Larry Summers: Europe, US on Brink of Deflationary Spiral for Next Decade
Sunday, 25 Jan 2015 11:40 AM
By Dan Weil
Both Europe and the United States are on the brink of a "deflationary spiral," with Europe's economic morass possibly lingering for a decade, former Treasury Secretary Larry Summers has warned.
The European Central Bank (ECB)'s 1.1 trillion euro ($1.23 billion) quantitative easing (QE) program represents a positive step, but won't be enough to repair the damaged eurozone economy, said Summers, speaking at the World Economic Forum in Davos.
"Europe is on the brink of a deflationary spiral that could be gravely threatening to the process of growing standards of living, not for a year, but for a decade," he recently told Bloomberg TV. "Europe is lagging relative to every other region of the world. And the situation is getting worse."
In a deflationary spiral, households and firms cut spending while they wait for prices to fall further, causing the economy to slump, according to the Guardian.
"I am all for European QE. The risks of doing too little far exceed the risks of doing too much," he said at the World Economic Forum in Davos, Switzerland, according to multiple news reports.
"But it would be a mistake to suppose that QE is a panacea in Europe, or that it will be sufficient."
Summers also warned that the United States also faces a similar death spiral and "a depression-trap that would engulf the world if the Federal Reserve tightens monetary policy too soon," the Financial Times reports.
"Deflation and secular stagnation are the threats of our time. The risks are enormously asymmetric," said Summers. (Deflation is commonly defined as a decrease in the general price level of goods and services.Deflation occurs when the inflation rate falls below 0% (a negative inflation rate.)
"There is no confident basis for tightening. The Fed should not be fighting against inflation until it sees the whites of its eyes. That is a long way off," he said.
"Nobody over the last 50 years, not the IMF, not the US Treasury, has predicted any of the recessions a year in advance, never."
Summers contends the global economy is near a pivotal moment, the US expansion enters its seventh year, reaching the typical life-expectancy of recoveries.
The FT reported that Summers warned that "any error at this critical juncture could set off a 'spiral to deflation' that would be extremely hard to reverse. The US still faces an intractable unemployment crisis after a full six years of zero rates and quantitative easing, with very high jobless rates even among males aged 25-54 — the cohort usually keenest to work — and despite America's lean and efficient labor markets."
Meanwhile, the eurozone economy grew an annualized 0.6 percent in the third quarter.
Summers also listed three reasons why QE will probably have less impact in Europe than it did in the United States, the Financial Times reports.
•The Federal Reserve's QE came when bond yields were higher and thus could be pushed down by QE. The 10-year German government bond yield now stands at just 0.42 percent.
•QE was unexpected in the United States so it was a surprise for the economy.
•U.S. QE went through capital markets, while Europe's is going through banks, where money flows less freely. "So, there is every reason to expect QE will be less impactful in Europe," he stated.
"These are not signs of economic health," he told Bloomberg TV. "This is like a thermometer showing a very high fever and people are against the administration of medicine and it is a very serious problem," he said.
"If the US is in a bad place, we are short of any engine at the moment, so I hope you are wrong," said Christine Lagarde, the head of the International Monetary Fund.
Iconic investor George Soros also offered a mix assessment of the ECB program. While he called it a "very powerful set of measures" at the World Economic Forum, Soros also said it could "reinforce inequality" in the eurozone, BBC News reports.
That reinforcement would presumably come as QE boosts financial markets as much as the economy. The wealthy, of course, hold many more financial assets than the poor and middle class.
"Excessive reliance on monetary policy tends to enrich the owners of property, and at the same time will not relieve the downward pressure on wages," Soros said.
On the plus side, he said that if the ECB succeeds in boosting economic growth, that will make it easier for countries such as France to implement restructuring measures to increase economic efficiency.
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Poster Comment:
This may send the FED into a slight panic.