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 deflation and inflation, including money-saving steps for protecting your wealth, download Elliott Wave International’s free 8-page report, Inflation vs. 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.

Why Your FDIC-Backed Bank Could Fail
November 11, 2008

With big bank bailouts dominating the news, there’s no better time to get the truth about bank safety.

This informative article has been excerpted from Bob Prechter’s New York Times bestseller Conquer the Crash. Unlike recent news articles that are responding to the banking crisis, it was published in 2002 before anyone was even talking about bank safety. However, you may find the information even more valuable today than ever before.

For even more information on bank safety, visit Elliott Wave International to download the free 10-page report, Discover the Top 100 Safest U.S. Banks. It contains details on how you can protect your money from the current financial crisis, updated for 2008.

Risks in Banking

Between 1929 and 1933, 9000 banks in the United States closed their doors. President Roosevelt shut down all banks for a short time after his inauguration. In December 2001, the government of Argentina froze virtually all bank deposits, barring customers from withdrawing the money they thought they had. Sometimes such restrictions happen naturally, when banks fail; sometimes they are imposed. Sometimes the restrictions are temporary; sometimes they remain for a long time.

Why do banks fail? For nearly 200 years, the courts have sanctioned an interpretation of the term ‘deposits’ to mean not funds that you deliver for safekeeping but a loan to your bank. Your bank balance, then, is an IOU from the bank to you, even though there is no loan contract and no required interest payment. Thus, legally speaking, you have a claim on your money deposited in a bank, but practically speaking, you have a claim only on the loans that the bank makes with your money.

If a large portion of those loans is tied up or becomes worthless, your money claim is compromised. A bank failure simply means that the bank has reneged on its promise to pay you back. The bottom line is that your money is only as safe as the bank’s loans. In boom times, banks become imprudent and lend to almost anyone. In busts, they can’t get much of that money back due to widespread defaults. If the bank’s portfolio collapses in value, say, like those of the Savings & Loan institutions in the U.S. in the late 1980s and early 1990s, the bank is broke, and its depositors’ savings are gone.

Because U.S. banks are no longer required to hold any of their deposits in reserve, many banks keep on hand just the bare minimum amount of cash needed for everyday transactions. Others keep a bit more. According to the latest Fed figures, the net loan-to-deposit ratio at U.S. commercial banks is 90 percent. This figure omits loans considered securities such as corporate, municipal and mortgage-backed bonds, which from my point of view are just as dangerous as everyday bank loans. The true loan-to-deposit ratio, then, is 125 percent and rising. Banks are not just lent to the hilt; they’re past it.

Some bank loans, at least in the current benign environment, could be liquidated quickly, but in a fearful market, liquidity even on these so-called securitieswill dry up. If just a few more depositors than normal were to withdraw money, banks would have to sell some of these assets, depressing prices and depleting the value of the securities remaining in their portfolios. If enough depositors were to attempt simultaneous withdrawals, banks would have to refuse. Banks with the lowest liquidity ratios will be particularly susceptible to runs in a depression. They may not be technically broke, but you still couldn’t get your money, at least until the banks’loans were paid off.

You would think that banks would learn to behave differently with centuries of history to guide them, but for the most part, they don’t. The pressure to show good earnings to stockholders and to offer competitive interest rates to depositors induces them to make risky loans. The Federal Reserve’s monopoly powers have allowed U.S. banks to lend aggressively, so far without repercussion. For bankers to educate depositors about safety would be to disturb their main source of profits. The U.S. government’s Federal Deposit Insurance Corporation guarantees to refund depositors’ losses up to $100,000, which seems to make safety a moot point. Actually, this guarantee just makes things far worse, for two reasons. First, it removes a major motivation for banks to be conservative with your money. Depositors feel safe, so who cares what’s going on behind closed doors? Second, did you know that most of the FDIC’s money comes from other banks? This funding scheme makes prudent banks pay to save the imprudent ones, imparting weak banks’ frailty to the strong ones. When the FDIC rescues weak banks by charging healthier ones higher premiums, overall bank deposits are depleted, causing the net loan-to-deposit ratio to rise.

This result, in turn, means that in times of bank stress, it will take a progressively smaller percentage of depositors to cause unmanageable bank runs. If banks collapse in great enough quantity, the FDIC will be unable to rescue them all, and the more it charges surviving banks in premiums,the more banks it will endanger. Thus, this form of insurance compromises the entire system. Ultimately, the federal government guarantees the FDIC’s deposit insurance, which sounds like a sure thing. But if tax receipts fall, the government will be hard pressed to save a large number of banks with its own diminishing supply of capital. The FDIC calls its sticker a symbol of confidence, and that’s exactly what it is.

For more information on bank safety, including how to choose a safe bank during the current financial crisis, download EWI’s free 10-page report, Discover the Top 100 Safest U.S. Banks.

Before it became the worst credit crisis since the Great Depression, the credit crisis used to be an arcane topic discussed only in financial publications. Now, it’s on every computer, television screen, and front page of every newspaper in the world.

It may have you worried about what you can do to get through it with your personal finances still intact. What can you do about it?

Download Your Free Credit Crisis Survival Kit

Elliott Wave International, the world’s largest market forecasting firm, put together this free resource featuring 15 hand-picked reports and videos that will show you:

1. How we got into this mess
2. How to survive and prosper from it
3. When you can expect the crisis to end

The detailed analysis covers topics worrying you and millions (if not billions) of other people around the world who are learning more and more about the dangers of the Credit Crisis every day.

Here are just 5 of the 15 topics covered:

• How Do I Find a Safe Bank?
• What Happens During a Credit Implosion?
• How Do I Ride Out this Crisis?
• What If You Can’t Sell Your House?
• Buy & Hold or Sell & Fold?

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The Primary Precondition of Deflation

By Robert Prechter, CMT
Elliott
Wave International

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

Deflation
requires a precondition: a major societal buildup in the extension
of credit (and its flip side, the assumption of debt). Austrian
economists Ludwig von Mises and Friedrich Hayek warned of
the consequences of credit expansion, as have a handful of
other economists, who today are mostly ignored. Bank credit
and Elliott wave expert Hamilton Bolton, in a 1957 letter,
summarized his observations this way:

In reading a history of major depressions in the U.S. from
1830 on, I was impressed with the following:

(a) All were set off by a deflation
of excess credit. This was the one factor in common.

(b) Sometimes the excess-of-credit situation seemed to last
years before the bubble broke.

(c) Some outside event, such as a major failure, brought
the thing to a head, but the signs were visible many months,
and in some cases years, in advance.

(d) None was ever quite like the last, so that the public
was always fooled thereby.

(e) Some panics occurred under great government surpluses
of revenue (1837, for instance) and some under great government
deficits.

(f) Credit is credit, whether non-self-liquidating or self-liquidating.

(g) Deflation
of non-self-liquidating credit usually produces the greater
slumps.

Self-liquidating credit is a loan that is paid back, with
interest, in a moderately short time from production. Production
facilitated by the loan – for business start-up or expansion,
for example – generates the financial return that makes
repayment possible. The full transaction adds value to the
economy.

Non-self-liquidating credit is a loan that is not tied to
production and tends to stay in the system. When financial
institutions lend for consumer purchases such as cars, boats
or homes, or for speculations such as the purchase of stock
certificates, no production effort is tied to the loan. Interest
payments on such loans stress some other source of income.
Contrary to nearly ubiquitous belief, such lending is almost
always counter-productive; it adds costs to the economy,
not value. If someone needs a cheap car to get to
work, then a loan to buy it adds value to the economy; if
someone wants a new SUV to consume, then a loan to buy it
does not add value to the economy. Advocates claim that such
loans “stimulate production,” but they ignore the
cost of the required debt service, which burdens production.
They also ignore the subtle deterioration in the quality of
spending choices due to the shift of buying power from people
who have demonstrated a superior ability to invest or produce
(creditors) to those who have demonstrated primarily a superior
ability to consume (debtors).

Near the end of a major expansion, few creditors expect default,
which is why they lend freely to weak borrowers. Few borrowers
expect their fortunes to change, which is why they borrow
freely. Deflation
involves a substantial amount of involuntary debt
liquidation because almost no one expects deflation
before it starts.

For more on deflation,
including the following topics, see Elliott Wave International’s
free guide to deflation,
inflation, money, credit and debt. There, you can also
download two free chapters from Conquer the Crash.

Learn more about these six important topics:

1. What
is Deflation and When Does it Occur?

2. Price
Effects of Inflation and Deflation

3. The
Primary Precondition of Deflation

4. What
Triggers the Change to Deflation?

5. Why
Deflationary Crashes and Depressions Go Together

6. Financial
Values Can Disappear in 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.

Elliott Wave International, the world’s largest market forecasting firm, has just released Bob Prechter’s 10-page market letter, FREE!

Wall Street Legend and best-selling author Bob Prechter reveals 28 answers to questions you may not know to ask and the government definitely doesn’t want you to know.

You’ll read blunt commentary and sharp analysis that reveals the truth about what’s really going on in the U.S. financial markets, in Congress, and at your very own bank.

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Warning: Prechter’s answers to these questions may shock you.

• Who does the government consider to be homeowners: you and your neighbors, or the banks that hold the deeds?
• Who really benefits when the government props up Fannie Mae and Freddie Mac, and what’s the fraud behind the idea of “too important” to fail?
• Who really endorsed the emergency Housing Act – and who will be hurt by it?
• What impact did the so-called “stimulus package” have on the U.S. economy?
• Can the Fed keep making loans to banks forever?
• Is it actually against the law in some states to warn people of potentially dangerous banks?
• In an economic depression, will pension funds keep most retired Americans afloat?
• And many more!

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• The Top 100 Safest U.S. banks (two for each state)
• How you can choose a safe bank.
• Five incredibly risky banking conditions.
• How even the FDIC can’t really guarantee your money.
• Tips on international safe banking.

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Bank loans to home buyers are bad enough, but government-sponsored mortgage lenders – the Federal National Mortgage Corps. (Fannie Mae), the Federal Home Loan Mortgage Corp. (Freddie Mac) and the Federal Home Loan Bank – have extended $3 trillion worth of mortgage credit. Major financial institutions actually invest in huge packages of these mortgages, an investment that they and their clients (which may include you) will surely regret. Money magazine (December 2001) reports that the CEO of Fannie Mae “may be the most confident CEO in America.” Certainly his stockholders, clients and mortgage-package investors had better share that feeling, because confidence is the only thing holding up this giant house of cards. When real estate prices begin to fall in a deflationary crash, lenders will experience a rising number of defaults on the mortgages they hold. My guess is that the Treasury will lose the $7 billion line of credit that it is required by law to extend to these quasi-government companies and even more if it attempts a bailout. In a strong economy, few give this risk any thought. Mangers of these companies are going to be utterly shocked when a depression devastates their portfolios and their earnings. Investors in these companies’ stocks and bonds will be just as surprised when the stocks prices and bond ratings collapse. Most rating services will not see it coming.

1. 1. Your bank deposits – can they stay safe?
   2. >How do you navigate the bear market in stocks?
   3. When will the bear market end?
   4. And: what do these issues mean for the broader economy?

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