Previously in Part I of this series, I explained the need to re-examine economic indicators to determine how they performed in previous periods of deflation. In Part II, I looked at the year-over-year M1 vs. CPI indicator during the Roaring Twenties. That examination showed that, in the 1920s, the M1 vs. CPI indicator generally worked well, with two differences from the Inflationary Era: (1) if anything, the indicator slightly lagged signaling the start of recessions, and led signaling expansions; and (2) when M1 was not growing -- when it was stagnant or declining -- it did not signal expansion even though its YoY change was less negative than a CPI deflation.

III. Great Depression, post WW 2 deflation -- monetary indicators

In this installment I will look at the same M1 vs. CPI indicator during the Great Contraction and New Deal portions of the Great Depression, and the brief post World War 2 deflation of 1948-49 (the last significant period of deflation before now).

Before we examine the Great 1929-1932 Contraction, let's look at the Recesion of 1937-38 (as previously, YoY M1 is in blue, CPI is in red):

As with the Roaring Twenties, our monetary indicator works flawlessly here, with M1 declining below CPI in June 1937, only one month after the onset of the recession in May 1937, and exceeding CPI in August 1938, two months after its end in June 1938.

I. Introduction

The supporting data normally cited in the welter of economic commentary suffers from an important limitation. Almost all of those indicators date from the 1950s and 1960s onward. That is to say, they cover a period where there was not even one single deflationary event. All of their reliability comes from a period of waxing and waning inflation -- but always inflation. As we are experiencing the most significant deflationary recession since the Great Contraction of 1929-32 and the Post World War 1 deflation of 1920-21, the applicability of these indicators is very suspect.

This point was driven home to me when I saw a graph of one such very reliable post-war indicator -- the yield curve -- dating from 1929. The graph re-posted below, shows a relentlessly positive yield curve (short term rates are in green, long term rates in red).

If one were ignorant of history, one would have expected that with the exception of a couple of brief bumps, the economy would have been expanding nicely throughout the entire period from 1929-1950! Even during most of the "great contraction" of 1929-32, the yield curve was positive.

When I diaried last week that we were in the midst of the biggest deflation since the Great Depression, I was met by a number of naysayers (at another blog) who criticized the diary on the grounds that the deflation was just the artifact of the bursting of the Oil bubble, nothing more.
That is not the case. We are undergoing a real deflation for the first time in over 50 years because consumers are full of debt and tapped out of cash, their assets (homes and stocks) are going down in price, and they are unable or unwilling to spend the money they have begun to save at the gas pump. With consumers not buying, demand for manufactured goods has cratered as well. I'll show why below the fold.

Consumer prices in December fell ( -1.0 %) non-seasonally adjusted. Inflation for the entire year 2008 was 0,1%! (meaning I have officially won my bet wtih Bonddad). In the first seven months of the year, driven by soaring gas prices, inflation surged 4.6%. And then the deflationary bust hit. In the last 5 months, prices have fallen ( - 4.4 %), or at an annual rate of ( - 11.0%). Here is how our Deflationary Recession compares with others from the past 100 years, as of year end 2008:

Recession dates/ YoY, monthly deflation/greatest +/- change

Like Tony Wikrent, I too found Yves Smith's article, Why so Little Self-recrimination Among Economists"" singularly enlightening, but for a couple of different reasons.