FRANKFURT, Germany, Sept. 4 (UPI) -- One of Germany's top economists is warning the country's leading bankers that Europe, and the rest of the world, are in dire danger of following Japan into a deflationary depression -- far more serious and prolonged than a conventional recession.
"The people running the world's central banks and those responsible for economic policy should take the signs much more seriously," argues Norbert Walter, chief economist for Deutsche Bank, Germany's largest, in a paper made available exclusively to United Press International.
Walter, sunk in gloom after returning from a research trip to Asia, is circulating the paper in a bid to influence the world's financial leaders at the autumn meeting of the International Monetary Fund and World Bank in Washington at the end of the month.
Speaking in his Frankfurt office as the New York and European markets followed the plunge of the Tokyo stock market Tuesday, Walter warned, "If we don't get this right, we face a second leg of recession, a double-dip, combining with deflation."
The world last experienced deflation on a serious scale during the Great Depression of the 1930s. It is a condition when prices start falling, investors stop investing and companies and individuals still committed to paying off old loans go bankrupt because lower prices and lower wages give them no money to repay.
"Look at the facts," Walter said. "Japan has watched deflation over the past three years. Consumers and entrepreneurs in all areas are postponing purchase decisions. The other Asian giant, China (including Hong Kong), is also experiencing a decline in the price level.
"In the U.S., consumer price inflation is running at just barely 1 percent. As studies like the Boskin report have shown, the method of price measurement overestimates the actual price level by about one-half to a full percentage point. This means the price level in the U.S. is practically stable, and the augurs now speak of a double-dip, a second drop in economic activity."
"In Germany, prices at the consumer level are following the U.S. pattern almost down to the decimal point and domestic demand is even more sluggish, particularly in construction and retail sales. Wholesale prices are falling."
"Around the world, the indicators leave no room for talk of an upswing. The economy is in a downswing, as declining capacity utilization and increasing unemployment show. Recession cannot be ruled out, considering the multitude and seriousness of the trouble spots and potential risks to economic growth. To mention just a few -- the accounting scandals, the crisis in Latin America and the looming war with Iraq."
Walter's prescription is for a coordinated international stimulus to get the world economy moving again. But with interest rates so low, the Japanese and American central banks have little room to cut them further, and the European Central Bank has been deaf to earlier appeals to cut rates from their current 3.25 percent. That leaves only fiscal policy and tax cuts -- and deficit spending -- as a way to get money into consumers' hands again.
"The people at the top seem to be losing the sight of the big picture," he added. "Procyclical policy is being declared the only politically correct attitude. See Germany's response to the flood crisis -- postponing a badly needed tax cut, a reaction ill advised by its implications for both demand and supply-side.
"Heads of state are not economists, and their minds are currently busy with other things. The central bankers either lack the means or the conviction to cut interest rates. So it would seem appropriate if the IMF's experts assume the unassigned role of international policy coordinators."
As well as a coordinated international effort to boost the global economy through fiscal measures, Walter also sees a need for more international coordination to correct current exchange rates.
"The U.S. and above all Europe must help the Japanese out of the deflation spiral by supporting them in their efforts to lower the yen. Since the U.S., bearing in mind the current account deficit, can scarcely afford a significant effective appreciation of the dollar, the EU will have to permit its own currency to gain more strength. That signals a particular need to stimulate domestic demand by interest rate cuts. The best thing would be if Europe were to support this process with stimulatory fiscal policy."
But with Germany distracted by its election, the European Central Bank required by its statutes to fight any sign of inflation, and the straitjacket of the EU's Stability Pact requiring euro countries to cut their budget deficits, stimulus packages look politically unlikely. The stars are all aligned, fears the top economist of Germany's biggest bank, for a very dismal economic outlook.
