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Friday, 11 January 2013

Pundits are warning for (hyper)inflation in The Netherlands. They could not have been more wrong! Demotion and wage reduction: buzzwords in a deflationary world!

More and more pundits and officials are predicting that the crisis might be over soon in The Netherlands. 2013 is thought to be the year of the pivotal change from getting deeper into the crisis towards getting out of the crisis.

Although the economy might show very moderate growth in 2013, the growth is thought to be sustainable.Under the wings of the United States and Germany, The Netherlands should be able to pick up the positively changing momentum and conquer the crisis after five difficult years.

Some of these pundits are now talking about soaring inflation and even the H-word – hyperinflation – is mentioned again, due to the recent increase of money in the European countries, spurred by the European Central Bank (ECB) and the European emergency funds EFSF (European Financial Stability Facility) and ESM (European Stability Mechanism).

First, I want to give an introduction on (hyper)inflation and deflation.

I cannot be called a particular sponsor of the inflation/deflation theory by the Austrian school, but it does make much sense to me.

To summarize this Austrian theory:
·     Inflation is when the combined amount of money and credit in an economy is rising

·     Deflation is when the combined amount of money and credit in an economy is dropping

What this theory does very well is explaining why a large increase of the money-amount in an economic area, like we experience today, does not automatically lead to soaring inflation or even hyperinflation.

The most important concept within the Austrian theory is that inflation is not caused by a growing money supply alone, but by the supply of money AND credit growing.

In times when the credit supply by the banks in an economic area is very limited, it is very hard for a government or central bank to produce so much paper money that it could outweigh the limited supply of credit by the banks. On the other hand, in times of vast credit supply, governments have a hard time keeping inflation low by reducing the amount of paper money in the market alone.

What is hyperinflation and how does it occur? Hyperinflation is – according to one definition mentioned in Wikipedia – when average prices rise for more than 50% within one month: an arbitrary but usable definition.

How does it occur? Again WikipediaHyperinflation occurs when there is a continuing (and often accelerating) rapid increase in the amount of money that is not supported by a corresponding growth in the output of goods and services.

If a certain country produces 50 million tons of output each year, but its citizens earn every year 10% more wages, than the country suffers from an inflation of 10% per year.

However, if this country produces 10% more output every year and its citizens earn 10% more wages per year, than there is no inflation in this country.

It is often very difficult to find out what the final trigger has been for starting a period of massive inflation or hyperinflation. Often this is caused by desperate governments that try to stir up a stagnating and depressed economy by massively increasing the money AND credit supply, without increasing the production capacity in such an economy.

Still, it is quite hard to spur massive inflation with paper money alone, as this doesn't say anything about the credit component of the equasion. However, when such a desperate government prints and hands out (distributes) excess amounts of paper money on a longterm scale, this could be enough eventually to spur hyperinflation. 

Please check out the mentioned article in Wikipedia for additional information on this subject.

Now about the predictions from the pundits about the economic growth in 2013 and/or the (massive) inflation and even hyperinflation that some of these pundits mentioned:

I seriously doubt if the economy will grow at all in 2013 (not even to mention the word “sustainably”). However, I also don’t believe one bit of this increased inflation / hyperinflation paradigm that some pundits are advocating at this moment.

About the economic growth: things within Europe and the Eurozone seem to come quite at ease lately. The Euro-crisis seems reasonably under control, the Greek credit crisis seems contained and today Spain had no extreme difficulties in rolling over loans at the international capital markets. 

The approach towards the euro-crisis by the combination of the IMF, the ECB and the EU might now have taken away the biggest pain symptoms from the Euro-crisis. These circumstances might be good for spurring Dutch exports to the rest of Europe.

On the other hand, when we look at the Dutch situation:
·    The Dutch consumers seem to have totally lost their confidence and spending power, in spite of all cheerful messages around Sinterklaas and X-Mas sales;

·    The number of financially healthy retailers is dropping rapidly, due to dropping sales as a consequence of these reluctant consumers;

·    There are large numbers of small and medium enterprise companies in various industries that are writing red figures for the fourth consequtive year now. Improvement of this situation still seems a mirage at the horizon;

·    Mass lay-offs are occuring everywhere in the Dutch economy: also in industries that are normally very strong and stable, like the financial industry;

·    The number of underwater mortgages has been soaring and the number of houseowners that cannot pay their mortgage anymore has been soaring too.

My prediction: if there will be any economic growth at all in The Netherlands in 2013, this growth will be anemic, in my humble opinion.

Then what about the H-word. Will there be large inflation, or even hyperinflation in The Netherlands?

If there would be large inflation, you would expect the prices to rise rapidly, right? The official inflation rate over the last year was 3%, which is quite high for Dutch standards. However, this inflation was largely caused by a VAT-increase (i.e. Value Added Tax) of 2% in 2012. In other words: mainly triggered by the central and (also) local governments.

·    The housing prices (a very important financial indicator that is unfortunately seldomly used in inflation calculations) are still rapidly dropping. At this moment 800,000 houses are underwater: roughly 12% of total housing in The Netherlands.

·    Large principals of consultancy firms, temp agencies and facilitary services companies at government bodies and in the financial industry, chemical industry and manufacturing industry are still putting massive pressure on tariffs and fees.

·    Intermediaries in the financial and insurance industry are falling down by the numbers, while their mediation prices are dropping rapidly.

·    The numbers of budget-shops and shops having continuous sales (not to mention final sales) in The Netherlands are rising.

·    The number of people that doesn’t go abroad, but stays at home during holidays is soaring.

·    The number of hotels, restaurants and pubs that became in financial trouble is soaring too.

These are not inflationary, but DEflationary signals.

My final proof: if there would be rapidly rising inflation, you would expect wages to rise rapidly too, in spite of stalling productivity.

The opposite is happening, according to a number of articles in the Dutch financial newspaper Het Financieele Dagblad:

The Dutch branch of IT-behemoth Capgemini asks ‘overpaid’ employees to structurally reduce their wages as soon as January. The wage reduction could ascend to more than 10% in some cases.

The salary reduction hits 400 mostly older employees. This is about 7% of the total population, according to CEO Jeroen Versteeg of Capgemini Netherlands. ‘There is a mismatch between the salary that people receive and the achievements they can make’.

Although wage reduction is a quite revolutionary concept for Dutch standards, it is considered more and more often in the boardrooms of companies. Other IT-companies didn’t dare to act accordingly yet, but the threshold is definitely lowered since market leader Capgemini has ran the gauntlet. 

Also IT-giant Ordina states that it wants to reduce salaries where these have a mismatch with the market value of workers.’This happens more often at older employees’, according to HR-managing director Wouter van Essenberg.

In the IT-industry, the reduction of personnel expenses is even more urgent than in most other industries: since 2008 total sales on the Dutch market dropped by dozens of percents after a salary explosion. IT became the primary target for austerity measures at banks and the government.

Also at the large banks, the salaries are under pressure. CEO Ronald Latenstein of SNS Reaal already warned in 2011, that the wages in the financial industry were about 10% to 15% too high. The large banks try to reduce their salary growth by coupling a larger part of the salary to the profitability of the workers.

Other articles on this topic mention the word ‘demotion’, as the opposite of promotion: Older and ‘overpaid’ workers (in the eyes of their employers) should get a lower position with an accordingly lower salary to become profitable again. Hardly an inflationary message…

In 2013, retirees will receive less pension payments as a result of tax measures by the government. The reduction could ascend to ‘more than 5%’.

This is stated by the Pension federation, the representative organization of the pension funds.

This reduction of the pension payments is not even connected with the reduction that the pension funds itself have to carry through in some cases, as a consequence of their financial situation. At April 1, the pension funds have to carry through these measures on top of the government measures, where applicable.

The lower pension is caused by an adjustment of the wage levy tariff in the first taxing tier to 19.1% from 3.9%, in combination with higher mandatory fees for  health insurance.

Yet again, these are not inflationary, but deflationary measures.

What are the reasons that the situation in The Netherlands is still deflationary, in spite of the enormous amounts of money that have been pumped in the system by the ECB and the European Union, through the EFSF/ESM complex?

First, the Dutch government increased various direct and indirect taxes and social security expenses and took additional austerity measures to the tune of billions of Euro’s. Thus, the government further reduced the absolute spending power of the Dutch consumers AND they caused a negative mood among the Dutch consumer, who sits on the fence, awaiting further measures.

The second and more important reason for the deflation in The Netherlands is that the money handed out by the ECB and the EFSF/ESM generally stops at the banks, who use it to improve their solvability and liquidity ratios - in combination with stringent cost reduction - and not for lending it to people and companies.

This proofs why the credit component in the Austrian definition of inflation is so important.

You can print as much money as you want, but when it never arrives at the citizens who should use it and spend it, but instead it is kept in the safes at the banks, then there will be no inflation whatsoever.

There is a catch in it, however: at the time when the banks do start to use this excess money to lend it to the people on a massive scale, then inflation might be soaring very soon.

I really doubt, however, if 2013 will be the year in which this happens. Until then The Netherlands will be a deflationary world.

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