Sunday, October 19, 2008


Will prices go up or down as we head into a recession or depression?

Should we prepare for inflation or for deflation?

In deflationary times, cash is king. In inflationary times, we want to own things like gold whose price will rise. My mother told me that in the Great Depression of the 1930's, “You could buy a car for ten dollars, but nobody had ten dollars.” On the other hand, in hyperinflationary times, a gold coin may be worth a fortune.

German Children Play with Money During the Great Inflation of the 1920's. Employees were paid daily or several times daily so they and their families could rush out and buy things before the money lost most of its buying power as prices skyrocketed.

Having cursorily researched expert opinion on the relationship between recessions and inflation and deflation, I can summarize the results as follows:

A recession may see either inflation (rising prices), or deflation (decreasing prices). Brilliant! Wikipedia: 'Recessions are the result of falling demand and may be associated with falling prices (deflation), or sharply rising prices (inflation) or a combination of rising prices and stagnant economic growth (stagflation).'

Armed with this lack of knowledge, I predict that despite the example of deflation during the Great Depression, we are entering a period of increasing inflation.

Logically, the economic collapse the United States is experiencing will result in loss of jobs, loss of spending power, and a surplus of goods over demand, which will lead sellers to slash the prices of refrigerators and television sets and automobiles in order to find buyers. So, prices will go down, right?

Yes, right in the near term for some items, but wrong in the longer term. The increase in the supply of money (combined with eventual decrease in production of cars, refrigerators, etc.) is the giant fly in the ointment. During the Great Depression the government let the money supply go down, but at present the government is creating money by the ocean-full and pumping it into banks virtually without limit. To my amateur eyes, this certainly looks like an unprecedented increase in the money supply which will drown any deflationary tendencies of the recession/depression.

The government's panicky efforts to make us borrow our way out of a crisis caused by borrowing will most likely result in a long-term tsunami of inflation. If production is decreasing, as we hear every day, then how can the supply of goods keep up with the supply of money? And when money supply grows in proportion to things for sale, the prices of things for sale go up. Even with the current financial malaise, most grocery items are “on sale” for far more than they were a year ago.

I would really appreciate some comments on the issues raised here. I want to know whether to buy a new refrigerator or a new car now, while desperate sellers are offering price-cutting sales, especially leading into Christmas, or whether I can get even better deals next year. I want to know whether to prepare for inflation by buying gold or gold mining stocks, or whether to prepare for a deflation in which “cash is king” by putting cash under the mattress.

I am betting on inflation and will be closely watching those sale prices to see if they go down or up.

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