They say that generals tend to fight the last battle. And the generals at the Federal Reserve are no different. They constantly say they are battling inflation. But the head of the Fed's Joint Chiefs of Staff, Ben Bernanke, has lately been worrying about deflation and doing his darnedest to head it off. He has even let worries about a credit crunch outflank concerns about inflation.
Long before Bernanke came on the job, though, Bob Prechter was thinking and writing about deflation. In this excerpt from Prechter's Perspective – the useful and interesting book of questions and answers taken from his interviews with the media over the years – Bob explains how a deflationary depression will affect real estate, credit, and the U.S. dollar.
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Excerpted from Prechter's Perspective, re-issued 2004
Q.: It seems there has to be some fundamental change in our current monetary stability to produce such an extended decline that we would be facing deflation.
Bob Prechter: The most widely held belief with regard to the future course of national financial affairs is that inflation will accelerate, or, at minimum, continue. I think the case for an impending deflation is overwhelming. The next monetary trend should be a period of severe deflation, just as occurred in 1835-42 and the 1930s.
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Q: So some day, people will want inflation?
Bob Prechter: Take, for example, the real estate crunch of 1990. Some people suffering from that minor deflation were already prescribing "cures." The Wall Street Journal ran two guest editorials on the desirability of government policies that would regenerate the multi-decade phenomenon of real estate values rising faster than the CPI. The essential message was, "Bring back the real estate bubble," delivered under the illusion that the bubble period was normal life and should last forever. Well, the incredible thing is, the bubble reflated! Now, we're right back where we were in 1989 except that the distortions are even greater. A perpetual credit-fueled bubble is not possible, either mathematically or psychologically, but people will certainly want it to continue. The same desire will extend to the stock market as it falls, and the economy.
Q: In the 1970s, when the economy and the stock market sputtered, real estate did reasonably well.
Bob Prechter: As big as the disaster in stocks is likely to be over the next five to 10 years, it will almost certainly be matched by the upcoming disaster in real estate–related investments. The 1970s were inflationary: the next period of difficulty should be deflationary.
Q: Are there manifestations of euphoria in real estate?
Bob Prechter: In the past five years, people have been erecting "McMansions" all over the place – million dollar homes crowded in like condos. It's all financed with credit, and that game is ending. The trap is set.
Q: Credit will contract?
Bob Prechter: Yes, from long-term bonds all the way down to the broader measures of the money supply.
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Q: At what point might the economy deteriorate so substantially that its condition and trend are no longer bullish for bonds, but bearish?
Bob Prechter: When it reaches depression, and a depression is exactly what is on the agenda if the stock market fails to the extent that the Wave Principle suggests. The only way for a bond investor to survive a depression is to hold bonds issued by a strong borrower. Weak borrowers, such as most corporations and municipalities, will default. As investors come to the realization that default is a risk, rates on weak debt will rise as its prices fall.
Q: What happens to the dollar?
Bob Prechter: During the deflation, the dollar's domestic purchasing value should rise, as debt instruments denominated in dollars are defaulted upon. As dollars disappear, the value of the remaining dollars will rise. The same thing has been going on with the Japanese yen in terms of how much you can buy for it in Japan. But how the yen or dollar will perform against other currencies, I couldn't say. We'll have to follow the wave counts.
Q: After the initial deflationary hit, what will turn currency values back down?
Bob Prechter: It will be the pressure on national governments to create paper money to pay off their debts. Which ones will be destroyed depends upon what course each government chooses when faced with bankruptcy. I am not optimistic that most will take the honest course. Whether or not all paper currencies eventually go to zero, it will be wise to own gold after the deflation.
Q: So, in the very long run, the dollar is in trouble?
Bob Prechter: I think so. Did you know that Roman inflation persisted, in recurring waves, for over 400 years before the monetary rot was thorough enough to allow invading armies to successfully sack the city? We've had nearly 70 years of dollar inflation in the United States. Can you imagine what another 300 years of persistent dollar inflation would do to the political fabric of the United States?
Q: Is there an alternative?
Bob Prechter: The only way to guarantee that politicians will never again inflate is to introduce private money and ban legal tender laws.
Q: Private money? Do you mean gold coins issued by a private mint?
Bob Prechter: Not a private mint. By anyone who wants to issue it! The marketplace will choose the soundest forms of money, and competition will insure that the science of money is advanced. Compare the old telephone monopoly to cell phones and the Internet, and you'll get an idea of what would happen.