Why Eurozone needs a bit more inflation

Joint press conference by José Manuel Barroso, President of the European Commission, Günther Oettinger and Connie Hedegaard, Members of the EC, on the launch of the EU framework on Climate and Energy for 2030. Environmental legislation and expensive energy constitute two major issues for the SMEs. (AC Audiovisual Services 22/01/2014).

It has become a bad joke to hear the European Central Bank’s Governing Council repeating monotonously that the inflation target for the euro area is below, but close to 2%. Most of the time, the same or the next day the EU’s statistical service (Eurostat) releases data confirming that Eurozone’s inflation is below 1% and slowly sliding downwards, towards the deflation region. To confirm who, the guilty party is for this ECB’s nonsensicality and inaction to fight deflation – which in a few months may become a deadly trap – the German Federal Minister of Finance, Wolfgang Schäuble, has stated on many occasions, that the euro area is by no means threatened with falling consumer prices.

As if this such a statement was not enough, last week he pushed this illogical logic one step forward and said that this is the time for ECB to raise its interest rates and follow a restrictive monetary policy. It’s really a disappointment to watch the largest and economically more powerful Eurozone country, to follow such a selfish and egotistic strategy. The reason for supporting this stance is simply that Germany, by asking for higher interest rates, tries to gain a larger yield for its large reserves, estimated at least at one trillion euro.

A miser’s policy

At the same time Berlin, by supporting this policy, shows the utmost indifference for the problems all the other Eurozone countries are enduring, while fighting to attain a sustainable growth path. The rising parity of the euro and the complete lack of bank credit, especially for the SMEs in the south is not enough to move the Germans, from their miser attitude. Berlin, in order to support a larger return on its accumulated reserves, appears willing to condemn every other economy to the abyss of recession and their populations to chronic unemployment.

Schäuble was very probably aware last week that Eurostat was about to announce a new retreat of the consumer inflation rate in February to 0.7% from 0.8% in January. Yet, he insisted that there is no danger of deflation and asked for higher interest rates. What is even more threatening, during the same month five Eurozone countries, Greece (-1.1%), Spain (0.1%), Italy (0.3%), Portugal (0.3%) and Slovakia (0.1%) are already in the deflation region on a monthly base (February over January). Another six countries are running monthly consumer inflation rates between zero and five decimal points.

Dried up finances

Deflation very simply undercuts by a multiple percentage all values in a country, including real estate and financial markets. In the current conjuncture more than half of Eurozone countries are suffering from complete lack of bank credits. This is particularly dangerous for countries like Italy, Greece, Spain,Portugal and Cyprus to name the worst hit countries, which are dependent on their SMEs even for exports. Germany keeps blocking the ECB from introducing a monetary policy aimed at facilitating the bank credit markets in those countries.

Berlin also denounces every proposal for an ECB policy targeted to directly help the SMEs find adequate financing as their counterparts in the core Eurozone countries, at the same interest rates or almost, for the same business risk. Presently, the Italian SMEs which before the crisis competed very effectively with their German and French counterparts, are today deprived of finance because Germany and France say so.

Pure vengeance?

This is a revengeful and deadly political hit below the belt, purposely designed by Berlin and Paris. Italian SMEs in the industrial, services and the agricultural sectors are producing an equal or even larger and more competitive variety of products than Germany and France put together. That’s probably why Germany insists that the ECB should do nothing to help the south Eurozone countries overcome their present dead-ends.

On the pretext that the sovereign borrowers of Italy, Greece, Spain and Portugal are not creditworthy, Germany has managed to use this fact to destabilize the entire financial system of those economies, by blocking the ECB from supporting their state debt. By the same token, Germany shows how shortsighted its political leadership is. This attitude may even drive the south Eurozone countries to exit the euro area, once they manage to zero their fiscal and foreign account deficits. Italy has come close to this possibility.

The south strikes back

Add to this the fact that Italy is a founding member of the EU and also one member state that Europe cannot do without, and you may arrive closely to what its new Prime Minister Matteo Renzi told to the German Chancellor Angela Merkel and the French President Francois Hollade this past week. His €90 billion package to restart the Italian economy is a direct challenge to the French and Germanic autocracy in Eurozone. Italy is the only country that can do that given that Greece, Spain and Portugal cannot survive, in the short-term, outside the Eurozone.

In short, Germany and France are now facing the demands that Eurozone needs more inflation at least around 2%, cheaper money in the region of 1.20 with the dollar, and the same financial conditions for the entire Eurozone business area (defragmentation). After Italy, Greece follows suit and Athens exploits the momentum created by Rome to even address itself to the capital markets for refinancing its huge loans. In this last case though, it will be very difficult for Greece to justify a capital market loan with an interest rate around 6%. The problem is that the country is borrowing from its Eurozone sovereign partners at 2.5% and will go immediately bankrupt if more new such ‘soft’ loans are held back.