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Road To Deflation

March 31, 2014

Lately the ECB press conferences have been very similar. Mr. Draghi reads out the statement using exactly the same sentences as last time and the journalist ask exactly the same questions. Trying to find something new there is almost the same as trying to find the differences in Johnny Bravo’s four hobbies, which are women, girls, chicks and babes.

Although the situation is pretty much the same, it doesn’t mean that the problems have disappeared.

Inflation is still the big elephant in the room which nobody wants to talk about and with good reasons. As Mr. Draghi mentioned in his last press conference, it is actually very difficult to predict inflation in long-term. The lady from Japan who was asking very good questions regarding the deflation worries made Mr.Draghi use the following (famous) sentence: „Europe is not Japan.“ Fair enough, we can all read the map but lets take a closer look, what happened in Japan before the deflation era began.

The Japanese asset price bubble took place from 1986 to 1991 when real estate and stockmarket prices were greatly inflated. The rapid acceleration of asset prices overheated the economic activity which was supported by credit expansion. Sounds kind of similar to what we had in EZ, doesn’t it? Lets compare some more data. After the bubble burst in Japan the private sector lending growth started to decline which meant that people were not making big purchases anymore.

That of course meant that less money was circling in the system and that started to affect the prices all over the country. Now, if you look at the EZ private lending, then you’ll see that the decline there is far more aggressive than it was in Japan, which gives even more reason to be worried. And lasty – the unemployment. In Japan, starting from 1988 the unemployment started to rise and peaked around 5,5% and it has been between 4% and 5% (roughly)ever since. In EZ things are not that good as right now we are battling with a 12% unemployment rate. All in all – things are not looking good.

What about exports in EZ, can that save the day? I really doubt that. If you look at the data then you’ll see that largely the EZ countries trade goods between each other, which means they basically put money from one pocket to another but the whole budget stays they same as no „new money“ comes in.

To sum up – predicting the inflation is the same as having a constructive conversation with Al Bundy or Homer Simpson as both are almost impossible tasks.

Only time can tell if the ECB manages to contain the situation and bring the inflation back to 2% area but the fact is that something needs to be done and perhaps on Thursday that „something“ is going to happen.

Capital Properties FX Team
31.03.2014