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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory
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To: Tommaso who wrote (33164)5/25/2005 3:20:47 PM
From: el_gaviero  Read Replies (1) of 110194
 
<<A drop in the dollar value of total credit extended is inflation. The drop in the value of bonds reflects a belief that the dollars in which they are denominated will be worth less in the future because prices are rising.>>

Prechter’s argument is far from clear, but I don’t think you got it right either.

Suppose last year the value of “total credit extended” equaled two million dollars. Suppose this year the value of total credit extended now equals one million dollars. In other words, the dollar value of total credit extended gets cut in half. Would this not, at least in some cases, be deflationary?

For example, suppose that I have a 30 year bond that I bought for 1000 dollars, which now is worth 500 dollars. Whereas last year I could have sold it for $1000, and put $1000 in my bank account, this year I can sell it for only $500. Last year, the bank could I have used my $1000 to increase its reserves by 1000 and its lending by 10,000 (if the reserve requirement were 10 percent). However, this year the bank only gets 500 and can only lend out 5000. In other words, because of the fall in the dollar value of credit, less money ends up being in circulation, hence there is deflation.
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