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Historical Periods of Deflation

Historical Periods of Deflation

Deflation can be a nemesis to any economy due to its crippling effect. Let's look at some major historical periods of deflation to be able to draw lessons from our past and the actions that caused the damage.
Ishani Chatterjee Shukla
Deflation is a dire economic crisis. To put it in terms of economics, deflation is marked by a general decrease in price levels of all products and services accompanied by a decrease in the quantity of money in circulation within the economy. Although it causes the value of the money to go up, you need to spend lesser amounts of money to pay for more goods or services. If this phenomenon is stretched for a long time, this can lead the entire economy to enter the malevolent deflationary spiral. The major cause of this sudden change, is due to fall in aggregate demand for various goods and services. Lowering of demand leads to lower production of goods and lesser generation of services. This in turn leads to lower employment requirements by manufacturers of such goods. Low and under employment in the society further leads to decrease in aggregate demand. This vicious cycle of deflation takes the entire economy towards a downward spiral of recession and unemployment. Let's look at some major historical periods of deflation to see how this malevolent nemesis has served to topple many during various time lines.

Historical Experience With Deflation

Following are some of the most prominent historical instances of deflation experienced by various nations around the world. Let's get an idea in brief, of the economic havoc that deflation wreaked on these countries during various periods.

Post Panic of 1837―United States
Following the Panic of 1837, which was spurred by all banks' insistence on accepting payments in either silver or gold coinage alone, there was a five-year long period of economic recession in the US during which the money supply in the US economy had decreased by almost 30%.

The Great Deflation―United States
This was a 20 years long period, spanning from 1870-1890, in the US when there was a drastic decline in the prices of goods, raw materials, labor and services throughout the country. This was a rare instance of a nation actually gaining from deflation as due to the low cost of materials and labor, the just-beginning-to-industrialize US economy of those times was better able to swiftly inundate itself with industries and set up factories and production units at a lower cost. During this time, the well-established industrial nations such as Great Britain suffered economically due to a fall in demand and prices. The cause of this deflationary period is attributed to the return to gold standard post Civil War.

The Great Depression of the 1930s
The Great Depression is, perhaps, the most notorious among all historical periods of deflation. It started with the catastrophic US stock market crash on 29th October, 1929. This phenomenon is also known as the Wall Street Crash and the day it happened is grimly remembered as Black Tuesday. The Great Depression was born of manifold reasons, such as massive failures in financial structures like banks and stock markets, contraction of money supply by the US Federal Reserve, decision to return to the Gold Standard by Great Britain prior to World War 1, etc. The ripples of this depression was felt worldwide, with most countries experiencing its onset at different times during the 1930s, till the early 1940s.

The Financial Crisis of 1997―Asia
It all started when the Thai Baht collapsed, as a result of the Thai government's decision to float the national currency by cutting down its peg to the USD. This decision was spurred by failure to support the Baht exchange rate after long periods of financial extensions, most of which was extended towards real estate. Thailand was already under a staggeringly high foreign debt, way before the Baht crashed, and was technically seeing bankruptcy in the eyes at that time. The currency crash only added fuel to the already raging fire of an economic collapse. Starting from Thailand, the Asian Financial Crisis spread its ominous grip upon a large part of Asia, including Indonesia, South Korea, Laos, Malaysia, Hong Kong and Philippines were the countries that received a major blow due to this crisis. Other Asian countries like China, India, Singapore, Taiwan, Vietnam and Brunei also felt the ripples, though on a much smaller scale.

The Japanese Deflation of the 1990s
Starting in the early part of the 1990s, the deflation in Japan, was a result of a combination of various economic and demographic dissonances. Chief among them were asset price deflation, investment in insolvent companies, extension of non-performing loans by banks, etc. Also, due to the large incidence of banks involved in non-performing loans, people in Japan prefer investing their savings in Treasury Bonds rather than in bank accounts, further pushing these banks towards insolvency. Another major concern is Japan's negatively lopsided demographics. A significant part of the Japanese population consist of individuals above the age of 60. This part of the populace is headed towards a decline and a higher death rate, which significantly exceeds the birth rate in Japan, making such demographics a major issue.

Financial Crisis of 2007-2010
The recent recession that rocked the global economy started with a decline in the liquidity that took place in the US banking sector. Widespread unemployment in terms of drastic decline in recruitment and a peak in firings by companies all over the world was witnessed during the period starting from December 2007 till June 2009. Repercussions and ripples of economic depression can still be seen and felt at present, though on a much smaller scale than when it started. This is why despite recession having officially ended in June 2009, the threat of a deflationary rebound still lingers in our minds.

That was a brief overview of the major deflationary occurrences in world history. Although there are certain technical differences between recession and deflation, both cripple the economy. Compared to deflation, inflation is the lesser evil as people don't lose employment and the aggregate demand keeps mounting, leading to increased production of goods and services which require employment and recruitment of more people. In fact, within a certain limit, a small dose of inflation now and then is actually good for any economy.