Euros, Deflation, and Greece

This article from The Economist has a great “dead parrot” picture in it… so hit the link.

http://www.economist.com/news/leaders/21627620-deflation-euro-zone-all-too-close-and-extremely-dangerous-worlds-biggest-economic

The euro zone
The world’s biggest economic problem

Deflation in the euro zone is all too close and extremely dangerous
Oct 25th 2014 | From the print edition

THE world economy is not in good shape. The news from America and Britain has been reasonably positive, but Japan’s economy is struggling and China’s growth is now slower than at any time since 2009.
[…]
Now that German growth has stumbled, the euro area is on the verge of tipping into its third recession in six years. Its leaders have squandered two years of respite, granted by the pledge of Mario Draghi, the European Central Bank’s president, to do “whatever it takes” to save the single currency. The French and the Italians have dodged structural reforms, while the Germans have insisted on too much austerity. Prices are falling in eight European countries. The zone’s overall inflation rate has slipped to 0.3% and may well go into outright decline next year. A region that makes up almost a fifth of world output is marching towards stagnation and deflation.
[…]
And, unlike Japan, which has a homogenous, stoic society, the euro area cannot hang together through years of economic sclerosis and falling prices. As debt burdens soar from Italy to Greece, investors will take fright, populist politicians will gain ground, and—sooner rather than later—the euro will collapse.

This parrot has ceased to be

Although many Europeans, especially the Germans, have been brought up to fear inflation, deflation can be still more savage (see article). If people and firms expect prices to fall, they stop spending, and as demand sinks, loan defaults rise. That was what happened in the Great Depression, with especially dire consequences in Germany in the early 1930s.

OK, they hype deflation quite a bit. Don’t get me wrong, deflation has its problems; but frankly I don’t see it as quite the ogre they see. OTOH, I’m glad my house is now “worth” about 9 times what I paid for it and the remaining mortgage is about 1/2 years pay instead of decades… but really, if gasoline costs 5% less and I can buy a hamburger for a dime less and maybe even can get a dishwasher for $20 less, am I really going to be sitting on my spending money?

IMHO, there’s a basic misunderstanding of how real people in the real world do their decision making that permeates Economics and especially Political Economics and decision making. In real deflation, the real injured parties tend to be folks with heavy debt loads; and the folks making big ‘delay the purchase’ decisions are those with a pile of money. In our modern society, not many people have a lot of money and most of the population pretty much spends what it has. A few companies and a few insanely rich people have excess cash, but even there much of it is not in cash, but is in investment vehicles. Yes, deflation is bad. But mostly to bankers and lenders who get more loan defaults and to people in heavy debt situations (the king of which is our own government… not me). But, leaving that aside for another day, we’ll “go with it” that deflation might be a horrible thing and admire Europe a bit more in that context.

But slowing prices and stagnant wages owe more to weak demand in the economy and roughly 45m workers are jobless in the rich OECD countries. Investors are starting to expect lower inflation even in economies, such as America’s, that are growing at reasonable rates. Worse, short-term interest rates are close to zero in many economies, so central banks cannot cut them to boost spending. The only ammunition comes from quantitative easing and other forms of printing money.

Aye, now there’s the rub… It’s the “stagnant wages” and weak demand. Now just how do “they” expect the average Joe and Jane to go out and buy more stuff, making more jobs and profits, if they don’t spend their cash? Can’t have them sitting on their piles of cash, now can we? Better “stimulate” them to go spend it!! /sarc;>

In reality, the average Joe and Jane are NOT sitting on their cash due to anticipation of deflation, or any other reason. They simply do not have it. Why? Because while overall price levels are not inflating, it is bifurcated. WAGES are more stagnant, while what we buy has been going up. We ARE spending our cash, just getting less for it (so less “demand” seen).

This, IMHO, is another example of what I call the failure of “over averaging”. Average together too many things and you hide the answers. Averages are used to hide the noise so you can see the signal, but too much averaging hides both. Averaging wage prices in with consumer prices hides the disparity of growth rates between them into one “deflation” that is really an ‘unemployment due to excess taxation and regulation crisis’.

So take a look at somewhere like Spain. With 40%+ youth unemployment, just how do you expect them to raise demand? And WHY are they unemployed? Think businesses just sit around thinking “maybe we can not hire folks in droves”? No. They look at cost to hire, regulatory environment, costs to fire if things change. Risk / reward. Over regulation, too many laws making hire / fire decisions painful. Too much social tax burden making other places look better. Those things are what kills job demand. Now average that in with rising costs for food, housing, clothes, cars, etc. (often from that same social tax burden) and net you get “deflation with weak demand”. An error of over averaging.

I would propose making two numbers. Income Inflation and Expenditure Inflation (and one could argue for a Manufacturing Inflation) and compare them. The delta between them would tell much much more about what is really happening in the economy than one bland over averaged “inflation / deflation” number that hides all the juicy bits.

The Economist proposes as the only “solution” more of the same medicine that has not worked and will not work as long as the root cause of too much taxation and too little freedom for companies and people remains. Bank Monetary Policy and free run Government Money Fiscal Policy.

If Europe is to stop its economy getting worse, it will have to stop its self-destructive behaviour. The ECB needs to start buying sovereign bonds. Germany’s chancellor, Angela Merkel, should allow France and Italy to slow the pace of their fiscal cuts; in return, those countries should accelerate structural reforms. Germany, which can borrow money at negative real interest rates, could spend more building infrastructure at home.

That would help, but not be enough. It is a bit like the early years of the euro debacle, before Mr Draghi’s whatever-it-takes pledge, when half-solutions only fed the crisis. Something radical is needed. The hitch is that European law bans many textbook solutions, such as ECB purchases of newly issued government bonds. The best legal option is to couple a dramatic increase in infrastructure spending with bond-buying by the ECB. Thus the European Investment Bank could launch a big (say €300 billion, or $383 billion) expansion in investments such as faster cross-border rail links or more integrated electricity grids—and raise the money by issuing bonds, which the ECB could buy in the secondary market. Another possibility would be to redefine the EU’s deficit rules to exclude investment spending, which would allow governments to run bigger deficits, again with the ECB providing a backstop.

Sigh. Yeah, that’s the ticket. /sarc;>

MORE government spending on “infrastructure” will just cause MORE taxes to be taken from the real economy. MORE difficulty hiring new employees to do anything other than that infrastructure project as there’s less left for them. MORE government issued funny money (via printing of whatever indirect kind) just cheapens the money left in the hands of regular folks all that much more. Sure, it will succeed in driving up the prices of what people buy. Sure, it will make the over averaged “deflation” look better as low inflation. NO, it will not get that 20 something in Spain a job and a home and the need to stock it with furniture and domestic goods. He’s still going to be in Mom’s basement with his Nintendo and hanging out with friends at the corner.

Not until all the regular ordinary day to day businesses, NOT just those with special contacts in government for ‘infrastructure’, get the freedom and ability to hire that kid will a job for him or her be forthcoming. It does nothing to make me willing to hire a new waitress if their mandated wage plus tax burden still exceeds their income generation. Repaving the street somewhere doesn’t change that.

That, IMHO, is the reason we have these persistent “stagflation” and now maybe “stagdeflation” episodes. Our rulers think that flushing more printed money out to their friends and cronies will make things better, and they know it will make their friends and donors happy, so that’s what they do. That money is taken from the rest of us, so makes for less ‘buying more’; and a slower economy, not faster. Or the money is just printed and effectively taken from anyone holding cash via dilution of buying power (which, thankfully, is rarely the average person). In the end, the cronies are richer, the politicians are rewarded with “contributions”, and the rest of us just grit our teeth and wait. Repeat until a generation just can’t stand it anymore and something really bad happens…

So what’s the real problem? Well, that would take a book or two to describe.

The short from is that in a truly free economy there is always an equilibrium wage rate for folks to be employed and there is always an adjustment to either inflation or deflation of the currency. It is only when the tax take is too large for businesses to be viable (or for employment of a person to be viable) or when various laws and regulations make it too expensive to have a business or hire more people; that is the time when an economy has structural unemployment and failure of economic growth.

Now we may not LIKE the equilibrium wage rate. When things slow down, it can drop greatly. Sure, you can have everyone employed at $1 / hour, but what good is it? But between the absurd end of that argument curve, and the reality of our USA and European wage and employment taxation process, lies a great gulf. We are presently in the realm where more “benefits” and more “minimum wage hikes” just mean more folks unemployed and fewer with jobs paying any taxes.

There is a real and objective value to the labor they offer, and when the costs to use that labor exceed that value, the job ends. It doesn’t matter if you have that “end” come from being fired, from having the company close down, from replacing the grape pickers with grape harvesting machines, or from having the factories pack up and move to China. The particular way the job is lost is just a linear programming problem for the operations analyst at the company to solve.

Right now we have ever increasing automation of farm work. In the USA there is a holiday dedicated to Caesar Chavez as the founder of the United Farm Workers union as a P.C. Holiday for Hispanics. Never mentioned is the millions he had put out of work via demanding wages in excess of the value provided by that labor. Where there used to be millions of farm workers, there are now machines, or crops that do not need those workers. (Much of it just moved to Mexico where the former migrant farm workers now get about $9 / day instead of the US $9 / hour… but at least they don’t have to drive up to California. Grapes moved to mechanical harvesters. Some orchards changed to mechanical harvesting, while others became pastures. Tomatoes got a very effective mechanical harvester. You can argue that those are better ways anyway, and I’m all for eliminating that ‘stoop labor’, but then again, it was not MY job that ‘went away’…)

It is that kind of thing that causes large, persistent, structural unemployment. Not how much paper the government prints or how much of it they give to Friends Of Government to tear down and build new bridges to nowhere…

In Conclusion

So my take on all this is that the EU, much like Japan, is headed into the same kind of StagFlation, but with higher structural unemployment and much greater political strife. Between the stresses between the countries and the more volatile cultures anyway, it will not be as ‘quiet’ as Japan has been. The banks will keep printing money (once Germany gets backed so far into a corner that they can’t avoid printing more money to loan to Greece) and the regulators will keep on heaping on ever more mandates until the ossification is so bad that the system fails. They are too wedded to their dogmas to do otherwise.

Greece is on the edge of default (again…)
http://money.cnn.com/2015/04/17/investing/greece-default-risk-rising/index.html

so the “more goodies to be handed out” v.s. “not enough jobs paying taxes” vs “not enough German money to suck in” is headed for a wall. Again.

Eventually that bullet can not be dodged and then things start to blow up, and then heal and recover. Until then, as long as the ‘same old same old’ non-working ‘cures’ are applied, the process will just slowly grind into dust.

Here in The USA we are having the same process under the Democrats. With luck we can swap them out for Republicans (or better yet Libertarians) in the next year or so; and hopefully those Republicans can be weaned off their own version of “spend and print”… as opposed to the Democrats “tax and spend and tax and print”… So with gridlock in congress via the last election, we’re doing a little better than the EU on recovery. Now if folks can just learn and generalize from that…

What we really need is a good pruning of regulatory burden and size of government along with taxation level. Toss out about 1/2 of the departments wholesale and all the dead weight burden on the economy that they represent with them. I know that will never happen. Only revolutions do that kind of thing (which is likely why they happen with such regularity…) and they often do not end well, so are generally to be avoided. While I might hope for a “good pruning”, I suspect that ‘stagflation’ is on the cards for us, perhaps even ‘hyperstagflation’ given the rate at which worthless paper is being used to fund a huge Central Authority Bloat Machine.

Oh Well.

Maybe, if we’re really lucky, the EU can collapse first and the USA can learn from it and avoid that fate… Or maybe I’m just getting a bit of ‘contact’ from the neighbors smoke… ;sarc/>

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