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First of all, let's remember that the terms
Inflation and Deflation refer to monetary conditions, in particular changes
in the value of currencies, which is most directly represented in changes in
the amount of currency necessary to buy an ounce of gold. A recession is of
course a period of poor economic performance, typified by unemployment. As we
will see, there are a variety of economic problems -- even disasters -- that
don't seem to qualify as recessions because everyone is working.
This note was inspired by a series of talks
with a friend of mine. He was asking -- did falling commodity prices indicate
a coming recession? These days, falling commodity prices seem to primarily
represent changes in Goldman Sachs' proprietary commodity indices, which are
followed by a large number of institutional "index" investors. GS
recently cut its crude oil weighting in half, prompting a wave of automatic
liquidation by index followers. (They pulled the same stunt this summer with
natural gas.) First of all, what are "commodity prices"? This
usually means some commodity index, which is usually heavily weighted in energy
and precious metals. Besides oil and gold, and now copper,
"commodities" have pretty much been on a tear to the upside, with
enormous gains for nickel, zinc, lead, tin, wheat, corn, and so forth. They
have been a bit weaker of late but the downturn is hardly noticeable within
the context of their skyward launch.
But back to my point: all of the recessions
since 1980 have taken place in an environment of monetary
deflation/disinflation. The recessions didn't cause the deflation -- more
likely the other way around, aggressively tight monetary policies, by Volcker
in 1980-81 (leading up to 1982) and Greenspan in 1988 (leading up to 1990)
created deflationary/disinflationary monetary conditions. The dollar rise of
1997-98 was, I believe, caused largely by the capital gains tax cut of 1997.
Anyway, the graph below pretty much sums up the picture:
You don't really need to be Sherlock Holmes to
notice a bit of a connection there, between monetary conditions (represented
by the gold price) and commodity prices. If you squint, you might notice that
monetary conditions (gold) lead commodity prices, by about a year,
which is about what one would expect. You will notice that the three major
recession since 1980 -- in 1982, 1990 and 2001 -- are during periods of a
below-average gold price (i.e., stronger than average dollar value), or
disinflation/deflation. There was also a period in 1985 when commodity prices
collapsed but the economy was booming. The same was true in 1999-2000. Funny
how nobody was going on about "Dr. Copper" when it was below $1.00
in 1999.
Thus, everyone's experience of recessions has
been formed during these mildly deflationary periods. The deflation wasn't
caused by the recession, but it probably added to it in some way, increasing
debt default rates for example. (We will have more on default rates in the
future.) Correspondingly, the recovery periods following recessions have
tended to be mildly inflationary/reflationary.
However, there were also two (I would claim)
inflationary recessions as well -- in 1973-74 and the late 1970s. Actually,
the late 1970s doesn't count as a recession. Actually, the
"official" GDP growth rate was quite good. However, anyone living
at the time understood that the inflation was getting quite disastrous, as
the dollar's value fell by a factor of 8x from $100/oz. in 1976 to $800/oz.
in early 1980.
During the other inflationary recession, in
1973-74, of course commodity prices soared as the dollar's value collapsed.
The dollar fell from $35/oz. in 1970 to $200/oz. in 1974, a sixfold decline
in value. Indeed, the recession was blamed on this explosion in
commodity prices, especially the price of crude oil! And where was Dr.
Copper? Soaring somewhere in the stratosphere. Then, in 1975-1976, the dollar
made a recovery, commodity prices fell, and the economy recovered.
My conclusion: if the dollar's value falls (as
shown by the number of dollars required to buy an ounce of gold), then
commodity prices tend to follow. If the dollar's value rises, commodity
prices tend to fall. There is a very close relationship there. However, there
doesn't seem to be much relationship with recession, per se. (Actually there
is, but you have to look closer. We will at some point.)
While it is largely true that the 1973-74
recession was caused by monetary inflation, the 1977-79 period is very
interesting because, although there was terrible inflation and commodity
prices soared, there wasn't a recession until Paul Volcker got busy in the
early 1980s. The reason that Paul Volcker was installed at the Fed was the
growing concern, bordering on panic, that the dollar was going to spiral into
oblivion and take pretty much all the world's currencies with it in a global
hyperinflation. Pretty heady stuff. But, there wasn't a recession! People
didn't lose their jobs, they didn't stop shopping, and in fact there was
quite a debt and housing boom going on (since people learned you could buy
real assets with phony money). The point is, in an inflation you might not
get the kind of bankruptcy/default/unemployment recession that we have become
accustomed to in the 1980-present period. Indeed, in the German
hyperinflation of the early 1920s, to take the most absurd situation
imaginable, unemployment was very low-- under 2% -- and you can be sure
nobody was defaulting on their loans. When you can sell a loaf of bread for a
wheelbarrow full of money, you can certainly make the payments on your
pre-inflation mortgage. Buying bread -- now that was the problem, and since
your savings had been obliterated along with your debts, you had to work!
What about when the dollar is stable, i.e.
pegged to gold? That was the case in the 1950s and 1960s under the Bretton
Woods gold standard arrangement. Take a look:
It appears that Dr. Copper has left the
building. That index is about as pancake-flat as any economic series you'll
ever find. Now, the NBER dates several recessions during the period, at 1949,
1954, 1958, 1961, and 1970. Also, the US was a greater portion of the world
economy at the time, so presumably the US economy would have a greater effect
than today on world commodity prices. (Later we will look at copper
specifically -- very interesting!) You could say these were 'flationary
recessions, which took place when monetary conditions were neither
inflationary nor deflationary.
There is considerable inflation today but not
enough yet, in my opinion, to completely negate the stupendous buildup of
debt, particularly mortgage debt, that would otherwise head into default in a
recession. Indeed, the subprime problems now appearing -- they appear ready
to cascade -- bear this out. At the same time, however, the inflation is
helping keep the game going longer than anyone accustomed to the deflationary
1980s-1990s recessions could have believed. I think the eventual -- and by
that I mean within two years -- result will be rather serious inflation, but
until then it appears there will be many twists and turns.
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset management.
Lewis has written for the Financial Times, the Wall Street Journal Asia, the
Japan Times, Pravda, and other publications. He has appeared on financial
television in the United States,
Japan, and the Middle East. About the Book: Gold: The Once and Future
Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is available at
bookstores nationwide, from all major online booksellers, and direct from the
publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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