The Motley Fool

Deflation Could Crack The Eurozone!

Back when the Bank of England and the US Federal Reserve were promptly doing the right thing with their sizable quantitative easing (QE) policies, the European Central Bank (ECB) was stubbornly resistant.

But denial can’t buck market forces, and with the eurozone falling further into deflation (while the UK and US economies are recovering pretty well), the ECB was forced to act and embarked on a 1 trillion euro QE programme last week.

Falling oil prices had helped push eurozone prices down 0.6% over 12 months by January, down from December’s year-on-year figure of 0.2%. And even without oil, retail prices have hardly been moving.

Deflation bad

Deflation is just about the last thing you want at a time when your economy desperately needs to start growing. It is retail demand that drives the whole thing, and if goods are going to be cheaper in the future then there’s little incentive to spend now — and it’s compounded by the value of debts getting bigger. We’ve already seen the same thing happen in Japan, which suffered a 20-year cycle of deflation that proved extremely hard to get out of.

If that was the only problem, QE would most likely be an effective solution. But there is also an enormous gap between the strongest and the weakest economies of Europe.

Unemployment in the zone is running at about 11.4%, which sounds tough but not insurmountable — except that there are huge regional variations. In Germany, unemployment stands at 4.8%, but in Spain it’s reached a painful 23.7% and Greece has 25.8% of its workforce unemployed.

Is a QE programme aimed to suit the needs of Germany likely to bring an end to the suffering in Greece and Spain? I don’t think it takes a professor of economics to work that one out.

Differential pain

The weaker southern economies are going to be hit much harder by deflation if it continues, and by lack of growth even if it doesn’t — and they’re going to fall further and further behind the more prosperous northern states.

And what’s more, their people are beginning to realise that maybe Europe isn’t actually set up to help the poorer states after all, but instead to preserve the advantages of the wealthy states who call the financial shots.

What Greece and Spain need is to be able to inflate their way out of their troubles, with their currencies allowed to devalue on the open market and get their exports moving again. But obviously that’s not possible, not in a political system tied to the needs of a country with only 4.8% unemployment.

The people are revolting

Greece’s election has demonstrated its citizens’ contempt for their enforced hardship, and Spain has an election due by December 2015. The euro-masters’ policy of forced austerity for its poorer members might actually work if it’s given long enough, but are the democracies of southern Europe going to accept decades of second-class citizenship status while it happens?

The Japanese didn’t really have anybody else to blame for their misery, but the Greeks and the Spanish do — and the rest of Europe needs to start listening before the growing cracks get ever wider.

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