Recent Updates

  • US: New Residential Sales, Final Building Permits (May)
  • Israel: LFS, Vacancy Rate (May); Turkey: Capacity Utilization (Jun); South Africa: Domestic Bond Holdings, Liquidations & Insolvencies (May); Algeria: CPI (May)
  • Cambodia: GDP (2017); China: Banking Assets and Liabilities, Central Government Operations (May), Central Government Debt (Q1); Taiwan: Visitor Arrivals, IP, Shipments and Inventories, Wholesale and Retail Sales (May); Vietnam: Motor Vehicle Sales (May); Singapore: CPI (May); Indonesia:
  • more updates...

Economy in Brief

EMU Inflation Brakes For Crisis...Except For Italy
by Robert Brusca  November 16, 2011

Inflation is a many-headed beast and that is on reason it is hard to fight. Economists are taught that inflation is always and everywhere a monetary phenomenon. But in the real world there are so many distractions and then are long lags, those erratic and variable lags, from money growth to price (inflation) results. In the end it is just all so confusing, to markets to politician and even to central bankers themselves with different notions of theory tucked safely where no one will see them and sometimes for central banks with a schizophrenic mandate (better known as a dual mandate).

Making inflation harder to deal with are the various ways of measuring it. Not just different measures of inflation: headline or core ? Or CPI, GDP deflator, or other?). But also there are questions of which tenor is best? Typically central banks seem to look at Yr/Yr rates of inflation but we know they look at price behavior over shorter spans.

In the end inflation which seems to be about the behavior of the price level goes from a simple concept in theory to a more complicated one in real life. And of course the most important measure is the one we can’t see and that is inflation expectations and what inflation will come to be over the next 12-months.

The Medusa effect
With that somewhat lengthy preamble on something you thought you knew so well, let’s turn to Europe where the number of inflation tentacles makes medusa herself appear nearly bald.

Each Euro-state reports is own inflation rate but the ECB looks at just one (wink, wink) to make policy. It looks at the headline HICP (genuflect, please). Its like each state gets to bake brownies but each has to use the same recipe as the method for inflation calculation has been harmonized. Even so with one currency and on recipe, inflation rates across the Zone are quite different. Some can take the scant material from the ECB and make a very large brownie while others manage a real consistency.

While Germany is still sporting relative high inflation overall (headline at 2.9% over 12-mos) it’s core rate has been stabilized in the range of 1.7% to 1.3% from 12-months to 6-months to 3-months. Italy, existing in the same currency area with the same central bank and the same (??) competitive forces has seen core inflation has zoomed from 2.9% over 12-months to 9.3% over 3-months must be some ‘special’ ingredient in the brownie mix...

Our table shows the cumulative results of price level changes since the EMU was launched. The table is for headline inflation but the final column gives the results for core inflation compared to Germany.

Columns six and seven in the table (the two right-most) are the reason for insistence that the Zone ought to just pack it in and call it a day. Austerity is starting to suppress inflation in the high inflation troubled borrower countries (see chart below). But they have such a long way to go.

Those who say that competiveness in the uncompetitive countries can be achieved by internal braking (instead of by adopting their own currency) and by using ‘internal devaluation’ should be candidates along-side Putin for the not-yet-announced Chinese prize in Economics to go along with its new Peace Prize (made-in-China from a pirated design constructed by child laborers).

This new term which I have never before encountered is a real economic curiosity. It’s the sort of thing you say when you want to be both truthful and obfuscatory. Upon ‘Googling’ this term I was pleased to find results.

Wikipedia offers this (hilarious) definition:
Internal devaluation
is an economic and social policy option whose aim is to restore the international competitiveness of some country mainly by reducing its labour costs - either wages or the indirect costs of employers. Sometimes internal devaluation is considered as alternative to 'standard' external devaluation, although social implications and speed of economic recovery can significantly differ between the two options.

Internal devaluation was first considered during the Sweden economic crisis during the 1990s and Finland's accession to the European Union in 1995. Internal devaluation gained popularity during the economic recession of 2008-2010 when several countries pursued such policies with aim to restore competitiveness and to balance national budgets. While internal devaluation is discussed by several publications in the magazines The Economist and The Wall Street Journal, generally there is lack of peer-reviewed research and that is why the widely discussed eventual success of internal devaluation can be partially considered as urban legend. Source: Internal devaluation

In fact ‘internal devaluation’; is nothing more than the policy of deflation. Isn’t that easier to say than all that? Given a much less evil-sounding name ‘internal devaluation’ has its merits. Deflation has been strangling Japan. In the US Fed Chairman Bernanke is doing all that he can, save pulling out the hairs of his beard, to stop it. But for Europe this is now the viable strategy? Good luck with that.

What our data in the table tell us is how far deflation (yeah, call it what it is!) will have to go to do the job. Using core inflation, the table identifies SIX EMU members that have a very steep hill to climb to get back to where they started in terms of Zone competitiveness. They would have to run policies that were deflationary relative to Germany (on the order of 2 pct points less inflation per year than Germany) for 7 years or more (for some that figure balloons to 15-years) to regain the competitive ground lost to Germany since EMU was formed.

This is a bridge to far, a load too heavy, call it what you will. Why would Europe- why IS Europe?- jumping through all these rings of fire for a task it cannot hope to achieve? I don’t for one minute think Greece is up to 15-years of running an inflation rate two percentage points below Germany’s. DO YOU? Who does? All the focus on EFSF, the ECB buying bonds to support Italy where inflation is poking its head far above the Euro-average suggests to me that folly is in full swing.

Let me make on added point and that is that the countries of Northern Europe (Germany and friends) are not –NOT- going to reflate to make the task easier for those in the South. This is the clear message in Germany’s restricting the use of the ECB balance sheet and in opposing most ways of ballooning the EFSF. Germany can see that this is just more rope off a ledge that is still too high. If Greece and others want to run the gauntlet so be it and Germans will cheer for them. They will not finance rest stops. Lest you think Germany is too cruel it is already tolerating more inflation than it would like and it has put up with its own arduous and debt ridden process of integrating East and West Germany. It is only asking EMU members who strayed to do what Germany itself did. Of course, Germany build something with its debt and the troubled EMU countries mostly have fritted it away in excess consumption, much like the US is now doing. They long for the day’s gone by of excess consumption and do not want to tolerate ordinary sustainable amounts of consumption that might have been sustainable and affordable. But to get back on track they will have to make do with even less consumption because they have debt and they have catch-up to do. That is austerity. It will require DEFLATION.

I can appreciate Europe wanting to make its grand experience a success. But it was an experiment and it has not succeeded. The Zone as constructed cannot survive. The members who would need to bite the bullet the hardest are the ones who have shown no taste for doing it. The numbers are compelling. Forget about how to raise money in the short term to plug a hole that isn’t going to get any smaller. The ECB is not like the little Dutch Boy. There are holes all over this dike and they are getting bigger fast. You need to evacuate people to higher ground take the losses and rebuild.

Interestingly the ECB has kept its eye on just the one ball (headline HICP) in the air which it nicely kept in its range according to its mandate. Had it instead looked at the many balls (Spain, Italy, Greece etc) that accompanied it, there might have been a different result. In early EMU though there were distractions. The bickering about rules. France and Germany were caught in the Mass-Trick violation and wiggled out, setting a precedent for everyone else. Germany was preoccupied with uniting Germany in the early EMU period. Getting used to the new system and each county making sure it had enough turf while expanding the Zone before it was known to be viable was real boo-boo. In retrospect it was real circus. It is surprising that so many countries have been able to hang with Germany but essentially that was the test. Some passed, some failed.

Maybe a new euro experiment can be a success someday; but not this day. Not this one. Inflation tells a tale ever more clearly than the complexity of debt metrics ever could. This zone is dead.

The dead zone.

Inflation/Price Increases Since Formation of the EURO
  1yr Since Diff from SAAR   Diagnostic:
Difference
Core:
Difference
Total HICP Oct-11 1999 EMU Rate Avg Rate Rank w/Germany w/Germany
Austria 3.8% 28.1% -1.8% 2.03% 10 4.9% 7.8%
Belgium 3.4% 31.9% 2.0% 2.28% 7 8.7% 8.0%
Finland 3.2% 26.8% -3.1% 1.92% 11 3.6% 6.4%
France 2.6% 26.3% -3.6% 1.91% 12 3.1% 5.2%
Germany 2.9% 23.2% -6.7% 1.68% 13 0.0% 0.0%
Greece 2.9% 50.6% 20.6% 3.36% 1 27.3% 27.4%
Ireland 1.5% 33.9% 4.0% 2.32% 6 10.7% 13.5%
Italy 3.8% 34.1% 4.2% 2.39% 5 10.9% 14.9%
Luxembourg 3.8% 40.8% 10.9% 2.82% 3 17.6% 19.3%
The Netherlands 2.8% 30.9% 0.9% 2.18% 8 7.7% 9.0%
Portugal 4.1% 37.7% 7.8% 2.61% 4 14.5% 16.8%
Spain 3.0% 42.4% 12.5% 2.88% 2 19.2% 19.0%
EMU Total 3.0% 29.9% 0.0% 2.13% 9 6.7% 8.0%
UK (EU) 5.0% 31.5% 1.6% 2.27%   8.3%  
US 3.6% 36.6% 6.7% 2.51%   13.4%  
close
large image