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.