Ambrose Evans-Pritchard looking as usual at the global picture sees problems getting worse.
Not a pleasing prospect
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16.7.09
World Bank warns of deflation spiral
The World Bank has given warning that global economy will fall into a "deflationary spiral" unless urgent action is taken to reduce high levels of excess capacity in industry.
By Ambrose Evans-Pritchard
Justin Lin, the bank’s chief economist, said factories running idle around world threaten to trap economies in a vicious cycle, risking further spasms of financial stress, requiring yet more rescue packages.
"Significant excess capacity has been built up and unless this issue is addressed, we will face a deflationary spiral and the crisis will become protracted," he told an audience in Cape Town.
Mr Lin said capacity use had fallen to 72pc in Germany, 69pc in the US, 65pc in Japan, and as low as 50pc in some developing countries, mostly touching lows not seen in modern times.
The traditional cure for countries caught in slumps is to claw their way back to health through devaluation, but this cannot be done today because the crisis is global. "No country can count on currency depreciation and exports as a way out of recession. Unless we deal with excess capacity, it will wreak havoc on all countries. There is urgent need for global, co-ordinated fiscal stimulus," he said.
Investments should be focused on infrastructure in poor countries that are bearing the brunt of the crisis. The downturn is already likely to trap over 50m more people in extreme poverty this year.
Mr Lin said some $30 trillion has been wiped off global stock markets and a further $4 trillion off US house prices, creating powerful deflationary headwinds. While emergency measures have eased the financial crisis, they have not stopped it turning into a deeper "real economy" crisis entailing mass lay-offs.
The comments came as the Bank of Japan agreed to extend its quantitative easing (QE) policies – mostly the purchase of corporate debt – and warned that business investment is "declining sharply". Headline inflation has dropped to minus 1.1pc.
Michael Taylor at Lombard Street Research said Japan has been too timid, repeating the error of its Lost Decade when it failed to carry out QE on a sufficient scale.
"Japan is already back in deflation, and it is here to stay. This year the economy will shrink by around 7pc, dramatically increasing the output gap and intensifying deflationary pressures. Cash earnings are down 3pc in the last year,"
The Bank of Japan downgraded its growth forecast, predicting that the economy will contract 3.4pc in the fiscal year to next March. This follows a catastrophic fall in output at a 14.2pc an annual rate in the first quarter, the worst ever recorded.
While industrial output has bounced over the summer, there are concerns that it may have been flattered by an "inventory rebound" as companies rebuild stocks.
Eurostat confirmed on Wednesday that the eurozone has slipped into deflation. Prices fell 0.1pc in June.
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