Hyperinflation Versus Deflation

What seems to be lost in the debate over deflation versus hyperinflation is that the world’s economy has fundamentally changed over the last 25 years. Prior to 1989, the world’s economy was divided into three major areas – the Capitalist West, the Communist East, and The Rest. In 1989, the Communist bloc collapsed and joined the Capitalist West. This was soon followed by major additions to the Capitalist economy such as China. The part of the international economy governed by market forces has grown by several orders of magnitude in a very short time. This expansion has added huge numbers of workers and consumers with a largely deflationary effect as their low wages and increased productivity restrain prices around the world. True, commodity prices have increased, but those prices have not pushed through to the rest of the economy as the deflationary effects constrain the ability of producers to pass on the higher costs and the rise in productivity in newly emergent capitalist countries lowers other production costs. The best way to look at this is that the parameters that govern our economy have shifted dramatically allowing for a huge rise in productivity that creates deflationary pressures. Will this change soon? Not likely. India is about to join the party in a big way along with other Asian countries not yet fully integrated in the international economy, while Latin American countries also are becoming more integrated. Even Africa is moving forward and will join more fully in the years to come. The upshot is that deflationary pressures are likely to continue for a very long time and the return to a “normal” monetary regime is not likely any time soon. This is not your Grandfather’s deflation, either, that was experienced in the Great Depression. There, a loss in demand led to a generalized drop in prices that had a self-reinforcing effect as the productive capacity of the world was greater than the ability of consumers to buy. Reversing the deflationary spiral proved extremely difficult. Today’s deflationary effect is almost a background factor and not the engine for price changes. Consumers are able to buy more goods at cheaper prices because the productive capacity of the new producers is so high. Prices are not dropping from a loss of demand, quite the opposite has happened. Demand is higher, but prices for many goods have fallen because of lower production costs. Consumers have realized a marked increase in their standard of living as a result, not a fall. There are downsides to this deflation, however. At the same time that consumers, largely in developed countries, have enjoyed the increase in lower-priced goods, the transfer of production to low cost areas has lead to a loss of jobs and wages. Those countries that have been able to increase their productivity levels, such as Germany, have been able to maintain employment, although incomes have not done as well. Those that have not been able to increase their level of productivity have seen higher unemployment and loss of income. In the US there is now a debate over what happened to middle incomes and it is likely that this deflationary process has contributed to the stagnation in middle incomes to some degree (The stagnation of income predates the beginning of deflation, however.) The US has not adapted as well as Germany, but still far better than most other developed countries. It is time we faced up to the fact that we are looking at a low interest rate environment with accompanying deflationary pressures for a very long time. And that’s not even accounting for an economic downturn/collapse in a place such as China which will then have huge production overcapacities that it will use to flood markets with goods to keep the country going (And that day appears to be drawing very close.). If you want to plan for the future, plan for how to negotiate a world that will present challenges for how to continue to integrate more productive capacity and its resultant deflation. There is a point in the future where this process will play itself out, but that does not appear to be coming soon. Inflation will then become a much more serious threat than it is today.