February 7, 2009
What is Deflation?
Deflation generally refers to falling prices and is often caused by a reduction in money supply or credit. Deflation could also be caused by reductions in government, personal, or investment spending and often has the side effect of increasing unemployment in an economy.
If you were on an island and there were ten equal goods for sale and ten $1 bills available on the island to purchase them with, we could assume that each item would end up costing $1. If the quanity of money increases to $20, the price would likely increase to $2, which is inflation. But, if the quanity of money decreases to $5, the price would likely fall to $0.50, which is deflation.
If the amount of money supply stayed the same but the quanity of goods increased, you would also see price deflation.,However, this deflation would be good, because it would mean goods are likely being manufactured more cheaply which could increase everybody's wealth.
Today, we are seeing short-term deflation in the U.S. as consumers are hoarding their Dollars and businesses are heavily discounting their inventories and having going out of business sales. With the U.S. government likely to print trillions of Dollars in the years ahead for its stimulus plans and bailouts, there will soon be too many Dollars chasing too few goods. We believe this short-term deflation will soon turn into a high level of inflation and ultimately hyperinflation.
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