Deflation Is a Harbinger of Economic Depression

“Deflation” means “monetary contraction,” the opposite of “inflation,” which means “monetary expansion.” Monetary contraction means that money disappears from the market. When deflation sets in, psychologically intimidated individuals reduce spending, causing consumption to fall sharply and, as a result, prices to continue declining. In addition, as consumer life contracts rapidly, production decreases, and employment declines as a consequence. In other words, production increases and employment rises only when consumer activity is vibrant; deflation is the opposite situation, so firms undergo restructuring or go bankrupt, unemployment rises, and ultimately the economy contracts rapidly, with consumer life deteriorating even further in a continuing vicious cycle.

A representative example of this phenomenon is the Great Depression, which began in 1929 and continued throughout the 1930s. “Depression” literally means a state of gloom or something like clinical depression, and the economy falls into precisely such a condition. The immediate precursor to an economic depression is deflation. In other words, under inflation there is still consumption, production, and employment, but under deflation all of these decline sharply.

In a deflationary state, however, the basic structure that supports the capitalist market economy begins to collapse. There was a 1957 film called East of Eden. This film is well known to us as a work featuring the actor James Dean. But the film was set against the backdrop of an economic depression. Readers may remember that James Dean’s father in the film ran a cabbage farm. Most of the farm’s produce was exported to Europe. That was because after World War I ended in 1919, Europe imported most of its daily necessities from the United States during its postwar recovery. For this reason, the West refers to that period as the “Roaring Twenties.” But by the end of the 1920s, Europe’s postwar recovery had been largely completed, and exports of American goods to Europe declined sharply. The fall in agricultural exports was especially pronounced. In the film, James Dean’s father committed suicide as a result.

The reason is very simple. His father had borrowed from a bank and recklessly expanded the business, but he became unable to bear the burden of that bank debt. During the “Roaring Twenties,” banks and finance had encouraged business expansion through low-interest loans. But when sales ran into trouble, those loans remained in full as enormous debt. The cabbage farm was also likely linked to an ice plant and a transportation company, which would have gone bankrupt as well, and industries connected to them in turn would have suffered domino-like chains of defaults. This is only one example. But when one industrial sector collapses, other sectors related to it collapse in succession, leading to mass unemployment. In addition, the financial sector that lent out the funds is unable to recover those loans and itself goes bankrupt, leading to a depression in which the economy completely collapses.

In South Korea as well, the low-interest-rate stance that has been entrenched since the 2008 Lehman Brothers crisis is turning everyone into debtors through finance and banking. In particular, because most of the money released into the market has gone into real estate investment, the rapid increase in corporate and household debt has occurred in direct proportion to rising real estate prices. Although massive amounts of money have been released into the market, the distinctive feature of South Korea’s “deflation” is that money does not circulate in the market.

Meanwhile, the United States, which had circulated massive funds in the market to stimulate the economy, began raising interest rates out of concern over inflation as signs of recovery appeared. During the Lee Myung-bak administration, South Korea also released massive liquidity into the market, even going so far as to conclude currency swap agreements with the United States, China, and Japan. But because those funds did not circulate actively in the market and instead disappeared into the hands of a small number of real estate capitalists and banks’ interest income, deflationary symptoms have appeared instead.

As of 2018, there are four fuse points in our economy. They are: ▲ Interest rate hikes: U.S. rate hikes will lead to domestic rate hikes and the outflow of foreign capital, and then deal a major blow to the domestic stock market and real estate market. ▲ Protective tariffs by the United States, China, and the EU: If our companies’ exports are hit amid the U.S.-China and U.S.-EU trade wars, corporate restructuring, successive defaults, large-scale bankruptcies, and unemployment will occur. ▲ A U.S.-China currency war: If the United States designates China a currency manipulator this coming October, China will suffer a fatal blow to attracting investment and exports, and South Korea, which has a large volume of trade with China, will also have to bear damage of an unforeseeable scale. ▲ International oil prices: Middle East instability recently caused by U.S. economic sanctions on Iran and Turkey and Iran’s threats to close the Strait of Hormuz is increasing the international community’s, especially China’s, dependence on U.S. oil. By sustaining this situation, the United States is holding the key to international oil prices.

All of these fuse points could explode at once at the end of 2018. In South Korea, despite the continuous expansion of the money supply since 2008, the strange situation persists in which deflation, not inflation, continues. The economy has worsened severely because there is not enough money circulating in the market and it has all disappeared somewhere. At present, the Bank of Korea is also in a position where raising interest rates is difficult. That is because raising rates is a means of preventing inflation, whereas our economy is now in a deflationary situation. Interest rate hikes should have been used to prevent the expansion of corporate and household debt, but it appears that the timing has now been missed. As of August 2018, Seoul real estate prices are said to be rising again because of low interest rates. This is a very dangerous situation. If U.S. rate hikes suddenly begin in earnest, the result will be an outflow of foreign capital, a stock market plunge, and a decline in the value of the won, and the damage will fall directly on companies and individuals living under heavy debt burdens.

If the four fuse points encircling South Korea’s economy in the winter of 2018 were to explode simultaneously, deflation would become even more severe, consumption would shrink, production would decline, and employment would once again fall, perpetuating the vicious cycle. The possibility that the economy could collapse and develop into a state of depression cannot be ruled out.

Ohjoong Kwon / Head of Research, Center for Diplomacy and National Security Studies

---

Original title: 디플레이션은 경제공황의 전조

Author: O-jung Kwon

Date: 2018-08-29

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=column&pn=17&idx=11074