When patients are dying, their blood pressure drops very low as their heart refuses to pump.
The same thing occurs with economies. We see it clearly in The Law of Supply and Demand. Demand greater than Supply, Prices Rise. Demand less than Supply, Prices Fall.
Deflation is a sinking of prices for everything, from workers to food to real estate. Deflations occur when economies are dying.
Today, in the U.S. and Europe, demand has fallen dramatically. Unemployment is the primary cause. People without jobs cannot buy.
Excessive debt. People holding debt cannot borrow again. Banks will not loan in this environment.
Business failures. Wherever we look in the West, we see businesses of every type closing their doors.
The cost of doing business had gone up in the boom that preceded this Depression. Those costs were no longer sustainable and these businesses failed. This was very apparent in the home building industry that relied on banks financing the construction of homes.
WHAT DOES DEFLATION DO?
In every great depression or major recession, there is a period of Deflation.
THE DEFLATION CYCLE
We see it today in Japan, which has had deflation for over twenty years. We see it as well in Ireland. In the U.S. house prices are falling continuously, and banks have stopped lending.
When deflation comes, debtors find it difficult to repay their loans. Their wages have gone down.
People anticipate the falling prices and avoid making purchases. This intensifies the recession/ depression. There is a downward spiral of all the economic functions. Prices go down, employment goes down, businesses collapse – everywhere there is depression.
As noted in my article, The Economy as a Patient, when a patient is extremely sick, all functions: kidney, heart, liver and finally, neurological, start to deteriorate, and eventually stop.
As we see in Wikipedia, the U.S. is already in a deflationary spiral:
Some economists believe the United States may be currently experiencing deflation as part of the Financial crisis of 2007 – 2010; compare the theory of debt-deflation. Year-on-year, consumer prices dropped for six months in a row to end-August 2009, largely due to a steep decline in energy prices. Consumer prices dropped 1 percent in October, 2008. This was the largest one-month fall in prices in the US since at least 1947. That record was again broken in November, 2008 with a 1.7% decline.
In response, the Federal Reserve decided to continue cutting interest rates, down to a near-zero range as of December 16, 2008. In late 2008 and early 2009, some economists feared the US could enter a deflationary spiral. Economist Nouriel Roubini predicted that the United States would enter a deflationary recession, and coined the term “stag-deflation” to describe it. It is the opposite of stagflation, which was the main fear during the spring and summer of 2008.
The United States then began experiencing measurable deflation, steadily decreasing from the first measured deflation of -0.38% in March, to July’s deflation rate of -2.10%. On the wage front, in October 2009 the state of Coloradominimum wage, which is indexed to inflation, is set to be cut, which would be the first time a state has cut its minimum wage since 1938.
This period of deflation will continue for over a decade as wages and prices fall and lenders finally find a reason to lend. In the meantime, the U.S. Government, like its predecessor in the 1930′s will expand its power, taking advantage of a population totally helpless to fight a disappearing enemy.
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