John, you asked:
>>would government devalue currency in deflation?<<
It may, but most likely will not, because one of the traditional reasons to devalue a currency is to make exports cheaper so as to increase or maintain the demand by foreign markets. If the deflation is already bringing the prices down in home currency then the products should be cheaper for the export market countries to pick up at the same currency exchange rate as before, thus rendering a currency devaluation unnecessary for that reason at least.
>>what is the goverment going to guarantee the debt instruments with?<<
The answers is Cash. In Canada the governments (Federal and Provincial) can raise cash through taxation, but only Federal government can borrow from the Bank of Canada (who prints it). Therefore the yield in Fed. gov't donds are lower compared to Provincial ones, because they have a higher level of guarantee behind them. When times get bad and corporate bankruptcies are on the increase, the yield difference between Corporate and Government bonds increase due to the increased level of risk, since Corporations may not be able the raise the cash to pay either interest or principal or both.
Generally speaking , the best investments in a deflation is cash or cash-equivalents, that's why I am stressing the government guarantees on the bonds. With cash you essentially buy the goods cheaper in the future compared to what they cost today, so you store your savings in cash to maintain/increase the purchasing power of your dollar.
Cash is King, in deflation!
However, if the central bank prints money excessively, that's inflationary and the markets picks that up in the western world almost immediately and the picture changes totally, and gold should then be the store of value.
Jaakko
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