The European Central Bank should worry less about the “phantom risk” of inflation and instead focus on the rising threat of deflation which could result from a currency war, economist Nouriel Roubini said in an article for Roubini Global Economics clients.
The ECB’s concerns over the threat of inflation in the euro zone are stifling the recovery of the euro-zone’s debt-battered periphery of Portugal, Italy, Ireland, Greece, and Spain (PIIGS),Roubini said.
Instead, the bank should consider further quantitative easing like its British and American counterparts.
“The stubborn ECB would rather kill any chance of the PIIGS recovery rather than consider further QE, which it finds unacceptable, citing the threat of a rise in inflation,” Roubini said.
“Deflation, not inflation, is the risk which plagues the PIIGS,” he added.
Roubini said currency tensions have reached a boiling point. Overspending countries need to reduce domestic demand to deleverage, while over-saving countries refuse to reduce their reliance on net exports, he said.
“This zero-sum game in currencies and net exports means one country’s gain is some other country’s loss, and a competitive devaluation war has ensued," Roubini said.
If China, emerging markets and other surplus countries keep their currencies from appreciating via intervention—preventing a rise in domestic inflation—the only way deficit countries can achieve depreciation is via a persistent deflation that will lead to a double-dip recession, Roubini said.
This problem is exacerbated for the PIIGS, which badly need a nominal and real depreciation of the euro, he said.
“Instead, the monetary policy of the ECB and the tight fiscal policy of Germany strengthens the euro and encourages more recessionary deflation in the PIIGS that are already slumping,” Roubini said.
He added that this deflationary dilemma was even worse for stagnating Japan, which faces more deflation and therefore needs a weaker yen, yet runs a large current account surplus which tends to lead to a stronger yen.
“This rise in the euro will soon cause massive pain to the PIIGS as their recessions will deepen and their sovereign risk will rise to a breaking point.”
Europe will need to intervene in the currency market, but this intervention will be “unlikely to stop the rise of the euro if — as likely — it would be sterilized and small scale,” Roubini said.