The Specter Of Deflation

For quite some time now I've been saying that the short term problem stemming from the financial crisis and the real estate collapse is deflation and not inflation. Massive amounts of wealth disappearing from stock markets and home prices is a massive deflationary pressure. Here in America, Helicopter Ben is printing money and selling US Treasury debt by the boatload, increasing the money supply and combating the trillions lost in deflationary wealth loss.

In Europe however, the problem is the opposite.

Prices in the 16-nation zone fell 0.1% in the past year, Eurostat said. The inflation rate had been 0% in May.

Inflation in the eurozone has been dragged down by lower energy and food prices, and by falling demand for goods from companies and households.

The European Central Bank's target rate for inflation is just below 2%.

Some analysts fear that this is the start of a period of deflation for the eurozone.

Deflation is considered damaging to an economy as consumers tend to delay making purchases until prices fall further. Without consumer spending to stimulate growth, economic output falls.

"There are plenty of reasons to believe that the annual decline of 0.1% in June is just the beginning of a downward trend," said Daniele Antonucci from Capital Economics.

"At this stage, we expect negative inflation rates for the next six months or so. With factory gate prices falling, wage growth likely to slow sharply and a big amount of spare capacity in the economy, core inflation will decelerate considerably."

This is terrible news, really. Deflation is far worse for an economy than inflation, and people tend to foget that strictly from a GDP standpoint, the Eurozone economy is the world's largest, bigger than even the United States.

That means the shape of the global economy will not be dictated by the pace of America's recovery, but by the pace of the Eurozone's recovery. And right now, it's looking like the Eurozone is headed straight down the tubes into multiple quarters of deflation. This will only serve to delay any real recovery in the global economy. The worst part is the European Central Bank's head, Jean-Claude Trichet, refuses to take any steps to fight deflation because he's too worried about inflation.

In other words, any improvement in the U.S. economy will be more than offset by the Eurozone's deflationary spiral.