The value of credit — at best — returns to the level it was before the program began.

See how it works?

Is the analogy perfect? No. The idea of pushing credit on people is far more dangerous than the idea of pushing Jaguars on them. In the credit scenario, debtors and even most creditors lose everything in the end. In the Jaguar scenario, at least everyone ends up with a garage full of cars. Of course, the Jaguar scenario is impossible, because the government can’t produce value. It can, however, reduce values. A government that imposes a central bank monopoly, for example, can reduce the incremental value of credit. A monopoly credit system also allows for fraud and theft on a far bigger scale. Instead of government appropriating citizens’ labor openly by having them produce cars, a monopoly banking system does so clandestinely by stealing stored labor from citizens’ bank accounts by inflating the supply of credit, thereby reducing the value of their savings.

I hate to challenge mainstream 20th century macroeconomic theory, but the idea that a growing economy needs easy credit is a false theory. Credit should be supplied by the free market, in which case it will almost always be offered intelligently, primarily to producers, not consumers. Would lower levels of credit availability mean that fewer people would own a house or a car? Quite the opposite. Only the timeline would be different.

Initially it would take a few years longer for the same number of people to own houses and cars – actually own them, not rent them from banks. Because banks would not be appropriating so much of everyone’s labor and wealth, the economy would grow much faster. Eventually, the extent of home and car ownership – actual ownership – would eclipse that in an easy-credit society. Moreover, people would keep their homes and cars because banks would not be foreclosing on them. As a bonus, there would be no devastating across-the-board collapse of the banking system, which, as history has repeatedly demonstrated, is inevitable under a central bank’s fiat-credit monopoly.

Jaguars, anyone?

……….

For more on deflation, download Prechter’s FREE 60-page Deflation Survival eBook or browse various deflation topics like those below at www.elliottwave.com/deflation.

• What happens during deflation?
• Why is deflation bad?
• Effects of deflation
• Deflationary spiral
• And much more in Prechter’s FREE Deflation Survival Guide.

---

Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter 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.

This article is part of a syndicated series about deflation from market analyst Robert Prechter, the world’s foremost expert on and proponent of the deflationary scenario. For more on deflation and how you can survive it, download Prechter’s FREE 60-page Deflation Survival eBook, part of Prechter’s NEW Deflation Survival Guide.

The following article was adapted from Robert Prechter’s NEW Deflation Survival eBook, a 60-page compilation of Prechter’s most important teachings and warnings about deflation.

By Robert Prechter, CMT

Myth 1: “War Will Bail Out the Economy”

Many people argue that war will bring both inflation and economic boom. Wars have not been fought in order to inflate money supplies. You might recall that Germany went utterly broke in 1923 via hyperinflation yet managed to start a world war 16 years later, which was surely not engaged in order to inflate the country’s money supply. Nor are wars and inflated money supplies guarantors of economic boom. The American colonies and the Confederate states each hyperinflated their currencies during wartime, but doing so did not help their economies; quite the opposite. With respect to war, the standard procedure today would be for the government to borrow to finance a war, which would not necessarily guarantee inflation. If new credit at current prices were unavailable, either the new debt could not be sold or it would “crowd out” other new debt. The U.S. could decide to inflate its currency as opposed to the credit supply. As explained in Conquer the Crash, doing so would be seen today as a highly imprudent course, so it is unlikely, to say the least. If it were to occur anyway, the collapse of bond prices in response would neutralize the currency inflation until the credit markets were wiped out. Despite these arguments, I concede that war can be so disruptive, involving the destruction of goods and the curtailment of commercial services, that the environment from the standpoint of prices could end up appearing inflationary. To summarize my view, the monetary result may not be certain, but an inflationary result is hardly inevitable.

There is in fact a reliable relationship between monetary trends and war. A downturn in social mood towards defensiveness, anger and fear causes people to (1) withdraw credit from the marketplace, which reduces the credit supply and (2) get angry with one another, which eventually leads to a fight. That’s why The Elliott Wave Theorist has been predicting both deflation and war. You cannot cure one with the other; they are results of the same cause.

Myth 2: “Deflation Will Cause a Run on the Dollar, Which Will Make Prices Rise”

This is an argument that deflation will cause inflation, which is untenable. In terms of domestic purchasing power, the dollar’s value should rise in deflation. You will then be able to buy more of most goods and services.

It is unknown how the dollar will fare against other currencies, and there is no way to answer that question other than following Elliott wave patterns as they develop. From the standpoint of predicting deflation, the dollar’s convertibility ratios are irrelevant. There may well be a “run on the dollar” against foreign currencies, but it would not be because of deflation. I think the impulse to predict a run on the dollar comes from people who own a lot of gold, silver or Swiss francs. They feel the ’70s returning, and so they envision the dollar falling against all of these alternatives. If deflation occurs, a concurrent drop in the dollar relative to other currencies would be for other reasons. Perhaps the dollar is overvalued because it has enjoyed reserve status for so long, which might make it fall relative to other currencies. If this is what you expect, what are you going to buy in the currency arena? The yen? Japan has been leading the way into the abyss. The Euro? Depression will wrack the European Union. Maybe the Swiss franc or the Singapore dollar. But these are technical questions, not challenges to deflation or domestic price behavior.

Myth 3: “Consumers Remain the Engine Driving the U.S. Economy”

Only producers can afford to buy things. A consumer qua consumer has no economic value or power.

The only way that consumers who are not (adequate) producers can buy things is to borrow the money. So when economists tell you that the consumer is holding up the economy, they mean that expanding credit is holding up the economy. This is a description of the problem, not the solution! The more the consumer goes into hock, the worse the problem gets, which is precisely the opposite of what economists are telling us. The more you hear that the consumer is propping up the economy, the more you know that the debt bubble is growing, and with it the risk of deflation.

……….

For more on deflation, download Prechter’s FREE 60-page Deflation Survival eBook or browse various deflation topics like those below at www.elliottwave.com/deflation.

• What happens during deflation?
• Why is deflation bad?
• Effects of deflation
• Deflationary spiral
• And much more in Prechter’s FREE Deflation Survival Guide.

---

Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter 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.

This article is part of a syndicated series about deflation from market analyst Robert Prechter, the world’s foremost expert on and proponent of the deflationary scenario. For more on deflation and how you can survive it, download Prechter’s FREE 60-page Deflation Survival Guide now.

The following article was adapted from Robert Prechter’s 2002 New York Times, Wall Street Journal and Amazon best-seller, Conquer the Crash – You Can Survive and Prosper in a Deflationary Depression.

By Robert Prechter, CMT

Seventy years of nearly continuous inflation have made most people utterly confident of its permanence. If the majority of economists have any monetary fear at all, it is fear of inflation, which is the opposite of deflation.

As for the very idea of deflation, one economist a few years ago told a national newspaper that deflation had a “1 in 10,000” chance of occurring. The Chairman of Carnegie Mellon’s business school calls the notion of deflation “utter nonsense.” A professor of economics at Pepperdine University states flatly, “Rising stock prices will inevitably lead to rising prices in the rest of the economy.” The publication of an economic think-tank insists, “Anyone who asserts that deflation is imminent or already underway ignores the rationale for fiat currency — that is, to facilitate the manipulation of economic activity.” A financial writer explains, “Deflation…is totally a function of the Federal Reserve’s management of monetary policy. It has nothing to do with the business cycle, productivity, taxes, booms and busts or anything else.” Concurring, an adviser writes in a national magazine, “U.S. deflation would be simple to stop today. The Federal Reserve could just print more money, ending the price slide in its tracks.” Yet another sneers, “Get real,” and likens anyone concerned about deflation to “small children.” One maverick economist whose model accommodates deflation and who actually expects a period of deflation is nevertheless convinced that it will be a “good deflation” and “nothing to fear.” On financial television, another analyst (who apparently defines deflation as falling prices) quips, “Don’t worry about deflation. All it does is pad profits.” A banker calls any episode of falling oil prices “a positive catalyst [that] will put more money in consumers’ pockets. It will benefit companies that are powered by energy and oil, and it will benefit the overall economy.” Others excitedly welcome recently falling commodity prices as an economic stimulus “equivalent to a massive tax cut.” A national business magazine guarantees, “That’s not deflation ahead, just slower inflation. Put your deflation worries away.” The senior economist with Deutsche Bank in New York estimates, “The chance of deflation is at most one in 50” (apparently up from the 1 in 10,000 of a couple of years ago). The President of the San Francisco Fed says, “The idea that we are launching into a prolonged period of declining prices I don’t think has substance.” A former government economist jokes that deflation is “57th on my list of worries, right after the 56th — fear of being eaten by piranhas.” These comments about deflation represent entrenched professional opinion.

As you can see, anyone challenging virtually the entire army of financial and economic thinkers, from academic to professional, from liberal to conservative, from Keynesian socialist to Objectivist free-market, from Monetarist technocratic even to many vocal proponents of the Austrian school, must respond to their belief that inflation is virtually inevitable and deflation impossible.

……….

For more on deflation, download Prechter’s FREE 60-page Deflation Survival Guide or browse various deflation topics like those below at www.elliottwave.com/deflation.

• Is deflation a precursor to depression?
• The case for deflation
• US deflation risk
• Can the Fed stop deflation?
• And much more in Prechter’s FREE Deflation Survival Guide.

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Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter 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.

The following article is excerpted from a recent issue Elliott Wave International’s Financial Forecast.

Elliott Wave International (EWI) is offering the full 10-page issue, entitled “The Most Important Investment Report You’ll Read in 2009,” free for a limited time. In addition to the following market commentary, it includes independent forecasts of stocks, bonds, metals, the U.S. dollar and economic trends.

Visit EWI to download the full report, free.

By Steve Hochberg and Pete Kendall
Editors of The Elliott Wave Financial Forecast

As Conquer the Crash so boldly counseled, prosperity entails managing one’s finances and livelihood so as to be in tune with a 1930s’ style deflationary depression. But conventional wisdom disagrees. “There’s no comparison” to the Great Depression, says the world’s leading financial authority, U.S. Federal Reserve Chairman Ben Bernanke: “I’ve written books about the Depression. We didn’t have the social safety net that we have today. So let’s put that out of our minds.” He cites as evidence a 25% unemployment rate, a one-third decline in U.S. GDP and a 90% decline in stock prices, all of which occurred during the 1930s’ depression.

Unfortunately, what Bernanke’s managed to do is put one important word out of his mind—yet. Like the rest of the “this is no depression” camp, he fails to note that his cited figures are the extreme readings of that era. Bernanke also ignores the critical fact that today’s bear market is actually ahead of where the stock market was at the same point during the 1929-1932 decline and that the economy is lurching lower in a manner suggesting strongly that it will have little trouble keeping pace with the economic contraction of the 1930s (see Economy & Deflation section below).

Another common refrain is that, in contrast to the early 1930s, there are now competent financial authorities doing everything in their power to unlock the credit markets and reignite the bull market in equities. It’s certainly true that the Fed is doing everything in its power, and even some things that aren’t, to reel in the crisis. The U.S. Treasury is doing likewise. By Bianco Research’s tally, the potential total of U.S. bailouts is closing in on $9 trillion. But these efforts are every bit as impotent as Conquer the Crash and the September issue of The Elliott Wave Financial Forecast suggested that they would be. Here’s the key quote from the September EWFF: “The bailouts keep coming at lower lows, signaling further declines ahead.” Incredibly to most people, since this quote appeared the Dow has declined by another 30% and various government financial wizards have put forward even bolder yet more haphazard “rescue” initiatives.

The ballooning bailout makes us more convinced than ever that it will fail. The whole “Keystone Cops” approach to “the rescue” strengthens our conviction. One day the bailout is aimed at jacking up asset prices; the next it is buying mortgages; the next it is rescuing the consumer; and the next it’s all-hands-on-deck to prop up whoever it is that happens to be failing on that day. The alphabet soup of rescue programs now includes ABCPMMMFLF (no, we didn’t make this up), which is supposed to “shore up” the $1 trillion asset-backed commercial paper markets. And still, credit spreads shoot higher.

Another program, the “systematically significant failing institutions program” (SSFIP), was established in November to deliver a $40 billion “equity injection” into AIG. The problem, which will probably become the focus of intense Congressional scrutiny at some later point, is that the injection was made in October, before the program even existed. The Wall Street Journal puts it this way: “Practically every day the government launches a massively expensive new initiative to solve the problems that the last day’s initiative did not.” At the latest economic summit in mid-November, the U.S. and other nations were reputedly “close to a deal to create a new ‘early warning system’ to detect weaknesses in the global financial system before they reach epic proportions.” Among the stated objectives: greater transparency. Of course, “sources spoke on the condition of anonymity because plans are still being worked out.” The real reason that these people want to remain anonymous is that like everyone else, they recognize the proportions of the unfolding epic and thus the futility of the bailout effort.

For more information on navigating the current market turmoil, including forecasts of stocks, bonds, metals, the U.S. dollar and economic trends, download Elliott Wave International’s free 10-page report, The Most Important Investment Report You’ll Read in 2009.

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Steve Hochberg began his professional career with Merrill Lynch & Co. and joined Elliott Wave International in 1994. He became co-editor of The Elliott Wave Financial Forecast for its inaugural issue in July 1999. Pete Kendall joined Elliott Wave International as a researcher in 1992. He has been co-editor of The Elliott Wave Financial Forecast since its inception in July 1999. He is also the director of Elliott Wave International’s Center for Cultural Studies.

Here’s a forecast for you. Clear and direct. As quoted by a Reuters reporter in his January 15, 2009, article, entitled, “Global Lending Thaw May Yet Return to Deep Freeze.”

“‘This is a temporary respite and when it’s over, the stock market will make new lows…,’ says Robert Prechter, chief executive officer at research company Elliott Wave International in Gainesville, Georgia.” [Reuters, 1/15/09]

But there are lots of forecasts out there – for the economy, for the Dow, for the price of oil, for the chances of the Boston Celtics repeating as NBA champions – so the question arises, how can you tell a good forecast from a bad one?

Bob Prechter addressed that very question with another reporter in a Q&A originally published in the book, Prechter’s Perspective.

Editor’s Note: For more market insights from Bob Prechter, visit Elliott Wave International to download Prechter’s FREE 60-page Deflation Survival eBook, part of Prechter’s NEW Deflation Survival Guide.

The following text was originally published in Robert Prechter’s 2004 bestselling book, Prechter’s Perspective.

By Robert Prechter, CMT

Q: In general, is there any way for a person to tell a good forecast from a bad one?

Bob Prechter: There is a subtle way to tell a potentially useful forecast from a useless one. Most published forecasts are at best descriptions of what already has happened. I never give any forecast a second thought unless it addresses the question of the point at which a change in trend may occur.

As an example outside the financial markets: a sportswriter for the Atlanta Journal-Constitution published his ratings (scale 1-5) for each of the players on the Atlanta Braves baseball team as a forecast of how they would perform in 1984. At the start of the season, he rated 1983′s Most Valuable Player a “5,” Atlanta’s slugger a “4,” and the right fielder a lowly “2″ due to bad performance in 1983 following two excellent years. Later in 1984, the MVP was batting only .215, and the slugger was batting a dismal .179, while the lowest-rated player, the right fielder, had hit 8 home runs and led the team in batting average and RBIs.

The point is not that the sportswriter was wrong in his predictions. The point is that he didn’t make any predictions, even though he thought he did and said he did. He was merely rating the 1983 Braves in retrospect. He ignored possible bases upon which to forecast the 1984 season, things like motivation, new developments or events in a player’s life, cyclic changes in playing success, etc. As with most forecasts, these things weren’t even considered.

Read forecasts carefully. If they are mild-mannered extrapolations of a recent trend, it’s probably the best policy to toss them aside and go search for something potentially useful.

Q: Obviously, the same holds true in finance.

Bob Prechter: All the time. When economists say, as they so often do, that they see “no reason to expect anything different” from the recent past, they mean it from the bottom of their knowledge. The linear projections they typically employ result in logic such as that expressed by an economist in a national newspaper, who said, “This rising consumer confidence is good news for the economy. Rising confidence spurs the economy, and the pickup in the economy then serves to heighten confidence.” By this line of reasoning, no change of direction could ever occur. That’s why, absent other knowledge, the only forecasts even worth your time considering are those that predict a change. Not because the forecaster is certain to be right, but because it shows that he is thinking and perhaps employing a tool that can anticipate trends.

Q: So the word “prediction” doesn’t necessarily apply to the future!

Bob Prechter: Right. And it’s those predictions about the future that are the tough ones. That’s why economists stick to predicting the past, which is a crafty solution. It leads to misery among the people who follow them, but it doesn’t seem to affect economists’ jobs, so it certainly keeps them happy!

Q: Do you think that predicting the economy is possible?

Bob Prechter: It is not only possible, it is downright easy compared with predicting the stock market. One economist has gotten a lot of chuckles by saying that the stock market has predicted something like 19 of the last 13 recessions. However, that is only a reasonable statement if you believe that a certain rigid definition of a recession is the only one that is viable. In fact, if you look at the ebb and flow of economic activity and generally realize that it lags stock market activity of between 0 and 12 months, you will find that there is no better single indicator of what the economy is going to do than the stock market. Not only that, but even 19 out of 13 is infinitely better than any economist has ever done.

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For more on deflation, download Prechter’s FREE 60-page Deflation Survival eBook or browse various deflation topics like those below at www.elliottwave.com/deflation.

• What happens during deflation?
• Deflation survival
• Why is deflation bad?
• Deflation personal debt
• And much more in Prechter’s FREE Deflation Survival Guide.

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Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter 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.

Elliott Wave International, the world’s largest market forecasting firm, receives thousands of questions every year from web site visitors and subscribers on their free Message Board.

Here the company shares 6 of the recent critical questions on the financial crisis and 6 answers provided by their professional analysts.

For more free questions and answers or to submit your own question, visit Elliott Wave International’s Message Board.

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Q: Can increased government spending help stop the crisis?
What do you think about the new mortgage bailout plan – or bailouts and proposals for additional government spending in general? The opinions on whether or not this will ultimately work seem so divided…

Answer:
In Ch. 13 of his Conquer the Crash, “Can the Fed Stop Deflation?”, Bob Prechter writes; quote: “Can the government spend our way out of deflation and depression? Governments sometimes employ aspects of’ ‘fiscal policy,’ i.e., altering spending or taxing policies, to ‘pump up’ demand for goods and services. Raising taxes for any reason would be harmful. Increasing government spending (with or without raising taxes) simply transfers wealth from savers to spenders, substituting a short-run stimulus for long-run financial deterioration. Japan has used this approach for twelve years, and it hasn’t worked. Slashing taxes absent government spending cuts would be useless because the government would have to borrow the difference. Cutting government spending is a good thing, but politics will prevent its happening prior to a crisis. … Prior excesses have resulted in a lack of solutions to the deflation problem. Like the discomfort of drug addiction withdrawal, the discomfort of credit addiction withdrawal cannot be avoided. The time to have thought about avoiding a system-wide deflation was years ago. Now it’s too late. It does not matter how it happens; in the right psychological environment, deflation will win, at least initially.”

Q: In deflation, what’s best: to have no debts or preserve capital?
During a deflationary period, if you had to choose one or the other – debt reduction or preservation of capital – which one is MOST important?

Answer:
In Ch. 29 of Conquer the Crash, “Calling in Loans and Paying off Debts,” Elliott Wave International’s founder and president Bob Prechter writes; quote: “Being debt-free means that you are freer, period. You don’t have to sweat credit card payments. You don’t have to sweat home or auto repossession or loss of your business. You don’t have to work 6 percent more, or 10 percent more, or 18 percent more just to stay even. …the best mortgage is none at all. If you own your home outright and lose your job, you will still have a residence.” Of course, one could pay off some debts AND keep some capital – it all depends on an individual’s risk appetite and tolerance.

Q: Which news and events can move the market and which can’t?
I’ve noticed that a lot of times, the stock market does the opposite of what the news suggests it should do – or does nothing at all. Can you make a distinction, if there is one, between news that does not move the market and the news that does? I’m talking specifically about the news and anticipation of another bailout plan plus stimulus package that is supposedly rallying U.S. stocks right now.

Answer:
The subject of the news is almost irrelevant. What IS relevant is the state of investors’ collective mood at the time of the news release. If they feel bullish (or bearish), they will interpret just about any news story as bullish (or bearish) too. (Or “dismiss the news,” as financial commentators often put it.) If you need a good example, just compare the February 6 horrific U.S. jobs report with that day’s rally in the DJIA. Or, contrast the February 10 passage of the “$838 Billion Economic Stimulus Package” with a 300+ drop on the Dow. The important thing to keep in mind is that while the news can cause short-term price spikes, it has no effect on the longer-term trend; only social mood does.

Q: If this deflation deepens, will the US dollar crash?
Bob Prechter’s Conquer the Crash and your monthly publications like Bob’s Elliott Wave Theorist, you’ve been saying that in deflation, “cash is king” as the value of the dollar rises. But won’t the U.S. government’s spending spree cause the dollar to crash instead against the euro and other currencies?

Answer:
It’s very important to make a distinction between the dollar’s domestic and international values. In a deflation, the value of any currency – the U.S. dollar, in this case – rises domestically: As asset prices fall, each unit of currency buys more domestically-available goods and services. “Cash is the only asset that assuredly rises in value during deflation.” – Bob Prechter, Conquer the Crash, Ch. 18. However, the USD’s international value (as represented by the U.S. Dollar Index) in a deflation can rise OR fall relative to other currencies. If, for instance, the euro is deflating faster than the dollar, then the dollar’s value relative to the euro will rise, and vice versa.

Q: Won’t government bailouts turn deflation into inflation?
Trillions of dollars in bailouts “injected” into the economy – won’t they reverse deflation and turn it into inflation instead?

Answer:
Here is a quote from Bob Prechter’s October 2008 Elliott Wave Theorist: “Believers in perpetual inflation think that the government can keep assuming others’ bad debts infinitely. But it can’t. The only reason that Congress has gotten away with issuing this latest blizzard of new IOUs is that society is still near the top of a Grand Supercycle, so optimism and confidence still have the upper hand. But as pessimism and skepticism continue to wax and the economy contracts, the bond market will figure out that the Treasury will be unable to fund all these obligations with tax collections. Then Treasury bond prices will begin falling as if they were sub-prime mortgages. A collapsing bond market is deflation; it is a contraction of the outstanding credit supply. Recent bailout schemes will not reverse the deflationary freight train. They will serve only to confuse the marketplace and hinder the efficient retirement of bad debts, thus exacerbating the crisis and aggravating investors’ uncertainties and thereby falling right in line with the declining trend of social mood.”

Q: When will recession end – and DEPRESSION begin?
When do you think the economic DEPRESSION will officially begin?

Answer:
It took mainstream economists over a year to recognize the “official” start of the recession! Because a depression is a much bigger and rarer event, the delay with its “official” recognition will likely be even greater. Not to mention the fact that, interestingly, there is no “official” definition of a depression; even if there were one, ours here at Elliott Wave International would probably differ. Rest assured, though: We intend to update subscribers on any “progress” in that direction.

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Elliott Wave International (EWI) is the world’s largest market forecasting firm. EWI’s 20-plus analysts provide around-the-clock forecasts of every major market in the world via the internet and proprietary web systems like Reuters and Bloomberg. EWI’s educational services include conferences, workshops, webinars, video tapes, special reports, books and one of the internet’s richest free content programs, Club EWI.