George Soros on EU Deflation

This is an interesting article that includes some comments from a recent speech by George Soros:

Eddings, Cordell, Liedtka, Dave, 2010. Soros says germany threatens europe with 'deflationary spiral.' Bloomberg News, Oct. 5.

From the article:

"In May, the European Union offered a 750 billion euro ($1 trillion) rescue fund for Greece and other peripheral members of the region to help address concerns about sovereign default. The loan package imposed budget rules on distressed euro-area members. Governments in Spain, Italy and Portugal have all pledged to step up deficit-cutting efforts."

"However 'deficit reduction by a creditor country such as Germany is in direct contradiction of the lessons learned from the Great Depression of the 1930s,' the 80-year-old Soros said in prepared remarks for a speech at Columbia University. When both creditor and debtor countries reduce their deficits amid high unemployment they 'set in motion a deflationary spiral in debtor countries. It is liable to push Europe into a period of prolonged stagnation or worse.'"

In conjunction with the increased probability for deflation in the US and the ongoing deflation experienced by Japan, the mention that the EU might experience the same risks is concerning for future global economic growth. Deflation is one of the worst things that can happen to an economy.

It is because of the risks of deflation that central banks are pumping unprecedented amounts of money into the global financial system through quantitative easing. This practice is a race to devalue currency in the hope of preserving export trade especially for countries like China, Japan, and Germany.

One could argue that the general economic malaise is responsible for the central bank currency moves, however, a contributing factor is the policy of pegging the Chinese Yuan. Many suspect that pegging the Yuan has led to the upward pressure on the Yen, which in turn provoked the response of the Japanese central bank to do quantitative easing. This is a classic case of interfering with market forces to the long-term detriment of economic growth.

I do not think there is any question the Fed will do quantitative easing in an effort to ensure US economic growth for 2011.

It is not clear to me exactly how quantitative easing will affect the profits for specific companies, the main determinant of stock prices. As such, the recent rise in stock prices is probably based on unfounded speculation. Quantitative easing will cause some corporate profits to increase, however, I do not think anyone knows the specific stocks affected.

Even after near total financial collapse in 2008, there continues to be significant speculation in stocks. Perhaps another correction during the end of 2010 will remedy this situation.

In conclusion, Mr. Soros makes an interesting observation about the US policies:

"'There are times like the present when we cannot count on the private sector to employ the available resources,' he said. 'I do not believe that monetary policy can be successfully substituted for fiscal policy. Quantitative easing is more likely to stimulate corporations to devour each other than to create employment.'”

Creation of even larger corporations is not what the US needs for long-term economic growth. Larger corporations have more pricing power and tend to innovate less.

Mr. Soros might be correct on the ill effects of quantitative easing!