deflation

Economic Indicators during the Roaring Twenties and Great Depression (V).

This is the concluding installment in my series examining how the most reliable economic indicators during the Inflationary Era, perform during periods of deflation. I have done this by examining the Roaring Twenties, Great Depression, New Deal, and the Post WW 2 deflationary recession. The reason for doing so is that we are now in the midst of the first deflationary recession in 60 years. Most indicators used by economists and pundits do not exist or have never been tested that far back in time. Indicators which may work during inflations may not work during deflations. Having set forth the data for you, today we show exactly how two such indicators -- monetary and interest rates -- panned out, and the implications of those conclusions to our present situation.

Economic Indicators during the Roaring Twenties and Great Depression (IV).

Previously in Part I of this series, I explained the need to re-examine economic indicators to determine how they performed in previous periods of deflation. In Part II, I looked at the year-over-year M1 vs. CPI indicator during the Roaring Twenties. In Part III, I looked at the same indicator during the 1930s and the post-World War 2 deflationary recession of 1948-49. That examination showed that, in the 1920-1950 period, the M1 vs. CPI indicator generally worked well, but missed the 1927 recession and most importantly of all completely failed to appropriately signal the beginning, duration, or end of the 1929-32 Great Contraction.

IV. Interest rates and the yield curve

In this installment, I will look at NY Fed interest rates, short term rates, and long term rates as they apply to the entire 1920-1950 period.

Economic Indicators during the Roaring Twenties and Great Depression (III).

Previously in Part I of this series, I explained the need to re-examine economic indicators to determine how they performed in previous periods of deflation. In Part II, I looked at the year-over-year M1 vs. CPI indicator during the Roaring Twenties. That examination showed that, in the 1920s, the M1 vs. CPI indicator generally worked well, with two differences from the Inflationary Era: (1) if anything, the indicator slightly lagged signaling the start of recessions, and led signaling expansions; and (2) when M1 was not growing -- when it was stagnant or declining -- it did not signal expansion even though its YoY change was less negative than a CPI deflation.

III. Great Depression, post WW 2 deflation -- monetary indicators

In this installment I will look at the same M1 vs. CPI indicator during the Great Contraction and New Deal portions of the Great Depression, and the brief post World War 2 deflation of 1948-49 (the last significant period of deflation before now).

Before we examine the Great 1929-1932 Contraction, let's look at the Recesion of 1937-38 (as previously, YoY M1 is in blue, CPI is in red):

As with the Roaring Twenties, our monetary indicator works flawlessly here, with M1 declining below CPI in June 1937, only one month after the onset of the recession in May 1937, and exceeding CPI in August 1938, two months after its end in June 1938.

Economic Indicators during the Roaring Twenties and Great Depression (II).

Yesterday I discussed the need, given our deflationary recession, to examine the reliability of economic indicators during past periods of deflation, specifically to the period from 1920 to 1950. Today I begin that examination with the 1920s.

II. The Roaring Twenties: monetary indicators

The Roaring Twenties was an era of productivity- and debt- fueled urban prosperity that contemporaries called "The New Era" in which supposedly all of humanity's economic problems had been solved. Little did people at the time know of the severe hardships that awaited them when the bubble burst. Monetarily the decade was begun with the bursting of World War 1's high inflation (much like Paul Volker was to burst 1970s' inflation 60 years later), that settled into disinflation (declining inflation) and finally into deflation.

Today I will examine the monetary component of Paul Kasriel's "infallible recession indicator" as applied to the 1920s.

Economic Indicators during the Roaring Twenties and Great Depression (I).

I. Introduction

The supporting data normally cited in the welter of economic commentary suffers from an important limitation. Almost all of those indicators date from the 1950s and 1960s onward. That is to say, they cover a period where there was not even one single deflationary event. All of their reliability comes from a period of waxing and waning inflation -- but always inflation. As we are experiencing the most significant deflationary recession since the Great Contraction of 1929-32 and the Post World War 1 deflation of 1920-21, the applicability of these indicators is very suspect.

This point was driven home to me when I saw a graph of one such very reliable post-war indicator -- the yield curve -- dating from 1929. The graph re-posted below, shows a relentlessly positive yield curve (short term rates are in green, long term rates in red).

If one were ignorant of history, one would have expected that with the exception of a couple of brief bumps, the economy would have been expanding nicely throughout the entire period from 1929-1950! Even during most of the "great contraction" of 1929-32, the yield curve was positive.

Why the Deflationary Recession of 2009 isn't just about Oil

When I diaried last week that we were in the midst of the biggest deflation since the Great Depression, I was met by a number of naysayers (at another blog) who criticized the diary on the grounds that the deflation was just the artifact of the bursting of the Oil bubble, nothing more.
That is not the case. We are undergoing a real deflation for the first time in over 50 years because consumers are full of debt and tapped out of cash, their assets (homes and stocks) are going down in price, and they are unable or unwilling to spend the money they have begun to save at the gas pump. With consumers not buying, demand for manufactured goods has cratered as well. I'll show why below the fold.

The -In- DEflation Outlook for 2009

Here is a screen shot of the monthly readings of CPI for the last 3 years:

I include this because if you keep in mind what has been happening with Oil prices over that same time, a pretty decent picture of what is likely to happen to prices in 2009 takes shape. Remember that from August 2006 through January 2007, Oil prices decreased over 35% from $80 to under $55. Then Oil took off on a tear, hitting $147.50 in July 2008, before collapsing to under $35 by the end of the year. Oil prices are seasonal, rising in the first half of the year, and dropping in the later part of the year, and this is reflected in the "seasonal adjustment" of consumer prices.

The Deflationary Bust deepens

Consumer prices in December fell ( -1.0 %) non-seasonally adjusted. Inflation for the entire year 2008 was 0,1%! (meaning I have officially won my bet wtih Bonddad). In the first seven months of the year, driven by soaring gas prices, inflation surged 4.6%. And then the deflationary bust hit. In the last 5 months, prices have fallen ( - 4.4 %), or at an annual rate of ( - 11.0%). Here is how our Deflationary Recession compares with others from the past 100 years, as of year end 2008:

Recession dates/ YoY, monthly deflation/greatest +/- change

Recession Time Period -1.5% Deflation Largest Change
1/13 - 12/14 2 - 4/14 (-3.0%)
8/18 - 3/19 n/a (inflationary) +23.7%
1/20 - 7/21 8/20 - 9/22 (-15.8%)
5/23 - 7/24 4/24 (-1.8%)
10/26 - 11/27 1 - 5, 8/27 (-3.4%)
n/a 6/28 (-2.8%)
8/29 - 3/33 4/29, 3/30 - 8/33 (-10.7%)
5/37 - 6/38 1 - 12/38 (-3.4%)
2/45 - 10/45 n/a (inflationary) +2.8%
1/49 - 10/49 1/49 - 1/50 (-3.2%)
7/53 - 5/54 n/a (-.8%)
12/07 - ???? 10/08 - ???? (- 4.4 %)

The Deflationary Bust accelerates

Consumer prices in November fell ( - 1.9%) non-seasonally adjusted. The YoY rate of inflation is now only 1.1%. In the last 4 months, prices have fallen ( - 3.4%), or at an annual rate of ( - 13.2%). I am accordingly updating my table of Deflationary Recessions:

Recession dates/ YoY, monthly deflation/greatest +/- change

Recession Time Period -1.5% Deflation Largest Change
1/13 - 12/14 2 - 4/14 (-3.0%)
8/18 - 3/19 n/a (inflationary) +23.7%
1/20 - 7/21 8/20 - 9/22 (-15.8%)
5/23 - 7/24 4/24 (-1.8%)
10/26 - 11/27 1 - 5, 8/27 (-3.4%)
n/a 6/28 (-2.8%)
8/29 - 3/33 4/29, 3/30 - 8/33 (-10.7%)
5/37 - 6/38 1 - 12/38 (-3.4%)
2/45 - 10/45 n/a (inflationary) +2.8%
1/49 - 10/49 1/49 - 1/50 (-3.2%)
7/53 - 5/54 n/a (-.8%)
12/07 - ???? 10/08 - ???? (-3.4%)

Black September

Introduction

On December 3, John Bergstrom of Bergrstrom Automotive, a major auto dealer, appeared on CNBC and said,

on about September 10, we saw our business fall off 30-35%.

A similar sudden decline in consumer spending during September was reported by Shoppertrak:

Throughout 2008, the American shopper has endured record high gasoline prices, hurricanes and flooding, and a stalled housing market in their quest to shop. While the consumer has remained fairly resilient during this time, two very recent events are dramatically impacting mall visits and consumer confidence.
- Once the financial crisis emerged at the beginning of September, retail traffic declined even further. Between August 31 and September 20, SRTI total U.S. traffic fell an estimated 9.2 percent per day....
- After the failure of Washington Mutual, President Bush’s address to the nation, the presidential debate and the initial rejection of the TARP bailout, traffic fell by an average of 10.5 percent (September 21 – 29).
- The day the TARP bailout package was rejected by congress (September 29) and the NYSE Dow Jones Industrial Average lost 778 points, consumers again responded negatively as shopper traffic fell 12 percent as compared to the same day in 2007
- Sales, which were up 4.0 Percent for the Month of July, and up 3.5 Percent for the Month of August, fell 1.0 percent in September – "the first year-over-year sales decline since March 2003."

Shoppertrak has subsequently reported that "retail sales rebounded slightly, posting a very slight 0.7 percent increase in October. sales for the week ending November 15 dropped 3.1 percent as compared to the same period in 2007." But car sales have not recovered at all. In August car sales were already down about 19% YoY. In September the loss was 21%. In October it was 23%. By November car sales had declined close to 40% from already depressed levels in 2007.

And the stock market, which was only down (-18%) from its all time high in 2007 of 1565 to 1282 at the end of August, by October 10 was down (-43%) to 899.

In the 40 day period between September 1 and October 10, the shallow recession which had crippled the housing industry and Wall Street, but left Main Street virtually intact, suddenly metastasized into a collapse of the consumer economy that some were beginning to liken to the 1930s.

This diary is "the first draft of history", an attempt to look at not only what has happened, but as best we can tell from the vantage point of several months later, why it happened.

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