spotfxtrader

From AEP in the telegraph here

French President François Hollande must now pay the price for kowtowing to the contraction polices of the eurozone. His country is sliding into deflation.

French prices fell 0.6pc in January from a month earlier, and would have fallen even further without one-off tax rises.

Manufactured goods fell 3pc, and clothing fell 15.4pc as retailers slashed prices to offload stock.

France’s core prices have been dropping for months, even if the core CPI index is still just positive at 0.1pc on a year-to-year basis.

This outcome is exactly what the Observatoire Economique predicted a year ago would happen under the eurozone’s contractionary policy structure, that is to say under a triple squeeze of fiscal austerity, passive monetary tightening, and draconian bank deleveraging.

Surprise, surprise, the eurozone M3 money supply has been contracting since March.

People laughed at the Observatoire. Nobody is laughing any more. As the IMF said last night, Europe is one external shock away from a lurch into outright deflation.

“A new risk to activity stems from very low inflation in advanced economies, especially the euro area, which, if below target for an extended period, could de-anchor longer-term inflation expectations. Low inflation raises the likelihood of a deflation in case of a serious adverse shock to activity. In the euro area, low inflation also complicates the task in the periphery where the real burden of both public and private debt would rise as real interest rates increased.”

It is no mystery where that shock might come from. The Fed and the Chinese central bank are tightening into an emerging market storm that is turning more serious by the day.
A long list of countries are having to raise interest rates to defend their currencies, creating a further tightening bias. Some of these countries are coming off the rails altogether.

Optimists have a touching faith in the German locomotive that is supposed to pull the eurozone out of the swamp, but the latest data shows that German wages fell 0.2pc in 2013. Germany too is in wage deflation.

Which raises the question: how on earth are France, Italy, Spain, Portugal, and Greece supposed to claw back lost labour competitiveness against Germany by means of “internal devaluations” if German wages are falling?

This forces these countries to go into even steeper wage deflation to narrow the gap, and that in turn causes debt dynamics to spin out of control as the denominator effect does its worst.
There is a technical solution to this. It is called QE. The European Central Bank can lift the entire EMU system off the reefs by launching a monetary blitz to meet its own M3 growth target of 4.5pc.

Unfortunately, the German constitutional court has just raised the political bar for QE to such a high level that the ECB will have to wait until the shock hits before reacting, and by then it will be too late.

Contrary to widespread belief, there is no treaty prohibition against QE. Mario Draghi has said explicitly that it is “not illegal” and remains an option in extremis.
Maastricht prohibits the financing of budgets but not open market operations (QE) needed to maintain monetary stability.

The alleged constraint is entirely political and ideological, and driven by fear that German Eurosceptics will fight it in the courts.

So we have an impasse. What now happens if the damp kindling wood of eurozone recovery fails yet again? It has Japanisation written all over it.