Stress-testing Europe’s banks won’t stave off a deflationary vortex

Ambrose Evans-Pritchard
London Telegraph
July 19, 2010

Euroland’s authorities are inflicting a triple shock of fiscal, monetary, and currency tightening on a broken economy. They are doing so in a region where industrial output is still 14pc below its peak, where growth barely scraped above zero over the winter “recovery”, and where youth unemployment is at 40pc in Spain, 35pc in Slovakia, 29pc in Italy, and 26pc in Ireland.

They seem unaware that China is slowing and the US is tipping into a second leg of the Long Slump. Last week’s collapse in America’s ECRI leading indicator to -9.8 marks the end of the V-shaped rebound. If this means what it normally means – recession within three months – Europe must take immediate action to prevent being drawn into a deflationary vortex. Spiralling public debt precludes further Keynesian spending, so this must come from central bank stimulus. Tight fiscal policy offset by ultra-loose money is the only option for Europe, the US, and Japan.

No student of Milton Friedman is surprised by the US relapse. The Fed has allowed M3 money to contract at a 10pc pace for much of this year – the Great Depression rate. The economy has hit the wall with the usual lag. Textbook stuff. Never ignore the quantity theory of money.

The US Conference Board’s indicator is not yet flashing a red alert, but that is because it gives weight to “yield curve inversion”, where long rates fall below short rates. This indicator is meaningless in a Japan-style bust where policy rates are zero.

Full article here

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