“You come to us and tell us that the great cities are in favor of the gold standard. We reply that the great cities rest upon our broad and fertile prairies. Burn down your cities and leave our farms, and your cities will spring up again as if by magic. But destroy our farms, and the grass will grow in the streets of every city in the country!…We have petitioned, and our petitions have been scorned, we have entreated and our entreaties have been disregarded. We have begged, and they have mocked when our calamity came. We beg no longer. We entreat no more. We petition no more. We defy them…. If they dare to come out in the open field and defend the gold standard as a good thing, we will fight them to the uttermost. Having behind us the producing masses of this nation and the world, supported by the commercial interests, the laboring interests and the toilers everywhere, we will answer their demand for a gold standard by saying to them… You shall not press down upon the brow of labor this crown of thorns! You shall not crucify mankind upon a cross of gold!”
With that fiery oration, William Jennings Bryan captured the hearts, minds and presidential nomination of the 1896 Democratic convention. The trauma and anxiety he was appealing to was deflation.
Simply defined, deflation is the deterioration of the monetary standard characterized by falling prices. It was a new economic era in the late 19th century. Thomas Edison and his cohorts were propelling the industrial revolution forward at a rapid pace. Dramatic productivity gains were coming from the commercial introduction of the telephone and electricity.
Commodity producers on the other hand had seen prices tumble for their products. In fact wholesale prices fell by 50% from 1870 to 1896. As Bryan and the Silver wing of the Democratic Party saw it this long term decline in commodity prices was a direct result of U.S. monetary policy , which was based on the simple discipline of the gold standard.
This deflation, as Bryan saw it, was caused by a strict gold standard that resulted in too little money chasing too many new goods and services. His solution was to add currency to a liquidity starved economy by monetizing silver as an additional form of money.
Today`s deflation situation
Flash forward 102 years and, lo and behold, the trauma roiling the emerging global markets is the same that haunted Bryan`s supporters: Deflation. Again we find ourselves in a new economic era with dramatic gains in productivity driven by computers and telecommunications. Productivity growth in this seven year recovery, at 5.6% per year, is the highest of this century.
Meanwhile commodity prices are at a 21-year low and gold is at a 19-year low.Just in the past year industrial commodities are down 14%. Grains down 23%. Livestock down 25%. Energy prices down 25%.
So far, this first phase of deflation has been an enjoyable experience for the U.S. and other countries that are net consumers of commodities. This dramatic stretching of the dollar`s buying power has no doubt contributed to the ebullient consumer confidence enjoyed by the average American.
But for countries that are net producers of these commodities these are difficult times, and for net producers carrying heavy debt these are the worst of times. The second painful stage of deflation comes when squeezed commodity producers lose their capacity to pay their debts.
The Russian financial collapse is the latest example but Russia is not alone.
Numerous other emerging market countries are at risk if today`s deflation continues.Next in line for emergency action may be Latin American countries such as Brazil, Venezuela and Argentina. At risk with them are the money center banks with their heavy exposure to international lending.
The current deflation can`t be blamed on gold since the last vestiges of the gold standard were jettisoned almost three decades ago, but like Bryan understood a century ago deflation is a monetary policy phenomenon.
Today monetary policy comes from the Federal Reserve in their role as central banker. They analyze a dizzying array of data from unemployment rates to factory utilization rates in an effort to determine the optimum rate of non-inflationary economic growth. As currently practiced it is a complex and imperfect process that is highly susceptible to judgmental error.
The accelerating drop we have seen in commodity prices over the past 18 months is strong evidence that monetary policy is now erring on the side of tightness.
Again it is a case of too few dollars chasing too many new goods and services.
In summary today`s financial market calamity is a reaction to a monetary policy crisis manifested as deflation. If left unattended it can easily become a much more dangerous economic crisis, as debtors are forced to default to their creditors.
The good news is, the tools are available to restore price stability and relieve the global economy from this deflationary crown of thorns.
Ashby M. Foote III is president of Vector Money Management in Jackson. His e-mail address is email@example.com.