The eurozone is in trouble. If the UK’s 1.9 per cent first quarter fall in GDP was abominably bad, the worst in 30 years, Germany ’s 3.8 per cent contraction was abominable-squared. The whole eurozone contracted by 2.5 per cent. These huge falls risk pushing prices down, which could in turn force the authorities to use stronger and riskier deflation-countering medicine.
Europe’s implosion is proving worse than those suffered by the housing boomers, the US and the UK. More than three years of German growth has been eliminated in just two quarters. And the decline, though it can hardly remain as steep, is certainly not over.
Why should Germany and Europe suffer so much when, outside Ireland and Spain, house price fervour was not too much of a problem? The reason is that the exporting eurozone was a beneficiary of the lending boom which puffed up economies in both the west and the east.
That dependence on exuberance elsewhere offers Germany and Europe no reassurance now. American, British and east European customers must learn to save more and import less. Germany and the eurozone must adapt to lower export sales. The global rebalancing is going to be painful everywhere.
Painful, and potentially deflationary. Annual inflation in the eurozone has dropped to just 0.6 per cent. Producers who cannot find customers could cut prices more. To afford that, job cuts are required, pushing down wages. Heavily-indebted eurozone countries such as Italy are in no position to help — and are ill-placed to absorb falls in tax revenues that will be made worse by lower prices.
The possibility of deflation puts pressure on the European Central Bank. The eurozone's central bank has so far been more cautious than the US Federal Reserve or the Bank of England. But the deflationary threat will strengthen the hand of ECB members who want far more euros printed. Hitherto resolute German opposition may, like the German economy, wilt.
The near-term global danger is therefore of further economic contraction, soaring unemployment, falling property prices and, as markets’ euphoria evaporates, falling stockmarkets. But as these deflationary horsemen are countered by central bank money creation, another spectre may appear: uncontrolled inflation. The crisis seems to have far to go.
