The European Dilemma - Inflation Without Growth

Tuesday, November 08, 2005

Europe is in a dilemma. Whereas inflationary tendencies in the USA are accompanied by still very healthy growth numbers, the languishing Eurozone economy sees only light at the far end of the tunnel but feels inflationary pressures from high energy prices, now aggravated by the strong dollar; the currency in which oil and commodity bills have to be settled.
A parade of European central bankers has stepped up its warnings that the ECB is ready anytime to raise interest rates when needed. No sooner than they have stepped up their warnings they are drawing heavy flak from an impromptu army of European politicians who fear that a step on the rate brake might bring anemic growth, expected around 1% this year, to a complete standstill.
The ECB, already very lax in handling its mandate of price stability with inflation hovering above the target of 2% and money supply M3 growth almost double then the target rate of 4.5%, will have to move and it cannot be ruled out that they will not sit on their hands much longer. As the heating season is starting these days the ECB could be forced to get off the autopilot as soon as December after stayimg put since June 2003, the overnight rate at an unchanged 2% since then.
While the ECB stresses its independence one should not forget that the governing council that sets the interest rates is manned (no female CB chief yet) by the 12 central bank chairmen of the members of the Eurozone. Formally the majority of them is independent. But you don't become chairman without ties to the respective governments.
And Europe faces a string of difficult problems too. Record unemployment rates in the industrial powerhouses of the old continent, record consumer indebtedness, record company insolvencies, rising budget deficts well above the limit of 3% and real estate bubbles in a couple of countries will not become easier when the ECB would follow its strict mandate for price stability.
Don't get fooled by a few improving economic indicators. Only forward looking indicators appear to turn up while the hard numbers like inflation and economic growth paint a diffrent picture.
I have not come across a businessman in a while who said that his business outlook had improved. Companies that do dish up better profits do so mostly by layoffs and other saving efforts. But these efforts start a downward spiral at they spell problems for their suppliers and the people laid off. I doubt the newly unemployed can be counted on in reviving lacklustre growth.
As politics have a huge influence on business matters in Europe I can imagine that Europe's central bankers receive a string of incoming calls from business representatives these days, begging them not raise interest rates as this would stifle growth.
Somewhere I read recently that the gold price and inflation have a high correlation. Seeing gold hold up despite the surge in the greenback I am left with the conclusion that inflation is here to stay, no matter what we are officially told otherwise.

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