Deflation takes hold in Europe as policymakers remain in Denial

Economic growth


EU China CPI Feb15One by one, the Western economies are falling into deflation.  The Eurozone began the process, with deflation of -0.2% in December followed by -0.6% in January, as the chart shows (blue line).

Similarly Germany, Europe’s largest economy, moved into deflation in January, just 2 weeks after the deputy finance minister, Steffen Kampeter, told CNBC there was no risk of a “deflationary spiral”.

This highlights the sense of Denial that prevails amongst most policymakers today.  They refuse to accept that ageing populations create major headwinds for economic growth, despite official data clearly showing there are now:

  • More older households headed bythe over-50s than younger ones, and that
  • As a result, average household spending is now in steady decline in inflation-adjusted terms

This matters because consumer spending is at least 60% of GDP in most economies.  So less household spending must mean lower GDP growth.

The problem is that policymakers have spent the past 15 years claiming they could somehow overcome these powerful demographic forces.  Thus the future Chairman of the US Federal Reserve, Ben Bernanke, authored a key paper in November 2002 titled “Deflation: making sure “It” doesn’t happen here“.

Well, time will tell.  But it looks very likely that falling oil prices will take the US into deflation sooner rather than later, as Thursday’s announcement of January inflation will no doubt confirm.

But worryingly, as the German example highlights, policymakers are not prepared to accept reality.  Instead, they have begun semantic arguments about “good deflation” and “bad deflation”.   But as the BBC’s economics correspondent Robert Peston notes:

The Bank of England expects inflation to be zero or very close to zero for most of this year, starting in March.  And it says there is a greater than evens chance that it will turn negative, that prices will fall, for much of this period.  But the governor, Mark Carney, insists in his letter to the chancellor that this is not deflation.

“This is what he says: “The UK is not experiencing ‘deflation’: excluding food and energy, 68% of the underlying categories of the CPI are showing positive inflation, close to the 1997-2007 average of 67%”. 

“But it is quite a big thing to exclude oil, energy and food – where price falls have been significant and sustained. And those falls are in part linked to the weakness of the global economy.

The red line in the chart above confirms Peston’s point, and shows how China is now exporting deflation.  Companies around the world have vastly expanded capacity over the past 10 years, believing China’s demand would inevitably grow forever.  But now its property bubble is deflating as the ‘wealth effect’ comes to an end.

Too much supply and too little demand creates deflation.  Thus its producer price index fell to -4.3% in January from -3.3% in December.  In turn, China’s slowing demand has led to the collapse of oil and commodity prices since August.

And if policymakers don’t soon start to accept reality, we risk ending up instead with the worst of all possible worlds – deflation plus ever-rising levels of unrepayable debt.


My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 60%. “market remains in a firm contango, with sentiment for March and April decidedly more positive”
Brent crude oil, down 42%
PTA China, down 42%. Market closed for Lunar New Year
Naphtha Europe, down 40%. “Sentiment has been given a further boost by good pre-holiday buying from Asia”
¥:$, down 16%
HDPE US export, down 27%. “Domestic export prices continued to soften on lower ethylene prices and sagging demand”
S&P 500 stock market index, up 8%


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