Monday, June 17, 2013

The Deflation Factor

Many people believe that the US could be facing deflation similar to what happened in the 1930’s. And of course Ben always claims he’s running the printing presses to keep that from happening.

Here is what happened during the Great Depression. The stock market crashed in 1929 and it wasn’t uncommon for someone on margin to lose 4 times their investment. Then in the 1930’s the banks collapsed. When it was all over, the average person with $10,000 in savings ended up with about $1,000, a loss of 90 percent of their accumulated wealth. There were no food stamps, welfare, social security, company retirement plans, credit cards or unemployment insurance. If you owned a home with a mortgage, you had a problem. Most home loans were for 5 years, and very few were being renewed the banks; they needed the cash. You either paid off the loan or lost the house to the bank.

Consumption fell off a cliff in the 1930’s.If you had no money you were not in a position to stimulate the economy. If you were a business, sales were down to say the least. Most business of the time did not reduce wages, so in effect with the deflation your paycheck bought more (if you were employed).

Let’s fast forward to today. We had a real estate crash and no one lost a dime. We had a bank collapse and all deposits were insured. The unemployed have two years of unemployment. Food stamps for all that apply. The stock and bond markets have rallied. The government is spending 150% of what it takes in in taxes each year. And of course, the national debt has increased to 17 trillion dollars. Washington is going to save us by spending what we don’t have to spend.

If people want to argue over whether or not this is a global depression, be my guest. The real question is how long can government spending programs continue in this largess manner? No wonder, consumption has not fallen off of a cliff. It’s irritating to say the least, that entitlement programs allow the user more freedom to manage their discretionary income (A cell phone and cable TV are essential necessities). Being unemployed does not make you homeless and broke. This time around, you can move in with mom and dad; most kids’ parents live longer now.

Things are different this time. No money was lost, and failure was rewarded by bailouts and insurance. Low interest rates have literally ruined many retirement plans made 30 years ago with the assumption interest rates on savings would offer a return greater than inflation.

The deflation of the 1930’s was caused by too little money chasing too many goods. In today’s world, we have too much money chasing too few goods. Plus there is the interest rate factor. Why not spend your earnings on immediate gratification? The future reward (interest) for deferred consumption just isn’t there.

In today’s world, wages remain unchanged and purchasing power has decreased noticeably. World governments owe debts that cannot realistically ever be paid back. Just the thought of paying part of the debt off, creates riots in the streets; entitlements are where the cuts are made. The world in a global sense doesn’t appear to be clutches of deflation. People now have to work harder and longer to keep up with what they had the year before. Our standard of living is decreasing at a slow but noticeable rate. Next year many people in the US will earn the same amount but have $5,000 to $10,000 less to spend with the new health insurance.

Technically the health care tax should plunge us into a deflationary spiral. But the thing that will be most noticeable will be the future decrease in Federal tax revenues collected. Bernanke will be just like the high school kid that smokes a couple of packs of cigarettes and thinks he can quit at any time. The printing will have to continue.

The troubling thing I find right now is in the financial and real estate markets, people are so receptive to all of the experts. There is an answer and an explanation for every event. 40 years ago there was a complete disconnect between the experts and the markets -- That was the reason you had a stock broker, no layman could figure it out--IBM announced terrific profits and the stock dropped 15 points--go figure! In reality if the experts were any good at what they did, they wouldn’t have to work for a living; of course nobody’s going to point that out on a business program.

So what’s it going to be, deflation or hyperinflation? Deflation would make the national debt a lot harder to pay off; of course that’s already an impossibility, even at these very low interest rates. Congress is on a roll, spend whatever you have and don’t have.

What we need to realize here, is that we have a government machine borrowing our savings and spending it at a very fast and furious rate. Will we get it back when we go to retire?  Do you expect the government  to say "NO?" Ben's going to save us from deflation, well Go(l)d bless him.


Joseph Oppenheim said...

Much different than Great Depression. Much innovation - FB, GOOG,3D printers, Tesla, FB, etc and energy boom, etc - US is in better shape because of this, plus can't go broke since can print money and could back currency enough to maintain demand. Obstructionists in Congress do want to repeat problems where FDR caved to obstructionists in 1937 with austerity. So, there is some risk in 2014 elections. Real casualty is middle class, but many want them to suffer, by targeting unions, pensions while rewarding wealthy. Oddly, though crap like this, cheap workers keep inflation in check and likely make for a slower, but longer recovery. BTW, food is only abt 6% of budgets, so higher prices actually help the US agriculture industry and thus the US recovery. Etc, etc.

dearieme said...

"So what’s it going to be, deflation or hyperinflation?" First it'll be deflation, from which the government will try rescue-by-inflation. Eventually that'll overshoot and give, if probably not hyperinflation, then uncomfortably high inflation for some years.

When? I'd be surprised if deflation doesn't start within three years.

Jim in San Marcos said...

Hi Joseph

I think that the parallels to the Great Depression are mind boggling. There was a great transformation from an agrarian economy to the industrial age. Radio, electric lights, the dawning of commercial air travel, the automobile.

only 66% of the population owned a radio in 1933.And RCA went to $500 a share before the stock market crash. $500 would buy a brand new car. One of 5 owned an automobile in 1930.

Government was small by todays standard and the amount of debt was minuscule. The government had to step in and support farm prices because things got so bad, we were producing too much. Farmers were dumping milk in the streets.

I tend to agree with you that the middle class will take the hit on this as well as those retiring on fixed incomes

Jim in San Marcos said...

Hi dearieme

I think that Ben made sure that deflation cycle was avoided.

Every notch up in interest rates, will make servicing the National Debt more unmanageable.

There is a big "but" here. If the government pulls the plug on all of the free entitlements, we could get the deflation you suggest and from there a recovery.

The trouble is, that won't get you re elected to Congress. So the hyperinflation looks quite plausible, political suicide is not an option

dearieme said...

"The government had to step in and support farm prices because things got so bad, we were producing too much." There's no more effective way of guaranteeing overproduction than "supporting" prices.

"no Hoover-like pres during first few yrs": as historians point out, FDR was a very Hoover-like pres: probably the only really good thing FDR did (in my guess) is that he stopped the run on the banks. Almost everything else was as counterproductive as Hoover's policies. Between them they extended the depression on and on and on.

That such an intelligent mind as Hoover's and such an ordinary mind like FDR's should choose to do the same silly things probably contains a lesson for us all.

dearieme said...

Can anyone read about Hoover's career and not think him intelligent? How? He was clearly the brightest man to hold the office in many a year, and brighter than anyone since.

Unknown said...

Hi Jim,

When it comes to Bernanke and interest rates, this article from TF Metals really puts it into perspective:

Hard to stop QE when it could lead to an annual interest expense in excess of $1 Trillion.

Jim in San Marcos said...

Hi dearieme

I agree Hoover was at the top. He didn't like the Smoot Hawley tarrif himself, he only voted for it because the Republicans twisted his arm.

In a democracy, you do have to listen to the will of the people.

Anonymous said...

FDR didn't come up with anything. Everything he did was a continuation of and an implementation of the remaining steps that was on Hoover's program. Hoover set the government up so that it would turn a recession into a depression. The entrance of socialism was preparing us for full blown communism or facism. The USA accepted socialism and now will accept fascism. Unfortunately the USA has been on a downward trend instead of an upward trend over the last 100 years. Unintended consequences are still hitting us from legislation of the 30s.

Jim in San Marcos said...

Hi Heavenly Prepper

Thank you for the link.

I've mentioned several times that an interest rate of 8.5 percent would be the end. Tax receipts would equal interest on the national debt. Plus as the National debt increases, the interest rate needed for collapse drops lower.

Grab a bag of popcorn, this shouldn't take long. We've paid to see it.

Jim in San Marcos said...

Hi Anon 4:47

I tend to agree with you on FDR admin being an extension of Hoover's.

The voter has the misconception that when we change presidents, everything else changes. If it was a dictatorship, that would be a good assumption.

FDR started something with Social Security. The neat thing about it at the time, there weren't many people who lived to collect it. Advances in medicine have changed the parameters that the system was intended to support. Remember, age 65 was for the few, not the many.