Deflation: When falling prices are bad

February 11, 2015

 

john anderson

John Anderson

If you were at the San Joaquin Hispanic Chamber’s Business Forecast breakfast, you heard the Bank of the West’s Chief Economist Scott Anderson  mention the word deflation. He said that while the economy is slowly but steadily improving in the United States, a black cloud is forming over Europe.

The fear is that Europe’s economy is on the brink of a deflationary spiral that could linger as long as 10 years. Economists say it gravely threatens the decade-long growing standards of living.

In January, prices in the eurozone were down 0.6 percent from January 2013, according to the BBC. Energy prices dropped 8.9 percent in January. The last time Europe saw prices drop like this was in July 2009 during the recession.

Last October the managing director of the International Monetary Fund (IMF), Christine Lagarde, pointedly warned that the eurozone could fall back into recession if action was not taken to prevent it.

In mid-January, the European Central Bank finally launched a big program of quantitative easing (QE), creating money to buy financial assets, in order to fight the eurozone’s slide toward deflation. The fear is that it won’t be enough to repair the damaged eurozone economy. The plan to create more growth will not be achieved by writing checks.

As we said, at the heart of Europe’s problems is deflation, a general drop in the price of goods and services. While many of us who lived through the ‘70s have been brought up to fear inflation, deflation in some ways is even worse for the economy.

Deflation means the euro is devalued. In fact, compared to the British pound, one euro is worth just around £0.80, which creates a worry for the European Central Bank, European Commission and the European Parliament which legislates the 18 eurozone nations.

Deflation is occurring in Europe because eurozone economies are crashing, particularly in Greece and Cyprus. The euro is not sustainable as a combined currency. The idea of connecting the European currencies in order to build security and limit currency fluctuations started after World War II, continued through the ‘70s and finally, Europe is seeing the  result.

America, on the other hand, has regained substantial economic milestones after suffering near financial disaster.

  • A rally in 2015 would mark the seventh consecutive year of gains for the S&P 500, which would be a first.
  • Since 1928, the S&P 500 has only rallied more than that twice (eight years from 1982 – 1989 and nine years from 1991-1999).
  • It’s estimated and expected that 2015 will produce earnings growth of 10 percent.

Here are expectations for 2.15:

U.S.: +3.2 percent economic growth

China: +6.8 percent focusing on quality of growth

Euro Zone: +1.2 percent slow recovery continuing

Japan: +1.2 percent (with economic policy failing?)
Global growth is expected to accelerate to 3.8 percent in 2015 from 3.3 percent in 2014.

After considering policies and economic forecasts, coupled with growing reality that “we are all in this together,” it appears United States has a green arrow pointing upward while other countries will continue struggling to right there economies for many, many years.

 

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