Recently, I often hear people talking about consumption downgrading, economic downturn, and being on the brink of deflation.
Once the economy falls into deflation, it will enter a spiraling downward channel, deteriorating continuously, getting worse and worse.
If this is really the case, it is indeed very terrifying.
Deflation, also known as "deflation," refers to a general decline in prices and an increase in the purchasing power of money.
It may sound like a good thing, after all, things become cheaper, and money is more valuable.
However, deflation is actually a major crisis in the economy.
It can trap the economy in a vicious cycle, leading to business failures, skyrocketing unemployment rates, and even potentially triggering social unrest.
Today, let's use the Great Depression in American history to explain in detail why deflation is so frightening.
Firstly, we need to understand what deflation is.
Simply put, deflation is the continuous decline in the prices of goods and services in the market, not because of reduced costs, but due to decreased demand.
When consumers and businesses reduce spending and investment, goods in the market are not sold, and prices begin to fall.
1.
Triggers of Deflation Deflation usually has several main triggers: - Decreased Demand: For example, during an economic downturn, consumers and businesses tighten their belts and are reluctant to spend money.
- Insufficient Money Supply: There is less money circulating in the market, reducing the ability to consume and invest.
- Bank Credit Contraction: Businesses and individuals cannot get loans from banks, liquidity becomes worse, and demand is further compressed.
- Rising Unemployment Rate: More people are unemployed, leading to a decline in overall consumer spending power.
2.
The Vicious Cycle of Deflation The biggest characteristic of deflation is that it forms a vicious cycle.
When people expect prices to continue falling, they will delay consumption, thinking they will buy when things are cheaper.
Businesses cannot sell products, profits decline, and they will reduce production, lay off workers, or cut wages.
After unemployment increases, consumer spending power further declines, making it even harder for businesses to operate, and this cycle plunges the entire economy into recession.
The most severe economic crisis in American history—the Great Depression from 1929 to 1939—is a typical example of an economic collapse caused by deflation.
During this period, the United States experienced a massive economic downturn, with businesses going bankrupt, unemployment rates soaring, and the financial market crashing.
1.
The Beginning of the Great Depression: Stock Market Crash The spark of the Great Depression was the stock market crash in 1929.
At that time, the stock market was rampant with speculation, and many people were borrowing money to invest in stocks.
When the stock market bubble burst and stock prices plummeted, investors rushed to sell their stocks, causing panic in the market.
A large number of banks went bankrupt, deposits evaporated, and many ordinary people lost their life savings overnight.
2.
Sharp Decline in Demand After the stock market crash, consumer confidence plummeted.
Many families lost money and dared not spend anymore.
Market demand sharply declined, and people were afraid to buy houses, cars, or invest, with many goods piling up in warehouses and unsold.
As a result, businesses reduced production or even stopped production, leading to massive layoffs.
3.
Deflation Intensifies Economic Crisis Due to the sharp decline in demand, businesses had to lower product prices to reduce losses.
This was the beginning of deflation.
The prices of goods and services continued to fall, and although money became "more valuable," people's purchasing power actually decreased.
Why?
Because the unemployment rate rose sharply, and many people had no income, unable to afford even cheap goods.
- Falling Prices: Businesses could not sell products at the original price and had to keep lowering prices.
However, the problem was that the more prices fell, the less profit businesses made, even incurring losses.
As a result, more businesses went bankrupt, and more people became unemployed.
- Wages Falling: To maintain operations, businesses that could still survive also cut employee wages.
Wages falling, purchasing power was affected once again, and consumption shrank further.
- Investment Stagnation: In a deflationary environment, businesses were unwilling to invest and expand production because there was simply not enough demand.
Even if they invested money to expand production, they could not sell the products.
4.
Bank Credit Contraction During deflation, the banking system also encountered problems.
A large number of banks went bankrupt, bank deposits were eroded, depositors lost trust, and rushed to withdraw their deposits.
This led to banks not having enough funds to issue loans.
Businesses could not get financing, and more businesses had to close.
Why is deflation so terrifying?
The Great Depression showed us the multifaceted impact of deflation, which is not just a decline in prices but a comprehensive economic and social crisis.
1. Business Failures and Soaring Unemployment Rates Firstly, deflation puts businesses in a difficult situation.
When prices fall, businesses' revenues decrease, profit margins narrow, and they cannot pay operating costs and employee wages, eventually having to lay off workers or close down.
During the Great Depression, tens of thousands of businesses in the United States went bankrupt.
Some otherwise healthy companies went bankrupt due to the breakage of capital chains.
The unemployment rate also rose sharply.
At its peak during the Great Depression, the unemployment rate reached 25%.
A quarter of the workforce was unemployed, household income directly decreased, leading to further decline in consumption capacity, forming a vicious cycle.
2.
Consumption Shrinkage Deflation makes consumers lose confidence in the future economy.
People start to tighten their belts, only buying the most basic necessities of life.
Even if prices fall, everyone still dares not to spend money because they worry about unstable income and the possibility of unemployment in the future.
This consumption shrinkage further hits businesses.
Without enough market demand, businesses are powerless to expand production and even cannot maintain the current scale of business.
3.
Investment Reduction, Economic Stagnation In a deflationary environment, businesses are afraid to invest.
Because there is simply not enough demand in the market, even if they invest money to expand production, they cannot sell the products.
Businessmen and investors are afraid of losses and would rather keep the money in their hands than take the risk of investing.
The government also faced the same problem during the Great Depression.
Due to reduced tax revenue, government fiscal revenue plummeted, many public projects were stalled, and economic growth could not be stimulated.
4.
Intensified Social Turmoil The economic collapse is not just a numerical loss; it also triggers social unrest.
During the Great Depression, the stability of American society was greatly threatened.
The unemployed wandered everywhere, the urban poor population surged, many people could not afford food, and were homeless.
Social dissatisfaction was high, with frequent strikes, demonstrations, and protests.
Unemployment and poverty led to an increase in the crime rate.
Many people turned to crime for a living, and social security issues became increasingly serious.
The social pressure brought by deflation not only affected the economy but also plunged the entire society into crisis.
The impact of deflation brought by the Great Depression could not be eliminated in the short term.
It left a deep scar on the American economy and affected the global economic pattern.
Even the impact of deflation continued until World War II.
1.
Global Economic Downturn The Great Depression not only affected the United States but also plunged the global economy into a slump.
As the United States was one of the most important economies in the world at that time, the economic collapse of the United States directly affected global trade and financial systems.
Other countries also fell into economic recession, and the global economy fell into a slump.
2.
Policy Changes The deflation crisis forced the government to change economic policies.
During the Great Depression, the government took a large number of intervention measures, including launching new policies, implementing monetary easing policies, and strengthening bank supervision.
These measures helped the United States gradually emerge from the quagmire of deflation and recover the economy.
In particular, Keynesian economic theory was widely applied during this period.
The government stimulated demand by increasing spending, which promoted economic recovery.
3.
Evolution of Monetary Policy One of the lessons of the Great Depression is that the harm of deflation is even worse than inflation.
Therefore, many central banks of countries began to pay more attention to the risk of deflation in the economy.
Modern monetary policy pays more attention to maintaining economic growth through moderate inflation.
Central banks of various countries prevent deflation by controlling the money supply.
In the face of deflation, governments and central banks need to take active measures to deal with it, otherwise, the economy may fall into a long-term recession.
Common countermeasures include: 1.
Monetary Easing Policy Central banks can stimulate the economy by lowering interest rates and increasing the money supply.
When interest rates fall, the cost of borrowing becomes lower, and businesses and individuals are more willing to borrow money for consumption and investment.
This helps to increase market demand and alleviate the pressure of deflation.
2.
Fiscal Stimulus The government can stimulate the economy by increasing public spending and implementing infrastructure projects.
Large-scale fiscal stimulus plans can create jobs, increase consumption, and drive overall demand.
3.
Protecting Employment and Wage Levels In the deflation period, protecting employment and wage levels is key to maintaining consumption capacity.
The government can alleviate the living pressure of the unemployed through social welfare, unemployment benefits, and other means to ensure social stability.
In summary, deflation seems to be a decline in prices, but behind it lies a huge economic and social crisis.
Through the example of the American Great Depression, we can see how the vicious cycle of deflation can plunge the economy into a long-term recession.
Soaring unemployment rates, consumption shrinkage, business failures, and social unrest are all terrible consequences of deflation.
Therefore, preventing deflation and maintaining moderate economic growth are important goals of economic policy in every country.
