EMU Inflation Stabilizes at 2.4%- but the Devil is in the Details

EMU inflation posted a Yr/Yr rate of 2.4% for the third month in a row. And while that is above the ECBs target/cap of 2% the core rate (ex food and energy) has been below 2% (1.9% to 1.8% on a yr/yr basis) since January of this year. The ECB purports to not target the core but when oil prices are gyrating, the core is probably a better guide to reality.

Inflation Trends are Lower

The graph shows that yr/yr inflation is on a down swing over most countries. Even Italy with a more stubborn and higher rate seems to show inflation losing momentum. Only Germany, Greece and Ireland of the original EMU members have inflation at or below 2% over the past year.

Small Group of Achievers

Since EMU was formed only Germany, Austria and France have kept this headline rate averaging below 2%; Finland is close at 2.02%.

Still, the Zone has had a Positive Influence... but with Negative Impact

Inflation in Greece has averaged one percentage point more than the EMU ceiling rate at 3.07%. Compared to pre-EMU Greek inflation that is quite an achievement. But compound that difference with Germany over the life of EMU and Greece’s price level is up some 25.6% more than Germany’s over this period when their currency ‘rates’ have been locked together (same currency). The table allows for other such comparisons as well. And that gap is a big problem; is THE big problem.

THE Single Currency's Single Conundrum'

When people talk about ‘solving’ the Euro Zone’s problems I think of this table. Some think of reducing deficits (fiscal and current account) across countries and how to trim national budgets or what taxes to hike as the Zone’s BIG issues. And while budgets need to be controlled and deficits reigned in, my point has always been that if you could WAVE A MAGIC WAND and solve all those problems THIS ONE problem of uneven competitiveness would remain. And this one would be the undoing of the Zone because competiveness differences like this would foster new persistent trade and fiscal surpluses and deficits among Zone members. Having some completely uncompetitive members within the Zone is a death sentence for the Zone.

What to Fix:

My view of the eurozone crisis is that fixing competiveness comes first in any truly workable plan. In a rather long report yesterday I wrote about the state of EMU and how symptoms can become problems. And certainly you must put out the fire before you rebuild the burned down home. But if you do not fix the gas leak that caused the fire, rebuilding is folly. Europe is on the brink of folly.

Who to Blame

I understand that markets require that banks be shored up and that deficits be fixed and fiscal policy put on firm footing. But none of that is really done unless a nation rationalizes its competitiveness position and this is the one thing that the Zone has truly failed at. Failing to have a solid fiscal backstop by letting the Maastricht criterion become violated contributed to competitiveness erosion. And this was no stealth operation. Each month EMU members report their inflation numbers IN THE FULL LIGHT OF DAY and there is no excuse for members not to have seen the steady competiveness erosion that was underway. Indeed, the strong countries financed the excessive expansion in the high inflation weaker countries.

Mass-Trick

Not only did Germany and France balk and undermine the Maastricht rule (or as I prefer the Mass-trick rule) when they violated it, but they were silent as huge areas of the Zone became uncompetitive in a steady month-by-month slog of too-high inflation. I suspect that the low inflation countries felt this was good for them as they were gaining competitiveness. In that respect no one seems to have realized how much everyone in the Zone was really bound together and would share the same fate. It’s as though they were all in one big boat the Germans said ‘Don’t worry, the hole is on the Greek side of the ship.’Ignoring this erosion really did not make any sense.

How are they doing?

So now we can look at the numbers… Italy, Portugal, and the Netherlands are the high inflation countries based on yr/yr inflation. Portugal and Italy are countries undergoing austerity and yet their competiveness problems are getting worse. Portugal is already the fourth worst and Italy the sixth worst in terms of lost competitiveness based on the HICP ranking.

So how is it that austerity is making things better? I don’t see it.

The Always Silent Conundrum

The one conundrum that is never discussed in how to fix the competitiveness breach that the EMU formation has created. Germans blame the high inflation countries for having run high inflation. But it was Germany and France that busted the Maastricht mechanism that might have corralled budget deficits in Southern Europe and that might have short circuited their impact on inflation. On top of that, German banks financed Greek excess.

The Path to Zone Survival

EMU needs to have a pointed discussion about how countries that are uncompetitive will be able to survive if they remain in the Zone and have to work out their competiveness issues without the help of currency depreciation. Having Germany say that everyone must do what they agreed to sounds good. But that was a better option on Day-One than it is now with all the excesses that have been allowed to develop and to fester. And all that was done in the full light of day. This situation smacks of communitywide guilt.

If the e-Zone cannot bring itself to deal with this problem in a very public forum it has no hope of enduring.

Inflation/Price Increases Since Formation of the EURO Diagnostic: Core Total HICP 1yr
Jul'12 Since
1999 Diff from
EMU Rate SAAR
Avg Rate Rank Diff w/
Germany Diff w/
Germany Austria 2.1% 30.4% -2.0% 1.97% 111 5.2% 8.6% Belgium 2.1% 34.0% 1.6% 2.18% 8 8.8% 7.8% Finland 3.1% 31.3% -1.1% 2.02% 10 6.1% 8.9% France 2.3% 28.6% -3.7% 1.87% 12 3.5% 6.2% Germany 1.9% 25.2% -7.2% 1.67% 13 0.0% 0.0% Greece 0.9% 50.8% 18.4% 3.07% 1 26.6% 25.7% Ireland 2.0% 37.5% 5.1% 2.37% 5 12.3% 15.1% Italy 3.7% 37.0% 4.6% 2.35% 6 11.8% 15.6% Luxembourg 2.7% 45.9% 13.5% 2.82% 2 20.7% 22.5% The Netherlands 2.6% 35.0% 2.6% 2.23% 7 9.8% 11.8% Portugal 2.8% 40.4% 8.0% 2.53% 4 15.2% 18.0% Spain 2.2% 45.6% 13.2% 2.80% 3 20.4% 20.1% EMU Total 2.4% 32.4% 0.0% 2.09% 9 7.2% 8.6% Median (group) 2.2% 36.0% 3.6% 2.3% -- 10.8% 13.5% UK (EU) 2.6% 33.5% 1.2% 2.15% -- 8.3% -- US 1.4% 38.9% 6.5% 2.45% -- 13.7% --