First published on 14 April 2015 by the New Left Project
Deflation, as we have already seen, involves a transference of wealth from the rest of the community to the rentier class and to all holders of titles to money; just as inflation involves the opposite. In particular it involves a transference from all borrowers, that is to say from traders, manufacturers, and farmers, to lenders, from the active to the inactive.
John Maynard Keynes in A Tract on Monetary Reform (1923)
For more than three decades economic policy-making in western economies has been dominated by financial interests – those of bankers, creditors/moneylenders, investors and financiers. Their interests have been eagerly supported by most of the mainstream economics profession (including private, academic and official economists) in a variety of helpful ways. Perhaps the most helpful was the tendency of economists to look away.
Most economists have very little understanding of money and credit and of how the banking system operates. Hard though this is to believe, classical economic theory neglects the role of money, debt and banks in the economic system. Instead orthodox economists theorise as if money is neutral, simply a ‘veil’ over activity in the real economy, as if changes in the stock of money have no impact on wider economic activity.
This has led economists (wilfully or blindly) into promoting policies that have accelerated the capital gains of the financial sector, building up mountains of unpayable debts. These policies include the de-regulation and liberalisation of capital flows (‘globalisation’); the removal of constraints on lending and on interest rates charged to consumers and firms; the abolition of legislation that divided the speculative divisions of banks from their retail divisions, such as the Glass-Steagall Act in the US; and tax breaks for debt-financed investments – to name but a few.
But the most important element of these pro-finance policies is, and was, their anti-inflationary, or the downright direct deflationary, bias. Deflationary policies were actively promoted by orthodox economists at the IMF, at western central banks and in OECD Treasuries.
Its easy to understand why. Inflation erodes the value of a financier’s most valuable asset: debt.
‘Inflation’ for these economists and financiers is strictly defined and refers to the inflation of wages or prices – rises in earnings of workers and in the prices charged by firms. But there is another kind of inflation – asset-price inflation – and for decades economists and central bankers ignored asset-price inflation, when they weren’t actively stoking asset-price bubbles.
Assets are owned on the whole by the rich and the rentier class – and include real estate, race horses, works of art, brands, software, football clubs etc. – from which an endless stream of rents flow. (Think of revenues from the sale of ManU tickets and t-shirts flowing straight into the pockets of the Glazer brothers.)
While wages and prices were suppressed, asset prices were allowed to let rip. Which goes a long way to explaining why the rich got richer and the rest got poorer over those three decades.
Now finally inflation has been slain, and deflation is taking hold across the world. In the UK, as Geoff Tily of the TUC hasshown, inflation is falling faster than across the Eurozone. This is largely the consequence of private debt, which first caused the catastrophic collapse in 2007-9, and is now constraining recovery, exacerbated by austerity. This has meant prolonged weak growth in incomes, while the UK economy, for example, has performed well below its capacity, and the Eurozone is weakening fast.
Financiers, their friends in the media, most notably the Financial Times, and the economic profession, are celebrating ‘good deflation’. Their argument is that falling prices provide room for consumers to spend more, and that deflation will therefore boost the economy. This approach requires them to once again turn a blind eye: this time to the vast volume of private debt that continues to act as a drag on economic activity, in particular on investment and on the creation of skilled, well-paid employment.
As prices fall, the relative value of debt, and of interest rates, rises. (Just as inflation erodes the value of debt, deflation inflatesthe value of debt.) So, for example, if generalised prices fall below zero by 2% and interest rates remain at 2%, then in this deflationary environment the real rate of interest is 4%.
The prospect of debt and interest rates rising in value, regardless of the actions of borrowers or central bankers, even while prices fall and incomes remain low, is of grave concern. It is particularly concerning for all those productive actors in the economy that need to borrow. This includes businesses who need to make improvements to their firms, and anyone who needs an overdraft, student loan or mortgage. Deflation is a particularly big threat to households that have had to borrow large mortgages to afford a decent home.
In 1933, Irving Fisher concluded gloomily that:
deflation caused by the debt reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes. ……Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe. The more the economic boat tips, the more it tends to tip. It is not tending to right itself, but is capsizing.
How often has deflation been mentioned during this General Election campaign – by any of the political parties? Because this generation has never lived through a period of deflation, and because the finance sector has so successfully captured the imaginations of politicians, there is widespread ignorance of deflation’s impacts.
Far from being lulled into complacency, society and the political parties should be protesting loudly at the failure of the government and the Bank of England to adequately address the threat of deflation to the people of Britain, who are burdened by some of the highest levels of private debt in the world.