I can’t remember off the top of my head reading much fiction that used conflicts arising from inflation or deflation, but as Neal Stephenson demonstrated in his System of the World books, you can actually generate some pretty cool plot conflicts that way. But many people lack a good understanding of what inflation or deflation really is and how it comes about, and I suspect authors are similar. So let’s dive in.
(We’re going to focus on the political/inequality effects of inflation and deflation, rather than purely economic. So I’ll be skipping discussion of inflationary spirals, for instance.)
One tricky bit is that when we speak of “inflation,” we might be talking about at least three separate phenomena:
- Price levels are rising because people are actually getting richer and are spending more money on things, somewhat faster than production can increase in response (which we will call “wealth-driven inflation”).
- Price levels are rising because real wealth is staying the same, but a bunch of new money is sloshing around the economy due to borrowing or other forms of money creation, leading to artificial demand not backed by real increases in wealth and consequent distortions in wealth distribution (“monetary inflation” or “bubbles”).
- Price levels are rising because it is literally getting more expensive to make anything, so price increases coincide with destruction of wealth and real increases in poverty (“stagflation”).
Similarly, “deflation” could mean a few different things:
- Gentle price declines due to increasing technological or organizational efficiency over time.
- Sudden price crashes due to the collapse of a speculative or demand bubble.
- Ruinous price declines because nobody has any money left to buy things with (i.e. persistent economic depression).
Generally, a healthy economy ought to see alternations of wealth-driven inflation and gentle efficiency-led deflation, so that new production and innovation are encouraged and then make people’s lives better. Unfortunately, “prodigals and projectors” (as Adam Smith referred to reckless overborrowers) tend to leverage themselves to the hilt whenever possible; and at the same time, governments often try to magic money out of thin air in order to pay for their programs, without paying as much attention to creating real wealth.
On the flip side, even mild deflation becomes terrifying to the Powers That Be as more and more of the economy depends on free-flowing debt on the one hand, and massive investments in fixed capital that need to be repaid over long periods of time on the other. Both debtors and owners of fixed capital would be crippled by price declines that lead to declining profits, since they would no longer be able to pay their debts or obligations generally. (The same applies to the government itself, which relies on tax revenue funded by economic activity and generally has rigid obligations.) Thus, governments have tended to favor mild inflation instead of allowing gentle oscillations between inflation and deflation; the Federal Reserve, for example, has an explicit target of 2% inflation.
As a result, governments often promote increases in the money supply, promising that it would be a cure for all that ails us. Instead, it tends to fuel violent booms and busts, of the type that we are well familiar with today.
Note that an increase in the money supply doesn’t magically spread across the entire population instantly. It starts when one corner of the economy suddenly earns a lot of new money—perhaps from striking gold in the hills, perhaps from exporting oil and sowing the seeds of Dutch Disease, perhaps by selling bonds to the Federal Reserve (paid for with dollars hot from the metaphorical printing press). That first sector then spends the money in other sectors, like luxury cars and real estate for example, and bids up the prices there; and eventually the tide of new money washes across the economy in general. But the initial “nouveau riche” sector was able to spend money at almost the original prices, while successive groups had to pay higher and higher prices for goods, while the very last people to be “enriched” by the new money end up suffering from inflation well before they actually “benefit” from it.
(The foregoing was a very brief summary of a point made by the brilliant Henry Hazlitt in his 1946 book Economics in One Lesson, in Chapter 22—starting at page 148 in this free edition in the paragraph beginning “[a]n increased quantity of money comes into existence,” though properly the discussion begins on page 145. Every person who has any opinions at all about economics ought to read this book, more than once.)
Note also that if prices increase in this way (due to increased buying pressure), by definition this will hurt the poorer segments more, simply because they don’t have the purchasing power to keep up. This is especially true with food. If luxury autos double in price, a poor family won’t care; but if eggs and milk double in price, suddenly the poor face a serious threat to their well-being. The net effect is that high inflation harms the poor more than those better off, tilting the relative balance towards the rich (though even the rich might not actually be better off, in real terms).
Some people say that inflation is good for the poor, because it would tend to increase their wages; but that’s rarely correct. First off, if the poor are net borrowers, they simply pay higher interest rates on new borrowing. Even existing debt, if it is variable-rate, becomes more expensive. People with a lot of existing fixed-rate debt do benefit, but such people are rarely poor. Second, even if nominal business profits are rising from higher prices, that doesn’t automatically translate into higher wages. If there is a lot of competition for jobs, from other workers or from technological improvements, then employers need not pay any extra or could even reduce wages. (Arguably, this has been the story of the last forty years.) Only if the labor market is tight, and employers desperately need to keep their employees happy, will wages tend to rise along with revenues.
Prices could also increase due to real increases in the cost of production or sale. This is easiest to see when fuel and electricity prices go up. Energy is an input into almost everything in the economy, so even if total wealth stays the same, producers will have to raise their prices or go bankrupt. This means that fewer people will afford to buy what they used to; most people will have to cut back. In other words, the rise in prices simply means that society has gotten poorer, because it is harder to make things.
Energy is not the only input that could cause this effect. Increased regulation, difficulties in transportation or supply-chain management, higher wages, higher salaries for executives, or increases in crime and property destruction can also impose costs on companies, often forcing prices higher. (Some of these costs might come with benefits, while others might be pure waste, but that is a different discussion.)
As we noted, mild deflation is usually healthy—if prices are declining because the economy is getting more efficient at making things, that’s another way of saying that people are getting richer because they can buy more things. However, prices can also decline as part of the hangover from a speculative bubble. We can see this in the stock market when prices suddenly collapse after a long bull market. But it happens in the real economy, too. For example, one major cause of the Great Depression was that lots of manufacturers built new factories in the middle and late 1920s, each of them overestimating the total market demand for their goods and underestimating the amount of competition that would be online by the time their own factories were finished. As a result, the market was soon flooded with manufactured goods, and most of the manufacturers went bankrupt.
(A famously influential book on booms and busts was written by eminent economist Irving Fisher during the depths of the Great Depression. He also summarized the book in this article, which is quite a useful read. Fisher’s book was a major inspiration to John Maynard Keynes in the development of Keynes’s general economic theory.)
In a deflation due to a shortage of money, and a consequent excess of production, people sometimes rediscover that money is only one way to pay for things. People might resort to barter. Communities might create alternate payment methods such as local currencies or scrip. If you are lucky enough to find a supplier willing to extend credit, you can receive inputs now and pay for them once you have sold your goods. These means are usually inefficient compared to money, however, which is why they tend to disappear when the economy recovers.
If a deflationary episode persists for too long, it might lead to a deflationary spiral—people fear that prices will continue to drop, and therefore buying anything today is a surefire way to lose money. So people hoard their money instead, causing producers to lose their buyers and go bankrupt (especially if they have to meet payroll or mortgage payments). If it goes for too long, a deflationary spiral can permanently cripple the economy and reduce economic output.
Not everyone suffers in a deflationary spiral, however. Prices for everything become cheap—especially investment assets such as troubled businesses, stocks and bonds, or land, as their owners face financial ruin and need to sell quickly at any terms available. And if you have money in the bank, a deflationary spiral can be a fantastic opportunity to buy up assets and make a massive profit once prices normalize (assuming that they do!). (For example, if you had perfectly timed the stock market bottom midway through 1933 during the Great Depression and bought into the S&P 500, you would have nearly tripled your money by 1936.) As the saying goes, during deflation, “cash is king.”
All of the above being so, it would be easy to imagine that evil oligarchs might deliberately engineer a sequence of booms and busts in the economy, so they could buy assets cheaply during crises and then sell them to overexcited investors during the good times, gradually concentrating much of the world’s wealth into their desiccated, claw-like hands. The extent to which this happens in real life is, shall we say, unclear. But it would be a fantastic fictional plot, wouldn’t it?
And in any case, you can use the concepts here to impel several kinds of plots. For example, the biblical Book of Ruth is kicked off when Naomi’s family leaves Israel to escape an economic depression.
(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders. No idea when it will be finished, but it should be fun!)