The Many Dimensions of Deflation

William Krehm

While the Bank of Canada and other central banks are manning the ramparts against inflation as the one peril that they see threatening the world, it is actually deflation that is taking over. In central bank orthodoxy imposed several decades ago, the main threat is always inflation, while the very word "deflation" is unspeakable. In 1997 when the predecessor of the present BoC Governor, Gordon Thiessen, uttered his concern about deflation before a Senate Committee, he was back in a week to apologize, expressing his likely regret for the rest of his life for having mentioned the word. Nobody seated at the political table above the salt even asked the obvious question: why would the head of a central bank founded in 1935 to try to pull the country out of a disastrous decade of deflation have to apologize for mentioning the subject? – And at whose behest?1

Deflation is a distemper that has since come at us from just about every point of the compass. To begin with, the terms of the Deregulation and Globalization have been more effective in importing into the First World the lowest labour costs and environmental and health standards from wherever these are to be found. And the market bubble, compounding hot air and corruption at the highest executive levels, once punctured, becomes a powerful engine of deflation. The amount of fictitious capital that has disappeared in the US alone is reported in the $7 trillion range. That is within hailing distance of a whole year’s GDP – and the process of sorting out fact from fiction in stock valuation has hardly spent itself. Though the ban was on the mention of deflation in the world of commodities and services, the contrary was the case when it came to stock market valuations. There even an expression of concern by Chairman Alan Greenspan himself about the "irrational exuberance" of the stock market was slapped down. That mighty walking-ikon was told to stick to commodity inflation and leave the stock market alone. The Chairman complied and spoke no more about the overheated state of Wall St. until the roof had collapsed, and it was too late.

The post mortems on the raunchy tales of immorality and corruption that fuelled Wall St.’s finest decade have shaken not only the accountancy of the financial sector but the basic morality necessary for any business transaction. That means that capital is harder to raise for launching firms. Fewer people trust their counterparties in deals. With less lending and financing to replace the massive holes ripped in the near-money supply, powerful deflationary gusts are sweeping the economy. Nor is there any lack of whistling in the dark. From high government sources on either side of our undefended border we have been fed endless nonsense: though the stock market has had both legs and reputation shattered, the fundamentals in the rest of the economy are declared sound. So Wall St. is a basket-case, but consumer demand is healthily brisk. Boasted government surpluses have disappeared as earnings of corporations are being restated for years back, and employment mounts.

As corporation after corporation files for bankruptcy protection, hundreds of thousands of workers are being laid off throughout the world each week. New unsuspected channels by which the plague of deflation spreads are coming into view. Thus The Wall Street Journal (14/08, "Telecom Glut Could Linger as Failed Networks are Rescued" by Dennis K. Berman, H. Asher Bolande and Almar Latour), reports the latest of these:

"Buyers have begun rescuing financially troubled fiber-optic telecommunications networks for cents on the dollar, but by giving these companies new life they risk perpetuating the world-wide capacity glut that sent the industry into a tailspin.

"Just last week investors took over Global Crossing Ltd., a bankrupt Bermuda company that was once a darling of US investors. In its heyday, Global Crossing built undersea fiber-optic cables capable of handling unprecedented volumes of voice and data traffic. But it and other companies flooded the market with capacity at a time when demand started to falter. When a number of these companies filed for bankruptcy, including Metromedia Fiber Networks Inc., 360 Networks Corps., and Williams Communications Group Inc. of North America and KPNQwest NV and Energis in Europe, it appeared that the industry was undergoing a sensible correction that would flush out unneeded communications systems.

Bankruptcy Restructurings Fuel Deflation

"Now with rescue efforts underway for a number of these telecom providers, including the latest bankruptcy filer, WorldCom Inc., that [excess] capacity may be here to stay. ‘If you want to solve the problems with the telecom industry in North America, you better liquidate, period.’ says Stephane Teral, research director at RHK of South San Francisco.

"As struggling companies are bailed out, and the massive debt they incurred to build their lines is wiped away, they ‘are in a much stronger position to compete on pricing,’ says To Chee Eng, a Singapore-based analyst with the US market research firm Gartner Inc.

"A revived WorldCom could be an especially nettlesome competitor of the likes of AT&T Corp. and Sprint Corp. Upstart companies such as Global Crossing or Williams still have to fight inch-by-inch to win the largest corporate customers. But WorldCom already has those relationships, and if it eventually slashed prices, it will put the most direct pressure on big competitors such as Ma Bell." That could mean more massive layoffs, and more bankruptcies.

No contagious disease spreads faster than deflation. Yet the mere mention of it was verboten by the deep thinkers who run the world’s central banks. Such inevitable results can be traced back to the drive towards exponential growth incorporated into stock market valuations.

"‘If a carrier erases its debt costs, it can start offering ‘bandwidth’ as telecom capacity is called, at a price close to its barest operating expenses. For example, between London and New York, a basic fiber-optic connection cost $22,000 annually at the start of 2001. The glut has forced the price down to $5000 today. For a carrier without any debt payments the price may drop to $2000, Dr. Jean-Pascal Crametz, a former Stanford University professor who studies telecom pricing, says. ‘I don’t know how the Sprints of the world can compete.’

"The Global Crossing bailout, meanwhile has set a benchmark for what creditors will accept for financially distressed networks. Hutchison Whampoa Ltd. and Singapore Technology Telemedia Pte. have offered just $250 million for a 61.5% stake. That bid values the company, which had $12 billion in debt when it filed for reorganization in January, at just one cent on the dollar."

Nor is this killer aspect of deflation confined to the telecoms. The Wall Street Journal (16/08, "Europe Airlines Fear Impact of US Carriers’ Woes" by Daniel Michaels and Scott McCartney) report the identical phenomenon amongst the tottering international airlines: "‘We’ve long been concerned by the American airlines’ ability to go into Chapter 11, rid themselves of debt and come out and compete again,’ said Paul Moore, a spokesman for Virgin Atlantic. ‘Bankruptcy protection – on top of the US government bailout – is a safety net their competitors simply don’t have.’"

William Krehm

1. See Krehm, William (ed.) (1999). Meltdown: Money, Debt and the Wealth of Nations. COMER Publications, p. 312.

— from Economic Reform, September 2002