We have studied past deflation in an attempt to understand the dynamic process involves. Blood in the Streets spelled out some of our conclusions as of 1986. We believe that deflation is much more likely at some times than others. Just as tornadoes or hurricanes occur only under certain atmospheric conditions, so spontaneous deflation and depression are not everyday dangers.

They are only likely as delayed reactions to a significant discontinuity, such as a change in political barriers, technological revolution, or a geopolitical shock. Deflation is a delayed compensation for inflation.

The world economy was buffeted in the early 1970s. The collapse of the international monetary system of fixed exchange rates based on gold disrupted price signals. And a dramatic geopolitical event (the oil shock of 1973) transfer trillions in wealth. At the same time, the economy began to experience a profound mega political transformation based upon the microchip. These developments present many parallels with the conditions that led to the deflation in the 1930s, as we argued in other posts on this website and others. There are also a number of more technical warning signs of impending deflation.

The first danger sign of deflation on the horizon is a rising percentage of debt compared to nominal GNP. In the United States in 1992, the ratio was approaching 195%, as compared to about 140% in 1929.

The second danger sign of debt deflation is a record of extraordinarily high returns in many forms of investment a decade or more ago. An unweighted average for all 15 investments listed in the frequently quoted Salomon Brothers study showed an average compound rate of return of 16.6% over the decade June 1970 to June 1980. The average compound growth rate of corporate profits since 1872 has been only 4%. And there have been many periods when the rate was much lower. Hyper normal returns like those of the 1970s, following decades of stable growth, are a danger sign that a period of some normal growth is likely to ensue.

Extraordinarily high profits during World War I were followed by lower than ordinary profits during the 20s and a massive fall off of profits in the 1930s. For the first five years of the 1980s, the unweighted average compound rate of growth for all 15 investments tracked by Salomon was just .8%.

The third danger sign of a massive deflation in the near future is the occurrence of debt compounding faster than income. As the end approaches, it is difficult for everyone to borrow with abandon. The trillions in debt added in the United States and other economies in the 1980s, however, have no parallel in their magnitude in any previous credit bubble. In the mid-80s, that debt issuance in the United States reached an astonishing 10 times the personal savings rate. For the decade as a whole, total debt grew by 11%, while nominal GNP grew by just 8%. A growing ratio of debt to income is inevitable if the real rate of interest exceeds the rate of growth of the economy. This was the case in the United States throughout the 1980s. There is clearly a limit to the percentage of income that can be devoted to debt service. It can jump from 20% to 40%. A further jump to 80% is highly unlikely. But still another doubling to 160% is mathematically impossible.

We will be discussing more of the different danger signs for debt deflation in more posts which you can find in our Articles category. We will see you then.

Most people believe that another debt deflation is no more likely than an invasion from Mars. And they behave accordingly. The average resident of English-speaking countries is deeply in debt, with the largest part of his assets invested in real estate. This is a gamble on inflation. For most real estate and other tangible assets to hold their 1990 value, let alone appreciate, inflation must rise sharply – as it seemed to be doing during the Kuwait Iraq crisis.

Even a modest deflation would stand inflated real estate, collectibles, and many other assets tumbling, wiping out many individuals, families, and businesses. Yet in spite of the huge investment stake we all have in understanding the dynamics of deflation, most individuals refuse to think about it, relying upon political promises that there will never be another depression.

Deflation More Likely Than People Think

You have heard the reasoning before…. politicians have high speed printing presses. They can make them run as fast as they please. In a choice, they would always want to inflate. Therefore, there can never be deflation. It is a sweet, simple argument. If it were true, it would make your job as an investor incredibly easy. All you would have to do to make a fortune is place a whole hog that on inflation. Just hock every asset you have, run your credit to the limit, buy some gold, and lie back to wait for the silly politicians to float your easy chair down to paradise on a river of red ink.

We don’t think it is that simple. Those who say the government has the power to prevent deflation are right. But they are answering the wrong question. Obviously, the government can print all the money it wants. He can slap any number of zeros on a piece of paper and raise the nominal money supply to a higher power. This has always been true. But it is a mistake to stop your inquiry there, because you have merely answered a misleading question. One could just as well say that the government has the power to prevent you from dying of cancer. It can. By taking you out and shooting at first. But the cure in that case, like the printing press cure for deflation, is worse than the disease.

The key to understanding the danger of deflation is to recognize that the process of deflation is less transparent than the process of inflation. Inflation corresponds to an understandable motive on the part of politicians it is easy to see how they could benefit from printing money. The early stages of inflation are often periods of boom. Easy money makes people feel richer than they are. The inflation euphoria is good for reelection prospects. Politicians tend to prosper when their constituents prosper. So if inflating puts more money in everybody’s pockets, it is clear why politicians are tempted to do it.

Inflation is particularly attractive to politicians in an economy with many organized special interests, what Mancur Olson calls distributional coalitions. These groups obtain special favors for themselves, such as subsidies, price supports, and monopolistic wages that are usually specified in nominal dollars. This means that inflation can devalue the loot that these groups take from society.

A dairy price support, for example, will be less costly to taxpayers and consumers if the dollar loses 10% of its value. A monopolistic wage that is 20% too high for prevailing conditions will cause less unemployment if inflation reduces it in real terms by 10%. For these reasons, modest inflation may in some respects increased real output. It is one of the few ways that we can do governments can loosen the stranglehold of special interests over the economy. They demand more than the economy can afford, perhaps even than the economy produces. If look total of their demands comes to an impossible 110% of output, a weak government can say yes to everyone, and use inflation as a convenient gimmick for devaluing its possible promises.

Of course we don’t pretend that major episodes of inflation in rich countries are solely explained by political expediency. Outside shocks like the OPEC embargo or world war that politicians would sell the court for short-term electoral effect also play a role. But the chronic inflations in the postwar world certainly do seem to fit institutional interests of politicians. Inflations correspond with a political motive that makes sense.

Deflation, on the other hand, doesn’t. Deflation makes many people poor. It reduces real output by tightening the stranglehold of special interests over the economy. Political rigidities and fixed prices that slow economic growth and waste resources when money is losing its value will waste even more when cash is suddenly becomes worth more. A monopolistic wage rate that is 20% too high for prevailing conditions would generate still more unemployment if deflation raised the value of the money. The loss of output due to monopolies and special interests like labor unions and professional lobbies under deflation is much worse than it is with modest inflation.

Making their constituents poor is not a rational act for politicians under most circumstances. Therefore it is difficult for many to understand how deflation could come about. Politicians apparently have no motive to set about to slash the money supply. So why do deflation’s happen? We will get to that in the next part of this series.

We answer that question in our following posts. Just as some stimulants in small doses make those who use them feel giddy, while larger doses are deadly, so there is a point where too much inflation is worse than none at all. As an ironic example, consider the British secret agents were said to have spread Argentine money through the country to undermine the economy during the Falklands war. If printing more money always made things better, governments at war would not counterfeit one others currency as an act of economic sabotage.

We will continue this series regarding the dangers of debt deflation in the modern world as 2010 moves on, and in our next post will be discussing some danger signs of impending deflation. We look forward to seeing you then on OhioLoanFind.com

It does seem rather strange that we would have to define and describe what a Prime Rate is, what it is worth mentioning quickly. Whatever the prime rate is at any particular time weighs on the entire market, businesses, and individuals like you living in Ohio who needs a loan for their small business or their family.

A prime rate is a reference note that banks use in pricing short maturity commercial loans to their best, or most creditworthy, customers. Commercial and industry loans are often priced at prime or prime plus a spread. You’ve often heard the term, “prime rate +1″, or “prime rate +2″, etc.

the prime rate is less important today in pricing bank loans to corporate borrower’s that have access to the capital markets. Starting in the 1970s, banks began pricing commercial loans at rates below the bank prime to their most creditworthy corporate customers. Many banks, however, still priced business loans under $1 million and loans to smaller borrower’s at spreads above the prime rate.

Alternatives to the bank prime rate are the lenders own cost of funds, and an index rate, such as the London Interbank offered rate (LIBOR). Although the prime rate is the definitive best rate for top-quality borrower’s, many banks maintain a two-tier pricing system where major corporations and even middle market firms are able to borrow at an even lower rate.

And you are probably wondering where the prime rate comes into play with families and individual borrowers who are financing a home or vehicle. Every loan on the market can be compared to the prime rate of course, but usually with loans such as vehicles and extras, are provided for borrowers at a rate of at least seven points above prime. If you have a really bad credit rating is possible to have a loan at a rate of 15 points above prime. It can get even uglier than that.

There are some business owners who borrow money on a corporate basis whether they be small businesses or large businesses and they can sometimes get their mortgage for their personal property at prime, a point below prime, or just a couple points above prime, but still better than what the average worker bee or employee gets their mortgage at.

Refinancing can become painstaking at times. However, while refinancing your current mortgage, you must keep in mind that there are plenty of options.

• Communicate with your existing mortgage lender and inquire about the terms and conditions of mortgage refinancing. They might wish you to lock in a particular interest rate. Inform them that you would consider it and you would get back to them. They might restrict the loan types you can obtain, however, the refinancing costs are normally nominal so frequently, it is the most suitable option.

• Don’t get restricted or feel committed to your present mortgage lender. When you’ve talked with your lender, get a reputable mortgage broker by getting references from your business partners, acquaintances or possibly from a real estate agent whom you know. They would ask for some more money against their services, but a reliable mortgage broker can help you locate suitable refinancing loans that can save you a lot of money in the end.

• Don’t make a commitment to any type of lock-in on the interest rate till the time your existing lender and mortgage broker have returned to you with the new terms and conditions so that you can compare them.

• Discuss with your credit union or bank. They might offer flexible refinancing terms and rates. Higher number of options always provides you a broad range of choices. More research is necessary, but the probability of saving money is quite high.

• Try to stay away from paying private mortgage insurance (PMI) if you can. One mortgage broker could save a borrower from paying PMI by refinancing a 15-year FHA loan to a 30-year traditional loan. The borrower had more than 20% equity in his home, but the existing mortgage lender would just refinance to another 30-year FHA loan, which necessitated PMI.

• Bargain. A number of charges on the settlement statement included in the mortgage refinancing paper works are flexible.