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Why the Threat of Deflation is Real

“The Federal Reserve is forging ahead with its balance sheet reduction”

by Bob Stokes
Updated: December 29, 2022

I know -- inflation has been grabbing all the headlines for a good while now -- so you may wonder why the subject of deflation is relevant.

First, the definitions of inflation and deflation go beyond commonly accepted meanings.

As Robert Prechter's Last Chance to Conquer the Crash says:

Inflation is an increase in the total amount of money and credit, and deflation is a decrease in the total amount of money and credit...

The most common misunderstanding about inflation and deflation... is the idea that inflation is rising prices and deflation is falling prices. General price changes, though, are simply effects.

That said, let's start off with an occurrence which is quite rare. Here's a chart and commentary from the December Elliott Wave Theorist:

M2

The chart, published by the Fed, shows that absolute M2 has been declining on a month-by-month basis for the first time in many decades, probably since the 1930s or 1940s. This trend is deflationary.

Keep in mind that M2 is a measure of the U.S. money stock that includes M1 (currency and coins held by the non-bank public, checkable deposits, and travelers' checks) plus savings deposits (including money market deposit accounts), small time deposits under $100,000, and shares in retail money market mutual funds.

Another factor regarding deflation has to do with the Fed.

Our November Global Forecast Service showed this chart and noted:

FedReserveBalanceSheet

The Federal Reserve is forging ahead with its balance sheet reduction, as the chart shows. This reduction in the central bank's assets which were paid for by money created out of thin air constitutes disinflation, and deflation (when the balance sheet is contracting on an annualized basis) will likely come by the end of the year.

So, now you see why deflation is very much on the radar screen of our Global Forecast Service, which can help you to prepare for what may be next.

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