A deflationary economy is one in which values of goods and services fall. With falling prices, on everything from stocks and property to food and clothes, the value of money necessarily rises. But there is less of it to go around as the amount of credit available shrinks.
The effects of a deflationary economy will be different for people in different positions.
If you are on a fixed income the purchasing power of your income will rise. You will have more left over after purchasing necessities than before. That is, as long as your income continues. If the bank or financial institution which pays your fixed income can continue to do so, that's fine. But in a deflationary depression many banks and financial institutions will fail.
Savers will be rewarded with increased purchasing power of their cash. The most prudent thing would be to purchase large items, like property, at cheap prices they can easily afford.
Debtors will find that they have more money left to pay debts during deflation, as the cost of everything else they purchase falls. As interest rates are also falling due to deflation, the dollar amount payable also falls. However, this only continues to be an advantage as long as their income does not fall. As deflation usually goes hand in hand with rising unemployment, this is often not the case. Then debtors find that the dollar value of their debt is actually increasing, just as the value of a dollar increases in deflation.
Owners of assets can see huge falls, and already have, when the value of their assets, such as their homes, falls sharply. If they are asset rich and cash poor and need to raise cash they may find themselves in the unlucky position of having to sell in a deflationary market. The same is true of any investment such as stocks and bonds.
Deflation in an economy also affects psychology. When people see prices falling, they hold off purchasing because they figure they can get it cheaper if they wait. They expect the situation will continue. So the psychology of a population goes from one of easy credit and spending, to one of saving.
This psychological situation will be the reverse of the mania experienced in the early 2000's. Remember when everyone was encouraged to 'get on the property ladder'? The mantra was, prices are rising and always have, if you don't buy now it will surely be more expensive later. No one believed prices could move in the opposite direction. At the peak of the mania it was assumed that those who did not buy were fools, especially if they considered that prices might stop rising.
When prices are falling, everyone will expect them to continue to fall. People will be discouraged from buying assets such as property as everyone around them will be insisting they wait to get it cheaper later, and that only fools would buy now.
This group psychology is important as it affects major financial decisions. If you follow the herd you will buy at the peak, and sell at the trough. The good news is that there exists a rational analytical method that has a forecasting history, which you can use to avoid this common pitfall. The Elliott Wave Principle understands that psychology drives markets, not the other way around. The proof of the superior accuracy of this principle is Robert Prechter's Conquer the Crash. Written in 2002, it predicted the 'credit crunch' causes and effects with unnerving accuracy. However, according to this book the worst is yet to come. If you want to be prepared for the coming deflationary depression, you need to read this book.
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