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Deflation Takes Hold in the Eurozone

September prices in Greece registered a 1% annual decline, and, according to Eurostat, the inflation rate in Latvia was also negative. The inflation rates in Denmark, Spain and Portugal are just above zero.

"Inflation across the euro zone fell to its lowest level in 3.5 years — just 1.1%. That was down from 1.3% a month earlier, and well below the ECB’s official target rate of 2%," according to an Oct. 23 article from the Wall Street Journal's Marketwatch.

The article adds that the real economic situation is even worse than what the headline numbers suggest. Here's an excerpt:

In Spain for example, a big hike in VAT, a form of sales tax, is still included in the figures. Strip that out, and inflation has fallen below zero. In Portugal, the rate is just a fraction over 0% once VAT is stripped out, and once you take out administered prices (that is, the cost of goods where the government impose limits on price rises and declines) it too is now an economy with falling prices.

In a healthy economy, deflation is nothing to really worry about — and much less than many economists assume. Stuff getting cheaper? What’s not to like about that? So long as your wages stay the same, or fall less than the price level, you are better off. The argument is sometimes advanced that it will deter people from shopping because they think prices will be lower in a few months’ time. But there are lots of industries where that is true — computers, cell phones and tablets get cheaper and better continuously, and most of us get used to it. We end buying the things we need even if we know we may get a better deal next month because we need them now. In the Victorian era, spells of deflation were common — and that didn’t exactly stop the economy from expanding.

But there are two situations were deflation spells big trouble — and unfortunately they both apply in the euro zone right now.

The first is where there are very high debt levels. Say a country has a gross domestic product of $100 billion, and debts of $100 billion. Deflation means GDP goes down to $90 billion, but nobody is really any better or worse off so long as wages have not fallen by more than that. But your debt is still $100 billion. The debt-to-GDP ratio has risen substantially, and you have less cash to service all that debt. Not good.

So how does the debt levels of those countries look? Terrible. Greece has total debts of 161% of GDP, the third highest in the world (Japan and Zimbabwe are ahead of it, in case you were wondering). Ireland, Italy, Portugal are all in the top 12 debtor nations, with debts of 118% of GDP to 126%. Spain is slightly better — but still on a punishing 85% debt-to-GDP ratio.

As they move into deflation, those debt burdens are just going to get worse and worse.

Read the entire article by clicking here.