| Deflation |
As difficult as it is for post-World War II Americans to comprehend in the light of economic conditions during the past half-century (during which government-caused inflation wiped out all dollar de-nominated technological gains in productivity and 95% of the dollar's purchasing power besides), we are now in a period of deflationary contraction, and we are threatened with severe economic deflation.
Two excellent articles about this are "The Optimum Price of Gold'' by Jude Wanniski,
The Wall Street Journal, January 7. 1998. p A22, and "The Coming Bust'' by James Grant, The Wall Street Journal, August 28, 1998, p A10.The summarizing insets of these two articles read: "A great boom is mortal precisely because it is great: It creates its own excesses. A self-absorbed market becomes its own reason for being,'' and "Gold's price has dropped to a level we have not experienced since 1979, which suggests the general price level will have to decline in order to equilibrate with gold.''
A glance at commodity prices shows the remarkable breadth of this contraction, which seems now to be spreading to the stock markets and will probably soon start to significantly affect general consumer prices.
Corn is under $2 per bushel (less than $0.04 per pound); wheat is about $2.50 per bushel; copper is $0.75 per pound; and crude oil is under $14 per barrel. Worse, it is predicted that corn could fall as low as about $1 per bushel, with many other commodities similarly weak. How much could the general price level contract? Following Wanniski's estimate that $350 gold represents the current price level, a contraction to the current gold price of $275 would be more than 20% - with large individual variations (government will, no doubt, continue to become more expensive, while farmers are bankrupted).
To those who have no debt, some savings, and an ability to continue with their ordinary work and personal lives even if their incomes markedly contract, deflation is tolerable - even advantageous, since correction of economic excesses sets the stage for the next expansion. For those, however, with debt and highly leveraged lifestyles, deflation can be very painful. Current farm prices represent negative incomes for many farmers, and a 20% contraction in real values exceeds the investment equity of a majority of the American people.
It is important to recognize that people bid for goods and services on the basis of their own
perceived wealth - not on the basis of cash in hand. Regardless of the fact that most stock market investors can never sell their stocks for prices as high as those quoted in the newspapers (the quotes are for current trades at the margin, while actual prices would be much lower if a significant percentage of people were to try to sell), these investors have been bidding for goods and services on the assumption that their stocks represent their actual wealth.If the stock market undergoes a long overdue contraction, literally trillions of dollars in perceived purchasing power will disappear from American markets. This would be deflation on a scale that no rational amount of government money creation could hope to counteract. How far could the stock market deflate in real terms? There is an excellent chart of gold price vs. the price of one share of each of the Dow Jones Industrial Average stocks during the past century at web address http://www.gold-eagle.com/editorials_98/jmiller082498.html.
Values of the gold/Dow ratio at the extremes in this chart are 1, 18, 2, 28, 1, 32 in 1897, 1928, 1932, 1966, 1980, and 1998 respectively. This suggests that the price of gold vs. stocks could reverse by a factor of about 30 during the next half-cycle. Since the two down half-cycles in the record were completed in 4 years and 14 years, the potential s for a fast reversal within the lifetime of most current investors. Reversal of this ratio could occur with many different values in dollar terms. For examples, the Dow could be 2,000 and gold $2,000; the Dow 500 and gold $500; or the Dow 10,000 and gold $10,000.
No one knows, of course, what any of these market prices will eventually be. We do know, however, that widespread deflation has begun. If it continues, the consequences will be unusual indeed for the American people and their activities in science and technology.