Stagnation with deflation: The crisis – Stage ten

[Oscar Ugarteche/Ariel Noyola Rodríguez, January 2014] Everything appears to indicate that stage ten of the crisis that began in August of 2007 has arrived in force; a crisis that has involved multiple bank failures and massive budgetary costs in the United States. This has been followed by serious adjustments in consumption that have resulted in an impact on the growth of the Eurozone economy as well as that of the United Kingdom. The injection of liquidity by the central bank in order to avoid deflation led to an increase in prices in commodity markets and gave rise to a two-speed crisis: prices frozen and prices that grew because of highly priced exports.

The programmes of monetary stimulus of the Federal Reserve and of the Bank of England since 2009, the European Central Bank since 2012 and the Bank of Japan since 2013, all resulted in greater leverage for investment banks and with this, led to speculative betting in variable income markets (commodities, stocks, exchange rates and real estate). This explains why the recovery of stock markets has not resulted anywhere in the recovery of the labour market. What happened was the artificial maintenance of slightly increasing price levels in a context of reduced levels of consumption in mature economies.

The decision of Ben Bernanke to end the Federal Reserve programme in May of 2013 made clear the fragility of global economic recovery and revealed US unilateralism in decisions made for the benefit of the US without consideration of the impact on the rest of the world.  In her presentation to the National Press Club in Washington in mid-January of this year, Christine Lagarde, head of the International Monetary Fund, became the first world authority to warn of “the risks of deflation” in “mature economies”. This is true of the United States but especially for the Eurozone, with an inter-annual inflation rate of 0.80% in December of 2013, below the objective of 2% fixed by the European Central Bank, so that official data indicate deflation for practically half of Europe as of May [2014]. Japan is barely emerging from their long term deflation that dates from the 1990s.

With the probability of reduced prices in the future, present patterns of consumption are contracting, with a negative multiplier impact on aggregate demand. Investment is reduced and banks are reluctant to grant loans. On the other hand, this leads to failures in banks and businesses, and increases the centralization of capital (See A. Graña, “¿El mundo en deflación?”, Data from before deflation indicate that during 2013, 269 European financial institutions went under (EUbusiness, 21/01/2014) while the same happened to 767 U.S. financial institutions between December 2010 and September 2013, according to the Federal Deposit Insurance Corporation (FDIC), the US deposit insurance agency.

On the other hand, according to the IMF report Perspectives of World Economy from January of 2014, emerging economies will grow by an average of 5.1% this year, led by China which will grow by 7.5%. As has become habitual, the estimates of the IMF are over-valued. The indicators for the Metals Futures Market of January this year indicate an 11 per cent fall in prices. The decline begun in 2011 has been accentuated with the announcement of the beginning of the end of the programme of monetary stimulus in May, which began in December of 2013 and took effect as of January. The prices of raw materials are determined partly by effective demand, but financial demand also plays an important role.

Hence what is taking place is the end of the triple arbitration of interest rates, exchange rates and prices of financial assets, which has been occurring since interest rates became negative in 2003 and fell even lower as of 2009.  The end of the triple arbitration implies the inverse with the impact on exchange rates of emerging economies, the inflation rates in these economies and interest rates. The consequence of a contraction of consumption in these economies could ultimately result in an economic recession in the emerging world. In addition this implies a global generalization of the crisis. The question is how long will the Asian continent remain at the margin of this dynamic.

“International monetary co-operation has broken down,” Raghuram Rajan, a former chief economist at the International Monetary Fund, and present governor of the India central bank, said in a Bloomberg TV interview. (Cited by Larry Elliott, The Guardian, 30/01/2014). “Industrial countries have to play a part in restoring that [co-operation between central banks], and they can’t at this point wash their hands off and say we’ll do what we need to and you do the adjustment.”  The truth is that they are not interested. While interest rates in mature economies continue to be negative in real terms, they will remain high in emerging economies; thus they will ensure a transfer of wealth as they attempt to contain the inevitable, at least in the short term.  The situation is similar to that of 1934, with the optimism based on the notion that the crisis was over and the disaster going out the door.
(Translated for ALAI by Jordan Bishop)

– Oscar Ugarteche is a Peruvian economist who works at the Instituto de Investigaciones Económicas of UNAM, Mexico. He is a member of SNI/Conacyt. Coordinator of the Observatorio Económico de América Latina (OBELA)., and president of ALAI
Ariel Noyola Rodríguez is a Member of the OBELA project. IIEC-UNAM. Contact: