Belt-Tightening Too Soon Would Cause World to Sink into Deflationary Quicksand

The Bank for International Settlements says Britain needs a primary surplus of 5.8pc of GDP for a decade to stabilise debt at pre-crisis levels, given the ageing crunch as well. The figure is 6.4pc for Japan, 4.3pc for the US and France. It warns of “unstable dynamics”, posh talk for a debt spiral. Words: 620

In further edited excerpts from the original article* Ambrose Evans-Pritchard (www.telegraph.co.uk) goes on to say:

Belt-tightening is the oppressive fact of 2010-2012 for half the world:
– Hungary, Ukraine, the Baltics and the Balkans are already under the knife.
– Latvia’s economy may contract by 30pc from peak to trough as it carries out an “internal devaluation”, ie wage cuts, to hold its euro peg.
– The eurozone’s fiscal squeeze is well advanced in Ireland.
– Brussels has told Greece to cut by 10pc of GDP in three years, Spain by 8pc, Portugal by 6pc.
– Britain must slash soon, or face a gilts strike.
– American states face a shortfall of $156bn in fiscal 2010.

While belt-tightening is indeed required cutting too fast would tip the West back into slump and kill tax revenues, solving nothing – a risk that austerity priests rarely acknowledge. Pacing is everything.

The West risks a slow grind into debt-deflation unless central banks offset fiscal tightening with monetary stimulus (i.e QE) to keep demand alive. Yet the Fed and the European Central Bank are letting credit contract:
– Bank loans in the US have fallen at a 14pc rate this year, caused in part by Basel III rules pushing banks to raise capital ratios.- The M3 money supply has fallen at a 5.6pc rate since September, 2009.
– The Fed’s Monetary Multiplier dropped to an all-time low of 0.809 in late February, 2010.
– The contraction of eurozone bank credit to firms accelerated to 2.7pc in January, while M3 fell by a further €55bn. – Japan’s GDP deflator has dropped to a record low of -3pc.

These are epic warning signals, with echoes of 1931 yet the Fed has just raised the Discount Rate. It is winding up liquidity operations, and preparing to reverse QE, even though the housing market has tipped over again. New home sales fell 11pc in January to 309,000 units, the lowest since data began, and 24pc of mortgages are in negative equity.

Fed chairman Ben Bernanke told us in his 2002 speech “Deflation: Making Sure It Doesn’t Happen Here” that:
1) Japan’s slide into deflation was “entirely unexpected”, and that it would be “imprudent” to rule out such a risk in America;
2) “Sustained deflation can be highly destructive to a modern economy and should be strongly resisted”;
3) that a “determined government” has the means to stop deflation, if necessary by use of the “printing press”.

Yet here we are, facing exactly that risk, unless you think one good quarter of inventory rebuilding has conjured away our debt bubble. The one-off inflation blip caused by a doubling of oil prices is already fading, revealing once again the deeper forces of deflation. Core prices fell 0.1pc in January. They plummet from here.

So why has Bernanke begun to flirt with disaster by tightening too soon? Has he lost control to regional hawks, as in mid-2008? Have critics in Congress and the media got to him? Has China vetoed QE, fearing a stealth default on Treasury debt?

Don’t go wobbly on us now, Ben. If the governments of America, Europe, and Japan are to retrench – as they must – their central banks must stay super-loose to cushion the blow – otherwise we will all sink into deflationary quicksand.

*http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7338857/Dont-go-wobbly-on-us-now-Ben-Bernanke.html

Editor’s Note:
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
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