For some different holiday reading this Christmas, we recommend David Hackett Fischer’s The Great Wave: Price Revolutions and the Rhythm of History.

While our investment approach does not rely on forecasting, we do think carefully about the range of possible outcomes that await us in an uncertain future, and how to prepare for what may come.

Interest rates have been the topic du jour since the GFC. The US Federal Reserve finally increased rates last night, for the first time in nearly a decade, but inflation levels are so low some fear deflation.

From media coverage one might derive the notion that deflation is some sort of insidious disease. In a genuine deflation, banks stop lending. Leverage works in reverse, amplifying borrower losses. Prices tumble because overextended businesses and consumers confront the necessity of selling assets in order to raise cash.

But that’s not the only view, says James Grant:

“Many years ago, falling prices were a sign of improved efficiency and expanding wealth, and of widening consumer choice. Thanks to the spread of electricity and other such wonders in the final quarter of the 19th century, prices dwindled year by year at a rate of 1.5% to 2% per year. People didn’t call it deflation – they called it progress.”

In trying to assess the forces acting on prices, The Great Wave provides superb historical perspective. It examines price revolutions that took place during medieval times, the 16th, 18th and 20th centuries. Each of the first three waves was followed by a protracted time of price stability. The price revolutions were associated with lagging real incomes, social instability and insecurity. By contrast, the periods of stable prices saw interest rates progressively fall and spawned the Renaissance, the Enlightenment and the great Industrialisation surge of the Victorian era.

It may then surprise some readers that there are historical precedents of long periods of stable prices with wave-like tendencies, that differ in amplitude and duration with no periodicity.

To the ardent monetarist it may also come as a surprise that two of these waves of stable prices were accompanied by large injections of additional money in the form of precious metal discoveries.

The point being made here is that the scare of flat or falling prices is normally misplaced as implicitly it reflects improving purchasing power by the populace (higher real incomes). The threat in modern economies lies in the extravagant and persistent rise in the use of credit as well as growing labour dependency which was absent in these earlier episodes.

In the cut and thrust of day-to-day living, it is easy to miss the subtle long term trends taking shape beneath us.

Students of every discipline are trained to think a certain way. This book’s greatest strength is its ability to simultaneously examine history through the lens of an economist, scientist and historian’s world view.

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