Mish uncharacteristically omits to connect one important pair of dots while citing more support for the deflationary scenario:
Eastern Europe, Spain and Ireland are now all experiencing the beginning of deflation. We believe that we will see much more deflation to come, which will have broad ramifications across the European banking sector. The periphery countries are net debtors, and the rest of Europe is the net creditor. When a debtor can’t pay, the creditor suffers. Germany, France and others will need to cope with recapitalizing the periphery and Spain. In the words of Plautus, “I am a rich man as long as I don’t pay my creditors.” A deflationary spiral means that most of the debt will need to be written off, and the creditors will have to absorb the losses.
Spain is not the only country facing deflation. It is a problem for the entire European periphery. Ireland, for example, has the highest rate of deflation in the world. Prices in Ireland are falling at an annual rate of 5.9%, well ahead of the drops in other countries – only Thailand, at 4.4%, comes even close.
That important question is: what did Spain, Ireland, and Eastern Europe all have in common. The answer, unfortunately for the green shoots-spotting crowd in the USA, is “housing booms”. As crazy as the US housing bubble was, the Spanish, Irish, UK, and Estonian bubbles were all even more out of hand. Germany, France, and Austria, on the other hand, saw no bubbles and therefore should be relatively well-positioned to the extent that they are not exposed to the deleveraging taking place elsewhere.