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by John Jagerson

Credit or liquidity crises have many aspects and causes but they all share surprising similarities to each other. In this video we need to do a little background on the real danger of a liquidity crisis which is deflation. Deflation is a natural result of a shift down in aggregate demand. To make this more clear I am going to illustrate it with supply and demand curves. These curves are not complicated but reviewing the video a couple times may help if you are new to this subject.

When an asset bubble pops and the value of those assets decline precipitously such as the real estate bubbles in the US and Japan it is usually being driven by a decline in demand. If the decline in prices of the assets in the bubble is significant enough it may lead to an aggregate decline in demand across the economy. That is what we are seeing in the US today and saw in Japan earlier. Declines in demand leads to a decline in supply as suppliers cut production. This is deflation.

The end result of falling production and falling prices is that there is no incentive or need for investment. Without investment there is limited or no economic growth. We all know what a lack of growth can do to stock prices and therein lies part of the opportunity for traders. The similarities between the US and Japan don't end there. The subsequent strategies employed by the governments to combat deflation is important as is a discussion of the opportunities that arise for savvy investors. We will discuss those topics in the concluding section of this series.

Note: This video was originally published in October 2008. In the subsequent videos in this series we will be evaluating how the crisis has continued to emerge, how the solutions are similar and what individual traders can do to profit today.

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