The spectre of deflation

The huge fall in energy and other commodity prices towards the end of 2014 has driven the overall rate of inflation of prices of all commodities down. Combined with faster growth in GDP and employment in the US, this suggests a more optimistic scenario for capitalism in 2015. Lower gasoline prices means that American and other households can spend more money on other goods and so boost demand.

At least, that is the argument of the optimists among the mainstream. This argument was recently well presented by Gavyn Davies, former chief economist of Goldman Sachs and now a columnist for the FT (

As he put it: “After several years in which inadequate demand has seriously constrained activity in the global economy, causing repeated downgrades to growth forecasts, 2015 should see an improvement. Lower oil prices and a more demand-friendly fiscal/monetary policy mix should result in faster growth in aggregate demand. ….This will be a year in which excess capacity in the global economy will start to be absorbed.”

Davies pins this forecast on the apparent pick-up in demand and employment in the US. With ‘potential’ long-term growth in the US fixed at about 1.7%, Davies expects the US economy to grow some way above that in 2015. He recognises that the Eurozone and Japan are struggling to avoid a new recession, but hopes the European Central Bank (ECB) will introduce quantitative easing although “It is very doubtful whether this will be enough to restore inflation expectations fully to the ECB’s target, considering that headline inflation will dip to zero as oil price effects feed through the system”.  Nevertheless, real GDP growth should improve in 2015. As for the emerging economies, China may be slowing down but will still manage 6-7% a year, so that overall global growth would reach 3%, up from 2014.

Well, all I can say about this forecast is that is full of holes. Just 3% global real GDP growth in 2015 – hardly a boom! And that depends on China not slowing down, Europe and Japan avoiding a deflationary depression and the US continuing to accelerate as consumers spend more from the extra income they get from falling gasoline prices.

When we consider the evidence of the first week or so of economic data around the world, it is not encouraging for Davies’ assessment. Take Germany, the only powerhouse of growth in the Eurozone. Factory orders there fell 2.4% in November, much more than expected. Germany factory output was also much weaker than economists had forecast in November, falling by 0.1% from the previous month. It is now falling by 0.5% yoy.

UK industrial production and construction output also unexpectedly contracted in November, falling 2% month-on-month, a bad miss from expectations for a rebound after October’s shrinkage. Construction output is up 3.6% yoy, – well short of hopes for a 6.7% reading. That’s a sign that the driver of UK growth in 2014, the property boom, is coming to an end. French industrial production also fell last November last year by 0.3% after a fall of 0.8% mom in October.

The US economy is now the global growth driver. Last year, its real GDP rose in absolute terms more than any other economy, including China. It contributed 18% of global real GDP growth, more than any other.  But will US growth be enough to stimulate the rest of the world?  Well, the latest figures of factory goods orders were not promising.  In November, they fell 0.7% so that the year-on year figure was down 1% compared to a rise of 2.1% in October.

The US jobs figures for December came out last Friday. The headline figure of 252k looked pretty good and in 2014, the number of jobs rose more in any year since 1999. The unemployment rate ended the year at 5.6%, the lowest since the Great Recession. But when compared to those of working age, the share of Americans with jobs or actively seeking employment fell back to a three-decade low of 62.7% in December.

US labour participation

And the level of long-term unemployed remains well above that before the Great Recession.

US long term unemployment

But most important, average hourly earnings rose only 2.3% in 2014. By comparison, wages for those workers advanced 3.7% in 1999, after growing 4% in 1998. So more jobs has not produced better pay and higher real incomes from work. Indeed, in November, hourly earnings for private sector employees fell by five cents to $24.57—marking the largest monthly decrease since at least 2006. What seems to be happening is that those getting jobs are doing so in low-paid sectors like retailing and in part-time holiday work. These ‘entry-level’ workers get paid less.

US hourly earnings

However, hours worked in a week for those working has reached a post-recession high, so weekly earnings recovered. In sum, employment is better, but pays less, so people are managing by working longer hours if they can get them.

And worldwide, the latest economic activity indexes suggest a slowdown, not an acceleration. In the graph below I have constructed a composite index of national business activity indexes (PMIs).  I find that developed capitalist economies (DE) are still expanding (above 50), but at a much slower rate than last summer, while emerging economies (including China) are not accelerating. So the world economy (green line) is in a lower gear than a year ago.

PMI December

While Gavyn Davies may be optimistic about global economic growth in 2015 because of ‘higher’ demand, Tim Adam, the president of the Institute of International Finance–a group that represents the world’s largest banks, pension funds and insurance companies is much less so: “The question is, can a wealth effect in a liquidity-juiced U.S. economy provide the engine of growth for the global economy… One could have a fairly pessimistic outlook on global growth if you take all these things into consideration.”

The slowdown in most economies combined with the sharp fall in energy prices has raised the spectre of deflation in the major capitalist economies for the first time since the Great Depression of the 1930s. In December, the Eurozone fell into deflation for the first time in more than five years. Japan is nearly back there and US and UK annual inflation rates are well under central bank targets of 2% a year.

Global inflation

The Economist magazine is worried ( As the magazine explains: “The drop in oil prices is in part due to higher supply, but it is also the product of slowing growth around the world. China’s slackened appetite for raw materials has hit emerging-market commodity suppliers particularly hard. And an energy-induced drop in prices, though good for consumer purchasing power, risks reinforcing expectations of lower inflation overall; it is part of the threat’s pernicious nature that such expectations easily become self-fulfilling.”

While lower prices may benefit average households in reducing their energy bills so that they can spend more on other things, it puts downward pressure on the profitability of capitalist production. This might inspire the introduction of new technology to lower costs. But there is little sign of that at present in the major capitalist economies. The energy producers are cutting back on investment globally (some 40% of total capital investment), but other sectors are not compensating.

On the contrary, most capitalist firms are continuing to try and boost profitability through raising profit margins by holding down wages. A recent staff paper by the Federal Reserve Bank of San Francisco argued ‘wage stickiness’ had hampered American firms’ ability to adjust costs during the Great Recession ( The paper argues that wage rates stayed up ‘too much’, so firms would rather not raise wages now in the recovery. Now if sales demand and price rises should slow again, there could be a ‘pent-up’ demand to cut more jobs. So the improvement in the US jobs market could grind to a halt.

The other problem with low inflation and/or deflation is that the real value of existing debt owed by firms and households rises and if the Fed goes ahead with its plan to raise interest rates later this year, then the cost of servicing that debt will rise, hitting the ability of companies to invest and households to spend.  Since the financial crisis struck in 2008 the world has become more leveraged; total public and private debt reached 272% of developed-world GDP in 2013, according to a report put out under the aegis of the Geneva Reports on the World Economy (see my post,

The European Central Bank will shortly announce a new round of credit injections or quantitative easing designed to provide the banks and big corporations with virtually free money to invest or spend. So far, QE in Japan, Europe and even the US has failed to convince as a weapon to avoid slow or deflating economies. The spectre of deflation remains.

8 thoughts on “The spectre of deflation

  1. “Well, all I can say about this forecast is that is full of holes. Just 3% global real GDP growth in 2015 – hardly a boom!”.

    Who said boom, not the author. It’s likely to be neither boom nor bust, that’s the current period.

  2. ECB must be getting desperate to launch full QE to fight EZ deflation but Syriza has complicated things for them.

  3. I can’t seem to comprehend how the US economy has allegedly grown more in absolute terms than the Chinese economy. Since the Chinese economy is well over half of the US economy in absolute nominal terms, and the Chinese rate of economic growth is around three times faster than the US rate of growth, it is simply a mathematical impossibility that the US economy grew more than the Chinese economy in 2014. The US economy is around 17 trillion dollars (in my opinion, a highly dubious way of calculating economic output) while the Chinese economy is around 11 trillion dollars. In PPP terms, or far more importantly, in industrial production terms, the Chinese economy now dwarves the US equivalent. In any case, last year, the US economy grew somewhere around 2.5%, while the Chinese equivalent grew at more than 7%. So China still comfortably is the global economic growth engine bar none.

    Another issue that the article above fails to notice is a ramifications of the global oil market. While there has been much celebration in the Western mainstream media over the collapse in the price of oil, it is in fact Western oil interests that will prove the losers out of this brief oil price collapse.

    Russian and Middle East oil production is extremely cheap, as it is based on giant onshore conventional oil fields that are extremely easy to extract oil from. This is not the case with oil production in the rest of the planet. African and Latin American offshore oil drilling is extremely expensive. The same applies for UK North Sea production, and Norwegian production as well (both in irreversible long-term decline)

    As for North American oil production (exclusively responsible for the current glut on the global market) that is exceedingly expensive and non viable in the long term. US shale producers were indeed losing money when oil was at 100 dollars per barrel. One can only imagine what they are losing now. It is only a matter of months (a year at the maximum) before the entire US shale industry collapses. Canadian tar sands production is also extremely marginal and will be also negatively affected by the current slump in oil prices (even though it will take a bit longer for Canadian production to collapse in relation to US shale)

    Canada is extremely dependent on oil exports for its prosperity and will suffer accordingly. Canada is also a custodian of a colossal housing bubble that will inevitably pop under the current negative scenario. To cut a long story short, without the tar sands oil boom, Canada would have seen no growth in the last decade or so.

    In the US case, something similar can also be said. The shale boom has significantly reduced the US trade deficit (which was gargantuan before) and has also been virtually the only bright spot in the US economy since the Great Recession.

    1. If we look at private consumption only, then US private consumption is about 67% of GDP or $11.4trn or more than China’s GDP. China’s private consumption is half that at around 35% of GDP, so about $3.8trn. If US private consumption rises about 2.5%, that’s $285bn and China’s rises by 7%, that’s $260bn. But you are right of course, it we look at GDP: US grew by $400bn and China by $770bn, much more, contributing 30% of world nominal GDP growth in 2014. That’s because China’s investment rate is huge at around 40% while the US is only 15%.

  4. Just a detail, Mike, but not really a niggle, if we see things in a Marxist perspective. You write: “In sum, employment is better, but pays less, so people are managing by working longer hours if they can get them.”
    When you write “people” you remove the class perspective. These are not just people in general, of course, but they are members of the working class, workers, proletarians who only have their labour power to sell and make a living from.
    So you distance your own argument from Marxism by your choice of words, at the same time as you obviously don’t want this to happen. Focus is all.
    It’s a bit like the huge sucking in of poor peasants and landless people displaced from the countryside into the swollen cities of non-developed countries being called “urbanization”. This tells us next to nothing, whereas “proletarianization” tells us exactly what’s happening and gives us all kinds of leads as to who is involved and why and what possible political actions might provide a solution.

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