Taking a Lesson from the Great Depression (A few trillion $$$ stimulus cannot mitigate deflation)

SeekingAlpha ^ | 7/5/2009 | David Goldman

[SeekAndFind]

The present deflation is worth putting in context. Below (click to enlarge) is the annual rate of CPI change since 1913:



We are in the first deflation since the Great Depression, albeit a mild one. In fact, raw materials prices have fallen just as far, but our consumption basket has shifted to items whose prices are slower to deflate.

Note that the great deflation of 1929-1933 is followed by a brief increase in inflation (to a 5% year on year CPI gain) before falling back into negative numbers. This was the result of FDR’s devaluation of the dollar against gold, from $20.67 to $35 an ounce (a level that held until August 1971 when Richard Nixon again devalued the dollar). That the effects of the dollar devaluation were quite temporary is evident from the chart.

It seems quite plausible that the dollar will fall sharply against some other currencies, notably the Asians, and against gold and other commodities. That may not, however, interrupt the deflationary tendencies which predominate, for to have actual inflation, someone has to take cash and buy goods rather than (for example) securities. If everyone hypothetically wanted to buy securities rather than goods, prices of goods would crash.

Something like this is happening, of course. An aging population increases its purchases of securities and decreases its purchases of goods as it saves for retirement. Americans have saved nothing for the past ten years, and the capital gains that they considered savings-substitutes have vanished. That means that an enormous savings deficit accumulated over more than a decade has been exposed, and that Americans must attempt to correct it quickly and under the worst of circumstances.

That creates a deflationary shock that a few trillion dollars’ worth of stimulus cannot begin to mitigate. America may have the worst of both worlds: currency devaluation AND price deflation, as in the 1930s. That is why TIPS and other nominal inflation hedges do not convince me. Gold, oil, commodities, and Chinese blue-chips are my preferred hedges against a dollar crash. Most of my portfolio remains in high-quality fixed income. I have sold lower-rated credit and taken profits in anticipation of further market weakening.

[GadareneDemoniac]

On the other hand, there is a question as to how accurate the CPI is. Don’t forget that many obligations of the U.S. government have increases tied to the CPI, and the government gets to pick and choose what goes into the basket of goods used to determine the index.

What’s the answer? Whatever they want it to be!

[SeekAndFind]

the government gets to pick and choose what goes into the basket of goods used to determine the index.

And for some reason, the price of energy isn't in the basket... wonder why...

[Carry_Okie]

In fact, raw materials prices have fallen just as far, but our consumption basket has shifted to items whose prices are slower to deflate.

To base a comparison thus is just plain wrong. In the 1930s the US was producing its own raw materials and manufactured goods within an economically closed system. Regulation has virtually shut down both domestic raw material and industrial production. Thus there is currently potential for a simultaneous inflation for purchase of raw materials and retraction within the domestic economy simply by currency fluctuation.

[ActrFshr]

Nonsense. CPI reflects US consumer’s buying power this month versus supply of goods produced last month. Seeking Alpha should reread some articles like these:
http://www.federalreserve.gov/releases/h6/Current/
http://mises.org/story/1363
http://ibdeditorials.com/IBDArticles.aspx?id=322266099122807

Or this one just referenced by FreeRepublic.
http://finance.yahoo.com/tech-ticker/article/273773/Bailouts-for-Everyone-But-Who%27s-Going-to-Rescue-Uncle-Sam?tickers=^DJI,^GSPC,TBT,TLT,SPY,FXI,UDN

Besides if we ever have DEFLATION the value of commodities such as gold will drop.

[ExtremeUnction]

Americans are not buying “stuff” at anywhere near the rate we had just a few years ago. Shipments into the ports of Long Beach/LA are off almost 40%. We are saving more. My wife just got an inheritance and the whole amount will be put away for retirement. I believe that commodities will fall dramatically. And look at the deflation in housing. My house could have sold at $440,000 three years ago. Today..$240,000. Almost everywhere I look I see deflation in our future. This also includes wage cuts, which I am seeing all around me.

[Carry_Okie]

I believe that commodities will fall dramatically. And look at the deflation in housing.

Two different things. The latter is because of an overstock in open inventory. The former has a regulatory floor price, at least domestically.

[ItisaReligionofPeace]

Yes, there is deflation in housing prices, but it’s only following high inflation in housing prices. In other words, your house may have sold for $440,000 years ago, but it wasn’t worth it by a logical valuation. Now it’s returning to reasonable and sustainable levels.

[Squantos]

*...........guns, gold, groceries, gardens and gas BTTT !

[Squantos]

Good points !

[SVTCobra03]

On the other hand:

http://www.gold-eagle.com/editorials_04/field042704.html

[hiredhand]

Good gracious! Yet another factor pointing to a future calamity. I’m still betting on the fall of the year. We’ll see...one way or the other, we’ll see!

[Carry_Okie]

Two regulatory externalities can perversely effect the domestic producer here. First, the permit represents a huge sunk cost, so even if they are losing money they are liable to stay in production for at least a while. Second, there are sometimes “use it or lose it” aspects to a permit, that one has to keep producing even at a loss to maintain the existing provisions of the permit, else the book comes out when the producer starts up again. Forestry has truly suffered here in California in that respect because the producer plants the trees anticipating one set of rules but is forced to harvest them under an entirely different regulatory climate (unless they have an NTMP, for those of you who care about minor details).

[ChildOfThe60s]

Hey, the government never lies & it always tells the truth. If you don’t believe it, just ask ask the government.

IMO, the CPI is as trustworthy as a guy that says I’ll love in the morning if you’ll just put out now.

[ChildOfThe60s]

I dispute the claim that we are experiencing real deflation in as far as the average American consumer is concerned.

When I read stuff like this, I feel like starting a spreadsheet of products and services that I need and plotting what they are costing me. I won’t even begin to list them here.

Sorry, Alpha, I’m just hoping that 70’s inflation is all we end up with. And that sucked pretty bad.

[PzLdr]

“Take a lesson from the Great Depression”...Get the Japanese to attack us?

[JPJones]

America may have the worst of both worlds: currency devaluation AND price deflation, as in the 1930s.

How's that supposed to happen? If the dollar is devalued then oil spikes, if oil spikes then prices rise.