Spain’s underlying inflation rate just turned negative in April for the first time
since at least a quarter century and this is likely the thin edge of the wedge as
we have yet to see the full brunt of fiscal austerity hit aggregate demand. Core
consumer prices, which exclude energy and food, fell 0.1% from a year earlier
from the minuscule +0.2% trend in March. All the deficit-challenged countries in
the Eurozone, which technically means all of them since none come close to
meeting the Maastricht budgetary targets, could be facing severe deflation
pressure in the future based on the amount of slack in their economies.
Ireland is already experiencing deflation, with nominal GDP falling faster than
real GDP (both are down for two years straight but nominal is falling faster —
nominal GDP was down by 11% in 2009, real down 7.5%). Not surprisingly,
there is a lot of slack in the economy and the output gap stands at -7.1%, which
suggests more deflationary pressures over the medium term. This problem is
now widespread: Spain has an output gap of -5.3%, Portugal -3.6%, Italy -5.7%
and Greece -4.6%.
Even with the recently announced austerity measures for Spain and Portugal,
these countries may have trouble improving their fiscal ratios, if deflation sets in
and GDP falls (as it has in Ireland). It’s otherwise known as the ‘catch 22’ — and
the future of the Eurozone project, as it currently stands, is more in doubt than
many are willing to believe at the current time. Either the Euro plunges or
several of the EMU members will inevitably opt for their own currency of
yesteryear to ease the deflationary pressure on their economies.
Meanwhile, there seems little dobubt that it’s this fear driving the market today. The dollar is rallying, gold is weak, and oil is getting hammered. And of course Europe got crushed.