RECOVERY? OR DEFLATION AND NEW FINANCIAL CRISES? +

Not only the global crisis persists, it seems far from over. The global economic power has again sounded the fanfare announcing the recovery of the world economy. This is the second time it does. The first time was in 2009 when, thanks to costly bailout programs implemented by central banks and governments, was achieved a relative stability of financial markets. However, on that occasion the European crisis stopped this uncanny triumphalism. Now and again, optimism lies in the recovery of the...

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Introduction
The global economic powers are once again hailing an economic recovery--the second time they have done so. The first time was in 2009, when, thanks to expensive bailout programs, a relative stability was achieved in the financial markets, and the stock markets began to rise. That time, however, the European crisis put a damper on the triumphalism. This time around, the optimism rests on the recovery of the U.S. economy, where to a certain extent growth has resumed and the unemployment rate has fallen, though neither has returned to its pre-crisis level. In its April 2014 report (IMF, 2014a), the International Monetary Fund (IMF) estimated U.S. economic growth of 2.8% and 3% for 2014 and 2015, respectively--exceeding the average of 2% for the preceding three years. At the same time, IMF managing director Christine Lagarde predicted a possible end to hard times: "This crisis still lingers. Yet, optimism is in the air: the deep freeze is behind, and the horizon is brighter. My great hope is that 2014 will prove momentous in another way--the year in which the 'seven weak years', economically speaking, slide into 'seven strong years' " (Lagarde, 2014).
The triumphalism of April was scaled back as early as July. The IMF reduced its latest projections of worldwide GDP from 3.6% to 3.4%, though it increased those for 2015 from 3.9% to 4.0%. Its prognosis for growth in the U.S. decreased more than a full percentage point, from the April estimate of 2.8% to 1.7% in July (IMF, 2014b). It attributed the diminished expectation of growth to the sharp first-quarter contraction in U.S. GDP (-2.1%) and to slowing growth in emerging countries. Nevertheless, it found cause for optimism: Financial conditions have eased since the April 2014 WEO was released. Long-term interest rates in advanced economies have declined further, in part reflecting expectations of a lower neutral policy rate over the medium term; indicators of expected price volatility have declined as well, and equity prices have strengthened. With euro area inflation in April below expectations, the European Central Bank cut its policy rate and deployed other easing measures at its June meeting. In this environment, capital flows to emerging market economies have recovered despite generally weaker activity, bond spreads for emerging market sovereigns have declined, and exchange rates and equity prices have stabilized or even strengthened in some of these economies. (IMF, 2014b) In my opinion, though it is true that financial markets have been more stable in 2014, than in 2013 when the Fed announced monetary normalization, the global crisis not only continues, but appears to be far from over. At this moment, two problems seem most important to me. One is the ongoing symptoms of a new recession in Europe, in spite of the weak recovery in some countries; the new European recession is determined by the maintenance of austerity programs and the reinforcement of deflationary trends. The other problem is the Fed's gradual withdrawal of monetary stimulus programs, the tightening of monetary policy planned for the middle of 2015, and the repercussions of these changes on emerging economies.
The United States and the European Union show conflicting economic signs. While the U.S. economy shows signs of recovery and the Fed is getting ready to end the monetary stimulus, deflationary trends are deepening in the European Union, and the ECB is moving ahead, if hesitantly, with the application of extraordinary stimulus measures. In this paper my objective is to offer some reflections on the development of these two contradictory realities. In the next part, I will examine the progress of the deflationary trends in Europe, and in Part 3, I will analyze programs of quantitative easing and their main effects. In Part 4, I will sketch out some ideas about the progress of monetary normalization in the U.S. and the risks implicit in this process. In the final section I will present some conclusions.

Deflation in Europe: A Real Threat
A specter is haunting Europe--the specter of deflation. In July 2014, consumer prices increased at an annualized rate of 0.4%, the lowest so far this year and comparable only to the 0.3% registered during the Great Recession of 2009. This rate is 1.6 percentage points lower than the 2% inflation goal fixed by the ECB. The rate of inflation has been decreasing steadily since 2011, when it closed the year at 2.7% .In fact, these aggregate data minimize the seriousness of the situation. The figures by country show that some (Greece, Portugal, Cyprus, Slovakia, and Bulgaria) are already experiencing deflation, and others (Spain, Switzerland, and Hungary) are on the verge of doing so. The decline in real estate prices in Spain and other countries that experienced a boom preceding the 2007 crisis has not yet ended (Figures 1 and 2).
The development of a deflationary threat would be a serious obstacle to any sustainable recovery in Europe and would change the course of the global crisis. As even Lagarde warns, "with inflation below the targets of many central banks, we see risks of deflation that would be disastrous for the recovery. If inflation is the genie, deflation is the ogre that must be fought decisively (Ibid)." The European deflation would not be the first nor the last example of generalized Deflation of financial assets was enormous in 2008-2009. In the period from January to November 2008 alone, the stock markets lost $17 trillion in value. In that period the stock indexes in developed countries fell 42.7% and those in emerging countries fell 54.7%.
Deflation in real-estate assets has been contained only through the enormous bailout programs implemented by the governments and central banks of the United States, the European Union, and Japan. Yet current deflationary trends in Europe are paradoxically related to these bailout programs, which were designed to avoid a depression and the deflation caused by the financial crisis of 2007-2008. The rescue of European banks drastically increased budget deficits and public debt in the countries of the European Union.
The private debts of monopoly-finance capital were socialized and converted into public debt (Guillén, 2012). The fiscal imbalances and levels of public debt with respect to GDP unleashed speculation in bonds of the European periphery and initiated a domino effect of insolvency in countries like Greece, Portugal, Ireland, Spain, and Cyprus. The European financial crisis, falsely attributed by mainstream opinion to excessive government spending, was followed by Latin American-style structural adjustment programs, with reductions in public spending, increases in regressive taxation, reductions in real wages (and unbelievably, virtually unprecedented cutbacks in nominal wages), dismantling of the welfare state, and privatization. In a word, it was "austerity" as a cure for imbalance, on the theory that once equilibrium was restored, economic recovery would be achieved.
The current deflationary trends in Europe are tied to two main factors: a double-dip recession (2008-2009 and 2012-13) that has still not clearly been overcome, and the contractionary policies of aggregate demand dictated by the "troika" and applied without much opposition by social democratic and right-wing governments alike. The structural adjustment programs have been a heavy weight on these governments. "The cuts in these structural deficits, a mix of tax increases and government spending cuts between 2010 and 2013, will be around 11.8 percent of potential GDP in Greece, 6.1 percent in Portugal, 3.5 percent in Spain, and 3.4 percent in Italy," notes Martin Wolf. Even those in the U.K., an outsider to the Eurozone, will be 4.3 percent of GDP (Wolf, 2013).
A generalized deflation would be catastrophic for Europe, with its high levels of debt.
Corporations and the financial sector have not managed to deleverage themselves as have those in the U.S., at least to a point. In spite of the cutting of budget deficits , public debt continues to grow (Table 2 and Figure 6). Public debt as a proportion of GDP grew from 66.4% in 2007 to 92.7%, more than 30 percentage points over the Maastricht criteria. In 2013, some countries exceeded 100%: Greece (175%), Italy (133%), Ireland (123.7%), Belgium (101%), and Cyprus (112%) ( Figure 5).
Deflation would put an end to any intent to reduce indebtedness and would plunge Europe and perhaps the world economy into a new recession (not just a "double dip"-but a triple dip). The reaction of the ECB to the new danger of deflation has been too little, too late. Its president, Mario Draghi, maintains that the observed slowing of inflation does not signify deflation, and that prices will rise as the recovery gains strength. However, in June of this year, the central bank decided to cut the reference rate to 0.15%, offer the banks a new program of cheap credit, and charge for the reserves that banks deposit with it--all with the purpose of reactivating credit. The Economist for August 4, although it celebrated the economic recovery, warned of the dangers of deflation: As in a complex film script, at least two storylines have been in play for the euro zone this year. One is brightly lit, featuring the revival of both consumer and business confidence, the return of investors to the troubled economies in peripheral Europe and the continuing recovery from the double-dip recession. The other is sombre, focusing on the weakness of that upturn, the onset of disturbingly low inflation and the continuing fragility of over-indebted economies and their banks. The past few days have brought a reminder that this second story is not yet fully told. (The Economist, 2014) One warning that the story is not yet over and that the financial situation remains precarious was the publicly-funded bailout of the Banco Espirito Santo, the leading bank in Portugal, which was overwhelmed with non-performing assets. 1 Another warning, this one in the productive sphere, was the announcement that Italy's GDP contracted at an annualized rate of -0.3% in the second quarter of 2014. Another worrying sign, though in a different part of the world, is the Japanese contraction in GDP in that same period: an annualized -6.9%. And along the same lines, the IMF warned in a recent report that "the recovery is weak and uneven. Inflation has been too low for too long, financial markets are still fragmented, and structural gaps persist: these hinder rebalancing and substantial reductions in debt and unemployment" (cited by The Guardian, 2014). It suggested that the central bank initiate a program of quantitative easing similar to that of the Fed.
Countering deflation in Europe will require increased stimulus programs and greater monetary relaxation on the part of the ECB, which would conflict with the "tapering" of the Fed's monetary normalization program, in which it has begun to reduce its purchase of bonds. It goes without saying that an increase in U.S. interest rates caused by the Fed's actions would have serious effects on the ability of European governments, corporations, and banks to service their debts.

Quantitative Easing in the U.S. and Its Effects
The U.S. economy shows moderate signs of recovery. After a sharp contraction of 2.1% in GDP in the first quarter of 2014, attributed to weather and seasonal factors, it rebounded in the second quarter, showing a growth of 4.2%. The unemployment rate has dropped in recent months, dipping to 6.2% in July. Job creation has averaged 230,000 jobs per month so far this year. However, in its July report the IMF lowered its growth to about 22%, and during the (approximately) seven months following the downfall of Lehman Brothers, it shot up to almost 55%. Thus, although the acceleration in the rate of expansion of the ECB's balance sheet was not as dramatic as that of the Fed's balance sheet, its time path was generally similar. . . (Cukierman, 2013: 3-4) At the start of 2014, the Fed's assets totaled more than $4 trillion, the ECB's €2 trillion, the Bank of Japan's ¥100 trillion, and the Bank of England's £400 billion (Figures 7-11).
There is no doubt that these programs of quantitative easing helped the exit from the Great Recession and prevented it from becoming a depression like that of the 1930s. But it is equally correct that the cost has been very high, and that they have not created the conditions for a sustained recovery. What have been the effects of this colossal injection of liquidity by the central banks? Orthodox economists are worried that QE will unleash an inflation that only they see on the horizon. But to our eyes there are serious omens, not of uncontrollable inflation, but of deflation.
One of the main problems with quantitative easing is that there has been no significant reactivation of credit and investment, in spite of interest rates that remain exceptionally low. Bernanke himself, evaluating the programs and their impact on credit, recognizes that "generally speaking, we are seeing expansions in bank lending in a lot of categories. . .
.Nevertheless, there are still scenarios where credit remains tight," and he cites the example of mortgages and credits to small and medium-sized businesses (Bernanke, 2013: 114).
The failure to reactivate credit is most evident in Europe. It is not surprising, given the persistence of an accumulation regime still dominated by finance, where high-risk operations remain highly attractive.
Corporations take advantage of low interest rates and issue bonds and other securities to refinance their debts, or take out credit to purchase their own stocks (buybacks) with the purpose of increasing share value, which in turn feeds the inflation of the stock indexes.
Banks freeze part of their resources as reserves in the vaults of the central banks, while the rest are only marginally directed at productive activity through the extension of credit. The major part of their resources is destined for the financial markets. Given that financial globalization remains untouchable, an important part of excess liquidity is directed to the financial markets of emerging countries through the practice of "carry trade." It is the logic of profit maximization of profits and not the needs of the productive base that determines the placement of resources. Financial profit continues to reign over other forms of appropriation of surplus value. As Stiglitz explains: In a world of globalization, money goes where the returns are highest--and not necessarily to the country increasing liquidity. Thus, some argue that the major impact of the increased liquidity by the Fed has been to increase demand in emerging markets (and perhaps to support asset price increases globally). . . . Why should an investor with access to funds invest them in the United States or Europe, where there is excess capacity and a long term slump, rather than in the high return booming emerging markets? (Stiglitz, 2013: 29) In the framework of QE programs, capital flows toward emerging countries have grown rapidly. According to data from the Institute of International Finance, private capital flows to these countries have doubled, from $623 billion in 2009 to $1.232 trillion in 2012 ( Figure 15). This has translated into stock market bubbles and currency appreciation. In the period January 2009-April 2013, stock markets showed an increase in value of 42% in Brazil, 74% in Chile, 102% in Turkey, 107% in India, 116% in Mexico, and 257% in Argentina. Currency overvaluation in emerging countries shares a large part of the responsibility for the clear slowing of economic activity observed since 2012 (Figures 12-14).

Monetary Normalization and Its Possible Effects
In May 2013, the president of the Federal Reserve, Ben Bernanke, announced that the Fed would begin a program of monetary normalization over the short term, through which it would gradually reduce and eliminate its purchase of bonds, and that once there was sustained economic recovery and the unemployment rate dropped below 6.5%, it would increase the interest rate on federal funds according to the specific conditions of the economy. Although Bernanke did not set a precise date to initiate tapering, the very announcement set off a disturbance in financial markets.
Tapering had its official beginning in December 2013. At that time it was decided to gradually decrease the purchase of bonds, which totaled then $85 billion per month. From that moment onward it would decrease by $10 billion per month, as long as the economy continued to improve. Currently, bond purchases are at $25 billion per month, and the program is expected to conclude in October 2014. The Fed's position is that it will maintain the federal funds rate at its current level for a "considerable time" after the end of tapering.
There are two opposing positions on the effects of tapering. The monetarist "hawks" believe that tapering must be accomplished in the shortest time possible and attention returned as soon as possible to the normal fixation on interest rates, because excess liquidity could provoke inflation. The "doves" believe that monetary normalization should not be rushed, because undue speed could interrupt the recovery.
In truth, inflation is not on the horizon, and gradual tapering will not produce either a recovery less lukewarm than the one we already have. That would be to attribute too much power and influence to monetary policy, which neither Marx nor Keynes would accept.
The principal danger, in my opinion, is that monetary normalization could create and actually are creating new focal points of financial fragility, especially in emerging countries. When the program was announced in May of last year, the interest rate on ten- year Treasury bonds increased significantly, from 1.76% in April to 2.90% in December Clearly, the turbulence in the financial markets has calmed during 2014. The interest rate on 10-year Treasury bonds has recovered somewhat since January 2014 ( Figure 16). Martin Werner reports that "the 10-year Treasury rate, adjusted for core inflation, is about 230 basis points below its 30-year average and the inflation-adjusted Fed funds rate is 320 basis points below" (Werner, 2014). However, no one can guarantee that the turbulence will not return, perhaps even stronger, in the future, particularly when the Fed begins to raise interest rates and the central banks begin to sell off their enormous quantity of bonds-presumably in mid-2015. 2 The economic recoveries in the U.S. and Europe are lukewarm and may not be sustainable. The real estate markets have not recovered. The majority of countries have inflated stock markets. European banks are fragile, and deflation is advancing. In sum, the global crisis continues and no doubt still has a long way to go.
2 In order to reduce the balance sheets of the Fed and avoid a collapse in bond prices, Bernanke proposes three methods: 1) pay interest on the reserve balances deposited with the Fed, which would discourage banks from expanding liquidity, during a phase in which interest rates would be increased; 2) "draining tools," which would consist of replacing reserve bonds with another type of obligation; and 3) wait for the bonds to mature or sell them on the market (Bernanke, 2013: 124)

Conclusions
The global crisis is far from over and its end is uncertain. Though the financial markets have shown greater stability in 2014, the recovery is weak in the U.S. Europe has not overcome its recession, and the emerging economies, including China, are slowing down.