Four years on from the great crash of 2008, world governments and central banks have managed to prevent a 1930s-style debt deflation. They’re still shovelling, but so far so good.
However the question still hangs there: has deflation just been postponed, or will we end up with the opposite – inflation?
The actions of governments, now exhausted due to lack of money, and central banks, still printing, have led to sovereign debt levels that are way beyond serviceable and central bank balance sheets that are, to put it politely, experimental.
The European Central Bank is focused on shielding governments from the debt markets to buy time while a more durable fiscal and banking union can be cobbled together.
To appease the Germans, the ECB must not only neutralise the monetary effect of bond purchases but also impose strict conditions on governments whose bonds it buys. The effect of that is simultaneously to weaken its own balance sheet, since it’s selling good bonds while buying bad ones, and to make it virtually impossible for the supplicant nations to break out of their deflationary spirals.
It is obvious that austerity does not work and none of the actions by the ECB deal with the fundamental problems of the eurozone: namely the crushing debt and the fact that Portugal, Italy, Ireland, Greece and Spain – the PIIGS – need deep micro-economic reform and deregulation to become competitive against the northern eurozone members.
But with unemployment of up to 25% there is no political capital to do anything meaningful.
Most importantly, private capital is staying away in droves; or rather it is being mobilised to run away from the PIIGS. And now ‘conditionality’ on the ECB’s bond purchases leaves open the prospect of devaluation. The ECB is NOT doing “whatever it takes”, as promised, because a country that fails to meet the conditions will not be supported, which means it will have to leave the euro.
So those five countries can reform their labour markets and deregulate all they like, but unless they can attract capital to invest it will be in vain. And capital will not invest if there is a material prospect that devaluation will wipe out half of it.
In the United States the Federal Reserve appears to be delivering on “whatever it takes” by announcing an open-ended bond and mortgage securities buying program at $US40 billion a month, for as long as necessary.