The ECB’s Gamble

The ultimate cause of this deflation is North Asia’s inability to reform and dismantle its once heavily protected and favoured manufacturing sectors at a time when the Western economies no longer possess their once-insatiable demand for imports of consumer goods. Certainly, Japan, China and Korea each relied on their respective manufacturing sectors for their initial economic development but these models have been allowed to persist for too long; the nature of the world economies has changed but these countries have not yet been able to adapt to these new circumstances, with the result that some considerable part of their recent output growth has simply found itself piling up in unsold inventories.

These countries have continued to actively “protect” their existing economic structures either by using overt weak currency policies (Japan) or less transparent subsidies and other means. Somewhat ironically, the financial markets may have fawned over Abenomics but, in reality, it has been a primary source of the current bout of global trade deflation that is both causing analysts to pare back their corporate earnings forecasts and leading many policymakers to become concerned.

There has become something of an element of the “Prisoners’ Dilemma” involved in many countries’ reactions to the increase in North-Asian-sourced price deflation. In a “perfect world”, the world’s policymakers might meet under the auspices of the IMF and agree a plan in which they all promised not to devalue but to attempt to boost their own economies. The IMF, though, has perhaps never really been able to live up to its founders’ ideals in this regard and certainly its current leadership has not been able to prevent countries going it alone and pursuing their own weak currency agenda.

Perhaps the previous boss of the IMF might have been more suited to the task of forcing countries to coordinate their individual responses to the deflation threat but he is otherwise engaged. Instead, we have many countries seeking to ensure that they are not the economy that is left with the “uncompetitive exchange rate” in what seems to have become a race to the bottom. Clearly, for the global economy this race to the bottom in the currency markets can only heighten the ongoing risk from deflation and also the threat to corporate earnings but, rather ironically, this turn of events has proved positive for financial markets.