Trichet Says Deflation Will Not Materialize, Austerity Will Not Cause Stagnation; Trichet Plays Politics; Welcome Back Deflation

A sure sign that something is either on the way if not already happening is denial by a central banker of the risks. With that idea in place, this headline speaks for itself: ECB's Trichet says austerity plans don't risk stagnation

"As regards the economy, the idea that austerity measures could trigger stagnation is incorrect," Trichet said, according to an English-language transcript published on the ECB's Internet site.

"I firmly believe that in the current circumstances, confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today."

DENIES DEFLATION RISKS

In a letter to G20 leaders last week, President Barack Obama warned against the premature withdrawal of stimulus policies and urged flexibility in implementing fiscal policy to safeguard and strengthen the recovery.

Billionaire investor George Soros said on Wednesday Germany's budget savings policy risked destroying the European project, pushing weaker euro zone members into a cycle of deflation.

Asked about the risk of deflation, Trichet said: "I don't think that such risks could materialize," adding that inflation expectations were well anchored.

Welcome Back Deflation

By my model the US and Europe are already back in deflation.

In the US housing has collapsed, government bond yields have collapsed, the stock market is not acting well, bank credit continues to drop, and mark-to-market value of debt is headed south.

Those are symptoms of deflation but collectively they tell the story of failed reflation efforts of central bankers.

For more on the symptoms of inflation and deflation please see Humpty Dumpty On Inflation

Nearly all of the conditions one would expect to see in deflation are once again present. GDP is still positive (for now), but that is only because of an amazing amount of stimulus (government spending) that has now clearly worn off already.

The private sector is in shambles and housing is back in the gutter.

Trichet Plays Politics

Of course Trichet cannot come out and say "Expect Stagnation" although stagnation is the very best one could expect. Another global contraction is far more likely.

Nonetheless, the ECB and UK have adopted the correct policy - to pay the price now. There can be no return to growth backed by government spending and more debt.

Greenspan's massive reflation effort led to the housing bubble that collapsed. This reflation effort did nothing but bail out banks and Wall Street at the expense of taxpayers.

It is absurd to think government is the cure when it should be crystal clear government spending is the problem.

Besides there is nothing at all wrong with deflation. Yes there will be some short-term pain, but the Keynesian "cure" just digs a deeper hole. For further discussion, please see Krugman Suffers Foot-In-Mouth Disease; Lessons on Price Stability.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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