Stocks — Part IV: The Big Ugly Event, Deflation and a bit on Inflation

Deflationary Depressions and Hyperinflation

So far we’ve seen that the stock market is a wonderful wealth building tool that goes relentlessly up.  Vanguard’s Total Stock Market Index Fund (VTSAX) is the only tool we need to access it.

But it is extremely volatile, crashes routinely and most people lose money due to their psychological tendencies.  Still, if we toughen up, ride out the turbulence and show a little humility regarding our investing acumen this is the surest path to riches.


Stock Market 1900 – 2012

There, in 1929, is the Big Ugly Event.  The Mother of all Stock Market Crashes and the beginning of the Great Depression.  Over a two year period stocks plunged from 391 to 41, losing 90% of their value along the way.  Should you have been unlucky enough to have invested at the peak, your portfolio wouldn’t have fully recovered until the mid-1950s.  26 years.  Yikes.  That’s enough to try the toughest investor.

Of course, if you had been buying stocks on margin (that is with borrowed money) you would have been completely wiped out.  Many speculators were.  Fortunes were lost overnight.

Lesson #1:  Never buy stocks on margin.

Lesson #2:  If a time comes when you are reading and hearing about people routinely making fortunes in an aggressively rising market using margin, something very, very bad is around the corner.  (Joseph Kennedy is said to have known it was time to exit the market in early 1929 when he started getting stock tips from shoe-shine boys.)

Lesson #3:  If you see Lesson #2 forming it is a good time to take your chips off the table.  Very tough to do when everybody is making “easy” money.

Lesson #4:  Once the crash comes, it is too late.

So what to do?

Does the possibility of another Big Ugly Event blow a big enough hole in this idea of “toughen up and ride out the storms” to make it useless?  The answer to that has everything to do with your tolerance for risk and your desire to build wealth.  There are ways to mitigate the risk and we’ll talk about them next time.

For now, let’s step back and consider a few things regarding The Big Ugly:

1.  It would have taken an investor of exceptionally bad luck to have borne the full weight of the the crash.  You would have had to buy precisely at the 1929 peak.

Suppose instead you had invested in 1926-27.  Looking at our chart this is about halfway up on the climb to the peak.  Many, many people were entering the market in these years.  Certainly they were destined to lose all their gains, and yet 10 years later, had they held on, they’d be back in positive territory.  Although another rough stretch was coming.

Suppose you’d bought at the earlier peak in 1920.  You would have taken an immediate hit and recovered five years later.  From the collapse in ’29 you’d be back even by 1936.  Seven years.

The point is that any given start would have likely been different and yielded an outcome not as severe as the widely quoted 90% loss, peak to bottom.

2.  Suppose you were just out of school and beginning your career in 1929.  Assuming you were in the fortunate 75% that kept their jobs, you would have had decades of opportunities to buy stocks a bargain prices.  Ironically, a crash at the beginning of your investing life is a gift.

3.  Suppose you were retired with a million dollars in today’s money.  By 1932 your stash is down 90%, to 100k.  Terrible for sure.  But remember the Depression was deflationary.  That means prices fell dramatically.  And that means your $100,000, while no longer a million, now has far more buying power than 100k did pre-crash.  Plus, it is poised to grow rather sharply from this low.

4. The Big Ugly Event has happened only once in the last 112 years.  Longer actually, but that’s how far back our DJIA data goes.  We haven’t had another in 83 years.  These are really rare.

5.  Many changes in economic policy were made post-1929 that, so far, have worked.  In 2008 we came right to the edge of the abyss.  Closer I think than most folks fully appreciate.  But we didn’t tumble over.  This I find encouraging.

Looking for Balance

What is not so encouraging is that a Deflationary Depression like that of ’29 is only one of the two possible economic disasters that can destroy wealth on a major scale.

The other is Hyperinflation.

Here in the USA we haven’t had to deal with this monster since the Revolutionary War way back in 1776.  But it destroyed Zimbabwe’s economy as recently as 2008.  Hungary had the worse case of it in history and many credit the German hyperinflation of the 1920s with ushering the Nazis to power in the 1930s.

Hyperinflation is very bad news, every bit as destructive as deflation, and it is exactly what it sounds like:  Inflation running out of control.

Zimbabwe money changer

A little inflation can be a very healthy thing for an economy.  It keeps the wheels greased and running smoothly.  It is the antidote to looming deflationary depressions.  This is why our Federal Reserve has been working overtime pumping money into the system these past few years.  We very much need to get some inflation going.  But, not too much.  It is a tricky balance and once in motion it can be hard to change direction.

In a deflationary environment delayed buying decisions are rewarded.  If you were considering a new house of late you would have noticed that prices are dropping, along with mortgage interest rates.  So you wait.  You can get both for less later. If enough potential buyers join you, prices and rates drop further.  Delay is further rewarded and action is punished.  Too much of this and the market slips into a deadly spiral of crashing prices.

But when inflation is high and growing, anything you want to buy will cost more tomorrow than today.

Buy that house (or car, or appliance or anything else) today and beat the price increase.  Delay is punished with higher prices later and action is rewarded.  Buyers become ever more motivated.  Sellers become ever more reluctant.  Too much of this and the market slips into a deadly spiral of increasingly worthless currency people are desperate to exchange for goods.

“Hyperinflation is often associated with wars or their aftermath, political or social upheavals, or other crises that make it difficult for the government to tax the population.”  Mmmm.  The quote is from Wikipedia and sounds a lot like our current situation to me.

Governments love a little inflation.  They can add money to the system, keep the economy humming and not have to raise taxes or cut spending to do it.  In fact, it is sometimes called “the hidden tax” because it erodes the buying power of our currency.  It also allows debtors, like the government, to pay back their creditors with “cheaper dollars.”

Given all this, it is hard not to see increasing inflation on our horizon.  In fact, it is far more likely today than any deflationary depression.

The good news for our VTSAX wealth building strategy is that stocks are a pretty good inflation hedge, as long as it is moderate and builds slowly.  After all, as we’ve discussed, in owning stocks we own businesses.  These businesses have assets and create products.  The value of those rises with inflation.

Still, if inflation rises too far too fast we’ll want to have something that reacts more quickly. So too for deflation.

The decision every investor must make is how much risk to accept in the wealth building process.  Looking at the past 100+ years, you have to ask yourself whether it makes sense to focus on the Big Ugly or to invest for the relentless rise that dominates.

None of this is to say that Big Ugly Events are not very scary and destructive things.

But they are rare and in the context of our overriding approach —Spend less than you earn – invest the surplus – avoid debt — they are survivable.

This is the first post of the blog:

The more able you are to live like the Monk, the more likely you are to live like the Minister.

Next time we’ll look at specific investments to build and protect our wealth.  As I promised in Part I, you won’t believe how simple it is.

Disclaimer:  Like everything else on this blog, this is only sharing ideas.  You are solely responsible for your own choices.

Addendum: For another perspective on the Depression and its real impact on stocks: It did not take 15 years for the stock market to recover

This entry was posted in Stock Investing Series and tagged , , , , . Bookmark the permalink. Post a comment or leave a trackback: Trackback URL.


  1. Trish
    Posted April 29, 2012 at 8:27 pm | Permalink

    Jim, these posts are so good – I spent part of my Sunday afternoon going back over some of the older ones. I’m going to make them required reading for my sons.
    Thanks so much – enjoyable, clear – if only you’d started this about 20 years earlier!

    • Posted April 29, 2012 at 9:55 pm | Permalink

      Thank you so much for the kind words. You made my day.

      20 years ago I had a pesky job that got in the way….

      …plus I didn’t know what a blog was back then. :)

  2. Posted April 30, 2012 at 1:42 pm | Permalink

    Sage, simple advice. Love it. Spend less than you earn, invest the surplus, avoid debt. I will be tuning into your blog to harvest investment wisdom. Well written and very readable insight into how to manage money – personally. Nice.

    • jlcollinsnh
      Posted April 30, 2012 at 6:48 pm | Permalink


      more money to travel the world sampling wines!

  3. Posted April 30, 2012 at 1:43 pm | Permalink

    Simple, clear, powerful advice. And I’m paying attention!

  4. Posted April 30, 2012 at 11:20 pm | Permalink

    My observation when I saw that chart in your previous post:
    If one put in half his money in 1929 and kept the rest in cash, then bought in at the low, he would have an almost 300% gain by the 1937 high. The big crashes make a pretty good argument for dollar cost averaging and sticking to the plan of buying when others are panicking.

    • Posted May 6, 2012 at 2:16 pm | Permalink

      Hi Yuriy…

      Thanks for stopping by!

      The challenge in what you describe is knowing where that bottom is. While waiting the half in cash is unproductive and thereby reducing returns.

      Many people expected the 2008 debacle to mimic 1929 and stocks to shed 90% again. They are still waiting to invest the cash they raised.

      Personally, except for the cash I keep on hand for up coming needs, I prefer to keep my money working full time.

      But certainly buying when others are in panic mode is a very good thing.

  5. Posted May 2, 2012 at 9:56 am | Permalink

    Jim, I think the key is to consistently invest in the best companies of America so that your risk gets spread out. I am also against margin trading. No one should do that. I use one simple approach to protect my gain. When both DJIA and NASDAQ go below 50 DMA(Day moving average), I sell everything and wait for the trend to be up. I sell weaker stocks first because they normally go down in value quicker than stronger stocks. I loved this article. You’ve inspired me to research 1929 crash to see how one could have avoided painful 90% loss. :)

    • Posted May 6, 2012 at 2:18 pm | Permalink

      Hi Shilpan…

      Always great to read your comments here. Let us know what your research uncovers!

  6. arebelspy
    Posted February 14, 2013 at 10:37 am | Permalink

    Jim, I read a terrific blog post today about the Big Ugly Event and it reminded me of this post you wrote, so I wanted to cross-link it here. It reinforces your comments the the event wasn’t that big, or ugly, if you just stayed the course.

    • Posted February 14, 2013 at 10:39 pm | Permalink

      Thanks, Arebelspy…..

      …that is a good one and worth reading. Hope you link to mine on his blog as well. 😉

  7. Posted August 7, 2013 at 5:27 pm | Permalink

    “A little inflation can be a very healthy thing for an economy. It keeps the wheels greased and running smoothly. ”

    “…it is sometimes called “the hidden tax” because it erodes the buying power of our currency. It also allows debtors, like the government, to pay back their creditors with “cheaper dollars.””

    Stealing from savers? Punishing lenders? Incentivising reckless borrowing with low rates? Raising prices? Sounds healthy to me. Just how much theft is the right amount to keep the wheels greased?

    I also take exception to your description of deflationary environments. You don’t wait to buy something you need. You buy it. Yes, it may cost less (or more) in another year…but you need those eggs today. Deflation makes life easier for those with savings but punishes those who borrow. Unfortunately for governments, deflation also lowers tax revenues…hence the inflationary policies.

    Sure deflation can lead to a spiral of falling prices. Even the poor can buy more stuff! Inflation leads to a spiral of increasing prices. Who wins then (now)?

    And why do you tie falling prices to falling rates? Rising rates lower home prices…at least, they did when I was a kid. You buy less home per payment at 16% than at 3% so the price has to fall.

    I absolutely agree that hyperinflation is more likely than deflation. History has proven that. If interest rates rise the gov’t is in real trouble. So…Damn the torpedoes!

  8. Clint
    Posted August 22, 2013 at 3:27 pm | Permalink

    There’s a lot of noise these days about the “bond bubble bursting.” Is this a perfect example of the kind of noise one should tune out if in for the long haul (20+ years), or is this an actual long-term concern that should make one wary of bonds?

    I’m 34, in the wealth building stage, and currently allocating 20% to VBTIX.

    Thanks so much. I can’t tell you how much I appreciate, enjoy, and share your investing series.

    • jlcollinsnh
      Posted August 23, 2013 at 11:19 am | Permalink

      Great question Clint …

      And it deserves a more complete answer than I can tap out on this little phone.

      Do me a favor? In late September repost it under the post on bonds. I’ll be back from Ecuador by then and at my computer keyboard.


  9. Andy Lomon
    Posted May 15, 2015 at 1:07 pm | Permalink

    Hello Jim,

    Amazingly well explained! Unfortunately in the 3rd world (aka here! [Argentina]) we have the evil twin to deflation, that is between 25-35 inflation for at least the last 5 years in a row. And to make it worst, unclear/uncertain official statistics.

    So if I got it right when inflation comes you want to be invested (mainly stocks-VTSAX) and when deflation hits you want to be in cash / bonds?


    • jlcollinsnh
      Posted May 17, 2015 at 12:26 pm | Permalink

      Thanks Andy…

      ..glad it made sense.

      Yep, you’ve got it.

      During times of inflation, money is losing its value. So it is better to have your wealth in tangible assets like businesses, which is what you own with a fund like VTSAX.

      With deflation, the prices of tangible assets drops, meaning money gains in value thru increased purchasing power. So cash increases in value. Since bonds pay you cash interest they benefit.

      For more:

  10. Sunflower
    Posted July 8, 2015 at 6:00 pm | Permalink

    Hi Jim,

    Came across your blog via a friend’s recommendation; love it! Thank you so much for the helpful tips!

    Quick question-I noticed the y-axis on the graph you used to show the DJIA on this page was skewed to be top heavy, thus exaggerating smaller movements in the early years of the DJIA, while compressing the fluctuations in the later years. When I took a look at the DJIA/SP 500/VTSAX over the last 20 years or so, the cyclical cycle of the market meant depending on when you started to invest, either many years would be required to get back to original levels, or you would have made a strong return on the upswing.

    Do you think it would be possible to monitor certain metrics to use as a rule of thumb to know when to buy or sell to minimize the downside? e.g. >10% decrease from the peak within 2 months =sell all VTSAX; >10% increase from lowest point over 2 months = buy VTSAX with all available funds.

    You address this in some of your posts, and the comments sections that because there is no way we can be clairvoyant, and thus we should keep to our investment philosophy and buy as the prices fall. Perhaps I am missing something deeper?

Post a Comment

Your email is never published nor shared. Required fields are marked *


You may use these HTML tags and attributes <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

Subscribe without commenting

Subscribe to email feed
Subscribe to RSS Feed