Concerns are growing that the eurozone economy is hurtling towards a deflationary spiral, a lost decade even, not too dissimilar to that which has plagued Japan -- although realistically, Japan is coming into its third lost decade.
Current metrics in the Eurozone are not good. Inflation in Europe is barely positive at 0.4 per cent annually. Growth isn’t much better at 0.8 per cent year-on-year. Yet as high as this anxiety might be, the likelihood of Europe becoming the new Japan is low. Japan’s problems are unique, with little to no chance of resolution (Why Japan will never recover, November 14). Importantly, Japan’s problems are not replicated in Europe.
Europe’s problems are tiny in contrast to Japan’s, comparatively at least. Indeed it’s not well understood that Europe has some of the best stability metrics in the developed world. I know this sounds odd having just come out of the European debt crisis, but it’s true. Concerns over European debt issues -- even Italy and Spain -- were always an absurdity, especially when compared to the position of Japan and even the US and Britain, which were so much worse. These fears proved to be an irrational bout of panic, pure and simple. Only tiny Greece had any genuine issues over solvency. Yet somehow that tiny problem morphed into a panic over the viability of the European Union itself! Utter madness, and yet it happened.
While all this attention was given to Europe’s supposed debt problems, Japan’s were -- and are -- far more real and serious. Total debt (private and public sector) was around 460 per cent of GDP on 2012 figures. That might be closer to 480 per cent now.
In contrast, Europe has a much more respectable debt position of 178 per cent of GDP -- that’s total public and private debt. There is, quite simply, no contest. Europe is not Japan, for the simple reason that unlike Japan, Europe can afford to pay off its debt. Japan in contrast has no reasonable hope of ever paying off its debt burden, especially with a shrinking economy and a shrinking population.
Consider that the euro area as a region runs smaller budget deficits that the rest of the advanced world, and in contrast to many other developed nations runs a current account surplus. This is an important fact. What it means is that Europe is effectively a lender to the rest of the world. It’s fair to say that Japan also runs a current account surplus, but let’s not beat around the bush: Japan’s biggest export is the money the Bank of Japan prints. It prints the money and then lends it out to the rest of the world. With much smaller deficits, much lower net debt and that current account surplus, Europe need only redirect some of the money that it lends abroad toward its own region. That is, if they were overly concerned about growth. But growth isn’t everything, as they say.
So, what about the scourge of deflation? Well there are a few things we need to remember here. Firstly and most importantly, concerns about deflation are unfounded. Deflation is impossible under a fiat currency system, unless policymakers want it. The former Federal Reserve chair, ‘helicopter’ Ben Bernanke, made that amply clear when he noted that authorities only need throw money out of a helicopter if they are concerned about deflation. It would be less dramatic in reality -- citizens would just wake up to however many thousands the central bank decided to print into existence and deposit in household accounts. Alternatively, the government could go on a spending splurge, funded by the central bank. Either way, inflation would very quickly be the result.
That Japan never actually did this is because inflation is the last thing they wanted. The country is running a massive budget deficit, and that has to be funded. It doesn’t pay to try a fund a deficit that size with interest rates spiking higher because of a lift in inflation. The only time to use inflation as a means of running down debt (as a percentage of GDP), is when the budget deficit is already firmly under control. While Europe’s budget deficits are substantially smaller than Japan’s, I don’t think they’d be too keen to see inflation spike either. QE, the ways it’s conducted now, instead channels money to banks, who then buy government debt. It’s better thought of as a funding arrangement rather than a tool to lift inflation or growth.
So, if a central bank is concerned about deflation, the last thing that would actually work would be quantitative easing. Just ask Japan. The ECB may well print money and conduct their own QE, but if it goes ahead it will have nothing to do with deflation fears or concerns over growth, regardless of the official rhetoric.
In any case, recent low inflation outcomes in Europe have more to do with prior exchange rate appreciation and the slump in commodity prices. There is little evidence of genuine deflationary pressure. On the flipside, and even if Europe were running budget surpluses, there would be no reason to inflate debt away either. As discussed above, the problem isn’t big enough.
Against that backdrop, any decision to print would be nothing other than other an opportunistic bid to monetise some debt and weaken the currency, because they can. That’s very different to Japan’s decision, which reflects the desperate act of an insolvent state.