Why the Threat of Deflation is Real
"The Federal Reserve is forging ahead with its balance sheet reduction"

By Elliott Wave International

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, a monthly publication which covers major financial and cultural trends:

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.

The November Global Forecast Service, an Elliott Wave International publication which analyzes 50-plus worldwide financial markets, showed this chart and noted:

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 Elliott Wave International's Global Forecast Service, which can help you to prepare for what may be next.

Understanding the Elliott wave price patterns of global stock market indexes can also be of help in anticipating what's next for major economies around the globe.

You see, the economy tends to follow the stock market, in each country.

Getting back to the Wave Principle, here are some insights from Frost & Prechter's book, Elliott Wave Principle: Key to Market Behavior:

The Wave Principle is governed by man's social nature, and since he has such a nature, its expression generates forms. As the forms are repetitive, they have predictive value.

Sometimes the market appears to reflect outside conditions and events, but at other times it is entirely detached from what most people assume are causal conditions. The reason is that the market has a law of its own. It is not propelled by the external causality to which one becomes accustomed in the everyday experiences of life. The path of prices is not a product of news. Nor is the market the cyclically rhythmic machine that some declare it to be. Its movement reflects a repetition of forms that is independent both of presumed causal events and of periodicity.

The market's progression unfolds in waves. Waves are patterns of directional movement.

Would you like to read the entire online version of this Wall Street classic -- for free?

You may do so once you become a member of Club EWI, the world's largest Elliott wave educational community.

A Club EWI membership is also free (no obligations whatsoever) and allows for complimentary access to a wealth of Elliott wave resources on investing and trading.

So, get started now by following this link: Elliott Wave Principle: Key to Market Behavior.

This article was syndicated by Elliott Wave International and was originally published under the headline Why the Threat of Deflation is Real. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.