The Primary Precondition of Deflation

Deflation requires a precondition: a major societal buildup in the extension credit and the simultaneous assumption of debt.
Economists Ludwig von Mises and Friedrich Hayek warned of the consequences of credit expansion, as have a handful of other economists. Bank credit and Elliott wave expert Hamilton Bolton, in a 1957 letter to Charles Collins, summarized the causal train this way:

"In reading a history of major depressions in the U.S. from 1830 on, I was impressed with the following:

• All were set off by a deflation of excess credit. This was the one factor in common.
• Sometimes the excess-of-credit situation seemed to last years before the bubble broke.
• Some outside event, such as a major failure, brought the thing to a head, but the signs were visible many months, and in some cases years, in advance.
• None was ever quite like the last, so that the public was always fooled thereby.
• Some panics occurred under great government surpluses of revenue (1837, for instance) and some under great government deficits.
• Credit is credit, whether non-self-liquidating or self-liquidating.
• Deflation of non-self-liquidating credit usually produces the greater slumps."

Self-liquidating credit is a loan that is paid back, with interest, in a moderately short time, from production. The production facilitated by the loan -- for a business start-up or expansion, for example -- generates the financial return that makes repayment possible. The full transaction adds value to the economy.
Non-self-liquidating credit is a loan that is not tied to production. When financial institutions lend money to consumers for purchases of big cars, yachts or luxury homes, or for speculations such as the purchases of stock certificates, no production effort is tied to the loan. Contrary to nearly ubiquitous belief, such lending adds costs to the economy, not value. If someone needs a cheap car to get to work, then a loan to buy it adds value; if someone wants an SUV to consume, then a loan to buy it does not add value. Advocates claim that such loans "stimulate production," but they ignore the cost of the required debt service, which burdens production.
Near the end of a major expansion, few creditors expect lots of default, which is why they lend freely to weak borrowers. Few borrowers expect their fortunes to change for the negative, which is why they borrow freely.
Deflation involves a substantial amount of bad debts because almost no one expects deflation before it starts. Surprise is a prerequisite of deflation.