Money plays such an important role in our lives that most of us could not imagine surviving without it. Yet that is exactly what you need to do if you want to prepare for an economic condition called deflation.
Deflation is the term economists use to describe a “general decline in prices, often caused by a reduction in the supply of money or credit.” A good way to think of deflation is as the opposite of inflation. Inflation occurs when there is too much money in circulation, which destroys its value and raises prices. When deflation occurs, there is too little money available, which often causes prices to collapse and the economy to shut down.
In severe cases of deflation there can be no money available at all not — even at the banks. This nightmare actually occurred during the Great Depression of the 1930s, when there were places in the United States where there was no cash available at all. More recently, it has happened in Greece, where ATMs ran out of cash and where banks placed limits on the amount of money that could be withdrawn.
People had no money to pay bills or buy food for their families. Employers had no money to pay employees, customers had no money to buy goods, and many people were reduced to bartering to survive. During the Great Depression, farmers would pay professionals such as mechanics and doctors with food because they had no money and no credit.
The situation got so bad that in some areas of the country, local governments, chambers of commerce and businesses issued their own currencies — the so-called depression scrip. The scrip often took the form of pieces of paper that people used as money because there was no government currency available. The scrip was used to pay workers or buy goods.
At one point during the Great Depression, the money shortage got so severe that the US government considered issuing a national scrip as an alternative to the dollar. That plan was eventually dropped and the government solved the crisis by simply printing more dollars.
Many people have known survivors of the Great Depression who liked to keep large amounts of cash on hand. Others would hoard food and other items. Those people developed that habit because they remembered what life without money was like. The fear of the deflation that occurred in the 1930s haunted them all of their lives.
The frightening reality is that the threat of deflation is still real. Some knowledgeable individuals, such as wealth preservation experts Will and Bill Bonner, believe that a sudden deflation leading to a national or international money shortage is still possible today.
The Bonners, who have studied some of the world’s knowledgeable investors such as George Soros, believe that the next financial crisis will begin with a “violent monetary shock” similar to the one that occurred during the Great Depression. They predict that money could suddenly disappear overnight, causing the economy to come to a grinding halt.
What Happens When Money Vanishes
Historical accounts of the Great Depression show us some of the possible effects of such a violent monetary shock. The damage caused by such a violent deflation can include:
The sudden collapse of prices. The Great Depression began with the collapse of stock market prices in 1929. That was preceded by the collapse of agricultural prices in the United States during the 1920s. During that crisis, land prices in rural areas collapsed, causing large numbers of rural banks to fail. When the banks failed, the government liquidated them and their assets, which included lots of foreclosed farmland, an action that further drove prices and made the crisis worse.
Everything you have — your investments, your home and your possessions — could suddenly lose all of its value. We saw this happen during the mortgage bubble of 2007-2008, when many people found themselves “underwater.” That occurs when the amount a home is mortgaged for exceeds the property’s value.
The collapse in prices during the Great Depression particularly hurt farmers who relied on commodity prices. Newsreels from the early 1930s show farmers dumping grain on the ground and pouring out milk because they could not sell them.