In 1975 financial newsletter publisher Vern Myers was certain money inflation had become so ruinous that it would soon collapse into deflation. Price inflation in 1974 was 11 percent. It was the first double-digit CPI since 1942.
It moderated to 9.1 percent the following year, but the pain to consumers was significant. Not only was the domestic economy taking a beating but the international picture was askew, too. One heard in the daily news that the Federal Reserve was on the job and soon equilibrium would be restored to the marketplace. The stock market would recover from its swoon from a Dow Jones Industrial Average of 1000 in 1966 to 576 in late 1974. Fed chief Arthur Burns assured us we would not want for monetary liquidity. He didn't appear to know that the banking system can't cure inflation by further inflating the money supply.
When Myers had visions of deflation in the 1970s inflation had been running non-stop since 1940. There had been only two small dips in the Consumer Price Index, in 1949 and 1955. He had seen the U.S. dollar plunge in that time to about 25¢. That inflation cycle had been going almost non-stop for 35 years when the old gentleman decided it was time to warn his readers of the coming deflation.
"Past periods of inflation have been extremely short lived," he wrote. "That was because it was impossible to sustain them against a background of real money. The circulation of debt certificates in place of money provided authorities with the facilities to keep the inflationary machine running."
Did it ever! Myers didn't live to see that 35 year inflation that worried him so stretch all the way into the 21st century. The specter of deflation is ever in the rear view mirror at the Federal Reserve and it is now engaged in the impossible task of keeping the inflationary machine running....but not too fast...plus bail out the giant investment banks in Wall Street, and help Congress in this election year rescue delinquent mortgage holders who are about to be kicked out of their houses.
It's 1975 all over again, only much worse. This 68 year inflation is getting ready to fizzle. We got this far for many reasons. The government changed its measurement of consumer price inflation to make it appear contained. The financial institutions devised so many high-risk paper debt devices to foist on investors we all came to believe that carrying heavy debt was a sign of wealth. We "borrowed ourselves into the good life!" One could own derivatives and not have the faintest idea where the certificates derived their value. Probably from a "security" which, itself, was an IOU.
Vern's deflation was papered over. It was postponed. But it's still on the horizon like a threatening storm.
"You may remember from your early chemistry classes," wrote Myers, "that if you were adding a weak solution of hydrochloric acid to a strong solution of sodium hydroxide, you could continue to add bit by bit without causing any noticeable change. But sooner or later there came a critical point when suddenly that solution changed. The clear mass was now cloudy. The precipitation had taken place instantly."
Myers saw inflation as the hydrochloric acid being added to a solution that has turned cloudy. After precipitation occurs in the economy the Fed can inflate all it wants, but it cannot undo the change. The damage is done. The marketplace is twisted all out of balance and the mistakes must be corrected. This includes re-valuing assets down to rational levels, a process which wipes out dollars by the billions. Even trillions.
When massive numbers of dollars disappear, the ones remaining become considerably stronger. Deflation strengthens dollars, inflation weakens them. You'll recognize deflation when average people feel poorer than usual and cut back sharply on their spending. They try to sell their unnecessary possessions (sometimes, even their necessary ones) and start doing without automobile upgrades, vacation trips, and big screen plasma TVs. Economic dominoes fall, chiefly borderline businesses that thrive during inflationary bubbles but can't keep the doors open when money gets tight.
Deflation sounds grim, to be sure. But it's a natural economic occurrence that comes along to sweep up after an inflationary mess. It restores balance. It levels the playing field, one might say. It rewards the prudent and smashes reckless high flyers.
Vern Myers described why deflations are inevitable in his 1976 book, "The Coming Deflation," published by Arlington House. His timing was off by some thirty years because he did not understand how willing Americans would be to buy into the idea of borrowing themselves rich. He thought the masses would awaken to the danger of promises by government to take care of them from cradle to grave. They didn't.
Most people living today do not think a deflationary depression can happen. They've never experienced one and believe 'the powers that be' are far too clever to let such a thing occur. However, Vern Myers understood why human nature and fiat currency invariably lead to disaster. He tried to warn everybody, but Americans had persuaded themselves they had conquered the old boom-bust cycle and would not be called on in the future to pay for their mistakes. He was generally considered a crank.
We know the feeling!
March 20, 2008
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