World economy: Deflation


Dave Deruytter looks at why the economy is in deflation and how we can get out of it.

Economic growth around the globe is essentially only moderately strong in the US, Germany and the UK, doped by rock bottom interest rates and massive asset buying by their respective central banks. Inflation is difficult to find anywhere. Slowing economic growth in China does not help the picture, nor do Brazil and Russia who have their own specific problems. India is Ok but still too small an economy, and not growing fast enough, to make an important difference. Finally, heavily indebted Japan has been deflating for more than a decade.

So, what are the causes of this situation?

There are ever more people on earth who can buy houses, cars, flat screen TVs, tablets, smartphones, holidays, etc. Infrastructure projects are plentiful. Medicare for the elderly is a booming business. On top of that, the profits of companies are strong.

Butwhere does the deflation come from?

Over capacity? Disintermediation (cutting out the middlemen)? The free internet? Robotics? Shale gas?

All of those have a part to play, but governments not netting the taxes they need from large multinationals and from Ultra-high-net-worth individuals (UHNWIs) is a cause too.

Effective tax rates for multinational companies have been continuously decreasing over decades, as they have for very rich people. The fact that at some point a large multinational had more available cash than a whole country is telling. Multinationals and UHNWIs are extremely rich and profitable and becoming even more so, whereas countries are becoming ever poorer as they carry too much outstanding debt. Individual countries are even helping those lowly taxed companies or rich people by offering them all kinds of tax incentives for investment or presence in their country. The OECD initiative on BEPS (Base Erosion Profit Shifting) is slow in implementation. The European Savings Directive, FATCA and the new Common Reporting Standard of the OECD are only slowly advancing or showing any results.

Social deflation? It needs to be studied but I cannot but have the impression that social values in the rich world are kind of under scrutiny or under pressure, and the evolution of developing countries towards more social support for their citizens (health care, pension, working standards, wages, safety, etc) is moving slower than before.

The chief risk with global deflation is that the outstanding debt of countries could become unbearable if the trend of deflation continues or accelerates. Since all the countries face similar problems, currency devaluation is not a viable solution since the other countries would (need to) do the same. So, if deflation continues, debt restructuring, taking important capital losses (haircuts) on debt, worldwide would become necessary, possibly leading to turmoil like during the Great Depression after 1929.

It is clear that governments and international institutions have been, and are, taking many useful measures to counter this deflation, but it seems to be taking a very long time before they have (enough) effect. One of the reasons is the fact that it concerns a problem persistent everywhere around the globe and with many causes.

On the positive side, the current low interest rate environment that goes with deflation does not only make the existing companies more profitable and more likely to invest or innovate, it also makes the cost for starters or new-born entrepreneurs lower, as well as for individuals wanting to borrow for a house.

Still more should be done on making sure that multinational companies and the very rich people pay enough taxes, for countries and the world to be able to function properly again. Efficient social support structures should be in place to keep on improving the standard of living of the people in more countries, both developed and developing. As for the internet, it should be allowed to keep its great function of efficiency improvement, innovation and disintermediation, but only if there is a level playing field for similar existing services. The best examples today are Uber and Airbnb. The regulations, taxes, licenses and other rules should be the same both for the new online offerings and the existing ones. Of course, it is good to take the opportunity now to revisit those regulations to see how they can be adapted or optimized.

The world economy may very well be in deflation, particularly if you discount for the extra debt or assets that governments, central banks and international institutions have, and are, taking on – an optimist can see some improvements thanks to the measures taken since the post 2007 crisis. The US, German and UK economy are humming and have low unemployment. Europe seems to be turning the corner. China is growing at a sizeable 7%. The Japanese deflation is contained.

Given that massive amounts of debt or quantitative easing have been used to reach this, there is no time for complacency. Structural changes are needed. We have to keep on acting now or the next crisis will hit us much harder than the last one in 2007-2008.