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Wednesday, 4 February 2015

The European Union: deflation seems to remain the name of the game in the coming months or years. The hyperinflationistas have been proven wrong with their fears.

For already a few years, the European Union has been the subject of a heated debate between economists and politicians. It concerned the question whether the EU was on the path towards deflation or elevated inflation.

The proponents of the latter theory – as always including the Germans, with their eternal fear for hyperinflation, as a painful heritage from the Weimar Republic during the interbellum – were afraid that the liquidity injections from Mario Draghi’s European Central Bank would eventually lead to strongly elevated inflation and perhaps even hyperinflation in the European Union. 

This was probably the main reason that Germany, and in its slipstream the whole Euro-zone, almost solely focused on austerity, budget balancing and debt slashing as the cure for the economic situation in Euro-zone countries. In the eyes of the political leaders and economic pundits, the EU had to improve the (Southern) European economies through the achievement of fiscally healthy government budgets and sound debt management. 

In the process, Germany tried to discourage or stop – one way or the other – every attempt of the Southern European countries and France and/or the ECB to increase the amount of liquidity in the European economies; irrespective if it would happen via Euro-bonds, Quantitative Easing, helicopter drops of money, low interest rates or lending facilities with very loose conditions. 

At occasions, when chancellor Angela Merkel seemed to give in too much to her European counterparts, the Bundesbank and the German Federal Constitutional Court in Karlsruhe acted as backstops: the latter, by openly investigating whether measures of the ECB and other European institutions would not violate the German constitution.

The result of this continued German policy was that very little happened in the Euro-zone besides the already worn out austerity policies, in spite of the fact that the southern European countries were sometimes litterally begging for looser monetary policies and alternative ways to acquire funds from the international capital markets (hence: the Euro-bonds). 

The results of this irrational German angst for loose monetary policies and hyperinflation are crystal clear: a seemingly unstoppable deflationary trend. 

All politicians and pundits, who think that this deflatory trend can be solely attributed to the recent dropping oil prices, should take a look at the following chart, based on the European Union inflation data of Euro-stat:

The inflationary trend data for the European Union from 2005-2015
Chart created by Ernst's Economy for You
Data courtesy of: Eurostat (
Click to enlarge
If this chart proves one thing beyond a reasonable doubt, it is that this deflationary trend already started to pick up steam in January 2012, when plummeting oil prices were still a thing of a distant future. 

And even more worrisome: no country – including the non-Euro countries – can escape from this deflatory trend, as ALL inflation trendlines point downwards at this very moment.

Perhaps even more disturbing is the fact that the wages and fees for lower and middle class jobs – which can be considered the lubricant of the economie  are more and more subject to wage restraint and even straight-forward wage reduction. This happens in The Netherlands and probably also in other European countries. 

Especially in the retail industry and among the small and medium enterprises there is absolutely no leeway for increased wages; too often wages must even be reduced, in order for companies to survive. This was proven by the V&D case two weeks ago. 

As both the retail industry and the small and medium enterprises - as big drivers for jobs in The Netherlands and abroad - are going through extremely rough times, there is a considerable chance that V&D will not remain the last large case of wage reduction in the coming months. 

Besides that, the unemployment and especially the youth unemployment in Europe remain at elevated levels (respectively 11.6% and 23% in average), with the countries in South-Europe as negative outliers. 

These are all strong deflatory factors:

  • When external causes for price increases are virtually absent, large quantities of unemployed and impoverished people keep retail prices low through a declined and structurally low demand;
  • Wage restraint and wage reduction make that people remain with the same or less purchase power than they had before. As people have to live within their means, this too will have a strong dampening effect on demand;
  • The higher taxes and levies, that were deployed almost everywhere, made that general purchase power for the largest groups in the European societies even further diminished;
  • The cautious growth everywhere in the international economies did probably the same for the energy prices; especially when the supply of oil and energy remained at elevated levels. 

Although it is safe to state that each country in Europe had its own special set of circumstances and actions, the point is that the deflationary trends are now visible everywhere. And it is not very likely that these trends will change soon. 

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