STAFF NEWS & ANALYSIS
Deflation as a Scare Tactic
By Staff News & Analysis - June 11, 2010

Irish price falls slow, deflation coming to an end … Consumer prices in Ireland fell at a slower pace in May, in annual terms, indicating that the early and sharp fiscal reforms that have boosted competitiveness would not lead to a long period of damaging deflation. Prices in May stood 1.1 percent lower than a year earlier, a bigger fall than the 1.5 percent drop expected by economists polled by Reuters. But prices were up month-on-month for the fourth successive month, rising by 0.6 percent. The annual figure compared to a trough of -6.6 percent last October when Ireland led other euro zone strugglers in implementing severe wage and price reductions and some analysts said the period of deflation had already ended. "I'd said last month that price deflation in Ireland is probably over and I think these figures would tend to support this view," Dan McLaughlin, chief economist at Bank of Ireland said. "Obviously the scale of the price falls we saw in 2009 still means that we are still seeing deflation on an annual basis but we will probably see the annual inflation rate back in positive territory." The Harmonised Index of Consumer Prices (HICP) used for intra-EU comparisons was flat on the month and was 1.9 percent down from the same period of 2009, compared with the 2 percent year-on-year drop predicted by analysts. Irish inflation rates have been well below those of the likes of Spain, which agreed new austerity measures last month and is arguing with unions over labour reforms. – Reuters

Dominant Social Theme: If you've got price deflation, you need austerity.

Free-Market Analysis: We've now explored the inflation versus price deflation argument in depth in two recent articles – and arrived at the conclusion that modern fiat-money economies are more likely to tip toward price inflation than price deflation, at least eventually. In fact, this article, excerpted above, from Reuters, would seem to confirm our further suspicions that price deflation has been launched as a dominant social theme justifying austerity measures.

Here's the crux quote from the article: "But prices were up month-on-month for the fourth successive month, rising by 0.6 percent. The annual figure compared to a trough of -6.6 percent last October when Ireland led other euro zone strugglers in implementing severe wage and price reductions." The wage and price reductions, the article tells us, were implemented in response to so-called price deflation, and now inflation (as a response to the Irish cost-cutting) has begun to creep up again, though it will remain in "manageable territory." Here's a little more:

"It's no coincidence that the only two countries that are still negative year-on-year in HICP are Latvia and Ireland, and the two that actually took the pain in terms of wage cuts and price adjustments," Bloxham Stockbrokers chief economist Alan McQuaid said. "While Ireland needs to make significant downward wage/price adjustments to become more competitive and return the economy to sustainable growth, the last thing we need is to get stuck in a price deflationary spiral like Japan, which will do more damage than good in the medium- to long- term."

We can understand several things from this last excerpt. First, Latvia and Ireland took the "hard medicine" and made necessary cuts and "price adjustments." Second, more are apparently needed if Ireland is to become more competitive and the economy is to grow sustainably again. Finally, this continued aggressive action is necessary if Ireland is not to get stuck in a "deflationary spiral" like Japan. Again, this is an evolving dominant social theme from our point of view, or more likely a sub-dominant theme in that it stems from the dominant central banking promotion and separates banking (and its supervision of central banking) from government.

According to the Reuters article, the Irish have been fairly successful with their austerity package. But not so fast, MarketWatch tells us: "Economists say [Ireland's] fiscal fate may rest outside of its control, dependent on further depreciation of the euro and a strengthening global recovery. Some even argue that may not be enough to keep Ireland from eventually succumbing to a massive fiscal deficit. Ireland sold its budget to the market with the claim that it has 'done the hard work first,' said James Nixon, European economist at Societe Generale. 'But we're skeptical as to whether that's really true. … We feel that Ireland is definitely likely to be one of the first countries to have to go cap in hand to the Europeans to ask for a bailout from the stability mechanism."

So it's not working so well in Ireland after all. Nothing wrong with cutting public sector benefits of course, but Ireland raised taxes as well – some US$70 billion and more tax hikes are apparently planned. And doubtless, these hikes will be made even more aggressive if Ireland goes to the EU asking for a further bailout. This is basically the IMF's "austerity" recipe. A given country's elite borrows from Western banks on the way up and then leaves the mass of citizenry stuck with the bill on the way down. The IMF is willing to lend, but only if "discipline" is enforced. High taxes, imploding entrepreneurial efforts and general economic desolation ensue.

In fact, Ireland is not a patient taking "hard medicine." Ireland is country made up of individual people who will gradually realize, we believe, that they have dragooned into "austerity" via a fear-based promotion featuring price deflation and the need for resultant economic discipline. Right now similar conversations are taking place in Spain, Greece, Portugal and many other countries. Britain as well. But we wonder if the Irish medicine is going to go down so smoothly elsewhere. (We wonder if it will come back up in the case of Ireland.)

The trouble is, of course, that price deflation itself is a dominant social theme – a fear-based promotion that is being used, in our opinion, to justify the Draconian cuts that are being called for. No, there is no morality involved. It looks to us more and more like an outright manipulation. Countries were suckered into the European Union based on the idea that the euro would provide sustainable prosperity. But cynically, the currency merely proved a way for most of the weaker European states to borrow more money than they could ever afford to pay back. Banks were glad to lend the money and EU leaders were glad to look the other way.

But now, the focus is squarely on the "problem" of Southern Europe profligacy and the solution is supposed to be a closer political union that allows Brussels (and Germany) to supervise the spending and budgets of other European countries. Again, the meme driving all this is "price deflation" – the idea that because Western economies are in a state of partial collapse (due to "over-spending"), austerity must be implemented.

Austrian economics tells us there is nothing with deflation in a free-market environment (it eases the pain). But the EU is anything but free-market oriented and price deflation in such over-leveraged communities is often a recipe for immediate ruin, and people know it. We begin to have a greater degree of certainty, then, that the powers-that-be are using the price deflation bogeyman as a methodology to implement greater control over Europe and also, ultimately, of Britain and the US.

In Europe especially the specter of price deflation can be used to promote a greater political union, higher taxes and to reduce the clout of Europe's powerful public sector unions. Ireland, of course, is supposed to be the success story in this regard, but as the MarketWatch article suggests, the entire tale may not yet be told. Give the Irish more time and the government may discover the Emerald Isle needs even more austerity.

After Thoughts

As we have attempted to point out in past articles on the subject, it is perhaps doubtful that serious price deflation can persist in the kinds of fiat-money environments that pervade the West today. Sooner or later, inflation will become more prominent – or so we believe – and thus we see the promotion of price deflation as something of a frenetic scare tactic for political purposes before price inflation begins to surge. If we are correct on this point, people generally need to internalize the mechanisms of fiat-money operations so they may better understand what lies ahead. Investors, too.

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