Deflation, on the other hand, increases debt and feels like being smothered by a lead blanket. In the interwar Great Depression, the economist Irving Fisher accurately described the process of debt deflation, in which lenders, worried by the deterioration of their asset quality, called in their loans, pushing borrowers to liquidate assets. That, in turn, merely drove down prices further, leading to more credit rationing, bankruptcies and bank failures.
CALLING FOR MORE
The political response to deflation is to call for a stronger state. Dealing with deflation is impossible within the bounds of normal market operations. Only the state is reliable enough to take on all debt, which private institutions are too risk-intolerant to hold. But economists’ abstract description of the resulting state intervention as an expansion of “aggregate demand” conceals the fact that the government conducts specific expenditures and makes political decisions that rescue specific businesses and individuals.
In the climate of scarcity that characterizes debt deflations, the specificity of bailout operations inevitably leads to intense political debate. We see this in the current discussion about the distributional effects of rescuing the automobile industry; or the worry that hedge funds, which are widely blamed for today’s financial malaise, should have access to the Fed’s emergency credit lines.
Currently, parallels are being drawn to Japan’s experience in the 1990s — a “lost decade” in economic terms that also undermined the legitimacy of the ruling Liberal Democratic Party. The Great Depression produced more alarming outcomes, as the political response to deflation throughout central Europe and Latin America destroyed the prevailing order, including several democracies.
Statism has been a characteristically 20th century response to new uncertainty. Its inadequacy may lead to the formulation of a much older answer: revulsion against the market economy, accompanied by indiscriminate condemnation of debt and debt instruments. Indeed, as governments scramble to respond to the current crisis, we should remember that deflation tends to produce not only radical anti-capitalism, but also a profound hostility to any kind of economic or political organization.
Harold James is professor of history at Princeton University in the US and the European University Institute in Florence, Italy.
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