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Deflation Is A Reality

"The Federal Reserve's warning about a minor, but increased, risk of deflation rippled through financial markets Wednesday." This is a quote from the May 8th, 2003 Investors Business Daily, commenting on the brand spanking new stance from the Federal Reserve that deflation is now a reality. This is the first time since the Great Depression that the Fed has publicly acknowledged deflation as a threat.

"Deflation is the most dangerous of all economic conditions. Cases of deflation have occurred so rarely in the last 200 years that the political, economic and business leaders are completely unable to cope." This is a quote from my September 30th, 2002 column. I grabbed onto the deflation idea a few years ago because of two things. The first was the post-bubble environment of 1930's America and modern Japan. The second was the chart of inflation from 1980 until today. These presented very strong pictures as to why we would be unable to avoid some deflation now.

Our leaders' immediate reaction to deflation will be to claim that it will be mild and over quickly. They will tell us they have tools to combat the situation, and there is nothing to worry about. The Federal Reserve discount rate currently stands at 1.25%, and the experts say the Fed will lower rates to keep things calm. At 1.25%, they can't go much lower. And Japan has been at 0%, to no avail. People also say the Fed will print dollars to avoid deflation. Flood the system with cash to get things pumped up. If the Fed starts printing dollars, run, don't walk, to your nearest gold store and load up on the metal. Printing more money to get us out of this situation is a monumental mistake, and I really do not believe the Fed will go that route. And lowering interest rates isn't going to be very helpful. In other words, the reality is deflation; let's deal with it.

And deal with it you must. If not, you will be run over by it. At first, deflation seems ok. Prices are going down, that's good right? Not when your competitors are dropping their prices faster than you can drop yours, and they steal all of your business. You have to constantly look for ways to reduce your overhead. Our entire economy will be threatened by deflation for at least a few more years, and the companies that cut their prices and expenses the quickest will win.

Entire nations are using their currencies as a weapon against deflation. The Japanese government is constantly saying it doesn't want the Yen to go higher because that would hurt sales of Japanese companies. Europe just lowered their interest rates in order to decrease the value of the Euro. They are hoping that will stimulate sales. And have seen the US dollar lately. It has been getting whacked. Watch for falling prices at Wal-Mart, and everywhere else you shop.

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