EU Speaks Of Deflation, As Inflation Looms

The European Union’s economy commissioner says that the 16-country region faces deflation if financial reforms are not made in most of the nations in the alliance. According to the AP, Olli Rehn said “it wasn’t enough for Greece and other`deficit countries’ to reduce their budget gaps in coming years and not make reforms to the wider economy — such as opening up the labor market, allowing more competition between companies and training workers for skilled jobs.”

While the analysis may be based on dynamics that can cause deflation, it neglected to look at trends outside the region.

China reported today that its economy grew at 11.9% in the first quarter. While the country reported modest consumer price inflation, the People’s Republic cannot grow at its current rate without a rising demand for crude, iron ore, and soft commodities. China will also need to raise real wages if it allows the yuan to be decoupled from its dollar peg. The demand for oil has already begun to ripple around the world. Crude trades at $85, and OPEC said that it is not likely to change its output soon. It may be eager to take windfall profits from the price increase driven by global demand.

The demand for goods is not only from China. India’s economy and the GDP of  nations in southern Asia are also rising at  rate of nearly 10%. While GDP growth in the US remains modest, mortgage rates and those on Treasuries have begun to move higher as America taps the global capital markets for tens of billion of dollars most weeks to cover rising deficits. Those same capital markets are being crowded by demand for money from nations from Greece to the UK. Corporations have also been tapping what was until recently relatively cheap money.

Europe also faces a higher cost for the goods it imports from Asia and North America. An economic recovery means that the cost of goods and labor will tend to rise, and those expenses will be passed along in the form of higher price.

The IMF has encouraged most developed nations to keep stimulus packages in place to support what has been an anemic recovery. The liquidity that these programs push into the market create capital to buy equities, commodities, and real estate, which in turn could create bubbles within these sectors.

None of the factors in the global capital markets and those due to money put into the market by government trying to salvage their growth rates will cause deflation. On the contrary, inflation is the enemy of economic growth in Europe.

Douglas A. McIntyre