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Economy in Brief

EMU Inflation Trend Seems to Peak But It’s Still Over-Heated
by Robert Brusca  September 13, 2011

Divergent forces tear at the Zone - Weaker oil prices should help salve the over-the-top EMU inflation picture. But the 12% drop in the Euro’s foreign exchange value Vs the dollar form December is not going to help much at all. The ongoing debt crisis is likely to keep the euro on the ropes, but then again the concern this raises and the impact that will have on growth expectations should also help to keep oil prices at bay. That’s a pretty a tarnished silver lining, I’ll admit, but there it is.

Headline news... The debt crisis in Europe is clearly getting all the headlines and it is about all that anyone is interested in right now. Will some new investors really bail out Italy? Well today’s auctions were not very helpful in that regard, were they? The talk of Chinese support has been there but talk is cheap, unless of course you are Italian. Then it is getting more expensive by the day.

Trichet and other pressures - Trichet is under some pressure to reverse his previous tightening but he does not want to do such a thing with inflation still over the top in so many countries and in the Zone as a whole. The EU is being urged to bolster the ESFS further. But why bolster a safety net unless you really want to support someone who is doing still outrageous stuff and is still at risk of falling into it?

Skin in the game - The more that Europe takes steps and commits resources to give Greece and other troubled financial countries support, they more that it becomes hostage to the problems of those countries. Is that where Europe wants to go? Is it time for unrestricted support or time for tough love? Only the Germans seem to have taken a clear stand on this issue. But they continue to be dragged to do more by the rest of the Community that really has not made a clear choice.

Channeling Groucho too late? Maybe the EMU should have used the Groucho Marx standard when thinking about admitting Greece to the union (I don’t care to join any club that would have me as a member...). Did Europe really want to belong to a club that had Greece as a member? Arguably admitting Greece was the real failure. Making it wait such a pitifully short time before it was allowed to join was only an insult to Greece and not time enough for it make any real changes. Greece never acted like a full member of the Community. Its inflation rate was always one of the highest in the Community yet nothing was done to pull Greece back into the fold. La ti da, let them go. As Greece drifted farther and farther from what was price stability in the Zone that drift and its consequences were ignored. Since the Greek finances were OK (wink, wink) no one took this important inflation divergence as a meaningful signal. Greece’s fiscal shenanigans may have been less transparent but the Greek inflation rate, a very public sign of its troubles each month, was simply ignored. Spain and Portugal gave off similar discordant inflation signals as did Italy to some extent. But German, French and other banks continued to lend to Greece and to the others. There was no attempt to head off what was a clear rogue pattern I have been writing about excessive Greek (Spanish and Portuguese..etc) inflation in the Zone for at least five years. No one would listen.

Metrics of naughty and nice - Inflation has been one true and public metric of who has been naughty and who has been nice in the Zone. Still, a country like Germany with stellar inflation performance has a high debt to GDP ratio. Germany still suffers from the effort of integrating East Germany with West Germany.

Which model: Soup or the Bento box? - While the Euro-Area has turned into a spitting contest of sorts there are no innocents here; the whole of the Zone was at fault. Were the Germans simply happy to see that excessive Greek inflation because it meant Germany was going to gain competitiveness and could export profitably to Greece forever? Germany was glad to sell to Greece its old refurbished submarines, too, worsening Greece’s fiscal problems. And so on. There is very little evidence that EMU members ever gave a thought to the fact they were all in the same soup together and that the broth would circulate. They have treated the Zone more like it was a Japanese lunch box (bento box) where everything stays in its separate places. The Germans seemed to assume that with the euro mimicking the old deutschemark everyone in EMU would soon act as Germans do. This was an act of total Teutonic fantasy.

Asking the first question last? (Will you marry me?/Do you love me?) - We have ample evidence of how much Germans will suffer to integrate with someone like themselves as the East-West German reunion shows. But when it comes to integrating with folks that have different values, then what? Since that question which should have been the first question was not asked at the start, Europe is being forced to ask it now. And now it remains just as pressing question as ever, but it comes with more baggage and more clear-cut cost.

NOT the road to Morocco - We cannot say that the crisis and focus on austerity is forcing the ‘rogue’ members of EMU to act more like Germans but in Greece and in Ireland weak domestic conditions have dropped those countries’ near term and 12-montt rates of inflation below that of price conscious Germany. While Spain and Portugal have prices falling over three-months, a weaker performance than in Germany, their 12-month inflation still exceeds Germany’s 12-month inflation. Italy’s 3-mo month inflation trend finds prices falling and its 12-month pace is below that of Germany as well. So yes, we can conclude that austerity is pushing some of the rogue EMU states in the right direction. But the pace of adjustment is so slow and the distance to go is so great, and the pain of this process is so intense, that it is almost certain that this is not the road to price-level convergence.

A bridge-loan too far? Austerity does begin to bring some things into line. But there is so far to go. Since EMU was formed and since Greece was brought into EMU at what was deemed to be the ‘right’ level or at ‘parity’ Greece’s price level has risen by 22.5% above the price level in Germany and the Community said nothing about it until Greece’s financial shenanigans were revealed. Spain’s price level has been lifted 18% above that in Germany since the start of EMU when currency rates were welded forever together. Portuguese prices have drifted 13% above German prices and in Ireland the drift has been 11% higher. Italy has given up 9.3% to Germany as its price level has risen by relatively more since it joined. Belgium has dropped 8.7% in competiveness too. All these are metrics of countries that have lost competitiveness to Germany. Austria, Finland and France are in the neighborhood of having lost about 5% or less. They have stuck closer to the German performance.

When the force of competition turns to a farce of competition - This sort of monthly score-card, offered up by monthly inflation readings, has been ignored for too long. When a country is locked in a currency area with another and its price level drifts badly the message is that such a country is not well-integrated with the rest of the area. That may mean that Greece and Germany are not rivals in many industries so competitive forces simply are not at work. It may mean that other structural issues are at work that impede the existing, not the absent, forces of competition. If that is true the job of running a single monetary policy is much riskier.

Stuck between ‘not enough’ and ‘too much’- As I see it, the whole of the Zone is at fault for letting this situation develop and linger. But that diagnosis does not help. I’m very concerned about the effects of these extreme differences in prices that have developed within the Zone; they are quite a bit worse than what has developed among regions in the US over this same period. They signal that a schism exists in the Zone. It is not one region. It is not easily managed with one monetary policy. It is hard to put something back together when the edges no longer match up, as they no longer do in the Zone. This is the challenge for the Zone, its institutions and its members. Beyond that there is the question of the will to do the things at the regional levels to make up for the Zone’s imperfect set up in which monetary policy works differently in different regions. Fiscal policy not only needs to be disciplined (as it has not been in the past!) but it may need to be adjusted region by region to keep the union on an even keel. Simply blending finances together (the Euro-Zone bond) may not be enough even though at the moment is seems to be too much.

EMU early Inflation reporters
  Monthly Annualized Annualized
  Aug-11 Jul-11 Jun-11 3Mo 6Mo 12-Mo
Belgium -2.1% 4.3% 5.4% 2.5% 2.3% 3.4%
Germany 1.1% 3.3% -1.1% 1.1% 1.8% 2.4%
Italy 3.2% -8.1% 2.1% -1.1% 1.6% 2.2%
Luxembourg 8.0% -0.9% -3.1% 1.2% 1.6% 3.6%
The Netherlands 1.4% 6.7% 1.2% 3.1% 3.1% 2.8%
Portugal -0.4% 1.8% -3.4% -0.7% 1.2% 2.8%
Spain -1.5% -5.2% -4.0% -3.6% 1.5% 2.7%
Ireland -1.1% 2.3% -3.3% -0.7% -0.2% 1.0%
Greece -3.9% -5.8% 4.0% -2.0% 0.8% 1.3%
  3M-6M 6M-12M 12M-12MAgo
5 Decelerating 63.6% 72.7% 9.1%
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