The Last Period of Deflation

Housing has been in a deflationary period since 2006 but not the economy overall. In March of 2009 stocks began a huge rally after this article below was written, though stock "dividend" yields may never reach 5% again: 

Per Merrill Lynch Advisor magazine in February 2009, will deflation (lower prices) jeopardize the recovery?

"...The last period of true deflation in the U.S. was 1954-1955. One bright spot was that dividend yields were 5% according to Mr. Rosenberg.

In Japan, according to Mr. Bernstein, stock rallied more than 33% in some years through deflationary periods of the 1990’s...."

Deflation (Major) Avoided So Far

The money supply plunged 29% during the Great Depression as a result of the Federal Reserve constricting the money supply. The result: the Consumer Price Index (CPI) declined 27%.



Japan's economy has suffered for over 10 years from the effects of deflation. So far, we have experienced a little deflation in the middle of this crisis but the CPI has not deflated to the extremes of the Great Depression mainly because the government is deficit spending and the Federal Reserve is insuring liquidity in the market place by many different actions (low interest rates, lending facilities of many newly invented types).



Look at housing, however, where deflation is major and a stumbling block to future recovery efforts. Some areas of the country have seen housing prices deflate by 50% or more. A bottom in the housing market (and also in the retail markets and the commercial markets) are necessary before a full, vibrant recovery can take place. Sometimes government intervention prevents the economy from reaching the bottom but it is necessary that we get there.

More on Inflation and Deflation

Some investors are worried about inflation because of the substantial amount of government spending and money supply growth fueled by the Federal Reserve.

I am in agreement with a previous Merrill Lynch RIC Report that a basic economic rule of thumb is that money growth alone is unlikely to fuel inflation. The fuel for inflation is the combination of monetary growth and credit growth. Needless to say, credit growth is still dormant even though the monetary aggregates have expanded at an enormous rate.

In other words, money supply is growing but money velocity is shrinking still and this portends a "liquidity trap" and deflation (look at the deflation in the housing market).

Once the credit access is fully functioning again and housing has rebounded then inflation may be a concern due to the excessive money supply growth but it does not appear to be a concern in 2010.