While in Europe over the Memorial Day weekend, where we celebrated the liberation of Holland and the D-Day landing at Normandy, I noticed many newspaper headlines bemoaning the specter of deflation hanging over the European economy.
In my opinion, recession, not deflation, is the problem. The price of gold in euros is bearing above its 10-year moving average, commodity prices are not falling and consumer prices remain above the European Union's target. Today, a euro's value relative to the dollar is $1.807. That is about the same as it was shortly after the euro's inception, when on Jan. 4, 1999, it set the record high against the dollar of $1.184.
Unfortunately, the threat facing the European economy stems not from deflation but from recession driven by bad governmental policies.
Tax rates are far too high, inflexible labor laws are counterproductive and the welfare state is stifling. Europe's economy did not grow in the first quarter of this year, and there is little evidence of revived growth.
In the United States, Washington and Wall Street are also abuzz with talk of deflation and the so-called deteriorating dollar.
In my opinion, deflation is not a problem today even though it was a severe problem between 1997 and 2001. During that time I tried to draw attention to the issue several times when deflation was causing enormous economic dislocations, both in the United States and abroad. In that time, the dollar appreciated by more than 45 percent, putting tremendous pressure on countries and industries with dollar-denominated debt. The recent 20 percent or so decline in the dollar's trade-weighted exchange rate since early 2002 is a sign that a readjustment is occurring that can help unwind many of the harmful effects of the previous episode of deflation induced by the Federal Reserve Board.
It is important to note that money is not intrinsic wealth; it is a unit of account, a measure of value. Imagine if the bureau of weights and measures changed the 12-inch ruler on a daily basis -- 13 inches one day and 11 inches the next -- but on average the bureau promised to keep it 12 inches in length. That would be preposterous. A currency is a measure of value. It cannot lengthen one day and shrink the next. And, it isn't sufficient that it retain a constant value "on average." "On average" you wouldn't have to wear a winter coat in either Buffalo, N.Y., or Green Bay, Wis.