The Global Deflation Crisis
The most popular and frightening topic in the global financial atmosphere is the dull prospect of long term looming deflation. To the common consumer, deflation is a great occurrence. Prices for non-durable and durable tangible goods as well as intangibles fall making their purchasing power parity greater. This should increase consumption and spur growth. However, this has not been the case throughout the world. Deflation leads to a lack of investment resulting in low and stagnant growth over the long term. What incentive does one have to invest now, when their dollar will be worth more tomorrow?
The Federal Reserve has successfully guided the U.S. economy upward past the Great Recession of 2008 with excessive bond purchases and low interest rates. Many naysayers have feared of inflationary risks due to a rapidly expanding Fed balance sheet. In reality, we are facing the opposite risk as disinflation has taken hold and the Fed is running out of monetary tools to change this. Risk Assessment
But the real problem is occurring elsewhere, since U.S. GDP growth has been steady in the range of 2-3% over the last two years. We have seen many countries of late attempt to devalue their currencies in order to boost exports. This should result in more domestic business growth creating more jobs with higher pay. Rising import costs leads to higher input prices for domestic companies eroding their margins. The gap will be filled through increasing prices for consumers, ending deflationary threats and contributing to inflation. Once inflation becomes controllably range bound, interest rates can be normalized and growth can be more predictable and stable. This describes the optimal situation, however this is not occurring in two specific areas, The Eurozone and Japan.
Japan has been rapidly buying bonds over the course of PM Shinzo Abe’s tenure along with having an extremely low 10 year bond rate. This devaluing of the yen has not had the expected results the Bank of Japan had in mind. Consumer prices have been stagnant and GDP has been negative over the last few quarters. Although the infamous Abenomics policies have not paid off, securing a mandate with the people allows him the power to continue manipulation of the yen to eventually get their desired results.
The Eurozone deflationary problem is more pessimistic. Practices of austerity along with low and dropping consumer prices has led to continually stagnant GDP growth. Germany and its Chancellor Angela Merkel focus on fiscal conservative measures where spending is tight. This is the main problem in the area. To grow, investments must be made throughout the area. Investments will create jobs, increase wages, and increase demand leading to higher prices and a solution to GDP stagnancy. Forcing Italy, France, and Greece to practice austerity with a large oversight will hamper Mario Draghi’s goals of increasing inflation by buying bonds, which is a difficult task to do given the nature of the customs union. The Eurozone still has a chance, but Angela Merkel needs to loosen the reins on austerity.