Jack Lew, US Secretary of the Treasury (on the left), and Michel Barnier, Member of the EC in charge of Internal Market and Services. (EC Audiovisual Services).
Yesterday Eurostat confirmed that the euro area inflation rate for December was down to 0.8% from 0.9% in November, dangerously approaching the negative part of the graph. The announcement coincided with IMF Managing Director Christine Lagarde’s warning that weak growth in Eurozone is now also threatened by deflation (continuously falling prices leading to real economy crisis). On Wednesday Lagarde spoke at the National Press Club in the U.S. capital. Her statement is an indirect but quite clearly targeted criticism against Germany, the lead euro area country. Berlin has imposed an austere fiscal policy on the entire single money zone, thus creating a major impediment to growth and continuously pushing down consumer prices.
A major side effect of this restrictive macroeconomic policy is that the falling rate of inflation (disinflation) threatens to turn into deflation (negative inflation) and thus freeze Eurozone’s growth prospects for years, if not triggering a real economy devaluation crisis. In this way, Germany, and consequently Eurozone, negatively contribute to the world’s growth prospects, by absorbing through a largely positive external trade balance the development dynamic of other regions of the world, like North America.
Transatlantic confrontation
During the past few months the US government has raised the tone of criticism against this austere economic policy followed by Germany and imposed on the entire Eurozone. The Americans say that the Eurozone, under Germany’s guidance, has based its weak growth on exports and a grossly positive trade and services balance, depriving in this its trading partners from their own development dynamic. At the same time, this austere economic policy has suppressed inflation way below the target set by the European Central Bank at below but close to 2%.
On 8 January the United States Treasury Secretary Jack Lew, was in Berlin and met with the German Finance Minister Wolfgang Schäuble. To the extent permitted by the fact that Lew was on official visit in Berlin, he criticised with the strongest possible language the austere German economic policies. Schäuble pretended that this was a usual American grouchiness, resulting from the growing negative US balance of trade with Germany. He didn’t accept Lew’s proposal that by an increase of the internal demand in Germany, Eurozone will quickly reach a sustainable growth path and the world will find another support point for growth. Not a word about more investments and consumption in Berlin, where austerity shadows everything.
Yesterday, it was the turn of the IMF to point a finger to the Germans for doing nothing to help the Eurozone and the world economy grow at a quicker pace. This time Lagarde had another quite convincing argument to support her ‘advice’ to Berlin to change policy line; the threat of deflation. IMF’s boss probably knew that Eurostat was expected to confirm on Thursday that inflation in Eurozone fell to 0.8%, much lower than ECB’s target around 2%. She had a lot to say on that. For a start she playfully noted that, “If inflation is the genie, then deflation is the ogre that must be fought decisively”. Then Lagarde choose to touch Germany’s pain point; the lack of cooperative spirit.
Think of WWII
She pointed out that in order “to move forward, the world needs the same spirit of cooperation and global solidarity today, as the multilateral impetus behind the founding of the IMF”. The IMF came into existence in December 1945, when its first 29 member countries signed its Articles of Agreement. The aim was to help the world recover from the unbelievable destruction caused by the largest armed confrontation in the human history. In short what Lagarde, a French woman, wanted to remind to the Germans, is that this is not the first time they don’t show cooperative spirit with the rest of the world.
In any case Germany’s inspired austere economic policies in Eurozone have now led to a point that may trigger the destructive forces of deflation. Following the course of core inflation in the last months the deflation prospect doesn’t seem as distant as the Germans believe. It’s very informative to follow the evolution of the rate of change of the inflation index excluding energy, food, alcohol & tobacco. This core inflation rate was 1.5% in December 2012, 1% in September 2013, 0.8% in October, 0.9% in November and 0.7% in December. The exclusion of energy, food, alcohol & tobacco from core inflation is justified on the grounds that those items do not represent the core productive structures of Eurozone’s economy.
In any case, if deflation reaches the core productive sectors of an economy, then there might not be an easy way out and the cost of it will be much larger than a timely change of course earlier on. This is exactly what everybody with one voice is pointing out to Berlin, from Washington and Paris to Athens and from Nicosia and Rome to London.
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