Hyperdeflation on the streets of Paris

By Bill Bonner Jun 26, 2009

Bill Bonner.

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Scarcely a block from our MoneyWeek office in Paris is a monetary phenomenon that has escaped the financial press. In one of the highest-cost economies in the world, you can buy a woman's shirt for €2. A dress? €4. A man's jacket can be had for the price of a cup of coffee. The shop is tended by Chinese merchants, apparently dodging France's employment laws by only hiring family members. The merchandise, too, dodges high rents by squatting the sidewalk, under improvised blue awnings.

How come you find such cheap duds in such a dear city? The latest figures show negative consumer price inflation (CPI) in 14 countries. In Ireland, prices are collapsing at a 4.7% annual rate. In the US, they are falling at 1.3%, the biggest drop in 59 years. Here in Britain, CPI is still positive, but falling. But clothing on the Boulevard de la Villette seems to have been thrown out of an airplane. It is not in deflation; it is in hyper­deflation.

What could cause it? A guess: excess capacity, inspired by excesses of credit, consumption and claptrap during the Bubble Epoque. Spurred by what seemed like insatiable demand from the US and Britain, Asians built superfluous factories, Greeks bought superfluous ships, and Americans built superfluous malls. Now, the action of the bubble years produces an equal and opposite reaction: excess supply bedevils the market. Unable to sell superfluous brand-name clothing, the rag trade strips off the alligators and polo sticks and dumps clothes on discount racks.

Last week, we warned of the extremely destabilising effects of hyperinflation. One day middle-class men are saving money for their daughters' dowries. The next, they are putting knives between their teeth and swimming across the Rhine. Today, we deny hyperinflation thrice before the cock crows... and then deny we denied it.

First, Professor Alan Blinder: "The clear and present danger, both now and for the next year or two, is not inflation but deflation."

Second, BusinessWeek elaborates: "The inflationary effects of the new money are being fully offset, or more than offset, by the far-reaching and long-lasting impact of household debt repayments. Whether it's voluntary frugality or under the coercion of creditors, Americans have abruptly switched from living beyond their means to saving more and working down the debts they incurred during the bubble years."

Third, as Ambrose Evans Pritchard puts it in The Daily Telegraph: "The Fed's efforts to boost the money supply are barely keeping pace with the deflation shock. Stimulus is not gaining traction. The credit system is broken."

Professor Blinder explains why: "In normal times, banks don't want excess reserves, which yield them no profit. So they quickly lend out any idle funds they receive. Under such conditions, Fed expansions of bank reserves lead to expansions of credit and the money supply and, if there is too much of that, to higher inflation. In abnormal times like these, however, providing frightened banks with the reserves they demand will fuel neither money nor credit growth - and is therefore not inflationary."

Reserves are what nobody wanted in the bubble years; now they are what nobody doesn't want. We live in a world of squirrels. Bankers add to their reserves; so do individuals and businesses. Americans saved an average of 7% of disposable income since the 1930s. In 2002-2007, that rate fell to zero. Now, it's back to nearly 5% and rising. Thrift is making a comeback. People are changing their own automobile oil. They are cutting their own hair and planting their own gardens. 

When consumers cease consuming, producers stop producing. Shippers have nothing to ship. World trade has collapsed by more than it did at this stage of the Great Depression. At 65% of capacity, there are more idle factories in America than at any time since they stopped making tanks and airplanes after World War II. Business earnings are falling, with no pricing power in sight.

In this respect, this downturn is more deflationary than Japan's recession of the 1990s. When Japan went into a slump, the rest of the world continued to grow. Japan could continue to manufacture and export products – at a profit. Still, with so much excess capacity, producer prices in Japan fell in nine of ten years in the 1990s. 

And now the denial. These commentators are right; deflation is the immediate problem. Our guess is that it will be deeper and more vexing than even they believe. The feds' money machine is broken. They can add reserves. But they can't turn the reserves into price inflation at the consumer level. Result: deflation – maybe hyperdeflation. But far from eliminating the danger of hyperinflation, falling prices practically guarantees it.

It's not inflation we worry about; it's the lack of it. Unable to stimulate inflation in the usual way, the feds are forced to resort to extraordinary measures.

Only central banks with their backs against the wall – like Germany in the 1920s, Argentina in the 1980s and Zimbabwe in the 2000s – would dare to risk hyper-inflation. But if its efforts to produce mild inflation don't work, America will eventually be in the same desperate position.

Published in Economics | More articles by Bill Bonner

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