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Deflation
Symptom of crisis
When a deflationary trend developed in Japan in the
mid-1990s, leaders in the USA and Europe regarded it as a Japanese peculiarity,
a local side-effect of the bursting of the 1980s bubble. Now some commentators
recognise that US capitalism, with a decisive influence on the world economy,
could be in a similar position to Japan then – on the verge of a deflationary
spiral. LYNN WALSH writes.
A SPECTRE IS haunting world capitalism, the spectre of
deflation. For over sixty years deflation was just a distant nightmare for
bourgeois leaders. It hardly gets a mention in standard economic textbooks. The
deadly enemy was inflation, which surged internationally in the 1970s and has
periodically engulfed crisis-torn countries. Fears are now rising, however, that
deflation – a broad decline in prices – poses a growing danger to the world
economy.
By increasing the burden of debt, deflation threatens to
prolong and deepen the current stagnation or even provoke a worldwide slump.
When a deflationary trend developed in Japan in the mid-1990s, leaders in the
USA and Europe regarded it as a Japanese peculiarity, a local side effect of the
bursting of the 1980s bubble and the consequential paralysis of the world’s
second largest economy. The relentless development of a deflationary spiral of
debt deflation, which the Japanese government has proved powerless to arrest,
has forced capitalist strategists to take it more seriously. Recently, a
deflationary trend has developed in Germany, while at least some economic
commentators now recognise that US capitalism, which has a decisive influence on
the direction of the world economy, could be in a similar position to Japan in
the early 1990s – on the verge of a deflationary spiral.
In pronouncements as ambiguous as those of the Delphic
oracle, Alan Greenspan, chairman of the US Federal Reserve, has minimised the
threat of deflation. While admitting there is a danger of deflation, he
optimistically claims that a US recovery is imminent and Fed policy will avert
the danger of a continuous, across-the-board fall in prices. But this optimistic
view has recently been challenged by two presidents of regional Fed Reserve
Banks, William McDonough of New York and Anthony Santomero of Philadelphia, and
also by Edward Gramlich, one of the Fed’s seven governors. (David Leonhardt, Fed
unanimity cracks, International Herald Tribune, 19 May) The April 2003 figures
showed the biggest fall in wholesale prices since 1947 and the sharpest fall in
consumer prices in 18 months.
Trapped in past economic dogma, capitalist policy-makers
have been slow to recognise the swing to deflation. But since the 1980s, in most
countries there has been disinflation – a continuous decline in the rate
of inflation. Inflation averaged 7.1% per annum in the advanced capitalist
countries during 1970-89, but only 2.7% during 1990-2001. (This has not
prevented countries going through deep crises, such as Argentina, experiencing
runaway inflation.) In the last two years, Japan and China, as well as Singapore
and Hong Kong, have experienced declines in both consumer and wholesale prices.
Canada, Germany, the US, Italy and France, in 2001 and 2002, as well as
Indonesia, Taiwan, and the Philippines, have seen wholesale prices decline. More
recently, US consumer prices fell 0.3% in March while in Germany prices rose
only 0.7% in May from a year earlier.
This is clearly not just a cyclical trend; rather the steady
fall in prices of most manufactured goods and tradable services is a long-term,
structural phenomenon. Optimists claim that lower prices merely reflect the
globalisation of manufacturing and the productivity gains of the last two
decades. The current disinflation, they argue, resembles the mild deflation that
accompanied the worldwide capitalist expansion in the last quarter of the 19th
century. Cheaper production methods are undoubtedly a factor. Nevertheless, the
current deflation much more closely resembles that of the 1930s, though the
current world economic conjuncture combines features of both periods (see box: A
short history of inflation & deflation). Worldwide disinflation and the onset of
deflation reflect chronic overcapacity in the major capitalist industries, the
steady weakening of demand, and the collapse of stock-exchange and property
bubbles in Japan, the US and elsewhere. In other words, price deflation and
associated debt deflation are part of a syndrome produced by the global
stagnation of capitalism. As the symptoms intensify, they systematically
aggravate the underlying malaise, raising the spectre of prolonged stagnation,
if not another great depression.
On 30 April, the IMF published a major study, ‘Deflation:
Determinants, Risks and Policy Options’ (www.imf.org), a somewhat
contradictory document. While showing that Germany is now sliding into
deflation, it says the IMF task force "did not see any compelling evidence of
generalise global deflation". (p6, p25) Yet the opposite conclusion could easily
be drawn from the material they present. Sustained mild deflation, says the
report, is far more serious than mild inflation. "Past episodes suggest that
sustained deflation can be unanticipated, even as inflation and nominal interest
rates fall close to zero". (p32) The first lesson of history, they say, is that
"deflation and deflationary episodes can take root surprisingly quickly". (p15)
The IMF calls on governments and central banks to be prepared to take
pre-emptive action to prevent inflation. Yet the report shows that sustained
action by the Japanese government on the lines recommended by the IMF (reduction
of interest rates to zero and a massive expansion of the money supply) has up to
now completely failed to halt Japan’s deflationary spiral. Will Germany and the
US do any better?
The debt time-bomb
WHY IS DEFLATION a problem? Falling prices surely mean lower
living costs – isn’t that a good thing? The problem is that the current
deflation – produced by excess capacity and weak demand – is a symptom of
capitalist malaise, the product of prolonged stagnation. For workers, any gain
from cheaper goods and services will be cancelled out by wage cuts,
unemployment, and other adverse effects of capitalist crisis.
When prices are falling, people put off buying things in the
expectation that prices will fall even further, depressing demand. Facing
shrinking markets, the capitalists also find their profits squeezed by falling
prices. At the same time, while real wages are rising (pay packets can buy more
as prices fall) the bosses inevitably attempt to reduce their wage costs by
launching attacks on nominal wages or by sacking workers. Either way, cutting
the wage bill undermines purchasing power and strengthens the forces of
stagnation.
The most severe effect of deflation, however, is that it
increases the burden of outstanding debts by pushing up real interest rates (the
rate that takes account of price changes). While inflation lowers the real cost
of payment of interest and principal over time, thus favouring borrowers against
lenders, deflation favours lenders. Interest on most business, consumer and
housing loans (with the exception of some British mortgages) are fixed at the
original nominal rate. As prices fall, however, the real rate rises (see
glossary). This increases the burden (the real value) of existing debt at a time
when the shrinking sales revenue of businesses and falling incomes of workers
make it increasingly difficult to repay debt.
As deflation sets in, of course, nominal interest rates also
tend to fall (though this does not help existing debtors with fixed rate loans
or ‘high risk’ borrowers who are charged premium rates). Nominal interest rates,
however, cannot fall below zero – negative nominal interest rates would mean
banks paying borrowers to take out loans and charging savers to deposit their
savings in the bank! But while the nominal rate cannot fall below zero, prices
can continue to fall, continually pushing up real interest rates and twisting
the deflationary screw.
The growing weight of debt, when the economy is stagnant,
gives rise to a liquidity or debt trap. With incomes and profits squeezed,
businesses find it increasingly difficult to service their debts. More and more
default, and if the banks take steps to recover some of what is owed to them,
debtor firms are forced into liquidation. An accumulation of bad debts
increasingly becomes a problem for the banks and finance houses, threatening the
most vulnerable with collapse. This is currently happening in Japan, were the
banks officially acknowledge bad debts of around $500bn, though unofficial
estimates put the true figure at about $1,000bn. Only huge injections by the
Japanese government have prevented a catastrophic chain reaction of banking
failures; but the bad debt problem remains unresolved. Naturally, in this
situation the banks become increasingly reluctant to lend money to potentially
risky borrowers, especially at virtually zero interest rates, even though, in
the case of Japan, the Central Bank has made massive additional funds available
to the banks in an attempt to stimulate business activity. Although base nominal
interest rates are extremely low in both Japan and the US, banks and finance
houses are in many cases charging business much higher premium rates for what
they consider ‘high risk’ investments.
Under conditions of stagnation or slump, price deflation has
historically been linked to asset price deflation, a collapse of share and
property prices. This was certainly true in the 1930s, and has applied to Japan
since its bubble burst at the end of the 1980s. During a boom, especially one
dominated by financial speculation, share and property prices are enormously
inflated. Speculative activity is invariably financed by borrowing (relatively
low interest rates compared to high levels of speculative profits). The scramble
for shares and property pushes up their prices, and these inflated assets are in
turn used as collateral to secure new loans to buy more assets – and so on, and
so on. A crash is inevitable at a certain point, when much of the inflated value
will be wiped out. This precipitates a chain reaction of bankruptcies, deepening
the downward economic spiral.
Japanese capitalism is a currently classic example of this
kind of debt deflation. In the 1980s, the Japanese government deliberately
encouraged the growth of the bubble as a cheap method of financing the
modernisation of the leading sectors of the Japanese economy on the basis of the
latest technology. This was aimed at increasing Japanese capitalism’s share of
world export markets, especially in the high-value, hi-tech sectors. This
resulted, however, in enormous overcapacity, which together with international
factors resulted in deflation during the mid-1980s. The Japanese bubble burst
after the international financial crisis of 1987, and Japanese capitalism has
never recovered. Property prices have fallen over 80% since their 1988 peak,
while shares have fallen to a 20-year low.
The bad debts of the banks are steadily increasing, a
time-bomb under Japanese and world capitalism. The early 1990s were marked by
disinflation, the result of a combination of factors: excess capacity, the bank
crisis, slackening consumer demand, and competitive price pressure from imports
(especially from countries like China). After 1994 disinflation turned into
deflation, which has continued until the present time, hovering around -1%.
Growth has been stagnant, with the economy going through three recessions in 13
years. While there are undoubtedly differences between Japan, and the US and
Germany, the latter two nevertheless face conditions very similar to those that
existed in Japan in the early 1990s.
An economic quick-sand
IF DISINFLATION AND deflation are the symptoms, what are the
underlying causes of the disease? In fact, features of the two different
variants of the disease are combined in the current outbreak:
(1) Prices have been depressed by massive worldwide
overcapacity resulting from a long period of relatively weak and declining
growth in the world economy. Despite the technology boom and the emergence of
the Asian tigers in the late 1980s-early 1990s, globalisation did not stimulate
an overall acceleration of growth internationally. According to UN statistics,
world GDP grew at an annual rate of 5.4% in the 1960s, 4.1% in the 1970s, 3% in
the 1980s, and 2.3% in the 1990s. This was inevitably accompanied by weakening
demand for goods (not that millions did not need goods, but their needs were not
backed by money). At the time of the Asian crisis in 1997, the then chairman of
General Electric (GE), Jack Welch, said: "There is excess global capacity in
almost every industry". (New York Times, 16 November 1997) Neo-liberal policies
boosted capitalist profits, but cuts in wage levels and social spending shifted
the distribution of wealth sharply away from the working class - further
undermining the market for capitalist goods. In 1998 The Economist warned of "a
malign deflation caused by excess capacity and weak demand", commenting that the
gap between sales and capacity was "at its widest since the 1930s". (30 November
1998) Since then, the oversupply of goods has further undermining the
capitalists’ ‘pricing power’ (their ability to raise prices). This variant of
deflation is comparable to the ‘demand shock’ deflation of the 1930s, though it
has not yet become so acute, even in Japan. It is combined, however, with
‘supply shock’ deflation comparable with that of the last quarter of the 19th
century.
(2) Prices have also been steadily depressed, especially in
the late 1980s and the 1990s, by the application of new technology, which has
cut costs by raising productivity and saving labour, materials and energy. New
technology, especially in communications, under conditions of a deregulated
global economy, allowed the multinational corporations and speculative investors
to relocate manufacturing in low-cost countries, such as China. (China combines
features of supply-led deflation, produced by the growth of new,
foreign-financed industries, with demand-led deflation, resulting from the
stagnation or collapse of state-owned enterprises and the growth of mass urban
and rural unemployment.) This began in labour-intensive sectors such as
garments, shoes, toys, etc, but has been spreading to microchips, televisions,
motor vehicles, and computers. Despite existing overcapacity in major
industries, corporations have continuously invested in new plant and equipment
in a ruthlessly competitive drive to cuts costs and increase their market share
at the expense of their rivals. Globalisation has intensified this predatory
competition, continuously driving down prices and adding to world overcapacity.
While the volume of world exports grew by 7.3% per annum during 1991-2000, the
price of manufactured exports declined by -0.8% per annum. This variant of
deflationary pressure, particularly strong in China, resembles the ‘supply
shock’ deflation of the 1880s, but it has developed (unlike the later 19th
century) under conditions of international stagnation, which has produced
demand-led deflation.
"If caused by rapid productivity growth, as in the late 19th
century", comments The Economist, "it [deflation] can go hand in hand with
robust growth. But if prices are falling because of a slump in demand, deflation
can be dangerous. Today the world exhibits both sorts of deflation, but the vast
amount of excess capacity suggests that it is mainly of the bad sort". (Hear
that hissing sound? The Economist, 17 May 2003) Big business was to some extent
cushioned from the full effects of overcapacity and the loss of pricing power,
first by the rapid growth of the Asian tigers and other ‘emerging markets’ up to
1997, and then by the speculative bubble of 1998-2000 in the US and elsewhere.
For a time, these developments provided highly profitable markets for both
investment and consumer goods in some sectors and certain regions of the world
economy. Even after the speculative bubble burst, relatively high levels of
consumer spending, linked to the housing bubble and financed by record levels of
debt, have postponed a precipitate collapse of demand. Prolonged stagnation
since 2000, however, with rapidly rising levels of unemployment in the advanced
capitalist countries, has once again brought the problem of overcapacity and the
decline of demand to the fore.
"The immediate danger isn’t deflation per se", writes the
economic commentator, Paul Krugman, "it’s the risk that the world’s major
economies will find themselves trapped in an economic quagmire. Deflation can be
both a symptom of an economy sinking into the muck, and a reason why it can sink
even deeper, but it’s usually a lagging indicator. The crucial question is
whether we’ll stumble into the swamp in the first place – and the risks look
uncomfortable high". (Fear of a quagmire? New York Times, 24 May)
A policy impasse
IN RECENT MONTHS, economic strategists within the US Federal
Reserve and the IMF have been debating the issue of deflation, largely behind
closed doors. The question they are grappling with, of course, is what policies
they should adopt to avert the danger of a deflationary spiral in the US. The
experience of Japan is hardly encouraging. A recent study of Japan by the Fed
concludes that the Japanese authorities did too little, too late. But the Fed
has little useful advice to offer now, and it is uncertain, to say the least,
whether more aggressive policy measures could have averted the onset of
deflation in the mid-1990s.
The stagnation of the last 13 years is the result of the
collapse of Japan’s 1980s bubble economy. There was massive overcapacity and a
decline of demand. The slump in share and property prices left a mountain of bad
debts, paralysing the banking system. Workers and the middle class attempted to
pay off debts, while reducing their expenditure. Massive government public
spending projects (mostly on big construction projects) ameliorated the slump
but failed to lift the economy out of stagnation. The Bank of Japan steadily
reduced interest rates to virtually zero and made vast funds available to the
banks – but there was no incentive for banks to make new loans, or for companies
to make new investments. As the deflationary trend got under way after 1994,
Japanese capitalism became caught in the liquidity trap. The deflationary spiral
has deepened, and there is the possibility of an even sharper downturn. Given
the decisive role played by Japanese capital in supporting the US dollar (by
hoarding huge dollar reserves) and in financing the US’s debt to the rest of the
world (by purchasing US bonds and investing in the US economy), that would have
a devastating effect on the US and world economy.
The US economist, Paul Krugman, is a lonely voice calling on
the Japanese government to turn to a policy of deliberately stimulating a
prolonged period of mild inflation (between 2% and 4%) to stimulate spending and
revive investment. The theory is that if money is losing its value through
inflation, people will spend sooner rather than later. Most bourgeois
strategists, however, are not persuaded that attempts to inject massive
additional liquidity into the economy would actually have the desired effect.
Capitalist leaders in Japan and elsewhere, moreover, fear that once inflation
was triggered, it could quickly accelerate into runaway inflation – a return to
stagflation!
In Europe, Germany is already following Japan’s lead. In
contrast to the US Federal Reserve, however, the European Central bank (ECB) has
been very cautious in cutting interest rates (cut to 2% in May) and has
maintained a tight money supply. Wim Duisenberg, head of the ECB, appears to be
more concerned about imaginary waves of inflation than the quick-sands of
deflation into which they are actually stumbling. At the same time, the fiscal
regime of the eurozone, under which budget deficits are supposed to be kept
under 3% of GDP, imposes a restrictive policy on economies, like Germany,
France, Netherlands, and Italy, which are currently approaching zero growth.
This demonstrates the perverse effect of the one-size-fits-all euro
straitjacket, which will deepen the contradictions within European capitalism.
The eurozone slowdown, moreover, has been accentuated by the rise of the euro
against the dollar (by around 30% since May 2002), which has hit eurozone
exports. As in Japan in the late-1990s, further cuts in eurozone interest rates
are likely to come too late to arrest Germany’s deflationary trend, which could
become a downward spiral ensnaring other EU economies.
In the US, Greenspan coyly refers to "the probability of an
unwelcome substantial fall in inflation" (Fed statement, 6 May), avoiding the
dreadful D-word. But there is no doubt that the Fed leaders are seriously
concerned about the danger of deflation. After seeing what happened in Japan,
the Fed moved quickly in January 2001 after the bubble burst, and again after
9/11, to reduce interest rates and expand the money supply. After a dozen cuts,
rates have been reduced to 1.25%, the lowest level for 40 years, and they may
soon be cut to 1% – virtually zero. This action undoubtedly prevented a severe
slump but, at the same time, has not brought the recovery that Greenspan
promised. US banks are not so weighed down with bad debts as their Japanese
counterparts, but many US corporations have huge debts while household debt has
reached record heights. Moreover, although Bush’s tax cuts for the super-rich
will produce a growing Federal deficit, extra Federal spending on arms and
security is likely to be more than offset by cuts in spending by the states
(mostly imposed by cuts in Federal grants). Unemployment is still rising, and a
growth rate under 3% will not prevent unemployment and overcapacity from rising
further. All these factors point towards the likely development of deflation. A
decline of the dollar, which will make imports more expensive in dollar terms,
may tend to counteract falling prices; but this effect is likely to be limited,
as overseas producers of manufactured goods will (as they already are) try to
reduce any rise in the dollar price (accepting lower profits) in order to
maintain their share of the US market. Japan’s slide into deflation developed
slowly over a period of ten years, and the US could well be following the same
path. With interest rates at 1.25% and ample liquidity, monetary policy appears
to be approaching the limits of its effectiveness. As Keynes said, cutting
interest rates at a time of weak demand and over-capacity is like pushing a
piece of string.
19 June 2003
A short history of inflation & deflation
THROUGHOUT THE period since the end of world war two,
bourgeois leaders have been preoccupied, if not obsessed, by the danger of
inflation. They remained haunted by the hyper-inflation that convulsed Weimar
Germany in the 1920s, which they blamed (somewhat simplistically) for
revolutionary upheavals and the rise of fascism. Despite the relatively low
inflation of the post-war upswing period the ideologues of big business
considered that the Keynesian framework (the ‘welfare state’ and state
intervention to sustain demand and full employment) had a built-in ‘inflationary
bias’. Historically high rates of GDP and productivity growth, however, allowed
governments to expand the public sector without provoking serious inflation. In
the advanced capitalist countries, inflation rose from around a negligible 2%
per annum in the 1950s to around a tolerable 4% in the 1960s.
As the upswing exhausted itself, however, and profits and
investment declined, inflation began to climb (to an average in 1969-73 of 6.4%
in Europe and 4.9% in the US). Inflationary tendencies in US capitalism
(exacerbated by spending on the Vietnam war) were transmitted to the world
economy. After the oil price shock of 1973, which marked the end of the upswing,
inflation surged (averaging over 10% in Europe during 1973-79 and exploding in
some countries to well over 20% in some years). Rapidly rising prices eroded the
real value of debts, favouring borrowers against lenders. High inflation
accentuated economic instability and provoked massive wage struggles by
organised workers. Big banks and wealthy investors in government bonds feared
that governments would increasingly resort to the ‘monetisation’ of their
national debt – that is, rather than relying on tax revenue and loans, they
would simply print money to cover their budget deficits, opening the door once
again to hyper-inflation. In the late 1970s, therefore, leaders of major
capitalist powers took a strategic decision to squeeze inflation out of the
world economy.
Led by the US and Britain, the ruling class turned to
‘monetarism’ (high interest rates and a restricted money supply) and the
policies since known as neo-liberalism – an assault on workers’ organised
strength, cuts in social spending, reduction of state investment in economic
infrastructure, deregulation of finance and industry, privatisation of services,
etc. Together with the development of new technology and globalisation,
especially the location of manufacturing in low-cost countries, this produced a
widespread trend of disinflation – that is, a broad slowing-down of the rate of
price increases – in the 1980s and especially during the late 1990s. Even so,
capitalist leaders still feared that inflation could easily rear its head again.
In 1994, for instance, just as the US economy was beginning to climb out of the
prolonged recession after 1990, Greenspan clamped on the brakes, by raising the
interest rate. The recovery faltered, and Greenspan turned back to a policy of
relaxing credit. More recently, the ECB has been very slow to follow the US
Federal Reserve in lowering interest rates. Despite the stagnation in the core
euro-zone economies and the appearance of deflationary trends in Germany,
Duisenberg, the head of the ECB, appears to be more concerned about the ghost of
inflation than the reality of deflation, like a general still fighting the last
war. Less blinkered bourgeois strategists, however, clearly recognise the
growing danger posed by a generalised and sustained fall in prices, and are
beginning to re-examine the past experience of deflation.
The Great Depressions
HISTORICALLY, WORLD capitalism went through two major
periods of deflation, during the last quarter of the 19th century and in the
1930s. Both periods were in turn know as ‘the great depression’, but their
characteristics were quite different, and it was the later period which
threatened the survival of the system. During the nineteenth century, as
capitalism developed on a world scale, there was a long-term trend for prices to
decline gradually. In the 1870s and early 1880s, however, there was a sustained
episode of deflation. This cut the capitalists’ rate of profit, caused debt
problems for farmers in particular, and gave rise to a series of financial
crises. At the same time, falling prices increased the real wages of sections of
workers, giving them the confidence to struggle for trade union rights. Overall,
however, the leading capitalist economies continued to grow. In fact, it was a
period of intensive and extensive capitalist growth internationally. The
application of new technology to production and transportation raised
productivity and produced a plentiful supply of goods, which resulted in lower
prices. (Apart from the expansion of the productive forces, a restricted money
supply may also have been a contributing factor, as there was in that period a
shortage of gold, the basis of the major currencies under the Gold Standard.)
The deflation of the inter-war period had a devastating
effect on world capitalism. Falling prices were not the result of expanded
production under conditions of worldwide growth, but the product of a slump in
demand and massive over-production. The deflationary shock was triggered by the
deep slump of 1929-33 in US capitalism, which dragged the rest of the world down
with it. The slump followed the speculative boom of 1925-29, particularly
frenzied in the US but paralleled by cyclical booms in Britain and elsewhere.
The financial bubble burst when the slump in production and profits made itself
felt. The sharp decline of producer and consumer prices reflected the collapse
of demand and massive over-production, but the deflation inevitably exacerbated
the crisis. Deflation made debt more expensive, and together with the collapse
of share and property prices, this precipitated a banking crisis and a breakdown
of the world financial system. The international crisis was undoubtedly
aggravated by a deliberate policy on the part of the US, Britain and other
powers of maintaining the Gold Standard, which severely restricted international
liquidity.
1929-30 was a classic slump in the US, with massive
overproduction and mass unemployment. It was followed, however, by an avalanche
of bank failures, debt deflation, and depression – the classic example of a
deflationary spiral. During 1929-33 real GDP fell by 30%, industrial production
by 46%; unemployment rose to 25% or about 13 million workers. Prices, which had
been steady between 1921-29, fell by 24% during 1929-33. Over a quarter of US
banks collapsed (about 6,000), wiping out the savings of about six million
families. The problems were compounded by the Fed’s policy of tightening the
money supply, which fell by 30% during 1924-33 (a mistake that it has not
repeated in the last three years). Each turn of the deflationary spiral further
depressed demand for goods, pushing back any recovery of profits and investment.
The dominant position of US capitalism ensured the transmission of deflation to
other economies, with Japan and Sweden experiencing particularly sharp falls in
prices (-25% and -20% respectively).
Surveying contemporary analyses of the 1930s slump, J
Bradford DeLong, professor of economics at UC Berkley, comments that
explanations were ‘widely divergent’: "Nevertheless, almost every analyst of the
great depression placed general deflation – and the chain of financial and real
bankruptcies that it caused – at or near the heart of the worst macroeconomic
disaster the world has ever seen". (Why We Should Fear Deflation, March 1999,
www.j-bradford-delong.net) Though ‘at or near the heart’ of the crisis,
deflation was the process through which deeper contradictions of capitalism
worked themselves out. The slump arose from a classic crisis of
over-accumulation of capital. During 1925-29 in the US there was a strong
investment boom and the rapid emergence of new, advanced technology industries.
But the intensified exploitation of the working class and their reduced share of
the wealth undermined the workers’ ability to purchase goods and services – and
therefore the capitalists’ ability to realise profits on their capital
investments.
Glossary
PRICES: Trends in the broad range of prices (aggregate
prices) are measured by several indexes. Inflation/deflation is usually
calculated by the trend in consumer prices, measured by the consumer or
retail price index (CPI or RPI). The index measurers the average price of a
typical ‘basket’ of consumer goods and services (and also mortgage payments,
council tax etc) purchased by the average household. The ‘headline’ rate refers
to the whole ranges of prices included in the basket, while the ‘core’ rate,
often referred to by economic commentators, excludes the mortgage rate, fuel
prices, seasonal fresh food, etc.
But deflation/inflation can also be expressed in terms of
the GDP deflator which measures the rise/fall of prices of a much broader
range of goods and services that make up the gross domestic product (GDP)
or in terms of the product price index, which measures the rise/fall of
factory gate prices of goods produced. The recent deflationary trend has
developed first and most strongly in product prices (as compared to consumer
prices), reflecting intensified international competition in core industries
under conditions of overcapacity and falling demand.
INFLATION: A general increase in prices, usually
measured by the index of consumer or retail prices (the CPI or RPI). The rate of
inflation is also measured by the index of wholesale or product prices (charged
by the producers) or by the index for GDP prices (the ‘GDP deflator’).
Inflation means that the purchasing power of a unit of
currency (pound, dollar, euro, etc) has been reduced. Put simply, people have to
pay more for the same goods or services. Inflation arises when (a) rising costs
(of materials, energy, labour or credit) per unit of output push up prices or
(b) when purchasing power or the money supply (through increased public
spending, an expansion of credit, etc) rise ahead of output, or (c) by a
combination of these so-called ‘cost push’ and ‘demand pull’ factors.
During periods of economic upswing (for example, 1950-73),
the growing economy goes through a ‘boom and bust’ cycle. Peaks (the booms) were
typically marked by short-term, cyclical inflation. Increasing interest rates,
or increasing taxes, tipped the cycle over into short-term bust (but always
against a background of growth). In periods of crisis, however, such as 1973-79,
following the end of the post-war upswing, capitalism can be hit by chronic
inflation, with rapidly accelerating price increases, tipping into
‘stagflation’, that is high rates of inflation accompanied by high unemployment
and stagnant levels of growth.
Historically, the most notorious episode of hyper-inflation,
was that which convulsed German capitalism in the aftermath of World War I. In a
desperate attempt to stave off economic collapse and socialist revolution in
1921-23, the shaky government of Weimar Germany furiously printed banknotes to
finance government expenditure (rather than increasing taxation or raising new
loans) in order to devalue the unsustainable burden of national debt due to
‘reparations’ demanded by the victors. In June 1923 prices peaked at nearly
20,000 times their 1914 level – workers needed a barrow-load of notes to buy a
sandwich. German hyperinflation and its consequences has haunted the bourgeoisie
ever since.
DISINFLATION: A steady slowing down of the rate of
inflation.
DEFLATION: A steady across-the-board fall in prices
(especially of manufactured goods). Prices may fall (a) as a result of the
expansion of production, productivity increases, and cheaper transport, as in
the last quarter of the 19th century; or (b) as a result of a broad decline in
demand for goods and services, resulting in overcapacity and intensified
inter-capitalist competition, as in the 1930s or Japan in the last decade; or
(c) a combination of these trends, as in the current world situation.
‘DEFLATION’: In the sense of a deliberate
deflationary policy refers to government measures (such as some combination
of higher interest rates, tax increases, tighter money supply, and public
spending cuts) aimed at reducing purchasing power in an attempt to reduce
prices. In other words, it is an anti-inflationary policy.
ASSET PRICE DEFLATION: Refers to a fall in shares and
bonds. Strictly speaking, it is a separate phenomenon from price deflation, but
in periods of economic depression such as the 1930s or in Japan since 1990, the
collapse of share and property prices has interacted with price deflation to
exacerbate the deflationary spiral. In particular, the collapse of share and
property prices (as in Japan) drastically reduces the value of collateral used
as security for loans; if the banks start selling off these collateral assets on
a big scale to cut their losses, they inevitable drive down share and property
prices even further. The downward spiral caused by a combination of price
deflation and asset price deflation is often referred to as debt deflation.
INTEREST RATES: Loan contracts (for business loans,
consumer finance, mortgages, etc) are made on the basis of a nominal rate of
interest - the ‘face value’ of the debt. Internationally, most loans are
made on the basis of a fixed nominal rate, though many British mortgages are
exceptional in having variable nominal rates. The real interest rate
takes into account changes in aggregate price levels (measured by the consumer
price index). The nominal and real rates coincide only in the unlikely situation
of ‘price stability’, that is zero inflation/deflation.
Inflation (prices rising, so each monetary unit will buy
less and is therefore devalued) effectively reduces the real cost of repayments
of principal and interest. For instance, fully repaying a one-year loan of £100
at 10% per annum nominal interest rate costs £110. But after a year, with
inflation of say 10% per annum, the £110 would only purchase the same basket of
goods that £100 had bought at the beginning of the loan period. To calculate the
real interest rate, the rate of inflation is deducted from the nominal rate.
With a nominal interest rate of 6% and inflation of 2%, the real interest rate
would be 4%. With a nominal interest rate of 15% and 10% inflation, the real
rate would be 5%. If inflation suddenly accelerates, there can be (usually very
temporarily) a negative real interest rate: a nominal rate of 15% with
17% inflation, would mean a real interest rate –2%. Good for borrowers, bad news
for lenders. Low or sometimes negative real interest rates developed during the
‘stagflation’ of the late 1970s, which is why in the early 1980s US capitalism
led a world-wide turn (starting with high interest rates) towards
anti-inflationary, ‘monetarist’ policies to defend the interests of the big
banks and finance houses.
Deflation (prices falling, so each monetary unit buys
more and is therefore appreciating in value) effectively increases the real cost
of repayments of principal and interest. For instance, fully repaying a one-year
loan of £100 at 4% per annum nominal interest rate would cost £104. But with
deflation running at 2% per annum the £104 would purchase 6% more goods. To
calculate the real interest rate, the rate of deflation is added to the nominal
rate. A nominal interest rate of 4% with 1% deflation gives a real rate of 5%. A
nominal rate of 1.25% with 2% deflation would mean a real rate of 3.25%. Nominal
rates cannot fall below zero – that would mean banks paying borrowers to borrow.
In a deflationary period, businesses and savers simply hoard their cash since
its purchasing power increases as prices fall. This has been the situation in
Japan over the last few years with the government desperately trying to persuade
people to spend.
WAGES: Nominal wages (or incomes) are expressed in
monetary units (pounds, dollars, euros, etc), while real wages take
account of across-the-board price changes (inflation or deflation) as measured
by the CPI or RPI. If prices fall, wages can buy more – in other words,
deflation raises real wages. Under deflation, bosses complain about the problem
(in economists’ jargon) of ‘sticky wages’ – that is, workers resist wage cuts,
so nominal wages do not automatically adjust downwards as prices fall. With
inflation, price rises erode the value of real wages without the bosses doing
anything, while capitalists can sell their products at higher prices – which is
why steady, mild inflation has often had a stimulating effect on growth during
upswing periods.
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