Letter: Record low inflation is sure sign of inflation

The government has been quick to dance and sing about the low level of inflation, but the reality is that the low inflation rate is a clear signal that we are in a recession and it is consistent with recessions of the past.

Since 1914 there have been eight recessions in the United States. Three lasted for a single year, (in 1953, 1957 and again in 1990). The longest recession being the "Great Depression" which lasted ten years from 1929 to 1939.

The recession of 1918 - 1921 saw a sharp drop in inflation from +20% to -10%, 30 percentage points during the three year recession.

In the case of Trinidad and Tobago we have experienced a drop from some 13.5% to 1.5% in 1 year.

During the first half of the great depression prices fell 10% a year and by the end prices were rising in the 2-3% a year range but then in 1938 prices lost 2-3% again.

During the 1953, 1957 and 1990 recessions prices fell very slightly with inflation moving from slightly above 0% to slightly below, 3% to 2% and 5% to 3% respectively. These recessions only lasted a year. These were not the classic boom and bust recessions.

The 1953 recession was caused by the government clamping down on the money supply in an effort to wring the almost 6% inflation out of the economy.

Unfortunately they over did it a bit which resulted in the one year recession. Monetary policy was tightened during the two years preceding 1957, followed by an easing of policy at the end of 1957.

In the 1980 - 1982 recession inflation fell very sharply from around 13% to under 4%.

The 1980 recession was closely related to the 1973 Oil embargo recession because the Iranian Revolution sharply increased the price of oil around the world in 1979, causing the 1979 energy crisis.

This sucked capital out of the system causing both recessions. One might say that this is similar to what is happening now.

Generally, stable or gradually decreasing prices are good for the economy but what we see are high inflation rates prior to the recession which are "wrung" out of the economy by a recession.

This was seen significantly prior to 1918 when inflation rates were 20% and in 1980 when they were over 13%.

The 2001 - 2003 recession was similarly caused by a contraction of liquidity after a stock market bubble this time the result of excess liquidity created by the FED flowing into the new "DotCom" stocks.

When this bubble burst it drastically reduced liquidity once again sending the economy into a tailspin.

But it's not all bad news, recessions although painful serve a useful purpose by wringing out excess liquidity out of the system and returning the economy to a more stable footing.

The key of course for individuals is to not get caught up in the excesses that precede the recession so they can weather the storm once it arrives. Unlike what happened with this government's spending spree.

High inflation certainly precedes the recession. Usually, high inflation corresponds with liquidity creation and a booming economy.

But after a while the party balloon can get no bigger and it eventually bursts. Liquidity contracts, inflation falls and the economy contracts into a recession. That is exactly what we are seeing now.

What you can be assured of is that it is not as a result of any prudent management by the government.

Garvin Nicholas (excerpts taken from Recessions and Inflations since 1914, published 09/02/08 on InflationData.com)