Central banking, Economics, Eurasia, History, Policy, Politics, Social development

Deflationary gap and the West’s war addiction

In June of 2014, a group of American researchers published an article in the American Journal of Public Health, pointing out that, “Since the end of World War II, there have been 248 armed conflicts in 153 locations around the world. The United States launched 201 overseas military operations between the end of World War II and 2001, and since then, others, including Afghanistan and Iraq.” To be sure, each of these wars was duly explained and justified to the American public and for all those Americans who believe that their government would never deceive them, each war was defensible and fought for a good reason. Nonetheless, the fact that one nation initiated more than 80% of all wars in the last seventy years does require an explanation, which I submit below: I posted the text below on my blog The Jubilee in 2011:

Deflationary gap

Although I studied economics at the university, I don’t recall coming across the subject of deflationary gap. The textbooks I still have don’t mention it, and a search on the internet yielded close to nothing on the subject. Wikipedia doesn’t even have an entry for deflationary gap. Answers.com provides a single vague sentence about it.

That’s strange, for we’re talking about a systemic flaw of the capitalist economic system that predictably corrodes the democratic framework of society and leads to the rise of fascism and militarism. In his book “Tragedy and Hope,” (by far the most fascinating history book I’ve ever read) Carrol Quigley devotes much space to deflationary gap as he meticulously traces the events leading to last century’s two world wars. He considers the deflationary gap as “the key to twentieth century economic crisis and one of the three central cores of the whole tragedy of the twentieth century”.

The subject of our analysis is a closed economic system, in which the sum total of goods and services appearing in the market equals the income of the system and the aggregate cost of producing the goods and services. The sums expended by the businesses on wages, rents, salaries, raw materials, interest, lawyers’ fees, and so on, represent income to those who receive them. The profits are entrepreneur’s income and his incentive to produce the wealth in question. The goods are offered for sale at a price which is equal to the sum of all costs and profits. On the whole, aggregate costs, aggregate incomes and aggregate prices are the same, since they represent the opposite sides of the same expenditures.

However, the purchasing power available in the system is reduced by the amount of savings. If there are any savings, the available purchasing power will be less than the aggregate asking prices by the amount of the savings, and all the goods and services produced cannot be sold as long as savings are held back. In order for all the goods to be sold, savings must reappear in the market as purchasing power.

Normally, this is done through investment. But whenever investment is less than savings, purchasing power will fall short of the amount needed to buy the goods being offered. This shortfall of purchasing power in the system, the excess of savings over investment, is the deflationary gap.

Methods of bridging the deflationary gap

The deflationary gap can be closed either by lowering the supply of goods or by raising the supply of purchasing power, or by a combination of both methods. The first solution will stabilize the economic system on a low level of economic activity. The second will stabilize it on a high level of economic activity. Left to itself, a modern economic system would adopt the former alternative, resulting in a deflationary spiral: the deflationary gap would lead to falling prices, declining economic activity, rising unemployment, and a fall of national income. In turn, this would cause a decline in the volume of savings, until savings reached the level of investment, at which point the economy becomes stabilized at a low level of activity.

This process was not allowed to unfold in any industrialized country during the great depression of 1929-1934 because the disparity in the distribution of income between the rich and the poor was so great that it would cause a considerable portion of the population to be driven to absolute poverty before the savings of the richer segment of the population could decline to the level of investment. Moreover, as the depression deepened, the level of investment declined even more rapidly than the level of savings. To avert social uprisings, governments of all industrial nations attempted to generate a recovery through two kinds of measures: (a) those which destroy goods and (b) those which produce goods which do not enter the market.

Averting depression through destruction of goods

The destruction of goods will close the deflationary gap by reducing the supply of unsold goods. While this is not generally recognized, this method is one of the chief ways in which the gap is closed in a normal business cycle. In such a cycle, goods are destroyed by the simple expedient of underutilizing the system’s production capacities. The failure to use the economic system at the 1929 level of output during the years 1930-1934 represented a loss of goods worth $100,000,000,000 in the United States, Britain, and Germany alone. This loss was equivalent to the destruction of such goods.

Destruction of goods by failure to gather the harvest because the selling price is too low is a common phenomenon under modern conditions, especially in respect to fruit and vegetable crops. While the outright destruction of goods already produced is not common, it has occurred in the depression years 1930-1934: stores of coffee, sugar, and bananas were destroyed, corn was ploughed under, and young livestock was slaughtered to reduce the supply on the market. The destruction of goods in warfare is another example of this method of overcoming deflationary conditions in the economic system.

Producing goods that don’t enter the market

The second method of bridging the deflationary gap, by producing goods which do not enter the market, supplies purchasing power in the market (the costs of production of such goods enter the market as purchasing power), while the goods themselves do not drain funds from the system, as they are not offered for sale. New investment would be the natural means to accomplish this, but modern economic systems in depression do not function this way. Rather, private investment tends to decline considerably. Alternatively, purchasing power must be supplied to the system through government spending. Unfortunately, any program of public spending quickly leads to the problem of public debt and inflation, which tends to compound the problems rather than solving them.

War: the irresistible solution

Approaches to public spending as a method of financing an economic recovery can vary depending on its objectives. Spending for destruction of goods or for restriction of output, as under the early New Deal agricultural program is hard to implement in a democratic country, because it obviously results in a decline in national income and living standards. Spending for nonproductive monuments or prestige projects like space programs is somewhat easier to justify but is not a long-term solution. The best approach, obviously is investing in productive capital goods, since it leads to an increase in national wealth and standards of living and constitutes a long-run solution.

Unfortunately, this approach runs into ideological head-winds in modern economies as it constitutes a permanent departure from the system of private capitalism. As such, it is easily attacked in a country with a capitalistic ideology and a private banking system. Instead, developed nations tend to favor the most dangerous method of bridging the deflationary gap: spending on armaments and national defense.

The appeal of this method is always rooted in political and ideological grounds. Military spending tends to help heavy industry directly and immediately. Heavy industry, which absorbs manpower most readily (thus reducing unemployment), suffers earliest and most drastically in a depression. This tends to make it very influential in most countries. Defense-related spending is also easily justified to the public on grounds of national security.

But increasing defense spending enhances the political clout of the military-industrial complex and tends to increase a nation’s reliance on the military in the conduct of its foreign policy and an escalation of conflict which leads to further increases in military spending. The vicious cycle ultimately results in the emergence of fascism: the adoption by the vested interests in a society of an authoritarian form of government in order to maintain their vested interests and prevent the reform of the society.

In the last century in Europe, the vested interests usually sought to prevent the reform of the economic system (a reform whose need was made evident by the long-drawn depression) by adopting an economic program whose chief element was the effort to fill the deflationary gap by rearmament. Quigley’s analysis, based on the historical developments in the aftermath of the economic depression of the early 1930’s closely parallels today’s events.

The economic crises which germinated from the same systemic feature present in the modern economic system, followed a similar pattern in economic and political developments that we are witnessing today.


To avert a depression, US Government ramps up military spending


In the last century, we have seen these developments lead to two world wars, the second of which included the use of nuclear weapons. Today, as we seem to be heading in the same direction, the question is: do we even know how to arrest this escalation of armed conflicts? If the most trigger-happy actor in this drama is a nobel peace-prize laureate (sorry, I can’t bring myself to capitalize “nobel peace prize”), I fear we have little grounds for optimism.

Nevertheless, if there should be any hope for humanity to avert further conflagration, a better informed, truthful debate just might lead the way to the needed economic and political reforms.


10 thoughts on “Deflationary gap and the West’s war addiction

  1. Sylvia Demarest says:

    This comment is on another subject. I just finished your book “The Killing of William Browder”. Although I reside in the US, I had to purchase this book from Amazon Canada since Amazon here in the US was somehow “persuaded” to discontinue sales. I would be interested in communicating with you further about both your book and about this entire situation.


    • Hi Sylvia, thank you for reading my book. Meanwhile Amazon scrubbed the book entirely from all their websites but still seems available on Barnes&Noble for now, maybe Book Depository and Abe’s books. Oh well, Browder the human rights crusader has a different concept of freedom of speech… If you wish, you can e-mail me. xela d0t reniark at gmail d0t c0m


  2. I agree with two of your observations. Firstly that, during a depression, people tend to defer consumption and investment which tends to deepen and prolong the depression. And secondly that, governments do indeed tend to respond with military spending.

    However I am not so sure that I agree with your proposed solution.

    I would tend to argue that depressions are usually (perhaps always) the result of government intervention in the markets in the first place. And the decisions to defer spending and investment, while indeed part of a feedback loop, are far more a consequence of the depression (a product of uncertainty regarding how the government might choose to behave next) than they are a fundamental cause of the depression itself. And adopting a solution of doubling down and increasing government intervention in the market place is compounding the problem rather than alleviating it.

    So I wouold worry that you are falling into the endless trap or proposing government provided solutions to government caused problems.

    Quoting from Henry Hazlitt:

    “It is true that this refusal to buy may intensify and prolong a depression. At times when there is capricious government intervention in business, and when business does not know what the government is going to do next, uncertainty is created. Profits are not reinvested. Firms and individuals allow cash balances to accumulate in their banks. They keep larger reserves against contingencies. This hoarding of cash may seem like a cause of a subsequent slowdown in business activity. The real cause, however, is the uncertainty brought about by the government policies. The larger cash balances of firms and individuals are merely one link in the chain of consequences from that uncertainty. To blame “excessive saving” for the business decline would be like blaming a fall in the price of apples not on a bumper crop but on the people who refuse to pay more for apples.”

    See http://steshaw.org/economics-in-one-lesson/chap24p2.html for more context.


    • Thanks David. Good to have quality feedback. I did not actually mean to propose that government spending is the answer – just that the current monetary system makes it inevitable to avoid recessions or depressions. The solution I would propose would be a drastic reengineering of the monetary system. At a minimum it would have to involve dual currency system. But that’s a very involved discussion.


  3. David says:

    The longer I live, the simpler I believe the answers to such questions are. Surely the simplest solution would just be to reduce the role of government in our society?

    That would eliminate many of the causes of depressions. It would certainly eliminate the typical government responses which almost inevitably exacerbate prolong depressions. And it would eliminate the ability of the state to wage war with the power it has extracted from its population.


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