by Archie M. Richards, Jr., CFP^®
February 17, 2003

Kate asks for an additional explanation of my comment in a recent column, which read, "I expect the nation to enter a long period of generally declining prices amid prosperity." (The column, dated 1/13/03, is posted to www.ArchieRichards.com.)

The trends began about twenty years ago, Kate. They're nothing new. I just expect them to continue and even to intensify. Here are the three main elements:

Advancing Technology. Computers and other labor-saving devices enable workers to produce more goods and services per hour of labor. This is called increasing "productivity."

Technology will continue to advance at ever-increasing speeds. Between 1910 and 1950, for example, the speed of mechanical calculators and later of computers doubled every three years. Between 1950 and 1966, computer speed doubled every two years. Computer speed is now doubling every year. American laboratories are producing a blizzard of technological changes of many kinds, enabling American workers to become ever more efficient. The result is, and will continue to be, an outpouring of goods and services.

Improving Government Policies. Back in the 1970s, government policies were dreadful. The U.S. had 70 percent tax rates, price controls over trucking, airlines, and interest rates, a government-enforced monopoly over the phone system, and at one point even general wage and price controls.

Throughout the world, voters are realizing that big government does more harm than good. More and more Americans are becoming conservative. Within five years, the shift to the right will probably cause the number of U.S. Senators who advocate big government to fall below 40. Liberals will no longer be able to bar conservative policies by filibustering. Government's impact on society will then diminish even faster.

Moderating Money Supply. Most U.S. money consists of bank deposits. The Federal Reserve Bank creates bank deposits by buying previously issued U.S. Treasury bonds and paying for them by entering numbers in the bank accounts of the sellers. Presto! Spendable money exists that didn't exist before.

With government policies so harmful in the 1970s, the Federal Reserve had to create an excess of money to keep the economy from spiraling downhill. But as government policies have improved, the Fed has been able to ease up on producing money.

Okay, let's put these factors together. Advancing technology and improved government policies have resulted in a flood of goods and services, while money supply increases have been moderate. With more things to buy and less money to buy them with, prices have risen more slowly. Indeed, the pace of inflation, almost runaway in the early-1980s, has fallen almost to zero. Interest rates have also declined.

Lately, in anticipation of an Iraqi war, the prices of oil and other commodities have advanced rapidly. But I expect the war to begin soon and to end not long after it starts. Commodity prices will again recede.

Because of continued improvement in the three factors - technology, government policy, and monetary policy - the slow pace of inflation prevailing today will eventually turn into deflation. Prices throughout the economy will fall.

During the Great Depression, America experienced deflation with poverty. But this time around, the deflation will be accompanied by prosperity. (The favorable trends I describe will benefit the poor most.)

For twenty years, the slowing of inflation has caused interest rates to fall. When inflation turns into deflation, interest rates will fall even more. Eventually, you may even have to pay to keep your money accessible in a money market fund. Long-term interest rates, such as those paid by bonds due in 30 years, should fall to around 2.5 percent. The best place to put your money is common stocks.

The favorable trends that began twenty years ago will persist and even intensify for years to come. Prices will fall, interest rates will fall, prosperity will rise, and the stock market will advance smartly. For America and the world, good times approach.