Sunday, April 4, 2010

Happy Easter--Enjoy the Coming Economic Collapse

The Econdata site has posted the above graph of the Consumer Price Index, CPI, since 1800.  I'm not sure how they calculated it for the 19th century because the Bureau of Labor Statistics didn't start its series until the first or second decade of the twentieth century.  There were various attempts to measure inflation in the 19th century so approximations can be made.   I can't vouch for their numbers but let's assume they're correct.

Notice that most of the inflationary peaks are around wars.  There's a peak following the War of 1812, a peak right at the end of the Civil War, a peak around 1920, following World War I, and then an upswing that starts around 1940 and doesn't abate. Around 1970 (the gold standard was abolished in 1971) the inflation rate surges. It surged at a faster rate in the 1970s than during 1980 to 2010, which is probably why many Americans believed that inflation had ended in the 1980s, which it had not.  It just began increasing at a decreasing rate instead of an increasing rate.

Compare the deflation that occurred after the post-Civil War peak with the deflation that occurred during the Great Depression of the 1930s.  During the Gilded Age, from 1865 to 1910,  the deflation was proportionately greater than in the period from 1930 to 1940 (notice that the twenties, which are usually considered a boom period, also saw some deflation).  The Gilded Age was the period of greatest rates of innovation, expansion and immigration.  Fundamental inventions like the telephone, the railroad (actually pre-Civil War but largely developed post-Civil War), the automobile, radio, A/C electricity, movies, all were created in that period.  As well, there was across the board innovation in processes and methods to a far greater degree than today, despite the lip service paid to total quality management and reengineering.  Moreover, on a proportional basis there was heavy immigration, a few years reaching as high as 500,000 on a base of less than 90 million.

Yet the rapid progress occurred during the largest deflation in American history.  The deflation during the 1930s was much milder, yet the employment effects far more severe.  Yet, academic economists base their arguments on the grievous harm that deflation causes.

Here is the reason.  In the Gilded Age businessmen and Wall Street complained endlessly. The deflation created political instability because real estate investors and farmers who were anticipating real estate profits suffered losses.  But the skimpy profits led to intensification of competition.  Reducing labor costs was hardly sufficient to compete. This led to innovation.

Wall Street, the real estate investors, farmers and businesses complained about the deflation, but the average American was better off.  There was an election that emphasized this issue in 1896, and the pro-gold (but pro-tariff) McKinley defeated the pro-silver Bryan.   Despite this victory, within seventeen years in 1913, the year of JP Morgan's death, Woodrow Wilson established the Fed, which was modeled after a recommendation that Morgan's associates had previously devised.

The depression of the 1930s was accompanied by a rapid expansion of the state and by continued missteps in monetary policy (especially in the late 1930s by Mariner Eccles, the Fed chairman, who caused a second stock market collapse).  The crash of 1929 was a second leg to the correction of the 1920 inflation that the Fed had caused.  The unemployment was intensified by federal policy.  For instance, Herbert Hoover, the last Progressive president, "jaw boned" corporations into not cutting wages.  This forced a much higher layoff rate than would have otherwise occurred (see Murray Rothbard and Ronald Radosh's New History of Leviathan for information about Hoover's role and Hoover's long standing commitment to price fixing and cartelization).  Following Hoover's loss to FDR, the nation embarked on a long term socialization policy that integrated Hoover's Progressive ideas (public works and cartelization via FDR's failed National Industrial Recovery Act) as well as additional ideas that the New Deal Democrats added--regulation of wages via the Fair Labor Standards Act; Social Security; the National Labor Relations Act; and price fixing for agriculture, the Agricultural Adjustment Act, which paid farmers not to grow.  As well, the Smoot-Hawley tariff, enacted in 1930, raised tariffs to the highest levels at any time in US history save in 1828.

The period of inflation from 1940 to today has been the worst in American history for the average worker.  The claim that deflation during the 1930s caused the massive unemployment is contradicted by the fact that a larger deflation in the late nineteenth century was not accompanied by such severe unemployment. 

In other words, the Democrats used the failure of their policies to justify intensification of their policies.  They are doing it again with health care.

Happy Easter!


CrisisMaven said...

I hate calling reckless monetary expansion "deflation". This "fear of deflation" is largely nonsensical. Deflation does not keep people from spending – they always spend what's necessary. And money NOT "spent" is then saved which means it is credit to someone who invests it for capital goods etc. thus it is again being spent, only not for consumption. Money never lies completely idle to any extent whether there's inflation, deflation, stability or a solar eclipse. For deflation to seriously happen, not only the current extreme credit expansion by the central banks and states (through "quantitative easing", stimulus packages, monetising and then spending national debt etc.) but also the money that was released into the economy PRIOR to the collapse would have to be "mopped up" again. This is nowhere to be seen nor would it be technically possible (confiscation aside) so we will rather see inflation than deflation.

R Davis said...

The numbers for the graphs of CPI come from the Federal Reserve Bank of Minneapolis on this page. It gives the source as the "Handbook of Labor Statistics", put out by the Bureau of Labor Statistics and lists several indexes that were spliced together to get the entire series since 1800. Regarding the relationship between the CPI and wars, you might find the graphs of CPI and M2 at this link interesting. It's best to look at the second and third graphs as they look at the change over 5 and 10-year spans and have less "noise". Finally, I blogged about the topic at this link. Thanks.