Deflation

A while back I saw a column [can no longer find] by Matt Yglesias commenting on the growth of barter networks in Greece. These barter networks, he commented, are signs of deflationary pressure. Downward pressure is being exerted on prices, but prices are proving sticky and resisting falling, so instead people build barter networks in order to make trades without the medium of money.

I was glad to hear about that for two reasons. One was, after reading endless stories about the Greeks rioting and burning things down, it was good to hear that the rioters do not speak for all Greeks and that some are responding to the crisis by doing something constructive. The other is that it confirmed my longstanding suspicions of that what was happening in Russia in the 1990’s was actually severe, though disguised, deflation.

So what was happening in Russia in the 1990’s. Basically, currency had stopped circulating. People were working in the coal mines 12 months a year and only getting paid two months a year. Pay was equally rare in other industries, with employers paying in products instead of money. Trades between enterprises were also generally by barter with only a tiny fraction taking place in cash. The Christian Science Monitor (apparently expressing conventional free market wisdom of the time) commented that this system of paying in kind was really just disguised unemployment, and that instead of taking necessary but painful measures, Russians were avoiding the necessary pain of laying all those people off and shutting down industries that couldn’t afford to pay in cash.

Their advice seemed outrageous. Coal miners were working 12 months a year and getting paid for only two months. That is to say, their pay had fallen to a sixth of what it once was, only instead of taking home paychecks for only a sixth of their usual pay, miners were getting their full paycheck only a sixth of the time. Coal was the fuel of much of the Russian economy. Was what it needed really to cut coal production to a sixth of its former level? The article also mentioned heavy boots, a popular and necessary item in Russia. Boot companies were paying in boots instead of cash. Did the Monitor really think Russia would be better off if people stopped making boots and started losing toes to frostbite? Attempting my own analysis, I figured out somewhere along the line that actually what Russia was experiencing was not disguised unemployment, but disguised deflation.

This impression was strengthened when I learned how Russia got into such a mess in the first place. It was a fascinating mirror opposite of the Weimar inflation. Contrary to popular belief, the Weimar inflation did not occur because France demanded unsupportable reparations so Germany responded by printing the money. Or rather, that may be an oversimplified explanation, but it really is not adequate. In fact, the French sought to foreclose such a possibility by demanding reparations in gold or in kind such as coal. The Germans did, indeed, debase their currency to promote exports so they could raise the gold to meet French demands. Inflation was in the double digits in 1920, triple digits in 1921 and quadruple digits in 1922. What sent it from quadruple digits to off-the-chart scientific notation levels in 1923 was that the Germans defaulted on their payments. The French then sent troops into the Ruhr (Germany’s industrial heartland) to collect reparations by force. The people of the Ruhr responded with a general strike. But they could not afford to stay on strike without getting paid, and employers could not afford to pay their workforce if they weren’t producing. So the government sought to fund the resistance by printing money.

Russia, by contrast, was borrowing huge sums and was unable to pay them back. The IMF agreed to give Russia a loan to tide them over, but only on the condition of making major cuts in expenditures, including coal miners’ wages. Presumably this was an attempt to force the Russian government to privatize the coal mines. But the government, fearing the mines would instead shut down and bring the entire economy to a screeching halt, instead took the desperate measure of keeping the coal miners on the job but not paying them. Without paychecks, the miners could not pay cash for groceries, and over time the cash shortage spread throughout the land. In other words, the Weimar hyperinflation was caused by paying people for not working. The Russian hyperdeflation (if there is such a word) was caused by working people without pay.

But it is only very recently that I have begun to understand that deflation is always disguised. This is because wages and prices are sticky and resist falling. Instead, downward pressure introduces distortions into the economy. While I was right to recognize Russia’s switch to a barter system as disguised deflation rather than disguised unemployment, only now am I beginning to understand that unemployment itself is often a form of disguised deflation. Other signs of disguised deflation are growing barter networks, working off the books, and the growth of the “informal sector.” Part of the trick to recognizing deflation is recognizing the distortions that it causes.