Monday, July 23, 2012

Greece’s Grinding Deflation: A Precedent for Spain and Italy?

The Lehmann Letter (SM)

Stocks opened lower today because of fears regarding Spain’s economy.

Will Spain go the way of Greece?

A July 20 article in The Wall Street Journal discusses the circumstances that led to Greece's grinding deflation.

This article serves as an excellent case study of the cost-dilemma facing Europe's southern periphery: Spain, Italy and Greece.

“Greeks Brace for More Pain on Wages”

Here are some key excerpts, beginning with Greece's entry into the euro zone and the inflationary process that boosted wages to uncompetitive levels.

“Money was flooding into Greece's economy, spurred by European Central Bank interest rates that were suited to a stagnant Germany but were too low for fast-growing parts of the euro-zone periphery. Banks and bond markets lent freely to the periphery, believing the risks were equally low everywhere in the currency zone.

"In Spain, Portugal and Ireland, the private sector went on a borrowing spree. In Greece, a public sector rife with waste and patronage was the main conduit of the credit bubble. The effect was similar: Inflated demand for goods and services sucked in imports while pushing up domestic prices and business costs. The trade deficit soared as the whole country spent more than it earned, requiring more foreign credit to cover the gap.”

The remaining excerpts describe Greece’s struggle to reduce its wages to regain competitiveness with other European economies.

“Greece, like other euro members that now need financial help, struggled to compete in the European and global economies as cheap credit and structural problems inflated prices and wages faster than its palette of products could justify. Now, lacking a national currency that can depreciate to make its goods cheaper in foreign markets, it must embark on a grinding "internal devaluation," pushing down its wages and prices….

“Greece, Spain, Portugal and Italy all face the same arduous route to recovery… They must push down wages and prices at the same time as they labor to pay down heavy public or private debts….

“In February, Greece's main creditors, the International Monetary Fund and the European Union, forced the government to cut the national minimum wage by 22%—32% for young workers—and made sector-specific pay deals between unions and private employers expire faster….

“Wages in much of Greece's economy have already fallen some since the country's recession began in late 2008. But the EU and the IMF say internal devaluation has a long way to go before Greece is competitive enough internationally to begin an export-led recovery.

“Estimates vary on how much prices need to fall in the euro-zone periphery, relative to the core economies. Economists say Greece and Portugal face the biggest challenge, while Spain and Italy need smaller but still painful adjustments.

“The EU-IMF bailout program for Greece seeks to cut labor costs by 15% in the next three years. A recent report by economists at Goldman Sachs says that, without major structural reforms, Greece would need an internal devaluation of nearly 30% to turn around its trade balance and end its dependence on foreign borrowing.”

Greece has a bitter pill to swallow. It may be a foretaste of what awaits Spain and Italy.

(Summer season: The Lehmann Letter will be in summer-vacation mode during July and August.)

(To be fully informed visit

© 2012 Michael B. Lehmann

No comments: