Friday, June 19, 2009

Inflation or Deflation

I've been expressing concern over looming hyperinflation for months now, but there is another contingent that anticipates deflation instead. Adam at Gold Versus Paper is one of the most consistent voices in preparing for deflation. He has a great post about deflation and I highly recommend reading it.

There is one important distinction to be made between the consequences of both deflation and inflation. Inflation benefits debtors, because debts diminish in size as the currency is inflated year to year. Consequently inflation harms savers because it is very difficult for those with savings to consistently find returns that exceed inflation each year.

On the other hand, deflation benefits savers with liquid assets. (Please see John Exeter's inverse liquidity pyramid at Gold Versus Paper for an explanation.) Savers benefit because their liquid assets--particularly cash and gold buy more during a deflationary period. Yet debtors are destroyed by deflation because their debts are in inflated dollars, while their income is in deflated dollars.

What this means for us now is that we must get out of debt and save as much money as we can to prepare for either inflation or deflation.

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