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‘Just as a bad cold leads to pneumonia, so over-indebtedness leads to deflation,” wrote the US economist Irving Fisher in 1933. The theory is, if there is too much debt, people spend all their money repaying it and so stop spending. Prices fall – inflation turns to deflation. What could be bad about falling prices? Well, the debts don’t shrink – so you end up using more of your income to service them, and you spend even less.
This actually happened in the US between 1929 and 1933, leaving economists like Fisher – and indeed the whole of society – terrified of it happening again. Economists call this the debt-deflation spiral, and since 2008 politicians have been haunted by the prospect of a repeat.
In Europe, that fear is justified: deflation is now close. Germany’s economy stagnated in the second quarter of 2014; Italy and France shrank by 0.2%. And since 2012, inflation in the eurozone has been falling steadily, down to just 0.3% last month. In response, the boss of the European Central Bank, Mario Draghi, last week slashed interest rates to 0.05% – a Rizla paper above zero – and signalled that Europe will, like the US, Japan and the UK, print money.
If it works, the eurozone will become the last of the big economic players to go on total life support – and what it tells us about the future of capitalism is worrying.
There are many problems specific to the euro crisis: this is the one region of the world where “rules” have triumphed over pragmatism, forcing pointless cuts in government spending and ensuring the politicians were always three moves behind reality. To continue Fisher’s analogy of a “heavy cold”, Europe – in the past two years – took a large dose of Night Nurse but then went wandering out unclothed into freezing rain.
However, the euro deflation crisis is also a symptom of a more general problem that affects the world economy: stagnation.
Last November, the former US treasury secretary Larry Summers alarmed the economics profession by resurrecting the phrase “secular stagnation”. He warned that if you need zero interest rates to sustain growth, you are in trouble. The dominance of high finance in a modern economy, its propensity to boom, bust and panic, means you are always going to need at some point – temporarily – to slash interest rates in the face of a crisis or downturn.
But when zero interest rates become normal, you can’t. You have to use printing money as the anti-crisis measure, and this is less effective. Printing money takes time to work, in a way that cutting interest rates does not. It took George Osborne three years, and a considerable amount of tinkering with the pipes of the banking system, to get the money printed through quantitative easing flowing through to homebuyers and construction firms. Draghi, too, will face this problem.
The bigger danger with a world of zero interest rates is that it promotes stagnation. It’s like being in a car with no first gear or – to adapt Irving Fisher’s image – less like a cold, more like post-viral fatigue. The economy feels listless forever.
What to do if the prediction is correct? It depends on what you think the cause is. Some economists believe capitalism has simply run out of steam. Productivity, population growth and education levels can’t go on rising fast enough to maintain growth. Others believe recovery is just a question of time: write down the debts, heal the banks, keep the life-support machine on for long enough and the patient will recover.
Either way, this debate now has a nickname – “secstag”, short for secular stagnation – and is comprehensively outlined in a new, free ebook from the policy portal VoxEU. The optimists in this debate – myself included – believe a new technology-driven upswing is possible, but only with a change of economic strategy so radical that it might not feel like capitalism.
But all sides of the secstag debate agree on one thing: the tendencies towards stagnation are higher in Europe than anywhere else. As Summers told the IMF ruefully last November, a crisis on the scale of the one that Lehman triggered is not over until it’s over. And what Draghi just did means it is not over.
If we do get secular stagnation, it will be hard to get our heads around – for the simple reason that it hasn’t happened before. The phrase itself comes from the end of the 1930s when everybody from Trotsky to mainstream followers of Keynes were predicting long-term economic decline.
The one modern example is Japan – where deflation ruled from 1997 to 2007. But Japan is in some ways a poor example: Japanese people themselves have funded the country’s debt – and it remains a big producing and exporting economy.
If Europe goes into stagnation, it is a different ballgame. First, much of its debt is owned abroad. Second, it is a place with a propensity to conflict. There is no culture of conformity, and Europe’s youth are quite prepared to riot over Gaza, let alone GDP.
If you were designing an economic nightmare, then, deflation or stagnation in Europe would be close to top of your list.
Paul Mason is economics editor at Channel 4 News. Follow him @paulmasonnews
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