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UNDERSTANDING MONETARY INFLATION - page 4 / 6

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Inflationary - Deflationary Cycles

Our experience over the centuries is that inflationary cycles are a permanent part of a capitalistic economy. If left unchecked and unattended, inflationary cycles tend to spiral out of control and end in a brief but brutal period of deflation we call a depression. A temporary collapse of the economic system is the end of the cycle, with a permanent loss in the illusory wealth created in the inflationary period.

The positive effect of inflation is that it requires capital owners to invest in profit-making ventures in order to counter the wealth-robbing effects of inflation. In an inflationary period, the economy tends to expand as capitalist look for more opportunities to invest as a hedge against inflation. However, investment in and of itself does not guarantee that profits exceeding the loss to inflation will actually occur. There is a risk of losing money in an investment or capital venture. In an inflationary period, the specter of reduction in capital value due to inflation is what drives the potential investor to take the risk.

So long as inflation occurs at a constant or low rate, or changes slowly, lenders and investors can factor it into their decision-making process, and inflation is not a big concern. Inflation becomes a concern when it begins to increases rapidly or unexpectedly. It is the uncertainty of future inflation rates that cause inflation to be such a concern for long term investments.

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Typical Inflationary Cycle as reflected in the Stock Market

Deflationary per od

140

120

Stock Market Index

100

80

60

Inflationary period

40

20

Real rate of growth

0

0

5

10

15 Time, years

20

25

30

Stock market indexes can be useful in visualizing an inflationary cycle, as they represent a significant segment of investments capitalists make to avoid losing out to inflation. The typical inflation cycle is depicted in the figure above. In this depiction the start of an inflationary period is at the bottom of depression, when the economy is finally starting to improve. Stock values increase in little jerks of over-speculation followed by small corrections of sell-offs, gradually increasing in speculation courage and retreats. Somewhere along the peak of inflationary cycle, with the rate of inflation increasing ever more rapidly, investors begin to realize they may be substantially over-committed. This realization seems to occur rapidly in the investor population, and as a result there is a sudden divestment or abandonment of risky ventures. Capitalist begin

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