Historical Perspective on CPI Deflations: How Damaging are They? Yet another central bank has announced a warning about the perils of deflation. Please consider China Central Bank Calls for Vigilance on Deflation. China's central bank governor Zhou Xiaochuan warned on Sunday that the country needs to be vigilant for signs of deflation and said policymakers were closely watching slowing global economic growth and declining commodity prices. Zhou's comments are likely to add to concerns that China is in danger of slipping into deflation and underline increasing nervousness among policymakers as the economy continues to lose momentum despite a raft of stimulus measures. "Inflation in China is also declining. We need to have vigilance if this can go further to reach some sort of deflation or not," Zhou said at a high-level forum in Boao, on the southern Chinese island of Hainan. Zhou added that the speed with which inflation was slowing was a "little too quick", though this was part of China's ongoing market readjustment and reforms. Historical Perspective On CPI Deflations In its March report, the BIS took a look at the Costs of Deflations: A Historical Perspective. Here are the key findings. Concerns about deflation – falling prices of goods and services – are rooted in the view that it is very costly. We test the historical link bet ween output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt. Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive. Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI ) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period. They are uniformly statistically insignificant except for the first post-peak year during the postwar era – where, however, deflation appears to usher in stronger output growth. By contrast, the link of both property and equity price deflations with output growth is always the expected one, and is consistently statistically significant. Conclusions The evidence from our long historical data set sheds new light on the costs of deflations. It raises questions about the prevailing view that goods and services price deflations, even if persistent, are always pernicious. It suggests that asset price deflations, and particularly house price deflations in the postwar era, have been more damaging. And it cautions against presuming that the interaction between debt and goods and services price deflation , as opposed to debt’s interaction with property price deflations, has played a significant role in past episodes of economic weakness. The exception to the general rule was the Great Depression but, that was also an asset bubble deflation coupled with consumer price deflation. Meanwhile central banks on every continent are worried about something they should welcome. Economic Challenge to Keynesians Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them. I have commented on this many times and have been vindicated not only by sound economic theory but also by actual historical examples. My January 20, post Deflation Bonanza! (And the Fool's Mission to Stop It) has a good synopsis. And my Challenge to Keynesians "Prove Rising Prices Provide an Overall Economic Benefit" has gone unanswered. There is no answer because history and logic both show that concerns over consumer price deflation are seriously misplaced. Worse yet, in their attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse, setting off what they should fear - asset bubble deflations following a buildup a bank credit on inflated assets. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
Euribor Goes Negative, Banks Paid to Borrow from Each Other; ECB Risks Freezing Repo Market Banks Paid to Borrow From Each Other Via massive QE purchases of bonds, ECB president Mario Draghi is flooding Europe with cash that European banks don't want and cannot use. One curious result of unwarranted QE is a negative interbank lending rate: Banks Paid to Borrow as Three-Month Euribor Drops Below Zero. Banks in the euro area can now get paid to look after each others’ cash for three months as the European Central Bank’s bond-buying program floods the region’s money markets with excess liquidity. The euro interbank offered rate, or Euribor, for that time period dropped to minus 0.001 percent on Tuesday, according to data from the European Money Markets Institute. That’s the first negative reading since Bloomberg started collecting the data at the end of 1998. The index represents the average rate at which the region’s banks say they see each other lending in euros for three months. Money-market rates have declined after several moves by the ECB. In June it introduced a negative deposit rate, meaning that commercial lenders were required to pay a fee to park their excess cash overnight with the Frankfurt-based institution. The ECB lowered the rate to minus 0.2 percent in September. Then in March this year the central bank started buying government bonds under a 1.1 trillion euro ($1.2 trillion) quantitative-easing program aimed at boosting growth and staving off deflation. “Excess liquidity keeps flowing into the system week by week because of the QE program,” said Nikolaos Panigirtzoglou, a strategist at JPMorgan Chase & Co. in London. “Banks find themselves inundated with deposits but they don’t want to pay the ECB for parking their money there. Instead they’d rather lend the cash in the interbank market.” “It’s good news for borrowers, not so good news for lenders,” O’Hagan, Paris-based head of European rates strategy at the French bank. “Mr. Draghi wants us to spend the cash, not keeping it in Euribor. The purpose of QE is to get us to take on some risk.” ECB Risks Freezing Repo Market An ICMA official says ECB Risks Freezing Repo Market. The European Central Bank (ECB) risks secured-lending or repo markets grinding to a halt unless it works more closely with national central banks (NCBs) to improve liquidity, a senior trade association official told Reuters. Godfried de Vidts, the chair of the International Capital Market Association's European Repo Committee, said unless the ECB took action within the next few months, investors might start avoiding euro zone bonds. "Investors could become reluctant to invest in euro zone debt," he said, noting that his committee had voiced its concerns to officials at the ECB. "We are scared about the market freezing," de Vidts said. In recent weeks, one 10-year Bund became so scarce that market players paid up to 2.5 percent to lend cash in exchange for the German bond, dealers said. De Vidts said the ECB's "securities lending" framework also relies too heavily on NCBs offering their own lending programs, and many of them have not yet put systems in place. NCBs are responsible for 80 percent of purchases under QE, with the ECB directly buying the remaining 20 percent in the roughly 7-trillion-euro euro zone government bond market. "We are driving without headlights in the dark," said de Vidts, proposing that the ECB centralizes the scheme in Frankfurt. "You are getting this scenario - which is a nightmare for the repo market – of a re-nationalization of a market that had developed to become European." Last week, ECB President Mario Draghi said the bank saw no evidence QE was creating a shortage of bonds, or that this might happen in the future. Come Hell or Frozen Water, Program Will Continue De Vidts believes excess liquidity might cause a freeze. On April 15, Mario Draghi made the claim "Stimulus is Working". "European Central Bank President Mario Draghi said the bank’s stimulus efforts are beginning to take hold in the European economy and batted away concerns in financial markets that the bank may have to end its more than €1 trillion ($1.1 trillion) asset purchase program early." If it's working, why wouldn't Draghi welcome ending the program early? Of course if it blows up in his face with unintended consequences, he may be forced to end it early. Either way, Draghi has put himself into a box that says he will continue his plan come hell or frozen water. The market may have something to say about that, perhaps sooner rather than later. Stunning Arrogance The arrogance of central bankers in spite of the fact they recently brought the world to the edge of financial collapse is stunning. Now they have created equity and junk bond bubbles of massive proportion and don't even see it. The program must continue. Why? Because we said so. All in the foolish belief they need to stop consumer prices from falling. Even the BIS recognizes the foolishness of the idea that falling consumer prices are damaging. For discussion, please see Historical Perspective on CPI Deflations: How Damaging are They? Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com