The US Federal Reserve’s battle against deflation could lead to the further demise of Japan and Germany.

The world’s three largest economies are facing a deflationary spiral. Japan has done so for more than a decade as falling prices, output profits and employment appear to be entrenched and government is offering no options, the recent $17bn rescue of Resona Bank notwithstanding. Germany also suffers from a weak economy (growth is expected to be revised to below 0.5% this year after contracting 0.2% in the first quarter), a growing output gap and high unemployment with limited policy options. And then inflation in the US dropped to a 37-year low in April to below 2%.

This cocktail comes amidst a huge weakening of the dollar, 29% against the euro since its peak in 2000 and much of it this year. And the US appears to have relaxed its strong dollar policy fuelling further strength in the euro and undermining eurozone exports, growth and inflation.

Will the US handle the struggle against deflation better than Japan and Germany? US Federal Reserve chairman Alan Greenspan describes the threat as minor but like Japan his supply of monetary ammunition or ability to cut interest rates, that are rapidly approaching zero, is limited.

A recent IMF study on deflation acknowledges the increasing vulnerability facing a number of countries with Japan top of the list followed in Asia by Hong Kong and Taiwan. The score for the US indicates a relatively low risk of deflation but there are considerable uncertainties with regard to the effects of equity price declines still in the pipeline, excess capacity in several major sectors and the impact of security and geopolitical concerns.

If Greenspan and the IMF are to be believed the US has the financial muscle and flexibility to avoid any downward spiral and, if necessary, the dollar could depreciate further thereby boosting prices, exports and corporate profits. But the US’ survival could severely damage others and possibly lead to Germany and Japan’s deflationary demise. The threat of deflation is very much alive.

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