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Friday, October 31, 2008

German Retail Sales Fall Again In September

German retail sales fell more than many economists expected in September as the financial crisis continued to discourage people from spending. Sales, adjusted for inflation and seasonal swings, dropped 2.3 percent from August, when they rose 1.9 percent. That's the biggest decline since May 2007.
According to provisional results of the Federal Statistical Office (Destatis), turnover in retail trade in Germany in September 2008 was in nominal terms 4.1% and in real terms 1.2% larger than that in the corresponding month of the previous year. The number of days open for sale was 26 in September 2008 and 25 in September 2007. When adjusted for calendar and seasonal variations (CENSUS-X-12-ARIMA), the September turnover was in nominal terms 2.5% and in real terms 2.3% smaller than that of the preceding month. Compared with the corresponding period of the previous year, retail turnover was in the first nine months 2008 in nominal terms 2.4% larger and in real terms 0.5% smaller.
Federal Statistics Office

And there is almost certainly worse to come, since slaes continued to fall in Germany in October, according to the Markit economics purchasing managers index (out yesterday), although not as rapidly as in September. The monthly sales index rose to 46.7, up from 44.6 in September.

The German government recently slashed its growth forecast for next year to just 0.2 percent. Last year, the economy expanded 2.5 percent. Merkel said this week her government will announce a package of "targeted, bold and sustainable'' measures in an attempt to boost the now severely flagging economy.

The Decline In Eurozone Retail Sales Gathers Momentum

The latest Bloomberg Euro-Zone Retail Purchasing Managers' Index, which is based on a mid-month survey of economic conditions in the euro area retail sector, fell from 46.2 in September to 44.3 in October, signaling a drop in euro-zone retail sales for the fifth consecutive month and one of the steepest declines recorded since the survey began five years ago.

The PMI, which provides data one month ahead of government-issued figures, based on a survey of more than 1,000 retail executives in Germany, France and Italy, showed that retailers cut employment at the fastest rate for four years in the face of falling sales and deteriorating profit margins. Also evident was a further easing of price pressures in the retail sector.

Sales fell in Germany, France and Italy as retailers reported the adverse effects of the global financial market turmoil, rising job market insecurity and stretched household budgets:

Italy saw the steepest drop in retail sales of the three countries covered. The rate of decline picked up sharply during the month with the month-on-month decline in the index the largest yet recorded by the Italian survey. The index plunged from 42.8 to 34.8.

Sales also fell in Germany, at the weakest rate of the current five-month sequence. The monthly sales index rose to 46.7, up from 44.6 in September.

Sales in France fell for the first time in four months, and at the weakest rate of the three countries surveyed. The index fell from 50.5 in September to a six-month low of 48.5.

Euro-zone sales remained well down on a year ago in October, with the annual rate of decline gathering pace to the joint-second sharpest seen over the past four years. The year-on-year sales index fell from 43.4 in September to 41.4. The annual rate of contraction in Italy was the second-strongest in the survey history, while more modest declines were seen in both France and Germany.

Thursday, October 30, 2008

EU Confidence Levels On The Decline

European economic confidence saw its biggest ever fall in October as the global bank crisis generated the bleakest outlook since the early 1990s, according to the findings of this months European Commission economic sentiment survey. The survey results give us just one more dramatic illustration of the devastating impact the financial turmoil is having on the real economy. Pessimism has risen dramatically on all fronts - from manufacturers' expectations about exports to consumers' fears about unemployment.

These gloomy results now make it almost a certainty that the European Central Bank will cut its main interest rate by at least half a percentage point to 3.25 per cent when it meets next week.

The European Union executive's "economic sentiment" indicator for the 27-country bloc fell by 7.4 points in October to 77.5 points. The latest index reading was the lowest since 1993 and marked the largest month-on-month decline ever recorded.

Among the largest EU members, confidence deteriorated most markedly in the Netherlands followed by France, Italy, the UK and Poland.

At the same time, the increasingly-worrying outlook for previously fast-growing eastern European economies is hitting business and reducing export opportunities across the rest of the continent. Details of the latest survey showed EU manufacturer reported export order books at their thinnest since June 2005. Consumers' expectations about unemployment trends in the next 12 months were the gloomiest since March 1994.

German Unemployment Continues To Fall In October

German unemployment continued to defy the global financial crisis, and the slowdown in the German economy itself in October, and fell below 3 million for the first time in 16 years, extending its longest drop since reunification. The unadjusted number of people out of work fell to 2.99 million, according to data from the Federal Labor Agency. That's the first time since November 1992 it breached the 3 million mark and down from a post-World War II peak of 5.3 million in February 2005.

The number of people out of work, adjusted for seasonal swings, dropped 26,000 to 3.15 million after falling 29,000 in September. The seasonally adjusted unemployment rate fell to 7.5 percent, a 16-year low.

According to the latest comparable data from the Organization of Economic Cooperation and Development, Germany's jobless rate was 7.2 percent in August. France, Germany's main trading partner, reported 8 percent unemployment compared with 4.1 percent in Japan and 6.1 percent in the U.S. The OECD average was 6 percent.

As the world economy cools in the wake of the financial crisis, that trend will probably reverse and become a political issue next year, when Chancellor Angela Merkel's Christian Democrats and their Social Democrat coalition partners contest national elections in September.

Employment is normally thought of as a lagging indicator of the economic performance and often benefits from high capacity utilization even as an economy slows. Indications of intended job cuts, such as those which are to be found in, for example, the Ifo business survey, or the PMI surveys need to persist for a number of months before they actually affect the labor market, and then as many of those who become unemployed are in the older age groups they may well disappear from the unemployment statistics altogether as they retire (possibly taking early retirement) and the economically active population falls.

``The weaker economy will have an impact on unemployment, but less so than in the past,'' said Frank-Juergen Weise, the head of the Labor Agency. ``Policy changes such as the rise of mini-jobs are putting people in registered employment where before they'd be unemployed.''
In a separate release (and based on a slightly different methodology - the monthly labour survey) the Federal Statistics office reported that, after the elimination of typical seasonal variations, the number of persons in employment in Germany stood at 40.36 million in September 2008. Compared with August 2008, that was a seasonally adjusted increase of 21,000 persons (or 0.1%). This compares with a seasonally adjusted average increase of 26,000 persons per month over the last six months.

According to provisional estimates by the statistics office, the number of unemployed was a seasonally adjusted 3.07 million in September 2008. Compared with September 2007, unemployment was down by a seasonally adjusted 450,000 persons or 12.5%. The seasonally adjusted unemployment rate – which is harmonised across the EU and measured as the share of unemployed in the total labour force – amounted to 7.1% in Germany and was thus considerably below the level of the corresponding month of the previous year (8.2%).

Wednesday, October 29, 2008

The Bank Bailouts Are Very Well Intended, But Where Is All The Money Going To Come From?

As every woman who has ever had dealings with a man knows only too well, it is a lot easier for people to make promises than it is for them to keep them. And when Europe's leaders met in Paris on the 12 October, a lot of fine promises (which were all, surely, very well intentioned) were made. The reality of having to live up to them, however, is turning out, as might only have been expected, to be much more complicated.

Basically, the kernel of the plan which is now being operationalised seems to have been thrashed out in Washington on 11 October, when key G7 leaders met with Dominique Strauss Kahn of the IMF, and it was decided to try and erect two great firewalls (corta fuegos) - at least as far as Europe is concerned. One of these was to be co-ordinated by the EU governments, and the other by the IMF, who were to act in the East. Both these parties essentially agreed to guarantee the banking systems in the countries for which they took responsibility, so the action, in a sense, moved from the banks (which are now, more or less "safe") to the governments and the IMF (who is ultimately backed by cash from governments), and it is the "safety" of these institutions which is likely to be more or less tested by the markets, with the first trial of strength taking place right now in Iceland.

So the big question now is, do these various institutions have the resources to back up their guarantees, should the need arise?

Problem Selling Bonds

In this context the Financial Times had a very interesting article yesterday about the fact that the Austrian government had decided to cancel a bond auction.

Austria, one of Europe’s stronger economies, cancelled a bond auction on Monday in the latest sign that European governments are facing increasing problems raising debt in the deepening credit crisis.
According to the FT article the difficulties Austria, which has a triple A credit rating, is facing only serves to highlights the extent of the deterioration in the sovereign bond market, where benchmark indicators of credit risk such as the iTraxx index hit fresh record spreads yesterday.

Austria now is the third European country to have cancelled a bond offering in the last few weeks - in the Autrian case the markets are getting more and more nervous over the exposure of some of its key banks (Erste, Raffeison) to the mounting disaster over in Eastern Europe - both Hungary and Ukraine received IMF loans this week (see below) and they certainly won't be the last.

Austria seems to have dropped its plans for a bond launch next week due to the size of the premiums (spreads) investors seemed likely to demand, although the Austrian Federal Financing Agency did not give any explanation for the decision.

Spain, which alos currently has a triple A rating, and Belgium have both cancelled bond offerings in the past month because of the market turbulence, with investors again demanding much higher interest rates than debt managers had bargained for.

So really many European governments are now facing similar problems to those their banks faced earlier, they can get finance, but only at rates which they consider to be punitively high (remember, the interest has to be paid for from somewhere, in the present recessionary climate from cuts in services more than probably, since, remember, if we look over at Eastern Europe, investors are very likely to "punish" those governments who try to go down the easy road, and run large fiscal deficits over any length of time).

Market conditions have steadily deteriorated in recent days with the best gauge to credit sentiment, the iTraxx investment grade index, which measures the cost to protect bonds against default in Europe, widening to more than 180 basis points, or a cost of €180,000 to insure €10m of debt over five years, on Monday.
This is a steep increase since only as recently as Monday of last week, when the index closed at 142 base points. Also the cost of default protection on European companies has risen to record highs this week on investor concern that the global economic slowdown will curb company profits. The Markit iTraxx Europe index of 125 companies with investment-grade ratings fell 3.5 basis points yesterday to 166.5, after hitting a record high on Monday.

The FT cites analyst warnings that the there is now a huge quantity of government debt building up in the pipeline, and the government bonds due to be issued in the fourth quarter and early next year will only add to the problems some countries are facing, and particularly those countries like Greece and Italy who already carrying large amounts of debt that needs to be refinanced or rolled over.

It has been estimated that European government bond issuance will rise to record levels of more than €1,000bn in 2009 – 30 per cent higher than 2008 – as governments seek to stimulate their economies and pay for bank recapitalisations.

The eurozone countries will raise €925bn ($1,200bn) in 2009, according to Barclays Capital. The UK, which is expected to increase its bond issuance from the current €137.5bn in the 2008-09 financial year, will take the figure above €1,000bn.

Italy, and Greece, both with a debt-to-GDP ratios of over 100 percent, are certainly the most exposed to continuing difficulties in the credit markets, (with analysts forecasting that Italy alone will need to raise €220bn in 2009). At the present time the Libyans are lending the Italian government a helping hand (and here) in struggling forward, but even oil rich Libya doesn't have the money to fund the long term needs of the Italian banking, health and pension systems.

IMF Have Only $250 Billion

On the other hand Bloomberg had an article yesterday on the growing pressure on the IMF's somewhat limited resources, as one country after another in Central and Eastern Europe joins the "consultation queue" in the hope of getting a bail out.

Bloomberg report that the cost of default protection on bonds sold by 11 emerging-market nations has now either approached or surpassed distress levels, raising the very immediate likelihood that the International Monetary Fund's ability to bailout countries may soon start to be put to the test.

Credit-default swaps on eight countries including Pakistan, Argentina and Russia have now passed the 1,000 basis points mark, the level which is normally considered to signify "distress", according to data provided by CMA Datavision. Funding one basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

``The resources of the IMF may not be sufficient for wider bailouts if needed,'' said Vivek Tawadey, head of credit strategy at BNP Paribas SA in London. ``If it can't raise the money, some of the more distressed emerging markets could end up defaulting.''
Ukraine, Hungary, and Iceland have already received IMF loans, while the fund is currently in "consultation" talks with Belarus, Turkey, Latvia, Serbia, Romania, Bulgaria and Pakistan, at the very least.

According to Simon Johnson, former chief economist at the fund the IMF only has up to $250 billion it can currently lend (as quoted in the Financial Times yesterday).

Credit-default swaps on Pakistan currently cost 4,412 basis points. Contracts on Argentina are at 3,650 basis points, Ukraine at 2,850, Venezuela at 2,400 and Ecuador costs 2,072. Default protection on Russia, Indonesia and Kazakhstan also costs more than 1,000 basis points, while Iceland costs 921, Latvia 850 and Vietnam 837. Contracts on Turkey cost 725 basis points.

The IMF agreed at the weekend to lend Ukraine $16.5 billion for 24 months and stated yesterday that they would contribute $12.5 billion towards a $25.5 billion loan for Hungary (with the other participants being the EU and the World Bank. Iceland got a $2 billion loan on Oct. 24 and Belarus has asked for at least $2 billion. Just how many more loans are now in the pipeline, and if the IMF does start to see its funds stretched, just who exactly is going to step up to the plate and fork the necessary money out? The sheer fact that they only put part of the cash for the Hungarian loan, and that the World Bank had to come on board with a symbolic $1 billion shows they are already aware that the problem may arise.


Well just after writing this, I see from reading the FT that Gordon Brown got there just before me. Beaten by a short head!

Gordon Brown on Tuesday spearheaded calls for a multi-billion pound "bail-out fund" to prevent the global crisis spreading to more countries, and warned of the need to stabilise economies "across eastern Europe".....

The prime minister on Tuesday urged the oil-rich Gulf states and China to provide "substantial" funding to the International Monetary Fund, before flying to France for talks on an increase to the European Union's bail-out fund. The government is keen to emphasise the link between global action and domestic voters' interests, as well as portraying Mr Brown as a world leader.

The prime minister said it was "in every nation's interests and the interests of hard-working families in our country and other countries that financial contagion does not spread". While he did not rule out the UK making a contribution, he insisted the "biggest part can be played by the countries that have got the biggest [balance of payments] surpluses".

The IMF's $250bn (£158bn) bail-out fund "may not be enough" to prevent the crisis destabilising more countries, Mr Brown said. His spokesman added the UK was "looking at a figure in the hundreds of billions of dollars" for the IMF. Mr Brown called for "action on this new fund immediately".

Also, another story in Bloomberg gives us a further glimpse of how the EU governments are planning to do all that financing. The German government, it seems, is going to print IOUs (sorry, bonds) and give them directly to the banks. That is, they are not going to auction bonds and give the proceeds, they are simply giving the paper, and presumeably paying a coupon (or interest). Oh yes, and the bonds will not be sellable, since this would, of course, damage the yield curve via the supply and demand process, but they will count as debt, which means that the German government is being very naieve here (assuming the report is accurate) since of course the rise in the debt may well mean a breach of the 2011 balanced-books commitment, and falling back on this will almost inevitably have an impact on the extra implied risk investors will be looking to get paid for holding the bonds.

Germany plans to finance part of its 500 billion euro ($636 billion) bank rescue package by issuing bonds to banks in exchange for new preferred stock, according to Finance Agency head Carl Heinz Daube.

``The banks will not be allowed to sell the injected government bonds,'' Daube said in an interview in Tokyo today. ``So far there's obviously not a huge demand for any rescue measures, but this might change in the coming weeks.''

Germany's rescue plan, approved by lawmakers on Oct. 17, amounts to about 20 percent of the gross domestic product of Europe's biggest economy. Chancellor Angela Merkel's administration pledged 80 billion euros to recapitalize distressed banks, with the rest allocated to cover loan guarantees and losses.

....Hypo Real Estate Holding AG, the Munich-based lender that's already had a 50 billion euro bailout, today asked the Deutsche Bundesbank for 15 billion euros to cover short-term liquidity needs. ....Frankfurt-based Deutsche Bank AG may also need 8.9 billion euros of new capital, more than any bank in Europe, Merrill Lynch & Co. analysts Stuart Graham and Alexander Tsirigotis wrote on Oct. 20.

The bailout plan is still being discussed in Berlin and more information will probably be released at the end of this week, Daube said.

Germany may meet additional funding needs for its bank rescue by selling six-month bills before examining options for borrowing using longer-term securities, Daube said. The government plans to offer between 212 billion euros and 215 billion euros of debt through its 2009 program, about the same as the 213 billion euros scheduled for this year.

The debt-for-equity swap will probably have ``next to no effect'' on the country's yield curve because the notes offered to banks won't trade in the so-called secondary market, he said. The yield curve plots the rates of government bonds according to their maturities, and increases indicate higher borrowing costs.

``The government deficit of course will increase, the outstanding volume of bonds will increase as well,'' Daube said. ``The number of outstanding bonds available in the secondary market will stay exactly the same.''

Gentlemen, we are out of our depth here.

Tuesday, October 28, 2008

German Consumer Confidence Rebounds Very, Very Slightly In October

German consumer confidence increased - ever so slightly - for a second month entering November as a decline in oil prices, and continued stability in the job market, left Germans just that little bit more confident about the level of their real incomes.

GfK AG's forward looking index for November, based on a survey of about 2,000 people, rose to 1.9 from 1.8 in October. Inflation slowed in September and the price of oil has more than halved since a July peak of $147.11 a barrel, boosting households' disposable income. On the other hand, a deepening crisis on global financial markets has sparked fears of a recession, curbing consumers' willingness to spend. At some point the rapid slowdown hitting the German economy will reach the labour market, and it is to be expected that confidence will then take another knock, in the meantime we should bear in mind that we are still only fractionally above Septembers very low level.

``Many Germans are playing a waiting game as far as their purchases are concerned,'' GfK said in the statement. While oil- price declines have ``supported income expectations,'' the ``panic on the international stock exchanges has shaken consumer confidence in the future economic outlook.''

Economic outlook: growing fears of recession

According to the GFK report, the economic expectations for October fell again considerably by 11.8 points to its current level is -27.5 points, which is a good 66 points down on the value of the same period in the prior year. The indicator is now at its lowest level since May 2003.

This is basically due to the fact that fears of a recession have been rising amongst Germans over the last month. The main contributing factor to this will have been the continuing turmoil on the international stock exchanges, which has shaken consumer confidence in the future economic outlook. Germans seem therefore to be in agreement with most financial and experts, who believe the German economy is "on the brink of a recession”, which is also the title of the autumn 2008 report which was recently published by the country's leading research institutes.

Income expectations: purchasing power not in any greater danger

The significant drop in oil prices has obviously supported income expectations in October. The income expectations indicator rose by more than one point to its current value of -12.9 points. Nevertheless, the level remains low, a fact that is further born out by the -12.2 point drop compared with the same period in 2007.

Up to now, consumers have remained pretty calm in the face of the extreme turbulence on the international financial markets, at least insofar as income expectations - a major determinant of the consumer climate - are concerned. A GfK survey on the effects of the financial crisis on investment behavior and consumer confidence in the banking sector carried out in mid-October also produced a similar result. On the one hand, relatively few Germans have invested in stocks and shares, whose value is well down due to the financial crisis. On the other, general conditions, such as the job market and the diminishing pressure of inflation, continue to remain positive.

Propensity to buy: fears of a recession leading to consumer reticence

However, following strong growth in September (a 15 point rise) reticence to purchase is currently on the increase again. The propensity to buy indicator fell back 5.4 points on the month to its current level of -18.2 points. This is still a good five points down on the value registered in October 2007..

Fears of the German economy lapsing into recession means consumers remain reluctant to make larger purchases. This has become particularly noticeable in the automotive and construction industries, and both sectors are already reacting to the decline in demand by curtailing their output. The easing of inflationary pressure has obviously not generated any noticeable stimulus in demand, and many Germans seem to be playing a game of "wait and see" as far as their purchases are concerned.

Monday, October 27, 2008

German Business Confidence Worsens Significantly In October

German business confidence hit its lowest level in more than five years in October as the deepening financial crisis started to have an effect on the outlook for economic growth. The Munich-based Ifo institute business climate index, which is based on a survey of 7,000 executives, fell to 90.2, its weakest reading since May 2003, and down from 92.9 in September.

If we have a look at the evolution of the index sub-components, we can see that the retailing and construction sectors have long been plumbing the bottom. What is new over the last few months is that the manufacturing sector has steadily been joining them as export growth has weakened. This means quite a sharp recession is on the way in Germany, in my opinion. Germany's leading economic institutes this month slashed their joint forecast for growth in what is Europe's biggest economy for next year, forecasting an expansion of just 0.2 percent in 2009, and even this may well turn out to be excessively optimistic - the risk of annual contraction is now a non-negligable one, especially if we are going by the Federal Statistics Office Non-calendar-adjusted reading, since there will be one working day less in 2009.

Germany exports fell for a second month in August while German investor confidence dropped for the first time in three months in October, to near a record low. The ZEW Center for European Economic Research said its index of investor and analyst expectations slumped to minus 63 from minus 41.1 in September. The index all time low is minus 63.9 which was in July of this year.

Deceleration in Germany's Manufacturing Sector Accelerates

" This impression is only confirmed by October's falsh PMI reading which indicated the sharpest decline in German private sector activity since mid-2003," Tim Moore, an economist at Markit Economics, said in a statement. "Market demand was shaken by the latest global financial turmoil, as firms became increasingly concerned about the economic outlook and access to credit."

The rate of expansion in the German economy seems to have dropped back to its lowest level in more than five years in October. The preliminary flash estimate of the composite purchasing managers' index for what is the euro zone's biggest economy fell to a 64-month low of 46.7 in October from 48.5 in September. Manufacturing activity in contracted for the third straight month with the reading plunging to 43.3 from a final reading of 47.4 in September.

In addition, economic activity in the service sector stalled for the first time since January as the flash reading slipped to 49.7 from 50.2.

However, the data showed input price inflation eased to its slowest for more than three years in October, with the month-on-month fall in the index was the largest since the series began in January 1998. This reinforces data out this morning (Friday) from the German Federal Statistics Office which showed that German import prices fell 1.0% month-on-month in September after declining 0.8% in the August, as crude oil prices continued to pull back from their record high in July. On an annual basis, the rate of import price increase slipped back to 7.6% from 9.3% in August.

The data suggests that the German economy may well continue to be in recession in the fourth quarter (assuming that the forthcoming 3rd quarter data do show a contraction) as demand across the global economy continues to falter, a process which will hit an export dependent economy like the German one especially hard.

Tuesday, October 14, 2008

German Investor Confidence Falls Again In October

German investor confidence dropped for the first time in three months in October, to near a record low, as the global credit crisis threatened to tip Europe into a recession. The ZEW Center for European Economic Research said its index of investor and analyst expectations slumped to minus 63 from minus 41.1 in September. The gauge reached an all-time low of minus 63.9 in July.

Germany's benchmark DAX share index dropped 22 percent last week, the most on record, as concern grew that bank failures and a credit-market freeze will drag the world into recession. German growth will slow to 0.2 percent in 2009 from 1.8 percent this year, the country's leading economic research institutes forecast today. Still, stocks surged after governments in Europe agreed to support banks and shore up financial markets.

Germany will provide as much as 500 billion euros ($683 billion) in loan guarantees and capital to bolster its banking system, the country's biggest government intervention since the Berlin Wall came down in 1989.

Monday, October 13, 2008

Europe's Leaders Agree To A Common Front In Fighting The Banking Crisis

Well, Europe's leaders have finally bitten the bullet. Faced with what IMF head Dominique Strauss Kahn warned could turn into a global financial meltdown, our leaders have risen to the challenge, at least to a certain extent. The details of what has been agreed continue to remain vague, but obviously I think it is a good FIRST move. More will now almost inevitably follow, but our reluctant leaders have finally got their feet wet, and the bathing costume is on. Now it is only left for them to dive into the ocean which lies in front.

And, of course, the situation was not without its theatricals. Initially billed as a "eurozone only" meet-up, Gordon Brown was ultimately summoned, a move which was not totally essential, but since he was the only one with a real "going plan" on the table, the invitation made sense. Of course Brown himself has been relishing it all, proudly proclaining that Britain will "lead the way" out of the credit crunch, and adding in true Churchilian style that "I've seen in the cities and towns I've visited a calm, determined British spirit; that, while this is a world financial crisis that has started from America, Britain will lead the way in pulling through."

Well, we will see.

While the details at present remain vague the important point would seem to be that Europe's leaders have made a commitment not to allow any systemic bank - in Western Europe (the guarantee does not extent to Hungary which today had to turn to the IMF for support) - to go bust, and it will now be hard for them to go back on this without losing all credibility. The deposit guarantees - which may be useful in terms of reassuring the general public - would now seem to be largely redundant, since if the large banks, and their debts, are to be guaranteed, then logically the deposits themselves are safe. And while Europe itself will underwrite the systemic banks, the national governments will be able to handle the smaller ones (Spain's regional cajas etc) at local level.

So government finances will guarantee the banks, but who will guarantee the government finances? This, at this stage may seem to be an idle question, since none are under direct threat, but I think we need to be clear here, the money which will now need to be spent - and it is way too early to start trying to put precise numbers - will have to come from somewhere, and by and large this will mean the national governments issuing debt, but if we come to individual national governments like Greece or Italy - where debt to GDP ratios are already over 100% - it is not clear how much paper they can actually issue without seeing what is know as the "spread" on their bonds increasing significantly. So while it is certainly time to breath a sigh of relief, we we far from being able to whistle the all clear. And of course the real economy consequences of what has just happened are pretty serious, and the funds which will be spent propping up the banks will not be available for fiscal stimulas packages, so the bottom line is that we, in the OECD world, may well be in for one of the longest and deepest recessions since WWII.

The Package Itself

Now, as I say, the details we have to date of what has been agreed are far from clear. What is clear is that the EU collectively has agreed to guarantee new bank debt in the eurozone (and possibly elsewhere, but this point still awaits clarification, since as I say the guarantee evidently doesn't apply to Hungary, and that should give us some sort of idea about just how strained everything is at the moment). They are also committed to the use of taxpayers money to keep any systemic banks which get into distress afloat, and by implication they are prepared to pool resources to do this (maybe by injecting funds into the ECB as the UK has pledged to do for the Bank of England). This is also a very important precedent: since the European institutional structure is something of a patchwork quilt at this point, it is clearly make, mend and improvise time.

Wolfgang Munchau clearly seems to catch the spirit of the times in a long and thoughtful article in the Financial Times this morning:

"I had a better feeling about Sunday’s eurozone summit. It produced a detailed and co-ordinated national response to recapitalise the banking system, and to provide insurance to revive the inter-banking market. But as far as I could ascertain, this was still agreement on ground rules for national plans, and it is not clear how well this agreement would cover the numerous cross-border issues that have arisen. There is no doubt that, in the eurozone at least, we have come a long way since Friday. It is an okay policy response, but I wonder whether this is going far enough at a time when global investors are pondering whether to pull the big plug."

Well look Wolfgang, my favourite phrase these days is "sufficient unto the day", we have come as far as we are able to come in one weekend. There will still be next weekend, and the one after. Clearly we have not come far enough yet, but as Paul Newman discovered in a once famous film, there are only so many hard boiled eggs you can eat in one sitting.

The key measures announced at the weekend were: a pledge to guarantee until the end of 2009 bank debt issues with maturities up to five years; permission for governments to buy bank stakes; and a commitment to recapitalize what the statement called `"systemically'' critical banks in distress. The statement gave no indication of how much governments were willing to spend or the size of bank assets deemed to be at risk, and European officials refused to estimate the price tag of the measures. Some indication of the numbers involved will start to emerge today, when France, Germany, Italy and others begin to announce their national measures.

"What has been done over the last three days should provide elements of reassurance,'' Dominique Strauss-Kahn, chief of the International Monetary Fund said on French radio Europe 1 today. The worst of the financial crisis ``may be behind us.''

Often criticized for its preoccupation with inflation, the European Central Bank abruptly reversed course last week, cutting interest rates for the first time since 2003 in a move coordinated with the U.S. Federal Reserve and four other central banks. The ECB doesn't have the legal power at the moment to follow the Federal Reserve and buy commercial paper to unblock a financing tool that drives everyday commerce for many businesses, according President Jean-Claude Trichet, who also participated in yesterday's Paris meeting.

``We are looking at our entire system of guarantees and we can imagine new measures to enlarge access to our system of guarantees,'' Trichet said.

As Wolfgang Munchau points out, there is now an almost unanimous consensus among economists about the need for a recapitalisation of the banking system, and for the provision of some form of public-sector insurance for the money markets, even if there is no consensus about how exactly to do this. We should not forget, of course, that it was precisely the practice of offering guarantees - via instruments like credit default swaps - for what appeared at the outset to be investment grade lending but which later turned out to be extremely risky that has produced the current "near meltdown", and we therefore need to be extremely careful about the kind of guarantees we are offering, since what we do not want to happen is to see public finances meltdown in the future in just the way bank finances have.

What Wolfgang doesn't draw too much attention to - perhaps he is too modest - is how few of us there actually are who have been who have been arguing systematically and repeatedly for just this kind of package of measures since the very start. Wolfgang is one of a very select company here, and I, if I may be so presumptious, am another. Back on July the 18th - in a post for RGE Europe EconMonitor - I said the following (the numbers were pretty rule of thumb, but in the light of what is now coming out they don't look that far off):

So what does all this add up to? Well, to do some simple rule of thumb arithmetic, just to soak up the builders debts and handle the cedulas mess, we are talking of quantities in the region of 500 to 600 billion euros, or more than half of one years Spanish GDP. Of course, not every builder is going to go bust, and not every cedula cannot be refinanced, but the weight of all this on the Spanish banking system is going to be enormous...............So it is either inject a lot of money now - more than Spain itslelf can afford alone - or have several percentage points of GDP contraction over several years and very large price deflation - ie a rather big slump - in my very humble opinion. And it is just at this point that we hit a major structural, and hitherto I think, unforeseen problem in the eurosystem (although Marty Feldstein was scratching around in the right area from the start). The question really we need an answer to is this one: if there is to be a massive cash injection into Spain's economy, who is going to do the injecting? Spain alone will surely simply crumble under the weight, and it is evident that the problem has arisen not as the result of bad decisions on the part of the Spanish government, but as a result of institutional policies administered in Brussels and monetary policy formulated over at the ECB. And yet, the Commission and the ECB are not the United States Treasury and the Federal Reserve, no amount of talk about European countries being similar to Florida and Nebraska is going to get us out of this one: and it is going to be step up to the plate and put your money where your mouth is time soon enough.

Well, getting through to the put your money where your mouth is stage didn't take that long, now did it? Twelve weeks and two days to be exact.

My central point at this stage would be that all of this is going to have, among other things, important implications for the real economy, since it is the degree of all that leveraging which we have been busy doing which is now going to have to be reduced, and while we are all busy "deleveraging", our real economies will notice a significant drop in demand. I wouldn't like to dwell too much on the point at this stage, but this was, of course, precisely what happened in the 1930s.

Basically, one economy after another in the developed world is now going to become export dependent. If I take Spain as an example, perhaps things will be clearer. Spanish households are now in debt to the tune of around 90% of GDP. Spanish companies owe something like 120% of GDP, and the government, which is just about to start accumulating more debt, owes about 50% of GDP. Adding that up, Spain incorporated owes about 260% of GDP at the present time. But the situation is worse than that, since debts continue to mount.

Back in the good old days of Q2 2007, when Spain's economy was busy growing at a rate of about 4% per annum, corporate and household debts were increasing at a rate of about 20% per annum. 4% growth for a 20% rise in indebtedness (or an increase of about 30% in debts to GDP) doesn't seem like that good value for money when you come to think about it - and in the meantime Spain Incorporated's indebtedness to the rest of the world (via the current account deficit) was growing at a rate of 10% per annum. Fast forward to Q2 2008, and household and corporate debts were rising at a mere 10% per annum (and government debt had also started to rise, at this point at a rate of around 2% of GDP per annum, or 4% of accumulated debt), but Spain's economy had reached a virtual standstill (true it was still growing at 1% rate year on year, but quarter on quarter it was virtually stationary). So not only is this a horrible "bang for the buck" ratio, it is also totally unsustainable. Indebtedness has to be reduced, not increased, and this can be done in one of two ways, either by ramping up GDP growth (which in the present environment is out of the question in the short term) or by burning down the debt by paying (or writing) it off.

This harsh but unavoidable reality has two important implications. The first of these is that Spain is going to need external help, and the second is that while the level of indebtedness is being reduced, Spain will not get GDP growth from internal demand, and any headline GDP growth there is will need to come from exports.

And of course Spain is just one (extreme) case. There will be a whole company of others who need to make this transition (the UK, Greece, Denmark, Ireland at least, and probably virtually all of Eastern Europe - now what was that football song I used to sing back then in the old days, over there on the Spion Kop... "when you walk through a storm...").

So the question is, while a host of new countries are suddenly struggling to export, who is going to do all the importing? No mean topic this one. The only person who seems to have even the inkling of a proposal here is World Bank head Robert Zoellick, who came right out with it on Sunday: we need a new multilateral structure. The global financial crisis underscores the need for a coordinated action to build a better system, he said on Sunday. "We need to modernize multilateralism for a new global economy....We need concerted action now to ... build a better system for the future." Never better said, and never was the fact that we live in an interconnected world placed under such a stern spotlight.

And just what will this system look like? Well, the details will all need working out, but in broad brushstroke terms, my strong feeling is that we need to bring-in the large developing economies like India, Brazil, Egypt, the Philippines etc en-bloc, and create a Marshall-Plan-type structure were all those newly created developed world savings can be put to good (and safe) use in facilitating the emergence of those long suffering emerging and frontier markets, and in so doing these countries will play their part by helping provide the customers which our own "export dependent" economies will all now so badly need. But, as I say above, sufficient unto the day......

Friday, October 10, 2008

The Deflation Threat Looms As Consumer and Investment Demand Falls While Oil Turns Year on Year Negative

Oil prices plunged below $85 a barrel on Thursday, the lowest level in a year, as Opec, the oil exporting countries’ cartel, called an emergency meeting to discuss reducing its crude production to halt the collapse in prices.

This morning it is more of the same, and prices plummeted to a one-year low below $83a barrel in Asia as investor fears of a severe global economic downturn sparked a panicked sell-off of equities and crude. Light, sweet crude for November delivery was down $4.00 to $82.59 a barrel in electronic trading on the New York Mercantile Exchange by midafternoon in Singapore, the lowest since October 2007. The contract overnight fell $1.81 to settle at $86.62.

The US Department of Energy reported this week that the country’s oil demand averaged 18.66m barrels a day last week, down 8.6 per cent against the same period a year ago as the economic downturn takes its toll on oil consumption. High prices during the summer have forced US motorists to cut their mileage, and now the looming recession will mean that they don't simply increase it again as oil prices drop.

Basically this is the point I was raising only one month ago on my personal blog, as to how long we would have to wait for oil prices to turn year on year negative. So now we have the answer, they just did.

Since I am - like everyone else I imagine - basically reeling under the volume of work which all that is happening is generating, I will restrict myself here to reproducing an excellent recent piece from my colleague Claus Vistesen on the issue of global deflation risk.

The Global Economy – Is Deflation the Next Macro Story?

by Claus Vistesen: Lausanne

As the horror story of financial markets continues at full speed it may seem a rather futile endeavor to try to make sense of what is increasingly becoming senseless by the day. Yet, you hardly need to be a financial literate to see that the world of finance and banking has been changed for good. I don’t think this was neither unwarranted nor unexpected. At some point, US authorities had to let someone on the Street fail and it turned out to be Lehman (with Merril Lynch of course coming close in behind as it was snapped up by Bank of America). AIG on the other hand was saved as their role as insurer was deemed too important and systemic to merit a collapse. Then we have Wachovia, the Washington Mutual Trust etc etc …I can understand if many will have a hard time gauging the playbook through which regulatory authorities decide who lives and who dies. As we learned this week that Paulson’s plan was not passed by congress the downside now resembles something of an abyss. It will be interesting to see what happens as the bail-out plan makes its second tour to congress.

Since rumors began of the peril of sub prime mortgages and credit crunch became the new buzz word in the financial vocabulary we have seen some quite eventful weeks not to mention days in which volatility has gone far beyond what any respectable VAR model would be able to foresee. Still the past two weeks must clearly take pole position so far. The numbers flying around and the movement in key market parameters have been extraordinary. That equities were down should not surprise us as we have seen it before this year when Wall Street’s office buildings have been re-shuffled. However, this time it was perhaps a bit different as yield on treasuries fell to almost 0% at one point as investors quit anything with but a faint smell of risky assets. Another specific and most unwelcome side effect of this was the corresponding seizure in credit and liquidity markets which followed. At some point, the cost of borrowing money in the interbank market almost doubled taking the LIBOR rate close to 650 basis points (now running at about 550 bps on the back of the échec of the Paulson plan) as well as the three month spread of LIBOR over the treasury climbed to over 300 basis points. These swings tell an important cautionary tale of the seriousness of this crisis. Especially, the lack of confidence and subsequent seizure of the short term financing market is one of the most tangible and severe effect from this crisis.

Meanwhile and beyond the immediate eye of the storm on Wall Street, Europe is entering its own house of pain as cracks in the banking sector begin to steadily emerge. Add to this that the macro environment is pointing towards a steep Eurozone wide recession and you have the ingredients for a very serious downturn on the European continent. I still hold that the lack of real response on the rate front will not only hurt the ECB’s credibility, but also worsen the inevitable slump.

In emerging market land, things are not looking brighter with the anticipated safe haven flows drastically eroding valuations of asset markets in these economies. Russia seems to be suffering more than most from the recent retrenchment of risk aversion. Now, before people let their thoughts wander back to 1998 and LCTM’s spectacular collapse betting on the wrong side of the Russian debt binge I don’t think that Russia stands before an imminent default. Around $700 billion worth of reserves in the form of foreign exchange and national investment vehicles will keep Russia from any kind of immediate default. However, with trading in the USD denominated RTS index halted twice during the last two weeks due the continuation of outflows from foreign investors, it is difficult to ask the subtle question of whether this time, it might not be a little bit more serious than mere tremors [1] .

On the back of yesterday’s news that congress rejected the bailout plan knitted together by Paulson and Bernanke, the MSCI World Index of 23 developed markets dived 6.8 percent, which was the sharpest decline in the measure's 38-year history according to Bloomberg. In Brazil trading was suspended after the Bovespa fell more than 10% and in India and aforementioned Russia equities were equally pummeled. Stephen Jen and his colleagues from Morgan Stanley (who itself is fighting for survival) have some interesting points on capital flows to emerging markets in the latest edition of the GEF.

What happens next is of course anybody’s guess, but below I would like to point to one plausible and tangible outcome of the wheels that were set in motion back in august 2007 when BNP Paribas announced subprime related losses and thus took the credit crisis to global levels.

Deflation as the Next Macro Story?

The macro themes which have characterized the past year’s eventful period have been fickle. As the Fed decided to let interest rates fall in the end of 2007 decoupling was the name of the game as gold and crude oil reached new highs at one and the same time as the USD was pummeled. However, as it became clear that the US was merely the proverbial canary in the coal mine for a much wider global slowdown the sentiment changed. One main question in this regard was always whether the obvious bout of stagflation, at some point, would turn into deflation; a question I also mused on a couple of months back. As per usual with these things there are arguments for and against. The strongest impediment to a worldwide deflationary slump is the continuing pressure from growth in emerging economies. To be sure, these economies are also going to be run down a notch, but the underlying momentum and the lack of global supply slack in terms of energy resources seem certain to keep headline inflation high as we move forward. [2] However, the crucial point here is exactly that the double barril of imported cost-push inflation at the same time as the economy is contracting may lead to a negative feedback loop that can provoke deflation. Consequently, when I look at the current deterioration in real economic activity across OECD as well as the ongoing tensions in credit markets I believe that deflation is now a fair and probable call in the context of key regions and countries.

Essentially, it is difficult not to notice that something has changed with the recent stream of incoming macro data for Q2 and Q3. In Europe, the Eurozone and key parts of Eastern Europe are likely to be in a recession and also Japan seems to have hit a brick wall. Meanwhile emerging economies also seem to be slowing sharply although recessions in that part of the economic edifice are very unlikely.

All this almost looks like de-coupling in reverse, but the US is unlikely have to have seen the worst yet. Re-coupling does not only work one way and just as the US has enjoyed a windfall from exports in H01 2008 so will the rapid deterioration of the rest of the world feed into US growth rates. It is important to note here that the US’ capacity for domestically induced growth is next to none with a consumer saddled with debt and a financial system in shambles. The US has not yet posted growth rates akin to a recession [3] but that will most likely happen as we come closer to 2009 (Q4 08 and Q1 09 would be my guess, but do go have a look at MS’s Berner and Weiseman for a one stop look at the US economy). In the briefest of versions this small view across the global economic edifice indicates that activity is coming down sharply across the board. In many ways, the effects on the real economy are only about to emerge as we move forward from here and this will be accelerated by the ongoing tensions in financial markets.

However, a sharp de-accelerations in activity need not lead to deflation and even if it does it may, according to some, be the only meaningful end result as well as means for correction for some countries. This begs the question of why am I invoking the deflation ghost and, more pertinently, what kind of deflation I am talking about?

In many ways, the current decline in real activity makes perfect sense as it comes on the back of an extraordinary run in terms of the economic cycle. Some are even talking about the end of one big mega-cycle with some debate on when this cycle is supposed to have started. I will leave this question neatly aside for now and merely conclude that with the added flavor of credit market turmoil and the velocity of the cycle that was (and is now gone), this present slowdown and crisis seem, in many ways, to be quite different than in previous global downturns.

To state that things are different however is scarcely enough to determine whether some parts of the global economy are headed for a sustained deflationary spiral (save perhaps for Japan, but I will touch on that below). However, I would still submit the claim this is actually a real risk at this point. In the following I will argue why.

Stating the Obvious

One key element in my call is a statement of the blatantly obvious. The credit crunch is consequently not just a figment of imagination but a real phenomenon with subsequent real and measurable effects, and what we really ought to be asking ourselves is what it actually means? An almost endless amount of commentary has been devoted to the answer of this question, but I still think that we should try to have a closer look for the sake of argument.

If we begin from the point of view of asset prices, I believe most people can agree that the world as a whole has now entered a prolonged period of asset deflation in key sectors. If we look at an asset such as real estate and housing it seems clear that a substantial amount of deflation lies ahead for many economies before previous imbalances can be corrected. Given the strong and accentuated wealth effect from real estate appreciation due to the possibility for equity withdrawal this is one of the main ingredients in the current crisis. In fact, if we peer across most economies who are now facing serious corrections real estate bubbles was an integrable part of past exuberance.

As regards financial assets we also seem to be in for a period of deflation even though the volatility of such movements makes this an entirely different beast. However, it is interesting in this respect to observe that whole classes of financial assets that were hitherto used to prop up many a financial institution’s balance sheet have now been completely evaporated. This is true not least for many credit products as well as it seem that many debt products backed by mortgages are heading for oblivion (the fascinating tale of the Spanish Cedulas here is a good place to start). [4] In this way, it is perhaps not so much a question of deflation in financial assets but more so about a process by which the asset base is narrowed. I do think this is a critical point to take aboard. This is not just about wealth destruction because risky assets fall in value; it is also about the destruction of entire asset classes and financial business models. If we add to this the general tightening of credit and liquidity provisions we end up with a massive and abrupt shrinkage of the global credit base.

Many would see this as a good and indeed quite necessary byproduct of the incoming slowdown. The past economic cycle was one of easy money and an unprecedented expansion of the credit and liquidity base through, not only through leverage, but also through simple product innovation in the context of financial products. I agree with this narrative, but there is more to this story than meets the eye.

What Does it Mean in a Macroeconomic Context Then?

Two things are important here I think.

One the one hand, economies that have been living well on foreign credit will now have to revert to a different or less extreme version of their previous growth path. Countries such as Spain, the USA, Australia, New Zealand, and many emerging economies in Eastern Europe are amongst the major candidates here. In general, it is clear that across the entire global economic edifice external deficit economies will need to tighten their belts due to the widespread global slowdown.
On the other hand, we also need to look at the credit side since this is not only a story about excessive exuberance on the part of debtor nations. It is also very much about the creditor economies and how they have been living high on foreign economies’ willingness and capacity to absorb the inflows. Now that the capacity for credit absorption is declining, so will creditor nations loose momentum as they are no longer able to tap foreign debtors to the same degree as before.

It is especially within this context that I see the potential for deflation. In particular, I would cut a lateral line through those creditor and debtor nations with distinct demographic profiles in the form of low fertility rates and subsequent high and rapidly rising median ages.

On the credit side Japan and Germany stand out as obvious candidates [5] . We can already see from the data how, absent support from external demand and asset income, headline GDP figures are tanking. Given the persistently depressed situation with respect to domestic demand and the deteriorating global credit conditions, there is a real chance that whatever endogenously generated trend growth path these economies can muster, the ensuing price trend could very well be one of deflation in core as well as key asset prices.

Turning to the deficit nations many commentators have noted how the US may be entering a Japan type of lost decade. I still think this is very unlikely; the amount of liquidity being pumped into the system as well as the much more stable demographic profile will prevent the US from falling under the yoke Japan did in the 1990s. However, I need to concede that the continuation of negative real interest rates at one at the same time as the public debt is being used to funnel corporate’s and household’s liabilities are not helping the US debt position. Without a shred of doubt, the US economy is hit much harder than was initially anticipated and at this point in time it remains to be seen whether the aggressive regulatory arrangements will have the wanted effect. In a more fundamental light I think it is quite obvious that the role of the US economy will change for good which need not be a bad thing but will take some adjustment of mindsets.
Meanwhile, I do see considerable potential for deflationary corrections in Spain, Italy and key parts of Eastern Europe. My rationale is that these economies perhaps stand before the most severe adjustment of all. In Spain the structural break is obvious. 6 years worth of housing booms, deficit spending and high growth driven by massive immigration and negative real interest rates will now need to be corrected. The rub here is however that membership of the Eurozone and a fixed exchange rate make wage deflation almost a certainty if a correction is to be achieved. Coupled with the unraveling of the housing market the downward momentum is extreme, and it should never escape our attention that before 2000 Spain was set to become to oldest society on earth. If she is not able to keep those immigrants the ensuing negative shock to the labour market will be quite severe.

In principal the same argument can be applied to Eastern Europe where the recent period of violent inflation may very well be the initial stages to a slump where wage deflation is the only possible way to correct in light of fixed exchange rate regimes. The greatest threat is that the slowdown becomes so severe that emigration intensifies further. This would have quite important consequences for these economies’ already distorted demographic profiles. One obvious question is the extent to which a prolonged period of wage and asset price deflation would be politically palatable. I would seriously doubt this and then we are back in the viper’s nest where the potential for an abrupt rupture of the Euro peg as well as a severe funding crisis à la Asia 1997.

As for Italy, it has long been my standing position that Italy, at some point, could tumble into a Japan like deflation trap. Whether it will happen during the turn of the current cycle is debatable, but the severity of the slowdown certainly suggests that the possibility is a real one. In passing, I would like to note that the issue of Spain and Italy (and quite possibly other economies in the Eurozone too) will not make life any easier at the ECB and in Bruxelles. The point here is simply that the ECB would not, under the current regime, be able to administer some local version of the Japan ZIRP in Italy and/or Spain. The consequences of this inability may unfortunately now become clear for everybody.

The main manifestation of the potential deflationary correction will be through wage deflation (especially in real terms) as well as a persistent gap between strong headline inflation and core prices. This is an undercurrent in the data I have been highlighting persistently in my analyses. The key point to latch on to is the inability of some economies to muster domestic demand which in turn will tend to have a deflationary effect; especially in the context of an incoming slowdown as we are seeing now.

Much Ado about Nothing?

If you have made it this far, you might ask with some legitimacy whether in fact I am not making much ado about nothing. After all, the means for correction here are pretty standard econ 1-0-1 type processes and deflation need not be an unwelcome thing as long as there is light at the end of the tunnel.

My main thesis however is that many of the economies which now face potential deflationary corrections do so principally because of their demographic profiles. If past experience is anything to go by this should raise more than a few eyebrows since we know how difficult it is to escape from deflation once you are caught in the web. This is the ultimate lesson to draw from Japan’s so-called lost decade. It was never exclusively about incompetent Japanese policy makers. Rather, the crucial question to ask is why Japan did not manage to muster sufficient domestic demand to recover and why Japan is now completely dependent on foreign demand and asset income to attain respectable [6] growth rates.

I believe that the answer to this question resides within the sphere of demographics and it is in this light I am worried that the global economy will see a number of economies join Japan (Germany already has I would argue) on the back of the current crisis.

If this turns out to be true it also highlights a number of crucial questions. The first is simply that if many hitherto net credit absorbers are now to become to net credit suppliers where is the extra global capacity going to come from? From my chair, it is as if everybody is talking about the need for the US to export its way out of trouble, but who the heck are going to take up the slack? Moreover, if I am right in the sense that many former deficit nations have suffered a structural break the re-shuffling of the global economy will not lead to a more balanced flow of funds, but rather the opposite. This would especially be the case if key emerging economies persist on maintaining an open life support to whatever is left of the Bretton Woods II system.
Another way to narrate this predicament would be to ask who will do the saving and, equally as important, who will provide yield for the accumulated stock of capital?

As for the first part of the question one is tempted to say everybody. External deficit nations will now have to work towards grinding down the debt and external surplus economies cannot, for the most part, do much but to cling on to the increasingly smaller batch of growing markets. I am still skeptical here that the unwinding of the Bretton Woods II à la traditionelle with China and Petroexporter et al. holds much promise to bring rebalancing. As for the part of the world actually able to act as buffers (e.g. India, Brazil, Turkey etc), they are clinging on with their nails, not only to prevent a rout on their capital markets as money pours out, but equally so in the context of actually absorbing the flows once the money start coming in again, because trust me, it will. The key point in terms of global capital flows is that the margins are simply getting smaller in terms of living off of one’s accumulated savings (assuming of course that you do not dissave) and that this will hurt economies in the old end of the demographic spectrum in particular.

In conclusion, one of the main forward looking macro themes I am watching at the moment is the potential for deflation. I would especially ascribe this risk to be high in economies in need of serious competitive and debt reducing corrections as well as in economies unable to muster sufficient domestic demand to stay above water when external demand falters. In my rudimentary analysis I use demographics as a yardstick and as such my claim is quite easily falsifiable. The only thing we need to do then is to watch and see what happens.

[1] My colleague Edward Hugh does just that, and I recommend you to go have a look.
[2] Even if it may turn negative y-o-y in 2008 on the back of the accelerated slowdown.
[3] Although most would agree that the US is now firmly in a recession based on the commotion in financial markets and the deterioration of the job market.
[4] The very aggressive expansion of central banks’ balance sheet and the de-facto ability of financial institutions to offload assets on to ”public” books will be an interesting case to gauge for economic policy makers and historians alike.
[5] Japan has obviously never actually escaped deflation.
[6] Respectable here can mean many things, but one simple derivative is the extent to which Japan need a certain degree of headline growth in order to keep on servicing its liabilities.

Thursday, October 9, 2008

German Exports Drop Sharply In August

Germany's trade surplus fell back in August as exports fell more sharply than imports, figures released on Thursday by the German federal statistics office showed. Germany posted a surplus of 10.6 billion euros, compared with 13.8 billion in July, and way down from 19.9 billion in June.

Month on month (with both calendar and seasonal adjustment), exports decreased by 0.5% and imports by 2.5% on July 2008.From a year earlier, exports declined 2.5 percent. Imports were up 2.6 percent from August 2007. The surplus in the current account narrowed to 7.3 billion euros from 11.9 billion euros.

Exporters are grappling with a slowdown in the economies of their main trading partners. Eurozone gross domestic product shrank 0.2 percent in the second quarter and is most probably set to shrink again in the third, making it quite likely that we will see the region's first recession since the euro was introduced in 1999. At the same time, the deepening financial market turmoil makes it likely that in the coming months the position will deteriorate even further.

Exports to EU member states dropped, since in August 2008, Germany dispatched goods to the value of EUR 47.2 billion to member states of the European Union, while it received commodities to the value of EUR 41.0 billion from those countries. Compared with August 2007, shipments to EU countries were down by 1.4% and arrivals from those countries increased by 1.1%. At the same time exports to the eurozone also fell, since goods to the value of EUR 30.0 billion (–1.3% y-o-y) were dispatched to the euro area countries in August 2008, while the value of imports from those countries was EUR 27.9 billion (–0.6% y-o-y). Goods to the value of EUR 17.2 billion (–1.6% y-o-y) were dispatched to EU countries not belonging to the euro area in August 2008, while the value of goods arriving from those countries was EUR 13.1 billion (+5.0% y-o-y).

And non-EU countries no longer acted as a support, since Germany exported goods to the value of EUR 28.5 billion to and imported goods to the value of EUR 24.1 billion from countries outside the European Union (third countries) in August 2008. Compared with August 2007, exports to third countries decreased by 4.4% while imports from those countries increased by 5.2%.

Since Germany is now totally dependent on exports for GDP growth this waning export performace more or less guarantees quite a substantial recession in Germany over the coming quarters.

Sunday, October 5, 2008

The German Economy Continues To Slow Rapidly

The condition of Germany's economy continues to deteriorate by the month. Industrial output is trending down, domestic demand is down, construction activity is down, exports are struggling to grow, and only employment growth and the services sector continue to show positive signs, and even here the impression is that the situation is gradually worsening.

The tumultuous events of late August and early September in the global financial markets are now evidently making their presence steadily felt on the real economy. And new factor emerged in recent days, with the global banking and financial crisis arriving right on German's doorstep, via the delicate position of the property company Hypo Real estate, who were to have been rescued during the week, but the exact end point of this affair is, at the time of writing, unclear.

With no effective remedy whatsoever being offered from Euope's core leaders, the worst is, most definitely, still to come. The crisis in the banking and financial sector, coupled with the rapid deterioration of the economic outlook in Russia and Eastern Europe is now casting a long, dark and rather awesome shadow over Germany's future. While the sums being mention in the case of the Hypo bail-out - Germany's Die Welt reported Saturday that Hypo may need 20 billion euros by the end of next week and 50 billion euros by the end of the year, while a further 100 billion euros may be needed to shore up the bank's finances by the end of 2009 - are large, there is no doubt about the ability of the German state to shoulder them (unlike its Italian and Greek counterparts), - but even Germany would seem to be in no position to assume such responsibilities and meet the needs of the budget balancing programme for 2011. And this is no mean issue, since should the worst come to the worst, and the state have to assume responsibility for more bank debts than simply the Hypo "trifle", then the net consequence would more than likely be simply a shifting of the financial pressure from the banking sector to German sovereign debt, via the now meticulous activity of those oft cricised entities, the credit ratings agencies. It should never be forgotten that the burden of assuming the costs of Germany's growing elderly population is not insignificant - and this is why it is so important to balance the books by 2011, but carrying the elderly committment and a large banking one would, in all probability, be simply too much for Germany to bear, particularly if the knock on consequences of an Eastern Europe unwind are going to be, as I fear, important.

September Global Manufacturing PMI Shows Sharp Contraction

Germany's manufacturing sector shrank at its fastest pace in at least 5 years in September as output, new orders and employment all fell at a record rate, according to the Markit Economics Purchasing Managers Index out last Wednesday. This result is hardly surprising, since September seems to have been the ultimate "mensis horribilis" for industrial output internationally, with global manufacturing activity contracting for the fourth consecutive month, and output falling to its weakest level in over seven years according to the JP Morgan Global Manufacturing PMI, which at 44.2 hit its strongest rate of contraction since November 2001, down from 48.6 in August (Please see the end of this post for some information about countries included and the JP Morgan methodology).

According to the JP Morgan report the retrenchment of the manufacturing sector mainly reflected marked deteriorations in the trends for production, new orders and employment. The declines in output and new work received were the second most severe in the survey history, while staffing levels fell at the fastest pace for over six-and-a-half years. The Global Manufacturing Output Index registered 42.7 in September, well below the 48.5 posted for August.

The sharpest decline in production was recorded for Spain, followed by the US, Japan and then the UK. Although the Eurozone Output Index sank to its second-lowest reading in the survey history, it was above the global average for the first time in four months. Within the euro area, France and Spain saw output fall at survey record rates, while in Italy and Ireland the contractions were the second and third most marked in their respective series. Germany, which until recently was the main growth engine of the Eurozone, saw production fall for the second month running and to the greatest extent for six years. Manufacturing activity in Japan fell to the lowest in over 6- years with the Nomura/JMMA Japan Purchasing Managers Index declining to a seasonally adjusted 44.3 in September from 46.9 in August.

At 40.8 in September, the Global Manufacturing New Orders Index posted a reading well below the neutral 50.0 mark. JP Morgan noted that the trends in new work received were especially weak in Spain, the UK, France and the US, with the all bar the latter seeing new orders fall at a series record pace (for the US it was the strongest drop since January 2001). The downturn of the sector led to further job losses in September, with the rate of reduction in employment the fastest since February 2002. Conditions in the Spanish, the UK and the US manufacturing labour markets were especially weak.

So basically this is where we get to learn what a global credit crunch means in terms of output and economic growth.

Manufacturing Growth

German headline PMI registered its lowest reading since June 2003, indicating the steepest decline in manufacturing output for six years. Even more preoccupyingly new export orders fell at steepest rate since aftermath of 9/11. The September data signalled a deepening of the recent downturn in the German manufacturing sector, as clients cut back demand in response to the unfavourable economic outlook and concerns over the latest global financial market turmoil.

Once the main engine of growth in the manufacturing sector, there were reports that export demand from the US, the UK and key Eurozone trading partners fell sharply at the end of the third quarter.

At 47.4 in September, down from 49.7 in August, the seasonally adjusted Markit/BME Purchasing Managers' Index (PMI) - designed to give a single-figure snapshot of operating conditions in the manufacturing economy - was below the neutral 50.0 mark for a second month running and at its lowest level since June 2003. At 46.1, down from 49.3 in August, the seasonally adjusted Output Index indicated the fastest reduction of overall production volumes for six years. Panellists widely commented that shrinking market demand had resulted in a fall in output at their plants in September.

According to Markit economics the latest deterioration in overall business conditions primarily reflected substantial falls in output and new work. September's drop in incoming new business was the fastest since mid-2003 and broad-based across the three market groups. Fewer new order intakes led to the most marked reduction of unfinished business since the series began in September 2002. The seasonally adjusted New Orders Index registered 44.9 in September, down from 46.8 in the previous month, to signal the steepest contraction of incoming new work since June 2003.
September data indicated a substantial deterioration in the volume of new export orders received by German manufacturers, primarily reflecting faltering economic conditions in the US and the UK. There were reports that global financial market turmoil had made clients more cautious about committing to new orders. At 43.1 in September, the seasonally adjusted New Export Orders Index was the lowest since October 2001.

Despite making significant inroads into their levels of work-in-hand (but not yet completed), German manufacturers indicated that production levels declined at the steepest rate for six years. Sector data signalled that the fastest fall in output was at intermediate goods producing firms.

Job creation slowed to virtual stagnation in September, as falling workloads gave manufacturers little incentive to increase personnel numbers at their plants. With a number of survey respondents anticipating lower production requirements in the final quarter of 2008, input buying fell at the fastest pace for over five years.

Meanwhile, stocks of finished goods were run down in September, as firms trimmed their sales expectations and sought to avoid unwanted inventory building. Input prices data provided some respite in an otherwise disappointing month for the German manufacturing sector. Average cost burdens rose at the slowest rate for seven months, helped by lower oil and other commodity prices on world markets.

However, German manufacturers indicated that factory gate price inflation remained at an elevated level, with robust increases in output charges broad-based across the three market groups. Factory gate price inflation eased to a three-month low in September. However, at 57.0, down from 59.1 in August, the seasonally adjusted Output Prices Index remained well above the series average and indicative of a robust rise in average prices charged by German manufacturers. September data signalled that marked increases in output charges were broad-based across the three market groups.

Average input cost inflation eased significantly in September, as the effects of lower crude oil and other commodity prices were felt by German manufacturers. Although the seasonally adjusted Input Prices Index fell to a seven-month low of 66.3, the latest reading was indicative of strong overall cost inflation.

Services Output Stagnates

Business activity in the German services sector stood close to stagnation in September.Incoming new work fell for first time in eight months, while future expectations were the second-lowest in the survey history.

September data signalled that business activity in the German service economy was virtually unchanged compared to one month earlier. At 50.2, down from 51.4 in August, the headline seasonally adjusted Business Activity Index was the second-lowest since August 2003 and indicative of a negligible rise in activity. There were widespread reports that weak business and consumer sentiment had held back activity growth at the end of the third quarter.

Markit economics also reported that some firms were noting how attempts to pass through a proportion of their additional costs to clients had a negative influence on market demand. In September, higher levels of activity were largely confined to companies operating in the Renting & Business Activities and 'Other' service sectors.

Meanwhile, slight reductions in activity were recorded at Financial Intermediation and Transport & Storage firms. The volume of new work received by German service sector companies declined for the first time since January. Although only marginal, September's drop in new business levels was broad-based across the service economy.

Anecdotal evidence from the survey panel suggested that global financial market turmoil had dented business sentiment in September, combined with deteriorating prospects for the domestic economy in the year ahead. Average input cost inflation eased further from June's ninety-three month high. Nevertheless, September data pointed to a strong rise in average cost burdens, driven by increased energy prices and staff wages. Faced with renewed pressure on profit margins, service providers increased their average charges at a robust rate in September.

German service providers were highly pessimistic about the twelve-month business outlook in September, with the degree of negative sentiment the most severe since November 2002. At 40.1, the Business Expectations Index was below the neutral 50.0 mark for a fifth successive month. Around 36% of survey respondents anticipate a fall in business activity over the year ahead, which they primarily linked to concerns over domestic economic conditions and weak consumer demand.

JP Morgan Global Manufacturing PMI Methodology

The Global Report on Manufacturing is compiled by Markit Economics based on the results of surveys covering over 7,500 purchasing executives in 26 countries. Together these countries account for an estimated 83% of global manufacturing output. Questions are asked about real events and are not opinion based. Data are presented in the form of diffusion indices, where an index reading above 50.0 indicates an increase in the variable since the previous month and below 50.0 a decrease.

The countries included are listed below by size of global GDP share, and the figures in brackets are the % og global GDP in each case (World Bank Data).

United States (30.5), Eurozone (18.7), Japan (13.9), Germany (5.6), China (4.9),United Kingdom (4.5), France (4.0), Italy (3.2), Spain(1.9), Brazil (1.9),India (1.7), Australia (1.3), Netherlands (1.1), Russia (0.9), Switzerland (0.7), Turkey (0.7), Austria (0.6), Poland (0.5), Denmark (0.5), South Africa (0.4), Greece (0.4), Israel (0.3), Ireland (0.3), Singapore (0.3), Czech Republic (0.2), New Zealand (0.2), Hungary 0.2.