The ECB’s balance sheet has fallen from €3 trillion to under €2.3 trillion

Eurozone inflation has fallen to the lowest recorded under two key measures, raising the risk of a textbook deflation trap if recovery falters or there is an unexpected shock.

Core inflation – stripping out food and energy – fell to 0.7pc, lower than at any time following the Lehman crisis.

“It's lower than when the European Central Bank was forced to cut rates in November,” said David Owen from Jefferies Fixed Income.

“A large number of countries across the periphery are either in deflation already or very close, and this is spreading to France. The ECB will have to do quantitative easing in the end,” he said.

Almost 25pc of the items in the price basket have dropped over the last year, the clearest evidence to date that the deflation ‘virus’ is becoming lodged in the system.

Assume (1) that the Germans are not going to change their anti-inflation stance, and (b) the ECB has reached the limits of their liquidity operations.

 

What happens next?

 

Do the peripheral countries rebel and revert to domestic currencies as they fall into deflation, debt traps, and a shrinking GDP?

Well if Greece has not reverted back to the Drachma after what they have been through and are still going through, it would appear that the exit barrier is very high indeed. That exit barrier is the benefit of holding a currency which is appreciating in domestic purchasing power (for the periphery)

Or is the size of coercive state spending ground down remorselessly, until taxes can be lowered and room made for private enterprise to rebuild a restructured economy in its, rather than the public sectors, image? Perhaps legacy sovereign debt will be written off when the corner is turned and the wealth creating private sector replaces the public sector in Spain, Italy Greece and so forth.

Can German levels of market priced labour productivity be achieved by the periphery is the key question here.

The hottest car in Europe this year is not a BMW, a Benz or a Bentley. It is Renault’s low-cost brand, Dacia, born in Romania .
Dacia ’s sales through November are up 21.1 percent from a year ago, to more than 260,000 vehicles, according to the European Automobile Manufacturers’ Association report released Tuesday, well ahead of equal second-place finishers Mazda and Jaguar, each with 15.6 percent gains. Not bad for a brand that only reappeared in 2004.
With unemployment in the euro zone above 12 percent and economic uncertainty high, Dacia has found a foothold with prices as low as 7,700 euros, or about $10,600, taxes included, for its no-frills Logan sedan.
For someone used to driving a Mercedes or a BMW, a Dacia would be “awful,” Jens Schattner, an analyst with Macquarie in Frankfurt , said. “But if you just need to get from Point A to Point B, it’s simple, reliable technology, and you get a three-year warranty. It’s all you need.”
Dacia is one of the bright spots in the European market, which has undergone a wrenching contraction since the financial crisis. Auto sales rose slightly in November in Europe for the third straight month, according to auto registration data released on Tuesday by the association, but they are still headed for another year of declines. Sales were down 2.7 percent for the first 11 months of the year in the European Union compared with the same period in 2012.
Dacia ’s success, and the continuing strength of the luxury segment, reflect a bifurcated sector in which the extremes are doing well while much of the market in the middle stagnates. The brand has also been a boost to Renault’s bottom line as competitors have struggled with the downturn in Europe .
Renault bought Dacia in 1999, a rusting artifact of the Communist regime of Nicolae Ceausescu, who had started the Romanian car company in the 1960s with a stripped-down old Renault 12 design that the dictator declared was “good enough for the idiots.”
Louis Schweitzer, Renault’s former chairman and chief executive, recognized that mass-market cars made for the developed world could not be sold profitably in Europe’s emerging markets, so he sought to make Dacia a place to build a new car platform, called the M-zero (or M0), that would be economical, reliable and cost just €5,000.
While he did not meet his price target, his gamble paid off when Dacia successfully debuted in 2004, targeting buyers in Eastern Europe and Turkey. To the industry’s surprise, it also caught on in Western Europe, especially after the financial crisis hit: Dacia ’s European sales nearly doubled in 2009 from 2008 to more than 214,000 cars. Today it boasts a full range of pickup trucks, SUVs, and station wagons. Its newest model, the Dacia Duster crossover, starts at €11,900.
“Anyone can say we took advantage of the crisis,” said Arnaud Deboeuf, the Renault executive who oversees the company’s entry-level segment around the world. “But there’s been a change in buying attitudes in Europe ; people don’t want to spend so much money on a car now.”
Mr. Deboeuf said the experience gained by developing a low-cost car from scratch had been hugely beneficial. “You can’t offer a car to your customers at an aggressive price if you don’t put pressure on your engineers, on sales, marketing, to control and reduce costs,” he said.
Dacia spends little on marketing, and distribution costs are relatively small, because the cars are sold through existing Renault dealers. And there is no discounting.
A big part of keeping costs down is the fact that none of the Dacia models that are sold in Western Europe are made there. Renault’s investment in the decrepit business transformed the company and created thousands of new jobs in Romania . But even Romania may be getting too expensive for Renault to hold the line. In April, the company warned the 10,000 workers at its factory in Pitesti , about 70 miles northwest of Bucharest , that it would move some jobs to Morocco if they did not moderate their wage demands.  Carlos da Silva, an analyst at IHS Automotive, said that a key reason for Dacia’s success in Western Europe was that it had created a new class of customers, people who would previously “have bought a five-year-old car, but now they can get a new car for the same price.”  Renault has been careful to keep the brands separate in Europe, he noted, as Dacia ’s image is not as prestigious as the parent company’s. The danger now, he said, is that Dacia sales could eventually begin to cannibalize sales of Renault’s own lower-end vehicles, eating into profit margins. “It’s a tricky equation,” he said. While Dacia has been a boon for Renault in Europe, the M-zero platform on which it is based has been even bigger in non-European markets including Brazil and India , where the cars are sold under the Renault brand. That helped Renault last year to record more than half of its car sales outside of Europe for the first time. Mr. Deboeuf said that there were no plans to enter the United States and Chinese markets, but that Renault is aiming to introduce Renault-brand M-zero cars next in Indonesia .
Mr. Schattner said Dacia now “has a monopoly” on the entry-level market in Europe, and will likely hold it for at least three to five years, because its rivals have not decided how to respond. Though the Dacia brand’s reliability ratings are mixed, it performs modestly well in safety tests carried out by the European New Car Assessment Program, a consortium of governments and consumer groups.
Mr. Schattner estimated that Renault’s margin on profit before interest and taxes, a key metric of profitability, was around 8 percent across the M-zero cars worldwide. In terms of profitability, he said, that puts them “in good company, on a par with the German premium carmakers.”
That has not escaped the attention of rivals. Executives of Volkswagen, Europe ’s biggest carmaker, have said that plans for a low-cost VW brand would be revealed within the next year, assuming such a car could be produced profitably and to the company’s standards.
Dave Wright, who lives in Preston, about 30 miles north of Manchester, England, said that he bought a Dacia Duster for 12,995 pounds, or about $21,200, plus £495 for the metallic paint option, earlier this year because he was attracted by its “tried and trusted technology with no frills or superfluous gadgets.”
The first one he ordered had a steering problem and, after some frustrating encounters with customer service, was replaced by the dealer. “All is good after three months,” he said. “So long as this vehicle remains reliable,” Mr. Wright said, “I look forward to future Dacia models. I like the Dacia ethos, it fits in with my own mind-set. It’s simple no-nonsense value for money. A niche the big manufactures have failed to fill.”

The US President, has nominated former Bank of Israel Governor Stanley Fischer as vice chairman of the Federal Reserve.  He will take over from Janet Yellen, who becomes the first female chairman of the central bank when Ben Bernanke's term finishes at the end of the month.  The appointment comes as the central bank starts to withdraw its historic stimulus.  Mr Fischer is regarded as one of the world's most prominent monetary economists and has taught many top economist, including Mr Bernanke and European Central Bank President Mario Draghi.   "Stanley Fischer brings decades of leadership and expertise from various roles, including serving at the International Monetary Fund and the Bank of Israel," Mr Obama said in a statement.   "He is widely acknowledged as one of the world’s leading and most experienced economic policy minds and I’m grateful he has agreed to take on this new role and I am confident that he and Janet Yellen will make a great team."   As second-in-command at the International Monetary Fund from 1994-2001, Mr Fischer played a key role in battling the Asian financial crisis. Before that he was chief economist at the World Bank. Mr Fisher, who has both US and Israeli citizenship, was more recently was credited with helping Israel safely navigate the 2007-2009 financial crisis. He stepped down as governor of the Bank of Israel in June, three years into his second five-year term. Mark Carney, Bank of England Governor, said in a statement: "I am delighted by the prospect of Stan Fischer re-joining the global community of central bankers. I had the enormous privilege of working closely with him when Governor of the Bank of Canada and as chairman of the Financial Stability Board. I have found Stan to be an immense source of insight and wisdom on issues ranging from crisis management to the conduct of monetary policy and the reform of the global financial system."  Mr Obama also nominated Lael Brainard, who recently served as the Treasury Department's top official for international affairs, to serve on the Fed board and Fed Governor Jerome Powell to a new term on the board ending in 2028.

In the wake of years of a crisis that have shaken Europe to the core and raised existential questions, 2014 will bring a major shake-up in the political forces ascendant across the EU, in the people running things, in how the EU's rival institutions cope with and against one another.

Elections for the European parliament in May promise to be the most momentous ever held for the Strasbourg chamber. The angst of the elites across the continent is that the chamber will be captured by a motley crew of Europhobes dedicated to the destruction or subversion of the institution they have conquered.

As a result of years of austerity, soaring unemployment and the "renationalization" of European politics, anti-EU populists will do well in the elections, from Britain to Greece. France could be the big one, with Marine Le Pen's Front National tipped to win the election nationally.

The mavericks and populists will not win the election. But they could secure symbolic victories, take around 30% of seats, shape the agenda, cause the mainstream parties to trim their policies towards the far-right, and benefit from the perceived failings of lackluster leadership among the mainstream in Europe.

The fallout from the elections will also affect the next bout of horse-trading. October will see the appointment of a new European Commission, a new president of the European Council chairing EU summits and mediating between national leaders, and a new foreign policy chief.

There will be a battle between the new parliament and national leaders over who should make these key appointments and there will be the usual multi-dimensional scrapping over the plum jobs.

While these games preoccupy Brussels, Europe's real world is one of deepening social and economic impact from years of austerity and euro crisis, of the political costs of minimal growth, effective deflation, mass unemployment.

The British question will move up the agenda. Will the UK be the first country, and a big one, to quit the EU? This will concentrate continental minds.

Angela Merkel in Berlin, in the first year of her third term as German chancellor, is Europe's undisputed leader. The year should show if she really has an idea of what she wants her European legacy to be and whether she can get there. France's President François Hollande cuts an increasingly sorry figure on the European stage – he needs a new deal with Germany but there is little sign of that happening. French weakness and Italian messiness will reinforce the prevalent sense of worry about European decline.

Ian Traynor in Brussels

Capitalism covers a very wide range of systems, and is not the direct culprit for our problems. However, the way capitalism is implemented today is a big problem, it is undermining democracy and radicalizing large portions of the population. It will not end well, if this trend is allowed to persist.

Probably the single most harmful detail is the stock exchange. There are many other issues also, but shareholders in particular have been given the rights of owners, which is illogical, as they are in fact speculators. The owners should be the long term caretakers of corporations, with managers more interested in short term benefits. All shareholders care about is the short to mid term value of the stock, not the long term viability of the enterprise. To get the managers to play this game, they have given managers salaries that approach investor profits in scale. As a result, capitalism has gone bananas, not caring for long term viability, the communities they function in, the environment, the law, not even the customers .... share value is all that counts these days and no cost is too great to achieve it.

Democratic Capitalism need not be like this, it is just the default mode of operation it will slip into if left unattended. And this mode is bent on self-destruction, with a tendency to degenerate into Fascism or Communism ... if left to play out its natural course. If this is not to happen, the democratic part of Democratic Capitalism needs to be more pronounced...point / counterpoint...Capitalism works because entrepreneurs and managers figure out how customers, employees, suppliers, communities, and people with the money all can cooperate to benefit....No it doesn't.

• Capitalism works by creating profit. Where there is profit there is deficit.
• Capitalism works by making profit out of the exploitation of those who create that profit in the first place. This is why workers are not paid the actual value of what they produce, because the capitalist or entrepreneur cant make any profit out of that.
• Capitalism may not be perfect, yet it is the greatest system of social co-operation ever created thus far.

No it isn't, the greatest system of social co-operation is where everyone is equal and treated equally, that is true co-operation. Capitalism is exploitation of the masses for the benefit of the minority.

The slump in business lending has deepened, it has emerged, further sharpening the contrast with a surging mortgage market.

Companies took £4.7bn less in loans in November, the biggest drop in more than two years and nearly five times the recent average monthly decline of £1bn, according to figures from the Bank of England. The slide was due to a fall in lending to large businesses, as loans to small and medium-sized companies actually edged up slightly.

Economists are split over whether the decline is due to weak demand for bank finance or lenders’ reluctance to grant loans to business.

Howard Archer, chief UK economist at IHS, said the data suggested that banks “have yet to become markedly more prepared to lend to businesses amid the improved economic situation and outlook”. But Blerina Uruçi, economist at Barclays, believes businesses are unlikely to be held back by weak bank finance as the corporate sector has amassed a large cash surplus in recent years. Businesses are also increasingly turning to the bond market as a cheaper alternative.

Mark Carney, governor of the Bank of England, has redoubled efforts to boost business lending by making it the sole beneficiary of the Funding for Lending Scheme, which allows lenders to borrow at rock-bottom rates in exchange for providing loans. Previously, the scheme applied to all loans.

The global economy had another difficult year in 2013. The advanced economies' below-trend growth continued, with output rising at an average annual rate of about 1%, while many emerging markets experienced a slowdown to below-trend 4.8% growth.

After a year of subpar 2.9% global growth, what does 2014 hold in store for the world economy?

The good news is that economic performance will pick up modestly in both advanced economies and emerging markets.

The advanced economies, benefiting from a half-decade of painful private-sector deleveraging (households, banks, and non-financial firms), a smaller fiscal drag (with the exception of Japan), and maintenance of accommodative monetary policies, will grow at an annual pace closer to 1.9%.

Moreover, so-called tail risks (low-probability, high-impact shocks) will be less salient in 2014.

The threat, for example, of a eurozone implosion, another government shutdown or debt-ceiling fight in the US, a hard landing in China, or a war between Israel and Iran over nuclear proliferation, will be far more subdued.

Still, most advanced economies (the US, the eurozone, Japan, the UK, Australia, and Canada) will barely reach potential growth, or will remain below it.

Households, banks and some non-financial firms in most advanced economies remain saddled with high debt ratios, implying continued deleveraging.

High budget deficits and public debt burdens will force governments to continue painful fiscal adjustment. And an abundance of policy and regulatory uncertainties will keep private investment spending in check.

The outlook for 2014 is dampened by longer-term constraints as well. Indeed, there is a looming risk of secular stagnation in many advanced economies, owing to the adverse effect on productivity growth of years of underinvestment in human and physical capital.

And the structural reforms that these economies need to boost their potential growth will be implemented too slowly.

While the eurozone's tail risks are lower, its fundamental problems remain unresolved: low potential growth; high unemployment; high and rising levels of public debt; loss of competitiveness and slow reduction of unit labour costs (which a strong euro does not help); and extremely tight credit rationing, owing to banks' ongoing deleveraging.

Meanwhile, progress toward a banking union will be slow, while no steps will be taken toward establishing a fiscal union, even as austerity fatigue and political risks in the eurozone's periphery grow.

In Japan, prime minister Shinzo Abe's government has made significant headway in overcoming almost two decades of deflation, thanks to monetary easing and fiscal expansion.

The main uncertainties stem from the coming increase in the consumption tax and slow implementation of the third "arrow" of Abenomics, namely structural reforms and trade liberalisation.

In the US, economic performance in 2014 will benefit from the shale energy revolution, improvement in the labour and housing markets and the "reshoring" of manufacturing.

The downside risks result from: political gridlock in Congress (particularly given the upcoming midterm election in November), which will continue to limit progress on long-term fiscal consolidation; a lack of clarity about the Federal Reserve's planned exit from quantitative easing (QE) and zero policy rates; and regulatory uncertainties.

Emerging markets' difficult year in 2013 reflected several factors, including China's economic slowdown, the end of the commodity super cycle, and a fall in potential growth, owing to delays in launching structural reforms.

Moreover, several major emerging economies were hit hard in the spring and summer, after the Fed's signal of a forthcoming exit from QE triggered a capital flow reversal, exposing vulnerabilities stemming from loose monetary, fiscal, and credit policies in the boom years of cheap money and abundant inflows.

Emerging economies will grow faster in 2014 – closer to 5% year on year – for several reasons. Brisker recovery in advanced economies will boost imports from emerging markets.

The Fed's exit from QE will be slow, keeping interest rates low. Policy reforms in China will attenuate the risk of a hard landing.

And, with many emerging markets still urbanising and industrialising, their rising middle classes will consume more goods and services.

Still, some emerging markets – namely, India, Indonesia, Brazil, Turkey, South Africa, Hungary, Ukraine, Argentina, and Venezuela – will remain fragile in 2014, owing to large external and fiscal deficits, slowing growth, below target inflation and election-related political tensions.

Some of these countries – for example, Indonesia – have recently undertaken more policy adjustment and will be subject to lower risks, though their growth and asset markets remain vulnerable to policy and political uncertainties and potential external shocks.

The better-performing emerging markets are those with fewer macroeconomic, policy and financial weaknesses: South Korea, the Philippines, Malaysia and other Asian industrial exporters; Poland and the Czech Republic in Europe; Chile, Colombia, Peru and Mexico in Latin America; Kenya, Rwanda and a few other economies in sub-Saharan Africa; and the Gulf oil-exporting countries.

Finally, China will maintain an annual growth rate above 7% in 2014. But, despite the reforms set out by the Communist party's central committee, the shift in China's growth model from fixed investment toward private consumption will occur too slowly.

Many vested interests, including local governments and state-owned enterprises, are resisting change; a huge volume of private and public debt will go sour; and the country's leadership is divided on how quickly reforms should be implemented.

So, while China will avoid a hard landing in 2014, its medium-term prospects remain worrisome.

In sum, the global economy will grow faster in 2014, while tail risks will be lower.

But, with the possible exception of the US, growth will remain anaemic in most advanced economies, and emerging-market fragility – including China's uncertain efforts at economic rebalancing – could become a drag on global growth in subsequent years.