Suddenly,
the D-word is starting to pop up in the discussions and articles in the
newspapers: deflation!
Deflation is a scary ghost that almost brought Japan to
ruins in the nineties and that led ultimately led Europe and the rest of the
world into the second World War almost 75 years ago.
The
effect of deflation – that prices and salaries are structurally dropping –
makes that people save their money and wait for prices to drop further and
further.
While
people wait and put their savings on the bank, their money becomes more and
more valuable, as it gains purchase power per day. This effect can be so strong
that savings even rise in value at a near zero (or even negative) interest rate.
Thus, one of the most powerful weapons of central banks (the interest weapon) becomes
defective: lower than a zero interest rate on savings amounts is impossible.
Therefore
deflation works on an economy like a handful of sand in a running engine:
everything comes grindingly to a halt.
What
makes such an event even worse, is that there is almost no way out of deflation,
unless something very dramatic happens: a war or a radical new invention or development.
I
explained the
cause for deflation in an earlier article:
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.
It
is good to read the aforementioned article in full, as it seems to be that I
was spot on in those days, when I predicted that the chance for hyperinflation
was close to nought. I think I may say that I was right the whole way.
And
now, the pundits are predicting deflation, but only in the southern European
countries and Ireland. I think that these people are still too careful in their
predictions.
Last
week, Eurostat presented its latest data on inflation within the European
Union.
EU down to 0.9%
Euro area annual
inflation was 0.7% in October 2013, down from 1.1% in September. A year earlier
the rate was 2.5%. Monthly inflation was -0.1% in October 2013.
European Union
annual inflation was 0.9% in October 2013, down from 1.3% in September. A year
earlier the rate was 2.6%. Monthly inflation was -0.1% in October 2013.
In October 2013,
the lowest annual rates were observed in Greece (-1.9%), Bulgaria (-1.1%) and
Cyprus (-0.5%), and the highest in Estonia and the United Kingdom (both 2.2%)
and Finland (1.7%).
Compared with
September 2013, annual inflation fell in twenty-three Member States, remained
stable in one and rose in four. The lowest 12-month average rates up to October
2013 were registered in Greece (-0.4%), Latvia (0.3%) and Sweden (0.5%),
and the highest in
Romania (3.7%), Estonia (3.5%), Croatia and the Netherlands (both 2.9%).
And
in an article, the Dutch newspaper De Telegraaf did indeed mention the D-word:
The average price
level in Greece and Cypres dropped sturdily in October, while at the same time
deflation is looming in Spain, Portugal and Ireland. This is disclosed in a new
forecast for the inflation in the Euro-zone, that was published by the European
statistical bureau Eurostat last Friday.
Deflation, a persisting
drop in price levels, forms a risk for the economic rebound in the weaker
Eurozone countries. It can push consumers to postpone their intended purchases,
in the expectance that prices will drop further. This erodes the profitability
of companies, which further endangers the employment. On top of that, deflation
makes that debt is relatively expensive, which makes it harder to settle.
Last week, the
European Central Bank (ECB) suddenly lowered the refi-rate in the Eurozone,
in an attempt to stimulate inflation
and support economic growth.
Especially in Spain
the inflation cooled off considerably during the last months. In July, the
prices still rose by 2% on an annual basis. In Ireland, prices are stagnating
since August, while the price level in Greece has been dropping for some time.
Here
are a number of charts showing the inflation rates in the Eurozone from 2005 -
2013, based on the inflation data by Eurostat. In these charts you can see why
people like me are fearing a period of deflation.
I
begin with the PIIGS-countries:
 |
| Inflation in the PIIGS countries from 2005 - 2013 Chart by: Ernst's Economy Data courtesy of: Eurostat Click to enlarge |
However,
also in the rest of the EU everything is not hunky dory. Please have a look at
the following charts:
 |
| Inflation in the larger Eurozone economies from 2005 - 2013 Chart by: Ernst's Economy Data courtesy of: Eurostat Click to enlarge |
 |
| Inflation in the smaller Eurozone economies from 2005 - 2013 Chart by: Ernst's Economy Data courtesy of: Eurostat Click to enlarge |
 |
| Inflation in the larger non-Eurozone economies from 2005 - 2013 Chart by: Ernst's Economy Data courtesy of: Eurostat Click to enlarge |
 |
| Inflation in the smaller non-Eurozone economies from 2005 - 2013 Chart by: Ernst's Economy Data courtesy of: Eurostat Click to enlarge |
What
makes this deflationary trend even more dangerous than the trend at the end of
2008, is that we now have 5 years of crisis behind us and we are back at where
we started: a rapid movement downwards of the inflation rate.
The
deflation in 2009 could be called a shock-effect from the explosively emerging
economic crisis; this deflationary movement is definitely no shock-effect
anymore and could prove to be much more substantial and enduring than the one
in 2008/2009.
It
proves once again that the hyperinflation pundits (and especially Germany) did
not know what the heck they were talking about at the beginning of 2013.
It
is my prediction that this economic crisis – I call it a depression(!) – might turn
into many, many years of anemic growth and deflation within the European Union:
the Japan scenario.
And
please don’t think that something like this will only happen to the
PIIGS-countries. The whole EU can be subject to deflation in the coming months
and years.
Unless…
the EU governments could do something dramatic; starting with Germany.
The
ECB has unfortunately fired almost all its monetary bullets, so don’t count too
hard on the magic powers of ECB president Mario Draghi.
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