Hyperdeflation

July 23, 2011 12:51 AM

Has there ever been a case of real-life hyperdeflation, where prices race downwards?

History is strewn with the ruins of hyperinflationary economies, like Weimar Germany and Zimbabwe and such. What I am asking is if there has ever been a real life economy suffering from an exactly opposite problem of prices decreasing. Not a revaluation as the Zimbabweans tried to do, but the economy messing about in such a way as to drop prices and screw debtors over.

posted by curuinor to society & culture (8 answers total)

Fisher's deflationary spiral suggests that this happened in the Great Depression.
posted by Paragon at 12:57 AM on July 23, 2011

Yes, I could be wrong, but I think you could argue that any significant (e.g. economy-wide) "bust" period was like this.
posted by ropeladder at 1:37 AM on July 23, 2011

Housing prices in Las Vegas from 2006 to today (and still dropping).
posted by Jacqueline at 2:30 AM on July 23, 2011

Not all price drops constitute hyperdeflation. Vegas housing, or other bust markets don't compare to the hyperinflation of Zimbabwe, where million Zimbabwe-dollar bills were being used as toilet paper. OP is asking about hyperdeflation, not whether deflation has occurred in the past.
posted by mnemonic at 3:01 AM on July 23, 2011

Ah great question! First off, I'm not an Economist rather an Econometrician by education and profession (don't be put off, its fancy word for Economics and Statistics applied into a Capital Markets environment), but I have taken far more economics at the graduate level than I care to admit (at least in social circles). But since you asked a great question I'll do my best.

There is an awful lot about deflation that we don't understand, simply because we don't see much of it historically. A very unusual phenomenon, and not researched as much as it probably should be.

A simple and very crude test: I've got access to the online academic journals (part time lecturer and PhD Finance student) so I searched journal abstracts and the word Inflation (88144 hits) is far, far more common than Deflation (8208 hits). As said, we just haven't seen too many episodes of systemic deflation. But sector specific deflation? Oh yes, very common but mostly ignored by folks. Think about the prices of consumer electronics. We generally expect prices to decline in that sector, even as overall revenue and even entity profitability increases. That is an example of what Salerno (2003) calls "sector specific growth deflation", but you get the picture.

So there is nothing wrong with a little deflation, just like a little inflation is healthy. But growth deflation is very fascinating; think of the American economy from 1789 through 1913; we saw incredibly (by current standards) high GDP even while prices fell, thanks to industrialisation.

China went though a sharp period of growth deflation from 1998 to 2001: retail prices fell in each of those years anywhere from 0.8 to 3.0%, while realGDP increased at an annual average rate of 7.6%-

And we have seen periods of systemic, not sector specific deflation in recent memory, the US just went through one.

This chart shows CPI (consumer price index) for the period 1947 to 2011, with recessions noted in grey vertical bars; notice that little dip around 2008? Let's look deeper.

This chart shows the massive deflationary wave that hit America with the evaporation of the shadow banking system. Very pronounced, but what was the policy response?

A sharp expansion of the money supply.

That's part of the reason why we just don't see system deflation. And systemic hyperdeflation? Well, generally (and there is no single accepted definition) hyperinflation is defined as YOY CPI of 80% or more for three years (among other criteria that aren't germane to our discussion). And yes, it has to be that pronounced (sidenote: the US has seen single quarters, esp right after The Korean War, where we've had 80% inflation, but never years -- these little episodes aren't generally known, especially by folks who seem to believe America has never undergone hyperinflation, we have, I only know about them 'cause I study this topic rather deeply but they are obscure) for economists to call it a hyperinflationary episode.

So hyperdeflation probably wouldn't happen as we'd see additional and very, very aggressive policy responses like the one noted above.

A little deflation? Yes, I thinks its highly probable. Here's the argument: since leaving banking I make my living lecturing in finance to a few Universities, as well as selling market commentary to five clients (Investment Banks and Hedge Funds). Last month we pitched some research we look at from time to time, and we don't think deflation has been excised from the US economy. Since the credit crunch began I've posted here several times that I believe stagflation was the most likely outcome. Not calling it yet but we're surely seeing something that looks a lot like stagflation. In any case, here is the presentation I gave last month on the topic of deflation, cleaned up to remove specific recs as well as to use public domain sources, the hypothesis begins on slide 12 after we review the macro (I do these presentations to banks several times a week, different topics everytime, and sometimes as many as five or six times, lots of fun to see what folks in The City are up to).

Finally I'd just like to point out that while the US Dollar was a commodity currency CPI was much, much more volatile than it is now. Because of that we tend to see pretty much equal occurrences of inflation AND deflation prior to the adoption of a fiat Dollar.

Great question! Hope this helped.

A little reading that might help if you're interested in going deeper.

• Akteson, A., Kehoe, P., J. (2004). "Deflation and Depression: Is There an Empirical Link?" American Economic Review Papers and Proceedings 94: 99-103.
• Salerno, J., T., "An Austrian Taxonomy of Deflation With Applications to the U.S.". Quarterly Journal of Austrian Economics 6 (Winter 2003): 84.
• Friedman, M., Schwartz, A., (2003). A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press, 1971; quoted in Joseph T. Salerno, "An Austrian Taxonomy of Deflation- With Applications to the U.S.," Quarterly Journal of Austrian Economics 6: 89.
• Fregert, K., Gustafsson, R.. (2008), "Fiscal Statistics for Sweden 1719-2003". Research in Economic History, volume 25

Oh yes, about that increase in the money supply. Well, I've posted often about how I went long gold & silver in 2004 / 2005. I sold enough gold about one year ago to pay off my mortgage, dumped 70% of my silver in April because of the speculative run up (*cough* bubble), started buying gold again at $1,500 a ounce and I've been slowly accumulating physical silver , mostly one ounce coins. Personally I'm debt free and liquid, but I'm purchasing high quality stocks 'cause they're so damn cheap these days and I just can't help myself. Think kid in a candy store.

I've been involved in the markets since I've been a kid and this is one strange market. So that's my market view.


posted by Mutant at 3:13 AM on July 23, 2011 [51 favorites]

(I am definitely not an economist, I just write about financial markets.)

There doesn't seem to be much to add to Mutant's very thorough answer - but I'll mention a few specific examples of famous deflations that you might want to look at if you want to see how these things have played out in the past.

One issue is that there are data problems that grow larger the further back you go. If you look at a very long run chart of inflation in many countries, you can seen what appear to have been very sharp generalised price drops from year to year back in the 1600s and 1700s - in the order of 20% or so sometimes.

Does this reflect the reality? Is it a problem with these data series, all reconstructed centuries on? Is it a consequence of more agricultural economies and so less relevant to the world today? And yes, as Mutant says, when currencies were tied to gold, CPI was more volatile anyway - from year to year it could swing between inflation and deflation, in part because of fluctuations in the gold supply from new discoveries and increased mining.

If we just confine it to reasonably modern times, there are a few episodes worth looking at. Immediately after the civil war, the US had several years of deflation into the 1870s, before it entered the more mildly deflationary boom Mutant refers to. Significant deflation occurred here, but took place over a long period of time - even at the steepest, consumer prices were falling by around 6% per year.

Japan after the crash (deflation actually emerged mid 1990s) is a similar story. Prices have fallen substantially, but slowly over many years. The maximum rate was about 2-3% and that was in the aftermath of the global crisis.

Hong Kong underwent deflation after the Asian crisis of 1997-98 until 2005, principally due to the currency link between the Hong Kong dollar and the US dollar. The rest of Asia adjusted in part through much weaker currencies, while Hong Kong - although much less directly affected by the crisis - could not do the same. The maximum rate of deflation was about 5% a year, towards the beginning.

So there are very few examples of famous deflations where a fast deflationary spiral occurred. The episode that obviously comes to mind is the Great Depression. During this there were a couple of years when consumer prices were dropping in the order of 10% per year in the US, for example.

Another time worth a look is just after WWI. Back in the days when the gold standard existed, countries would often go off the gold standard or use other tricks to increase the money supply during the way. Returning to the gold standard or withdrawing excess money supply would then lead to deflation post war.

So after WWI around 1920, we saw total deflation of 24% in France, 26% in the UK and 11% in the US (taking place over one year in the US and two-three in the UK and France.

I can't think of any episodes where the deflationary spiral was significantly worse than that - ie in the order of 20-30% or so per year, which may be what you are looking for if you're searching for true hyperdeflation.

As Keynesians will say, prices tend to be sticky downwards. So perhaps in even the worst circumstances, the price adjustment is likely to play out relatively slowly and over time. Instead, the high profile symptoms of distress are sharp falls in GDP, rocketing unemployment and collapsing capacity utilisation rather than immediate plunges in prices.

Where you will find the most severe deflation in these episodes is typically in wholesale prices rather than consumer prices. This is particularly true of commodity prices - you will see plenty of stories of farmers leaving crops unharvested or burning their stocks because it wasn't worth trying to get it to market to sell.

So if you're looking for very severe economy-wide deflationary spirals, I'd think you're most likely to find examples in heavily commodity-dependent economies, as the impact of collapsing commodity prices and falling producer incomes rolls through the wider economy.

Although even there it may not actually be general deflation. Qatar went from 15% inflation to 10% deflation in the space of one year after the recent crisis, but looking into it further, it seems like that was mostly falling energy earnings feeding through to collapsing rents, with limited impact in other prices (although it stopped most of them rising as quickly as they had done in previous years).
posted by Temagami at 7:43 AM on July 23, 2011 [4 favorites]

Well, there is also a purely mathematical issue. In an inflation, you can have prices go up indefinitely (theoretically). If we define hyperinflation as something like +80%, you still have room to move to 100%, 200% and so on. But that's not a symmetrical situation in the other direction. Prices can only fall to zero. Think of it as you would about stocks - if you short a stock, at most the stock can go down to zero, so you'll double your money (ignoring transactional costs), but if you go long, your upside is theoretically unlimited.

So it you are looking at some absolute number like 80%, to define hyperdeflation, you'll have a rough time coming up with many examples of such, whereas you can reach some pretty impressive numbers with hyperinflation. So are there any such examples for hyperdeflation?

Depending on how you define inflation/deflation, think of what happened to the South Vietnamese currency (dong), the dollar, and prices of goods as Saigon was falling. As the fall of Saigon was becoming reality, the dong was falling in value against the dollar, often at a mind-boggling rate from one hour to the next. But why shouldn't this be a case of hyperinflation, if the value of the dollar is steady against other currencies at the same time? Well, because in the case of South Vietnam, you could actually purchase goods for dollars at a violently falling prices, and the dong was losing all value as an instrument - people were selling houses, cars and other goods at dramatically lower prices for dollars, while the very same prices in dongs were increasing hyperinflationarily. So you had a violent deflation - hyperdeflation in dollar terms at the same time as there was a violent inflation - hyperinflation - in dong terms. How was that different from Zimbabwe? Well, of course, the price of goods was only becoming hyperinflationary in the Zimbabwean currency terms, but not as much in dollar terms, whereas in South Vietnam, you had the purchasing power of U.S. dollars go up violently, leading to objective hyperdeflation.

I'm sure one could dig up more such examples, especially more localized rather than country-wide, and as has been pointed out, there are many examples of sector deflation.

But the bottom line, is that deflation is limited mathematically, whereas inflation is not (at least theoretically), and that may have impact on whether you'll call something "hyper" - it's a lot easier to do with inflation.
posted by VikingSword at 4:20 PM on July 23, 2011

Oh yeah, also disclaimer: I'm in no way an economist. I don't even play one on TV - or anywhere else.
posted by VikingSword at 4:25 PM on July 23, 2011