Surely inflation is our greater enemy, isn’t it? Rising prices are bad for the economy. Falling prices are a good thing, aren’t they?

Inflation and deflation are due more to mindset than anything else. Let me explain.

Whether you realize it or not, you are infected with inflation mentality, which goes back to at least the 1970s. I can illustrate that for you:

Let’s say your favorite loaf of bread at your local store costs $3 today. If you go back to that same store in ten years time and are able to buy a loaf of bread identical to today’s, how much will you pay? Will it still cost $3 or will you pay more or less than $3?

Did you answer more? Why? Because you are conditioned to assuming that prices will keep rising. You would not have answered that way in 1937 and you probably would not answer that way today in Japan, where prices have been falling for many years.

What’s wrong with that? It’s true that inflation erodes the purchasing power of money, but as long as your income keeps up, rising prices are not the end of the world, are they?

There is a consequence of inflation that is far more sinister than the erosion of purchasing power and you are not even aware of it. Inflation sucks you into debt. Let me illustrate that for you as well:

Your car is three years old and you want to replace it, but you would rather wait another year. The new model costs $25,000, but you expect it could be $30,000 in a year’s time. Will you wait another year and save up a further $5,000 cash, or will you go into debt and buy it now? You will almost certainly borrow and buy the new auto now, won’t you? Why? Because you expect the price to rise. You go into more debt because of inflation. And you are infected with inflation mentality, which is the cause of the crazy, unsustainable debt bubble today. When you borrow that money from the bank, it is injected into the economy, increasing the money supply and fuelling yet more growth in consumer spending and thus the economy (and probably prices).

Now let’s reverse that situation. Let’s say you believe the price of that new auto you want will be lower next year. Say $20,000. Now will you be in such a hurry to buy it? No. You will almost certainly wait. And let’s say in 12 months time you expect the price to fall even further in the following 12 months, say to $15,000? Chances are you will make the old jalopy last yet another year.

But you will not be the only person thinking this way. Everybody will be putting off buying a new car. To such an extent that auto makers, who have failed to increase sales, even by slashing prices, have to scale back production and lay off employees. And if auto workers lose their jobs, will they be able to spend as much on shoes and clothes and restaurants and gadgets? No. But stores need cash flow to pay their rent and wages, so “50% off” sales appear everywhere. But even they do not work, and retail stores also have to shed staff. And the more prices fall the more the consumer expects them to fall, so the more they put off buying everything that is not absolutely urgent. And so the economy begins to contract and unemployment rises, all because of deflation mentality.

The lifeblood of an economy is consumer borrowing and spending, which is fuelled by the ready availability of money. When the mindset changes from inflation mentality to deflation mentality, people not only stop spending. They stop borrowing. In fact, reckless abandon changes to conservatism, and they even try and speed up the repayment of loans they already have. This disappears money from the economy back to the banks from whence it came, and so reduces money supply.

And thus the economy spirals down into a deflationary recession or even worse. Every depression in history has been accompanied by deflation, not inflation.

In the 1930s, was there any shortage of goods? Not at all. Stores were fully stocked. Was there any shortage of manpower? Hardly. Unemployment reached 25%. So what caused the depression? What was in short supply? Only one thing. Money. And the only way money comes into existence is by way of a loan from a bank. When people are reducing their indebtedness rather than increasing it, money supply shrinks and the economy contracts. Interest rates can be reduced to zero (as in Japan in recent years), but if people lose the courage and the capacity to take on more debt, they will not borrow. This is called “pushing money on a string.”

In my book “How to Profit from the Coming Great Depression” one entire chapter is devoted to this subject of deflation. You will learn why the coming downturn is inevitable and what you can do to escape the most serious consequences.

The Graham Dyer Newsletter has not missed a month’s publication since July 1983. His track record for forecasting is the envy of many, including the 1987 stock market crash, the demise of the Japanese economy and stock and real estate markets in the 1990s, the bull market for bonds from 1989, and the real estate boom this decade. His book is entitled: “How to Profit from the Coming Great Depression.” If you want to know the pitfalls of investing as well as the opportunities, Graham Dyer’s world class work is a must read. For more of Graham's work you can visit his Blog at http://www.grahamdyer.com/blog.