PKT message, Super-Bear-

An inflation policy made it possible for the largest borrowers namely Federal, State, and local governments, to pay off debt with cheaper money. One dollar in the 1930s is now worth less than 5¢ cents. In 1935 the price of a new automobile was $400 the medium priced house was $6000.

"Economies only expand with inflation and contract during deflation. In one respect, inflation is a process where the public raises it demand for products, thus bidding up the price. Therefore, economic expansion takes place when such periods exist. Companies hire more workers to increase production to meet demand." Princeton Economics Institute – The Economic-Confidence Model, page 34

Inflation during the last ten years it has permitted borrowers to payoff one dollar in debt with only 48¢ cents. Yet during this ten year period government income from tax receipts will have increased by almost 200%. The effect of paying off debt with cheaper dollars has helped borrowers in the private sector as well. This is partly the reason the owners of mortgaged real estate have experience appreciation of property values commensurate with the paying off of debt with cheaper money.

Let us assume the definition of inflation/deflation has to do with credit or debt creation vs. credit or debt collapse. In recent years new debt creation has been higher than normal. The real amount of debt must deduct collapsing debt, bad debt (defaults, write offs, debt cancellation, exchanges, workouts etc.). Currently we are witnessing the largest debt defaults and collapse in history (i.e. Enron, Worldcom, USSR, Turkey, Argentina, Indonesia, etc.) The bond market is ten times larger than equities. Historically, more money has been lost in bonds than has ever existed in equities.

If “inflation” implies an increase in credit, “deflation” would imply a decrease in credit. Thus, deflation results in a falling money supply or too little money chasing to many goods and services. The association between money growth and inflation is evidence for one of the principal monetarist propositions: sustained money growth in excess of the growth of output produces inflation; to end inflation or produce deflation, money growth must fall below the growth of output.

The significance of this is the speed that the credit collapse and deflation occurs. Inflation declines to infinity or near zero. This is because the Fed “policy” inflation rate percent is deducted from an ever-decreasing monetary value. Hence, it reaches infinity, the curve flattens out and we have the beginning of “deflation.”

On the other hand, the deflation rate or exponent is a function of the amount of a collapsing money supply and wealth. The amount gets progressively larger because it is “added” to an ever-larger number. The speed and magnification of deflation will be overwhelming to most. With 7% "inflation" rate applied to a 10-year period it results in the dollar losing 52% of its value, whereas "deflation" will increase the purchasing power of the dollar by 197%.

The deflation rate functions as an integer or exponent and results in a “compound interest rate” phenomena. It increases the value of money at an increasing rate. Deflation results in a commensurate accelerating decrease in the cost of goods and services i.e. general prices.

Japan is setting the pattern for modern worldwide deflation. The Bank of Japan is reporting that debt or money creation is falling by 5% per month, even before they "resolve" the enormity of bad loans held by their banks. Wages and salaries are also falling at 6% annually (falling credit worthiness). At this rate, loan demand or money creation will fall by nearly 50% in ten years. With both wages and prices falling and increasing bad debt, money creation is imploding.

The world’s central bankers encourage inflation for the reasons stated above. From the: BBC Daily E-mail: Wednesday, 20 November, 2002 “Argentina is to raise the cost of public services, in the hope of winning new loans needed to save the country from bankruptcy. The International Monetary Fund (World Bank) has asked for a 30% rise (inflation) before it is prepared to refinance loans owed to it. The price of water, power and other basic services in poverty-stricken Argentina is to rise by presidential decree, in an attempt to secure new international loans.”

*Argentines face price rises* http://news.bbc.co.uk/go/em/fr/-/2/hi/business/2494481.stm

Many financial institutions have already instituted lending programs that will take advantage of deflation. It should be no mystery of how lenders can offer “Zero Percent Financing.” Could it be possible that banks and other lending institutions not longer wish to create profits? What it really means is that their profits will come from payments in dollars that double in purchasing power in just 10 years.

In other words, loans require future payments that will become more valuable as time passes. This phenomenon is highly profitable because profits from deflation are “Not Taxable.” In addition to a market interest rate lenders will earn the 7% deflation gain. Deflation gain is tax-free. This means that if they are in the 30% tax bracket the 7% gain is the equivalent of earning 10% on their money. This is why we now see “Zero Percent Financing.” Not a bad investment!

Over the next ten years at using deflation at the 7% rate, one dollar will buy two dollars worth of goods and services. However it also means that each dollar in debt must be paid off with nearly two dollars. Governments would have to raise taxes by nearly 500% to balance their budgets. To make matters worse, government tax revenues are falling and confidence deteriorating. Early in December 2001, three bond rating agencies-Moody's, Fitch's, and Standard & Poor's-downgraded yen-denominated debt to a level three notches below the top rating, or to the same rating given to countries such as Italy and Slovakia. As Japan's deflationary debt crisis intensifies, further discussion has arisen about additional downgrades of Japanese debt. But do not look for the credit agencies to downgrade debt before the Japanese bond market collapses.

The effect of deflation is already being felt here. Twice this year the U.S. Treasury was forced to delay paying interest on U.S. bonds held by Government employee’s pensions funds in order to pay off maturing bonds to avoid default. Even after having received income tax receipts for the previous year there was not enough “cash flow” to pay off maturing debt obligations. “Read my lips” …government is in trouble. In light of historical precedents, the coming deflationary cycle and government bond default, bankruptcy and liquidation are just a matter of time.

Now is the time for bondholders to prepare for worldwide government bankruptcy. World bankruptcy courts are already conveying the government collateral, assets functions and operations to the bondholders.

"The 2000-2002 stock market slump failed to produce a financial crisis," writes Hale. "Wealth losses in the U.S. equity market since March 2002 have been unprecedented. They have been equal to 90% of GDP, compared with 60% during the two years after the 1929 stock-market crash. But during the past two years only eleven banks failed in the U.S. compared with nearly 500 during the 1989-1991 and thousands during the 1930s." From: Bill Bonner; dailyreckoning@xxxxxxxxxxxxx; January 06, 2003

It was in 1949, if we recall correctly, that stocks recorded their lowest-ever P/E, below 6. If the Dow were to fall to ‘49-style P/Es, it would have to sink to below 2,000. The bear market that began in March 2000 vaporized about $8 trillion in the 30-month slide that ended—if indeed it did end—in early October. That loss amounts to about 85 percent of the U.S. economy’s total output this year, which is equivalent to the loss during the stock market crash that began in 1929, [Bill] Miller [who runs the Legg Mason Value Trust, a $9.3 billion fund that has outperformed Standard & Poor’s 500-stock index 11 years running, a record unmatched in the mutual fund industry] noted” (Jerry Knight, Top Performer Declares End To Bear Market, washingtonpost.com, December 2, 2002).

"When prices fall, one reason may be that consumers do not have money to buy, as in most recessions with high unemployment. Or it may be the result of potential consumers withholding their money for still lower prices, as in Japan now and in some degree in China in 1998-2000. So deflation is caused by too many goods trying to attract too little money entering the market, but not necessarily too little money in the economy. Henry C.K. Liu: December 21, 2002:

But if every seller can realize a cash surplus in a subsequent repurchase in a bear market, where does all the surplus money go? Obviously it goes to pay interest on the idle money waiting for a cheaper price, reducing the central bank's need to issue more money to carry the interest cost on idle money. The net effect is a removal of money from the market and an increase in the amount of idle money in the economy. So deflation actually pushes up interest rates without necessarily altering the aggregate money supply. The effect is that until prices fall at a lesser rate than the interest rate on idle money, there

is no incentive to buy. Thus a deflation-driven rising interest rate creates more deflationary pressure in a bear market. High interest rates move more wealth from borrowers to lenders and from bottom to top in the wealth pyramid.

Moreover, the impact of a high interest rate modifies economic behavior differently in different groups and even on different activities within the same individual. When the prime rate at leading banks exceeded 20 percent in 1980, credit continued to expand explosively. The opposite happened when the

Bank of Japan reduced the interest rate to zero. High rates only work to slow credit expansion if the rates are ahead of inflation. And zero rate only works to stimulate credit expansion if there is no deflation. So raising interest rates to combat inflation or lowering rates to combat deflation can be self-defeating under certain conditions. http://www.atimes.com/atimes/Global_Economy/DL21Dj01.html

Reflation directly reduces the velocity of money while keeping prices artificially high but not verified by transactions. Reflation is not the same as moderate inflation that accompanies growth. Reflation does not expand the economy, but merely keeps the walking dead debtors walking, keeping companies and individuals from ruinous debt-equity ratios. The new money merely goes to pay interest on non- performing loans which otherwise would default, thus increasing the amount of idle money in the economy.

As reported here yesterday, the Japanese economy declined in the midst of the biggest fiscal stimulus program in history. By the year 2000, GDP per person was no greater than it had been 7 years before.

From: Bill Bonner; dailyreckoning@xxxxxxxxxxxxx; January 07, 2003

Treasury coupons of 3% or less were standard fare from the early 1930s through the late 1940s. "Deflation" means many things. To us, it connotes a comprehensive shrinkage in prices, incomes, wages and profits. It is more than falling prices. For that matter, to reinforce the point, inflation is more than rising prices. Deflation is in almost all cases a side effect of a collapse in aggregate demand," he said in his speech - "a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers."

Inflation is a monetary phenomenon. Deflation is a credit phenomenon. The causes and consequences of deflation are directly concerned with credit, i.e., with lending and borrowing. An excess of credit formation leads to misallocation of capital, overcapacity, price competition, bankruptcy and joblessness. The root cause of inflation is money creation. The root cause of deflation is credit destruction. From: The Daily Reckoning. http://www.dailyreckoning.com/home.cfm?loc=/body_index3.cfm&qs=id=4548 : James Grant is the founder of Grant's Interest Rate Observer,

Real selling didn't even begin until the S&P was already down at least 40% from its former highs. For the NASDAQ, it was closer to a 70% plunge before the equity fund net sales light bulbs popped on. Who knows, maybe the foreign community and domestic equity fund buyers will flock back to the domestic stock market in early 2003 for all we know. But for now it seems pretty obvious that a change in perception has descended upon both of these important sectors. From: Contrary Investor - Monthly Market Observations January 2003 http://www.contraryinvestor.com/moprinter.htm

"Deflation has powerful negative economic consequences. First, it increases the real value of household and corporate (and government) debt, impairing the ability to spend or invest. Second, as prices fall and cash gains in value over time, consumers have an incentive to postpone purchases. Most important, deflation renders monetary policy potentially ineffective”. Bruce Steinberg, Merrill Lynch Chief Economist, August 26, 2002