Yet, in context their fear is misplaced. During the early years of the Great Depression, prices declined primarily for three reasons: 1) The money supply decreased between 1929-1931, which caused a sharp contraction in economic activity.
The subsequent increase in the monetary base had no effect since production was declining and 2) there were approximately 9,000 bank failures between 1929-1933. This caused the money multiplication effect, which is the byproduct of a fractional reserve banking system, to be nullified. The FDIC was nonexistent in those days; so when a bank would fail, depositors lost their money. In this instance, the supply of money simply “disappeared” from the economy. But most importantly, 3) the U.S. operated under a domestic gold-standard as its monetary system. In addition and in contrast to today, gold coin freely circulated as money in those days.
This last point is crucial to reiterate because deflation cannot occur outside of a commodity-linked currency. Said differently, it is impossible to have price deflation (i.e. a sustained decrease in prices) under a fiat monetary system, except only when productivity outpaces money supply. Critics will point to Japan as an example of the consequences of deflation. However, Japan’s economic malice is the result of government intervention (see here and here for a detail analysis on this country).
As demonstrated by the following chart, prices declined in the U.S. from 1928-1933 and subsequently increased thereafter. (Insert Chart).
It is of utmost importance to highlight that on April 5, 1933, President FDR criminalized the private holding of gold and forbade the usage of gold coins as money to settle transactions. There is no coincidence that prices began to increase post-1933.