EU Finances Are Looking Grim. Deflation will not be denied.


As the pseudo educated clowns in the European financial elite circles are still trying to figure out whether or not they are in deflation, the big D is now solidly in charge of the region. As private credit is collapsing the Euro-zone governments and Central Banks are desperately trying to re-inflate by pumping up the public debt and using the proceeds for spending. Yet the reflation is finding itself oddly overpowered by the deflationary wind blowing against it. Sooner or later this public debt bubble, and a huge one, will reach its maximum size and start letting the hot air out. When that happens, there will be nobody to guarantee the sovereign debts. The longer the deflation is delayed, the stronger it will be.

Wall Street Journal. July 14, 2009.

EU Finances Are Looking Grim.

Debt Will Top 100% of GDP by 2015 as Crisis Zaps Growth.

MILAN – The dramatic rise in the euro zone’s debt load expected next year is just the start, economists predict.

Euro-zone public debt is likely to rise above 100% of euro-zone gross domestic product by 2015, putting the 16-member currency union on par with the poor finances today of Greece and Italy. If deflation sets in, the load is likely to be even greater.

The most recent official projection on Europe’s growing pile of public debt came earlier this month; the European Commission forecast total euro-zone government debt would rise to 84% of annual output in 2010, up from 69% last year.

But economists expect the trend to worsen notably as the financial crisis and policy responses drag down productivity, slowing future growth and making the task of trimming budget deficits more onerous.

Patrick Artus, chief economist of Natixis in Paris, said it is inevitable that euro-zone government debt will surpass 100% of gross domestic product by 2015.

Slower future growth will add 40 to 60 percentage points of GDP, respectively, to public debt levels in Germany and France within a decade, and twice as much in a deflationary scenario, according to Stephen King, chief economist for HSBC in London.

The commission also slashed its estimates of the euro zone’s potential growth rate to 0.7% for this year and next, from 1.3%. It offered no guidance after that, but warned of a “permanent loss” in potential output as investment lags and unemployment jumps.

If that growth rate is the new normal, then by 2015 the euro-zone’s annual output will be €800 billion ($1.226 trillion) less than pre-crisis trends indicated, said Kevin Gaynor, chief markets economist on Royal Bank of Scotland’s global macro strategy team in London. At that new rate, the cumulative shortfall in economic activity from now until then will amount to €2.8 trillion.

“In short, we will be substantially worse off,” he said.

Such a load would shrink tax receipts and possibly spur yet more spending by governments to offset the decline in activity.

Bringing back the euro zone’s annual budget deficit below the ceiling of 3.0% of GDP used as a criteria for joining the euro will take until 2015 — and only if governments are prepared for their cuts in spending to squeeze real growth down to zero, Mr. Artus said. The commission expects deficits to hit 5.3% of GDP this year and 6.5% of GDP next year.

A more gradual approach, aiming for growth of around 1.5% a year with budget deficits still running at 5.4% of GDP in 2015, will still take public debt above 100% of GDP that year, and raise the ratio of debt to annual tax receipts about 50% higher than is associated with a triple-A credit rating, he said.

If deflation takes hold, budget deficits will rise to double digits and push public debt to 129% of GDP, or more than three times annual tax receipts.

“Talk of a sovereign credit crisis or a violent currency slide would no longer be academic,” Mr. Artus said.

Inflation may look like the best bet to ease the strains on public finance, even though it would usher in new problems later, Mr. King said.

Indeed, what he called the “printing-press scenario” — boosting the money supply to buy government bonds to create negative real interest rates and temporarily increase growth — would curb the rise in public debt. Single-A Italy could actually cut its sovereign debt to 95% of GDP by 2020, as opposed to seeing it rise to 219% in a deflationary scenario, according to Mr. King’s model.

Attention will soon turn to “what central banks target as the acceptable inflation rate,” said Mr.Gaynor.

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