Mish’s Deflation Prediction
Posted by Moonage on 03 May 2005 | Tagged as: Opinions
Michael Shedlock ( Mish to the Fools ), has penned an excellent article on his assumption of impending deflation:
To understand the case for deflation we must turn back the hands of time. The year is 1914. WWI was breaking out in Europe and the US stayed out of it for three years. As a result of being a "safe haven" gold poured into the United States and US gold reserves rose 64% as Europe exchanged its gold for American goods. By the time the US entered the war much of Europe was ravaged. The US escaped unharmed. After the war ended the US trade surplus remained high and allies began repaying their war debts.
The US experienced rapid credit expansion as a result of the surge in gold reserves. Between 1914 and 1920 the US doubled its expansion of credit. During those war years, investment in machinery and equipment rose by 205% and the value of durable goods output increased in excess of 250% This surge in capacity led to general oversupply of goods by 1926. During the second half of the "roaring 20’s" credit expanded at moderate rate but the damage had already been done. The economy was no longer able to profitably invest in equipment so increasing amounts of money poured into the stock markets. The bubble finally burst in 1929 when profit growth (earnings) could not keep pace with rising stock market valuations. Share prices plunged, credit contracted, and bankruptcies proliferated.
There is much, much more to this article. It is a must read.
I ( Moon ) am not sold on a situation of "helicopter drop". I am more sold, due to the changes in technology and law since 1929, specifically since 1995, that it will be more of the same. Limited growth outside of specific markets, and many markets in marked long term decline. The US government has too many tools it did not have in the past to fight deflation. Notably, a multi-fold expanded ability to influx capitol into the markets. Secondly, a huge global economy that the US did not mingle with in past generations. It does not behoove many other countries to have the investment power of the US economy dried up. We are not in an isolationist economic environment any more. When Bush made it clear to the Saudis the harm the price of petroleum was doing to the US economy, the price suddenly dropped drastically whereas it had been rising steadily. The Saudis rely on our military and foreign investing. It does them more harm than good to have the US markets in decline. Things like this will not stop deflation, but it will temper the effect. There will be crunches and short term bubbles and valleys. But, the global US economy is a machine beyond what our grandparents ever imagined in 1929. The math and impacts of the global US economy is not the same as what it was 1929. I don’t think the economic ideologies have adjusted to those changes.
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