G20 recipe for deflation, protectionism

June 8, 2010

It may be folly or it may be prudence, but the move to fiscal austerity and restraint will be deflationary, will be bad for risky asset prices and will raise further the threat of protectionism.

The weekend’s meeting of the Group of 20 wealthy nations in Korea ended in a muddle of policies, with the final communique appearing to praise fiscal retrenching, expansionary policy, tighter regulation and slower implementation of that tighter regulation all at the same time, and all in the same impenetrable thicket of euphemism, buzzwords and consultant-speak.

To wit:

“The recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, growth-friendly measures, to deliver fiscal sustainability, differentiated for and tailored to national circumstances. Those countries with serious fiscal challenges need to accelerate the pace of consolidation. We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions. Within their capacity, countries will expand domestic sources of growth, while maintaining macroeconomic stability,” the communique issued at the conclusion of the meeting read.

For the perplexed, a gloss would be: “Europe having hit the fan, we can no longer agree on common policies to stimulate the wretched economy. Every man for himself! Well, except for the U.S., which should carry on buying all of the rest of our stuff.”

China is not taking serious steps to revalue its currency, deciding instead to fight inflation and an overheating property market at home. And over in Europe, if it isn’t French Prime Minister Francois Fillon praising the “good news” of a newly cheap euro it is German Chancellor Angela Merkel unveiling a package of budget cuts. Just as fiscal stimulus must be done in concert internationally, as some of the benefit of the money spent will “leak” through borders, so is austerity a bit of a communicable disease; you may be punished by markets if you are the one still expanding borrowing while others cut.

And if you are lucky enough to have a reserve currency, you end up with the unenviable job of U.S. Treasury Secretary Geithner, who will need to explain back home why the U.S. should be the world’s export-eating foie gras goose. He is likely to say brave words about how the strong dollar reflects U.S. robustness, but as mid-term elections near and a jobless recovery stays jobless that will sound increasingly hollow.

It is by no means a sure thing, but what starts with austerity programs can easily grow into beggar-thy-neighbor currency depreciations and trade barriers.


This is not to say that Europe, and Britain for that matter, are wrong to impose discipline on their budgets. Defenders of fiscal stimulus like to point out that, at current market rates, the cost of further borrowings is small, and that there is no sign, at least in the U.S., of anyone remotely resembling a bond market vigilante. To my mind that is a bit like looking at Lehman Brothers in 2006 with a highly levered and highly illiquid balance sheet and saying that, because the market is making it a good price in the short-term borrowing market, it is sound. Like the old joke about the guy going broke, that changed little by little and then all of a sudden. Losses of confidence in sovereign borrowers can be sudden and catastrophic, just as they can be for banks.

For euro zone members it was at first disquieting and then frightening as markets lost confidence in Greece. Seeing an emerging trend of distrust of France, Belgium and Austria must be terrifying. All three now cost more than 100 basis points to insure against default for five years and the market carried on marking up that cost for all three after the G-20 meeting.

On the face of it that is confusing because euro zone countries did not get roped into expanded deficit spending at the G-20, presumably making them better credits and more likely to repay their debts.

It is possible, only just but possible, that markets are moving precisely because the effect of the events at the G-20 will be deflationary and, as such, will worsen the situation of debtor nations. It is a lot harder to pay back your debt as your economy shrinks, and harder still to do it if inflation turns negative. A world which is only depending on a U.S.  consumer to take the strain, and one who is supported by the spindly crutch of government support, is a world that much closer to having to reckon with its debts.

This will hurt growth and with it riskier assets.

This may be an avoidable disaster or it may simply be a step that must be taken, disastrous or not.


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Posted by ghosalisuli | Report as abusive

Monetary policies do not rule the people — of course the world’s banking (monetary) leadership would acclaim austerity as the way forward. Moreover, bankers never did understand anything about foreign trade. The big fear of monetarists will always be that the people will vote against austerity measures, which only really leaves “printing” money as the only reasonable course of action since default is unthinkable. The future is inflation, and the G20 knows it in their hearts — such is the way of the world, past, present, and future. More at:

http://wjmc.blogspot.com/2010/05/student -recently-remarked-to-me-that.html

Thank you for the opportunity to comment…

Posted by mckibbinusa | Report as abusive

Forget about the US consumer – they’re in rehab from credit addiction

Posted by yr2009 | Report as abusive

Reuters, I’d like to suggest that you edit (block) comments that direct your readers to web sites. This would both improve the security of your readers’ computers, and limit contributors to those who have something to say (at least, something they can say within your framework).

Posted by Poalima | Report as abusive

These folks cooked up a mess of gobbledegook and hope some folks will not have the nerve to say “WHAT?”

Posted by macira | Report as abusive

All of this stumps the best economists. How can an average layman expect to grasp the ungraspable?

Posted by Northman62 | Report as abusive

When people talk about inflation as a way of magically making the problem go away they are simply in a dream world. It is going to be very painful to fix our situation. The only questions is whether we are going to have the courage to pay for our mistakes or are we going to make our grandchildren pay for our mistakes….

Under austerity and some deflation we pay for the problems we created. Under increased government sending and inflation we make our children deal with the problems we created plus additional postponement costs.

Posted by Gen | Report as abusive

I agree with Poalima above. Reuters, please block people from advertizsing in comments. Just block all links.

Posted by tmc | Report as abusive

[…] […]

Posted by Edward Hugh profiled in the New York Times and other links | Credit Writedowns | Report as abusive

There would be no need for austerity measures and draconian deficit reduction if the market had any confidence at all in the Euro sovereign bonds, and that’s a HUGE “IF”.
But unfortunately, having being burnt to crisp by the credit crunch, there is not much appetite for risk. That said, I still do believe that the Euro bond market and equities are severely undervalued,mostly because, nowadays, the trendiest type of economist is the doomsday sayer.
And they are all on the streets screaming apocalypse coming.
Burton Makiel wrote in his book A Random Walk down Wall Street : If everyday you keep saying market crash, eventually one day you will be right, and people will put you on a pedestal.
The austerity measures are important, not to prevent default, but to restore confidence, and the price to pay will be slow EU growth for the next few years.

Posted by Uriel | Report as abusive

Well some economists believe that deflationary pressure is not very serious in long term. Atleast the Eurozone is moving swiftly to cut the spending. Atleast the eurozone is not inflating its way out. In US there is no talk of consolidation of the spending. They are inflating to make the exports cheaper, but they cannot control the inflation which can spiral out of control in no time.

I see deflation to be a short term impediment to the economy but inflation is more serious.

Posted by Robosuman | Report as abusive

Macroeconomic models rely for their validity on some measure of equilibrium and substantiality being present in the money system, which is sadly far from the case today.

If the world were relying solely on the munificence of US consumers of whom significantly fewer remain afloat than US statistical conjuring acts imply, the world would be on the road to perdition. How much further down the same old road the world is inclined to travel based on faulty American navigation remains to be seen.

Should it finally dawn on the other 19 of the Gs that Good Ol’ Number 1 has been deliberately leading them around by the nose into all kinds of trouble to be borne on the backs of their citizens a certain amount of whiplash is to be anticipated, not so much inflation or deflation as economic annihilation.

Posted by HBC | Report as abusive