Europe: the Spectre of Stagflation

Thomas Meyer, founding director of Cologne, Germany-based think tank the Flossbach von Storch Research Institute. A speaker at the 24 February London conference, which was organised by Marketforce, he outlined the disparity of economic performance in key European countries and warned of the prospect of ‘stagflation’ in the region.

A former chief economist for Deutsche Bank, Meyer said the eurozone economy was in a ‘downswing’ of a credit cycle, the upswing of which led to the creation of excessive debt and the subsequent financial crisis.

If this debt cannot be reduced it will be monetised, he said, and stagflation will result. In stagflation, the inflation rate is high, while the economic growth rate slows down and unemployment remains steadily high. Any actions to lower inflation may raise unemployment and vice versa.

The eurozone debt has stabilised to around 450% of gross domestic product (GDP); however when the constituent countries of the zone are viewed separately, a different picture emerges, said Meyer. The debt to GDP ratio is increasing in France and Italy, has levelled out in Spain and is decreasing in Germany.

In fact Germany’s economic performance is divergent from the rest of the eurozone in many aspects. For example, when it comes to household debt – an important driver of the real estate cycle that is at the heart of the credit cycle – the figures from the eurozone as a whole look encouraging. The average debt as a percentage of disposable income is levelling off and residential property prices are stabilising.

However, looking at countries in isolation highlights the fact that Germany is driving these figures as Europe’s biggest has experienced a significant reduction in the household debt burden over recent years. France, however, is experiencing falling house prices and rising household debt levels. Declining house prices has led to reluctance among French citizens to spend money. Italy, where home ownership is more common than in France, presents a similar picture while Spain is beginning to stabilise after a period of sharp decline.

Sweden’s Example

Germany also differs from its neighbours in having declining private sector and public sector debt levels. France is experiencing rising public debt and stabilising private debt, whereas in Spain private debt is falling but public debt is rising. Outside the eurozone, in the UK both private and public debt are stabilising.

Meyer had limited time in which to present a solution to the eurozone’s woes. He pointed to the experience in Sweden, where the central bank attempted at the end of 2010 to exit from a zero interest rate and quantitative easing (QE) environment. The Riksbank raised rates when the inflation rate was at the target 2%, a move was considered as a blunder by many economists and economic commentators.

He said the bank had not realised that an increase in rates would have repercussions on the housing market. Swedish house prices plunged and the sharp falls caused balance sheet problems for indebted households. The Riksbank reversed its decision, rates were lowered and house prices rose again.
The Swedish economy has reverted to growth
, which has been achieved by the property market’s recovery.

At present, the eurozone is in the downswing of a credit cycle, said Meyer, which is depressing growth in the majority of its economies. The region is still ‘far away’ in terms of deleveraging for there to be confidence that growth will return on a truly aggregate basis.

Although the European Central Bank (ECB) is making great efforts to try to increase the inflation rate, the ‘debt mountain’ that exists in most countries within the eurozone is preventing the generation of growth. “Like in Japan, monetisation of debt will lead to stagflation in the euro area,” said Meyer.

Germany, he added, is different and the conflict between Germany and other economies in the eurozone will be “intensified”. While he didn’t address the Greek situation in detail he referred to the conflict between the Greek finance minister, Yanis Varoufakis, and Germany’s federal minister of Finance, Wolfgang Schäuble. This is likely to continue, he said, while there is a resistance in Greece to draw the consequences of their economic problems and opposition in Germany to a Greek exit from the eurozone.

In concluding, Meyer raised the idea not of a Greek exit, or Grexit, but of a ‘Gexit’ – or German exit from the eurozone. This scenario seems unlikely, as for Germany interest rates are under-valued in the eurozone, which helps boosts its exports and current account, which is currently at 6% of GDP.

Perils of Exit

Germany’s Bertelsmann Stiftung, the country’s largest non-profit foundation, released a study on Grexit and Gexit in 2013. It stated: “Eurozone membership provides Germany with significant economic gains that more than compensate for any advantages from a return to the deutschmark”. The currency union’s benefits would remain even if Germany was to retain the euro and take a significant haircut on its loans to the four eurozone countries hit hard by financial or fiscal crisis.

The study concluded that annual German GDP would be 0.5 percentage points lower between 2013 and 2025 were Berlin to have a separate currency. This reduction would amount to an economic loss of €1.2 trillion, or €14,000 per inhabitant, in the 13-year timeframe, a figure equal to about half the size of the German economy in 2012. The lower growth would also mean 200,000 fewer jobs in Germany.

The authors also pointed out that a Greek exit from the eurozone would risk “kindling a wildfire throughout Europe”, possibly even on an international level and potentially result in a worldwide economic crisis.

Germany also featured in the address at the conference on the global economy by Stephen King, chief economist at HSBC. Key economies remain weak, he said, even where policymakers have acted aggressively, such as in Japan.

He suggested a new international accord might help to jump-start the global economy. In this accord, the US would “stoke the engine of domestic demand to increase imports”, China would lower its household saving ratio by liberalising capital markets and facilitating the growth of consumer credit and finally, Germany would raise its retirement age to reduce the high level of savings associated with an ageing population.


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