Like everyone else I’m relieved that gas prices are dropping. As gas prices drop so do those of a lot of other things, like food and shipping and clothes. That’s all good, right? Yeah, unless they don’t stop dropping. When that happens you have deflation and it is very bad.

Simple definition:  “A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy.”

Deflation always means hoarding because investors and buyers hold on to their money because they don’t want to invest in even the most solid of securities.  Or commodities. Like oil. Or corn, whose price dropped 6 percent Monday.  Gold is up for the moment, but I think that is more a sign of desperation and clinging to an old idea and won’t last.

Very few folks around today know what a deflation is really like. My parents lived through the last great deflation in US history, but it was 1934 and they were too young to remember it. So if you have grandparents or great-grandparents around ask them about it. But do yourself a favor. Sit down before they start to talking.

Peter Rachleff, a labor historian at Macalester College, has a description of that deflation that is chillingly familiar. “These were industries where worker productivity was quite high, but workers were not earning back a significant share of what they were producing. So workers were increasingly turning to credit as a way to acquire consumer goods - refrigerators, vacuum cleaners, radios, and automobiles - that they were producing. And the wages never caught up. And that led to goods that were repossessed that weren’t done being paid for. That led to inventories swelling and workers being laid off or work weeks being cut, and spiral downwards then from that point in 1929 to really a low point, say, in 1932-33, when about a third of the work force was out of work altogether.”

Today’s economies are at far greater risk from deflation than they were in the 1930s. Financing is now much more integral to building than it was then so capital reserves are much lower. In a deflation, companies and people stop investing and spending because prices and profits are always going down. The less they spend, the more demand dries up and the more deflation. At least we think the economies are at far greater risk. The Fed is printing money like crazy as it did not do  in the 1929-1935 period and we do not know this amount of money creation can/will/may reverse the deflation.

How do you stop a rampaging deflation? Great question. In the 1930s, the government tried to increase demand via tax cuts and increases in government spending. In an attempt to stop the deflation and reflate the government went off the gold standard and devalued the dollar by 40%, a measure not really available to the Government today. There’s still a lot of argument over how much good, if any, that did. What is definitely true is that it took the hyper-demand generated by World War II to truly erase that deflation.

Current theory argues for lowering interest rates. We are now the test case for that theory. BTW, did you know that during the Great Depression there were negative interest rates?  And that we are near negative interest rates on government paper now and for the same reasons it occurred in the early 1930s? Sweet dreams.