Dec

19

G HaaveIt's important to note that deflation has happened many, many times in the history of this country. It was a regular feature of the business cycle. Demand goes down, prices go down. Simple stuff. Markets equilibrate, and things get going again. There are three examples of prolonged deflation that I will mention here.

First, the great deflation of 1875-1896. For thirty years, prices decreased an average of 1.7%. Also there was a prolonged deflation for three years, 1930-1933. Finally there was a prolonged deflation in Japan, from the 1990s until recently, although Japan may slip back into deflation.

What are the points to be learned? Those unfamiliar with the great deflation of 1875-1896 might automatically assume that those must have been tough times in the economy, as the great depression saw output plummet, and Japan has seen its economy stagnate. That could not be further from the truth. The great deflation was a time of great economic growth for the US.

What is the difference then, between the Great Deflation, and the Great Depression/Japan Slump?

The difference is that Macroeconomics had not yet been invented by 1875, and therefore the government didn't try to do anything about it. The government, and economists, never imagined that they could possibly model the endless millions of individual actors in the economy on a few simple graphs, and then conduct sweeping policy changes to "fix" the problem of falling prices.

F D RBy the 1930s all that had changed. Modern macroeconomics was forming, and in all its hubris thought it could accurately model the economy in simplistic terms. Those of a more conspiratorial bent will note that the Federal Reserve was now in existence, and controlled by those who most hated falling asset prices, the bankers.

So, the US government/Fed did everything that they could to prevent falling prices. FDR's government even allowed industries to fix prices to keep them from falling further. Hence, the economy was unable to equillibrate, and millions of people could not even afford food.

Japan also decided to try to prevent falling prices, when falling prices are exactly what an aging country needs. It is assumed that the generational problem in Japan is solely a matter of culture. Then again, who is going to have kids when one can hardly afford a one bedroom apartment? Falling prices are exactly what Japan needs, but the economists think they know better.

I thumb my nose at all the economists, politicians, and journalists who fear a "deflationary spiral." Ye of so little faith in the common man, and his ability to interact with his fellow man in mutually beneficial transactions. Get out of the way! Asset prices falling is not a bad thing. Their having gone up too far was the bad thing. Their coming down is what will fix the problem of them having gone up too far.

Assuming, however, that the politicians and bankers do not take my advice, what to do?

First, the record of the Great Depression and Japan's Slump is that the government can't in fact prevent deflation very well. Second, the UK did not do as well during the Great Deflation, owing to its heavy industrial asset base during a time of asset deflation.

The United States is a mixture of heavy and low asset base industries. My advice: buy the latter, sock 'em away for a few years.


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