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ORIGINAL FRENCH ARTICLE: L’Europe proche de la spirale déflationniste

by Kevin Boucaud

Europe Nearing Deflationary Spiral

Translated Saturday 30 August 2014, by Gene Zbikowski

The figures for economic growth in the second quarter in France and across the euro zone, which are to be published tomorrow, August 14, will certainly confirm the weakness of European economic activity and will probably not quiet worry regarding the risk of deflation.

Will one crisis be followed by another? Whereas Europe still has not recovered from the 2008 deflagration – the financial crisis having developed into a sovereign debt crisis – a new specter is haunting the continent: deflation. The French statistical bureau, the INSEE, is to give its first estimate of second-quarter growth on August 14 and everything presages a disappointment: the reversal that the government had hoped for will probably cede to a slowing-down in the pace of growth, or even in renewed negative growth. Many economic indicators are pointing in this direction: demand and investment are drooping and industrial production fell by 0.5% over the past three months. Thus the Banque de France revised its forecast downward last week, envisaging 0.2% growth in the quarter. This is something that will annoy French president François Hollande, who celebrated his 60th birthday on August 12.

In the past few weeks, Prime Minister Manuel Valls, followed by François Hollande, communicated their worry regarding this situation. Notably, the prime minister sharply criticized the European Central Bank (ECB), declaring that it was “powerless” in the face of the risk of deflation. François Hollande pointed to the same danger, but took care not to attack the ECB, whose seat is in Frankfurt. All the same, he turned to Germany, asking his partners there to give “firmer backing to growth,” and adding that “their trade surplus and their economic situation allow them to invest more.” But what is this new danger that is threatening Europe?

Economic mechanisms that have been understood and described since 1933…

Deflation is much more than just a general fall in prices, it is a negative spiral that drags the whole economy down. The fall in consumer prices inevitably leads to a rise in real interest rates – defined as the nominal interest rate less the rate of inflation. This leads to company over-indebtedness, which lowers their profit margin and thus leads to a fall in nominal wages and in investment. Then demand and production fall. These mechanisms, which have been well understood since their description in 1933 by economist Irving Fisher, feed one another: the fall in economic activity feeds the fall in prices, which reinforces the economic stagnation. This is called a “deflationary spiral,” which cannot be affected by monetary policy.

History has recorded several phenomena of this type, during the 1930s Great Depression that followed the 1929 stock market crash, or again during what economists call the “lost decade” in Japan in the 1990s.

With euro-zone inflation at 0.4% in July – the lowest level in five years – there is a real danger. It is accentuated by the austerity policies presently being followed, which undermine wages and slow economic activity.

Many specialists have long been warning of this danger. Among them, one may cite the “Economistes attérrés” (Dismayed Economists) collective, which rang the alarum bell in 2012 in their book entitled “l’Europe maltraitée”. More recently, Joseph E. Stiglitz, who won the 2001 Nobel Prize in economics, wrote in his 2013 book “The Price of Inequality: How Today’s Divided Society Endangers Our Future” that “the worst myths are the ones according to which austerity will cure the economy, and that greater government expenditures will only have the opposite effect.” Today, even the very free-trade Bundesbank thinks that wages in Germany need urgently to be increased to ward off the danger.

To meet this threat, the central banks usually conduct “expansionist” or “adaptive” policies, that is to say, policies that strongly favor the creation of money. Moreover, this is the alpha and the omega of all their actions, because, as Dominique Plihon, an economist and member of Attac, points out, “to counter the effects of the crisis (…) the central banks have inundated the banks with cash reserves.” In particular, they have had recourse to non-conventional policies of monetary easing. This is the course taken by the ECB, because in March it made the use of monetary easing possible and at its monthly meeting in June it provided itself with a new quantitative arsenal.

Both companies and households are seeking above all to decrease their debts.

Theoretically, this increase in the monetary base serves “to share out the monetary supply (the amount of money in circulation) by increasing the banks’ reserves, into order to push them to extend credit,” explains Patrick Artus, an economist working for Natixis. “Now, this time round, this isn’t possible, because both companies and households are seeking to decrease their debts,” the economist continues. The banks have used these cash reserves to feed the financial markets. Therefore, their main effect has been “to increase the price of financial assets and to feed bubbles,” Patrick Artus emphasized. As a result, “the Stock Market is doing better than the real economy,” Jésabel Couppey-Soubeyran, an economist at the University of Paris I – Panthéon-Sorbonne, said regretfully.

In the United States, the Dow Jones index and the S&P 500 index, the two main American indexes, respectively grew by 25.95% and by 29.09% in 2013, and both clearly went beyond their pre-2008 levels, whereas real U.S. economic growth stood at just 1.9% in 2013. In the euro zone, the Frankfurt Dax index chalked up a 25.50% increase to reach record growth, and the Paris CAC 40 index grew by 17.99%. At the same time, the German and French gross domestic products only grew by 0.4% and 0.2%. The divergence continued this year, with the CAC 40 index and the Dow Jones index respectively increasing by 2% and 1% in the first quarter, while French economic growth was zero and the U.S. gross domestic product fell by 2.9%

“Free trade ideology holds that markets can regulate themselves!”

In short, to ward off a deflationary risk – still a current risk – the central banks have fed this financial bubble. And, “if there is a shock, no necessary mechanism exists. Regulatory mechanisms and the banking union are inadequate,” Jézabel Couppey-Soubeyran points out. According to her, “we must not expect anything from the monetary policy,” and “the right policy mix (a policy combining monetary and budgetary policies – editor’s note) has not been adopted.” The consequence is that “we don’t have the means to absorb the deflagration,” she continued.

The root of the problem is “the free trade ideology, which holds that markets can regulate themselves,” Dominique Plihon said regretfully. This dogma is, nonetheless, at the heart of the crisis that they are trying to resolve. The alter-globalization economist thinks that, as concerns Europe, both the governments and the ECB have made mistakes. He believes the ECB “has to refinance the banks selectively and to establish easy terms for governments. On the government side, the financial sector has to be rethought. Public sector finance must be given a much more important role (…) in order to finance small-and-medium-sized companies and an ecological transition.”

This opinion is shared by Denis Durand, an economist and the general secretary of the CGT national labor union at the Banque de France, who emphasizes the role of government services. He explains that “it is essential to improve the quality of transport, health care, energy provision and the ecology, and to do that the ECB has to lend money directly to governments at a 0% rate of interest.” It is also necessary to reform the Public Investment Bank, in order to obtain “a more democratic mode of functioning.” Durand also puts forward the idea of a “European social and economic development fund,” a proposal which has already been espoused by the Left Front.

These suggestions echo the appeal issued by the European Trade Union Confederation (ETUC) which, during the last European election campaign, proposed to increase government investment by the equivalent of 2% of gross domestic product over a ten-year period, that is to say, by 260 billion euros. According to ETUC’s calculations, this measure, in combination with a real social contract, would make it possible to create 11 million jobs, to eliminate social dumping, and to improve public services and the rights of workers.

According to Denis Durand, “the ECB is afraid of the deflationary danger, but it is not attacking the causes and it has refused to change its policy.”

Jacques-Bénigne Bossuet, the bishop of Meaux, wrote in the 17 century: “God laughs at men who deplore the effects whose causes they cherish.” He must be laughing a lot today.

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