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Sunday, August 30, 2009

What Is The Real Level Of Unemployment In Germany And Japan?

With Japan having general elections today and Germany facing them next month, I though now might be as good a time as any to have a look at a topic which could turn out to be very important in the months to come: the real underlying rate of unemployment in both these countries.

While the present focus of most press attention is on the fact that GDP in Germany and Japan nudged upwards between April and June (over Q1), we should never forget that this increase follows substantial falls in output. Japan’s real GDP fell at a record pace in Q4 2008 and Q1 2009 (annualized declines of 13.5% and 14.2%, respectively), and German GDP fell by a quarterly 3.5 percent in Q1 and an annual 6.7% - making for the fourth consecutive quarter of negative growth. In both cases the fall in output was accompanied by only a much more moderate decline in employment.

Part of the explanation for this recent return of both economies to growth lies in the fact that both countries have very substantial stimulus and employment protection programmes in place, and these to some extent mask the extent of the output slump. At the same time both countries have been in run up periods to national elections, while both of them have rapidly ageing populations, rising health and welfare costs and steadily deteriorating gross debt to GDP positions. It is therefore highly likely that the positive stimulus programmes will wane somewhat after October as both governments are forced to move from very expansionary fiscal positions, to more or less "belt tightening" ones, and the big issue which lies in front is estimating just how far the respective labour markets can deteriorate in the two countries as a result. Fortunately analysts at Nomura (for Japan) and Societe Generale (for Germany) have recently produced what are very timely studies which help us get a better appreciation of the true underlying situation.

Japan's Sruggles To Raise Exports In The Face Of Tepid Domestic Demand

Apart from the temporary relief which came from a headline GDP growth reading in the second quarter, the news coming out of Japan at the moment is almost uniformly bad. The unemployment rate is now at a record high, raising even more doubts about the real sustainability of the recent economic recovery. The jobless rate rose to a worse than expected 5.7 per cent in July, up from 5.4 per cent in June. By Spanish or Latvian standards this may seem very tame, but if you take into account the extent of government subsidised "hidden unemployment" the true underlying rate may be nearer 12 or 13%, or at least this is what analysts at Nomura (see below) have recently been arguing.

In addition, Japanese core consumer prices fell at the fastest annual pace on record in again in July, potentially putting pressure on a reluctant Bank of Japan to rein in deepening deflation. Core consumer prices - the bank of Japan's preferred measure - which exclude volatile fresh food prices but include oil costs, fell 2.2% in the year to July.

Average monthly Japanese household spending fell in July by a price adjusted 2.0 percent from a year earlier to 285,078 yen, down for the first time in three months, while Japan’s July exports fell 1.3 per cent on a seasonally adjusted basis from June, a real big deal this in a country whose economy is almost entirely dependent on exports. Shipments in July fell 36.5 per cent by value year on year, outpacing the 35.7 per cent decline in June.

Under the Japanese employment protection scheme, the government pays two thirds of the wages of workers in certain specified situations. As of June 2009, some 2.383mn workers had applied for employment adjustment subsidies for 2009 onward (see chart). Although only 1.891mn had been approved as of June, Nomura expect this figure to eventually rise closer to the number of applicants.

In order to try to get a measure of the impact of this scheme on the unemployment level the Nomura analysts did a number of tests, and found that when indexing the number of those employed and real GDP to the output peak of Q4 2007 there was a considerable gap between the output adjustment and the employment one. Based on a simple calculation which assumed this "gap" to offer a good proxy for the amount of “hidden underemployment”, they arrived at a figure for “hidden jobless” in Q1 2009 of 4.7m. This number is far higher than the June unemployment figure of 3.48m. If the hidden jobless are included together with the registered “unemployed”, they calculate that the unemployment rate would have leapt from 5.4% to 12.2%.

This chart below shows estimates made by the Nomura analysts of the extent of hidden joblessness during previous economic downturns. In the majority of cases the number of hidden jobless did not rise at all, or employment fell by more than GDP did, suggesting that employment adjustments were quite swift. They did find, however that there was a comparatively large rise in the numbers of hidden jobless in Q4 1973, triggered by the first oil shock and in Q2 1997, following the Asian currency crisis, problems in the Japanese financial system and a consumption tax hike. The number of hidden jobless, estimated at about 4.7m in Q1 2009, seems to be well above the figures associated with these two earier downturns.

However, as the Nomura analysts point out, even if the difficult labour market conditions are not fully reflected in the unemployment figures, a deterioration in adjusted labor supply-demand could easily lead to major declines in wages even while companies keep the number of hidden jobless down by means of government support. In fact, according to Nomura it would be hard to explain the fact that the decline in wages (total cash earnings of full-time employees) in H1 2009, at 4.7% y-o-y, was far bigger than the equivalent declines in annual average wages of 2.3% in 2002 and 0.4% in 2003, when unemployment also reached new highs, if you don't take the hidden jobless factor into account (see chart). Thus the resulting pressure on wages and household income could easily become a serious impediment to any genuine fully fledged economic recovery.

As of June 2009, payments under the government's subsidy scheme for employment adjustment totalled ¥101.14bn. If the number of approvals grows to meet the number of applicants, Nomura estimate total payments will increase to ¥127.42bn, placing additional strain on fiscal finances. The Nomura analysts argue that dividing the cost of the hidden jobless and in-house unemployed between companies, households and government could well represent a major policy challenge for the new Japanese administration when it assumes office. Given the seriousness of the social and political problems that result from sharp rises in unemployment, it is quite possible the next Japanese government will strengthen the employment adjustment subsidy scheme by, for example, further relaxing its terms and conditions, and it is rather unlikely to try to limit the number of eligible cases by tightening conditions. The net upshot of this, will, of course, be a further deterioration in Japan's gross debt to GDP position.

Given this, and despite the distortions being produced by the huge number of hidden jobless, Nomura think the unemployment rate is unlikely to be allowed to rise too far beyond 6.0%. We will see.

And Germany Does The Same

Despite some small improvement in headline GDP numbers, the great German job machine effectively ran out of steam last autumn, and since that time the German economy has been adding jobs at an ever slower pace. Now the rate of job creation has turned negative, and less Germans are employed every month than they were a year earlier.

German unemployment rose again in July. The number of people out of work increased 52,000 to 3.46 million on an unadjusted basis. The seasonally adjusted total actually fell by 6,000, according to the statistics office due to statistical changes. Without the impact of the changes, the office estimates unemployment rose by 30,000. German unemployment began to increase in November after falling steadily for more than three years. The seasonally adjusted jobless rate was unchanged at 8.3 percent in July.

Analysts at Societe Generale, have examined the case of the German employment protection programme, and point out that while official unemployment in Germany has in fact only risen moderately in the current recession the underlying real effective rate is much higher. The unemployment rate (using the ILO measure) has risen by just 0.6ppt from its 7.1% low in Q4 2008, while in the euro area as a whole, the rate is up by 2.2ppt to 9.4% from its March 2008 low of 7.2%. As they say, it is also quite clear that this relative stability owes much to the widely-used practice of so called short-time working (Kurzarbeit).

The Societe Generale interpretation is broadly supported by survey evidence which suggests that the rate of contraction in employment has eased, suggesting there will be an even slower increase in unemployment in coming months. For example, the employment component of the PMI survey in manufacturing industry rose to 37.9 in July from a low of 32.9 in April, and in the services sector to 49.0 from a low of 45.2 in May. Employment intentions (in the European Commission survey) have also come off the lows in all sectors, but still remain in negative territory, implying further job losses. This evidence tallies with other recent evidence from official unemployment data, which show unemployment up by an average of 8,000 per month in May-July, a big shift downward from the average monthly increases of nearly 60,000 in Q1. This level of improvement will, according to Societe Generale not be sustained, although they do not expect to see a return to the pace of unemployment gains witnessed earlier this year. Of course, as SocGen point out, company employment intentions could easily deteriorate again if growth expectations get revised down, but for the nearer term, the evidence suggests that unemployment in Germany will rise at slower rates than observed earlier this year.

On the other hand they also underline that such short-time working arrangements evidently have a "sell by" date, and can't run forever. As a result there is some concern that a major increase in unemployment in Germany is merely a matter of time.

In fact the Societe Generale analysts are not that convinced by this line of argument, since they think that German legislation has already extended the period for which companies can run short-time working from 18 to 24 months. Examining in detail the evolution of the numbers on short-time working they find that the vast majority of companies only resorted to the programme in the very recent past, so that the 24 month limit will not bite until late-2010. Until the turn of the year 2008/09, the recourse to short-time working was very small indeed. Aside from the seasonal increases in the first quarters of 2007 and 2008, the numbers were small at around 50,000. To put the number in context, they point out that this represents 0.1% of the labour force and is equivalent to the monthly gains in unemployment that were recorded this year. Since then, the numbers resorting to the programme have indeed exploded and by March of this year (the latest available data), there were 1.3 million workers with shortened hours, and this number has probably now risen to around 1.4 million. These are clearly big numbers, amounting to about 3% of the labour force. If they were added to unemployment figures, total unemployment would rise to the previous historic peaks of around 5 million.

However, given that this increase only began in the final two months of 2008, these schemes could easily run for another 18 months, at least as far as the administrative rules are concerned. Whether the German fiscal position will allow this once the new government is installed is another question entirely. Indeed, according to an article in the Financial Times last week, Germany faces a potential wave of corporate restructurings just after the elections, restructurings which will involve substantial job losses and which have not been announced previously due to the existence of an implicit "pact" not to announce big job cuts ahead of the September 27 ballot. We will, as they say, see the proof of the pudding here in the ultimate eating, but levels of German fiscal support at the present level cannot run for that long unchecked after the election results are announced.

Saturday, August 22, 2009

Is Germany's Economy Really Powering Ahead?

Well, euphoria in Germany is certainly on the rebound, with a sudden surge in the ZEW investor confidence index and newspaper articles all over the place predicting the imminent renaissance of European economic growth, despite the fact that in 3 of the 5 big European economies - the UK, Italy and Spain - there is little in the way of evidence to back this view up.

The French economy is certainly holding up reasonably well, but the situation in Germany still remains deeply problematic due to the complete dependence of the economy on exports. Despite this we have a shower of articles (Below I present an extract from Frank Atkins writing in the Financial Times) explaining how "Europe's Economic Recovery is Gaining Steam" and the "German economic recovery powers ahead". I have already written up a an extensive summary of the actual state of play in the German economy, which is largely supported by a strong government stimulus programme, and a recovery in industrial output for export to levels which are more in line with the actual current level of demand than were the extremely low levels seen at the turn of the year (which were the product of demand being met from inventory run downs).

German economic recovery powers ahead
By Ralph Atkins in Frankfurt

Germany’s economic recovery has leapt into a higher gear, according to a closely watched survey that showed private sector activity expanding this month at the fastest rate for 15 months and lifting the overall eurozone economy’s performance

The purchasing managers’ index for Europe’s largest economy jumped to 54.2 in August, from 49.0 in July, signalling an unexpectedly brisk pace of expansion. The growth was driven by the service sector, where employment actually rose, but manufacturing also showed a further rebound.

The figures were the latest economic data from continental Europe to surprise on the upside and suggested the region had overtaken the US and UK in the pace of its recovery. France’s economy is also now expanding clearly, according to a separate purchasing managers’ index for the eurozone’s second largest economy.

The euro gained 0.5 per cent on the dollar to $1.43 and 0.2 per cent on the pound to £0.86

Germany’s rebound appears to have been powered by the country’s pioneering “cash-for-clunkers” incentives for new cars purchases and a pick-up in global demand for its exports. Earlier this week, the Bundesbank reported that consumer spending was likely to have risen further in the second quarter and described German shoppers as “remarkable in continuing to defy the negative effects of the global economic and financial crisis”.

The Bundesbank argued that a “further marked pick-up in overall economic output is possible in the third quarter”.

However, Axel Weber, Bundesbank president, has sought to rein in expectations, warning in a German newspaper interview this week that “the economy is not yet standing on its own feet, and the financial markets are still reliant on central bank help”. Other European Central Bank policymakers have also warned that a self-sustaining recovery may take longer to emerge – which also suggested the ECB will be in no rush to reverse the exceptional steps it took to combat the eurozone’s recession.

Evidently Frank Atkins is right up to a point (and his position may indeed even seem more extreme than it is due to poor headline writing). It is certainly the case Europe's economies continued to show signs of improvement in August - following a better than anticipated perforemance in Q2 - with the Markit Flash Eurozone Composite Output Index rising to 50 from 47 in July, thus ending a fourteen-month sequence below the no-change mark of 50. The Flash Purchasing Managers Index for the manufacturing sector stood at a 14-month high of 47.9 in August compared to 46.3 in July, while the services PMI rose to a 15-month high of 49.5 versus 45.7 in July. Markit only publishes flash readings for two eurozone economies, France and Germany. PMI readings give us the best up to the moment snapshot of where activity is at at any given point.

The Markit Flash Germany Composite Output Index stood at 54.2 in August, which was the highest reading for fifteen months, following an index reading of 49 for July. The German Flash services PMI rose to 54.1 in August from 48.1 last month. A very strong rebound for a single month, but do watch out, since elections are coming, and beyond that tricky little data point there is no evident explanation for this impressive rebound. It is suspicious for its strength, in what is an otherwise tepid environment.

Whilet he Flash Manufacturing PMI moved up to 49 from 45.7. A solid improvement, but we are still just short of expansion.

So obviously we should also take into account the latest PMI readings for the Eurozone, which were certainly positive, but hardly sufficient to start uncorking the champagne bottles. Basically, I would note two more things about the recent German performance.

i) We are in the direct run up to an election. This phenomenon has well known side effects for public spending etc. Certainly every project which can be will be being brought forward at this point. We need to wait and see what things look like in October before drawing too many conclusions.

Indeed, on this point, note what the Federal Statistics Office said in their latest press release on German public debt:

"As reported by the Federal Statistical Office (Destatis), the core budgets of the Federation and the Länder – as defined in public finance statistics – recorded a considerable financial deficit in cash terms in the first half of 2009. For the Länder, the financial deficit totalled EUR 15.4 billion, while in the first half of 2008 a financial surplus of EUR 3.1 billion was recorded. In the core budget of the Federation, the financial deficit rose to EUR 14.7 billion compared to EUR 13.1 billion in the first half of 2008. It should be noted, however, that the financial burdens of the Federation caused by the financial and economic crisis become obvious mainly in its extra budgets “Financial Market Stabilisation Fund” and “Investment and Redemption Fund”. Relevant statistical data will not be available until the end of September."

Please note that last little line - "Relevant statistical data will not be available until the end of September." - ie after the elections which will be held on 27 September.

ii) Bundesbank president Axel Weber may be over optimistic when it comes to the deflation threat, but he is far from being full of "irrational exhuberance" about the present timid bout of growth. This kind of view, however, is seldom reflected in those attention grabbing headlines. It would be a pity if all this new found German growth, like those famous wave of babies who were supposed to have been being born in Dussledorf last year, should turn out just to be a blip, undetectable when the annual figures are counted up.

Indeed the present situation (even down to the headlines) is very reminiscent of the reaction after the first quarter of 2008, when that famous decoupling thesis was first launched in all its splendour, which is why I am reproducing extracts from an article by Karl Zawadzky written at the time. He said then "the indicators suggest that the German government is on the safe side with its growth prediction of 1.7 percent. Some economic experts are already speaking of 2 percent or more." In fact German GDP started shrinking almost immediately after the words were written and 2008 whole year growth came in at only 1.3% according to the Federal Statistics Office (and more like 1% on a calendar adjusted basis, allowing for the extra day in February) as I was already more or less forecasting in July 2008 (just for those of you who think economists never get anything right).

My feeling is that by the time we get to the end of the third quarter of 2009 we will all be back to reality, including those among us who write newspaper headlines.

Opinion: German Economy Powers Ahead
by Karl Zawadzky: business editor Deutsche Welt Radio

The German economy surged in the first quarter of this year, defying a global slowdown. DW's Karl Zawadzky remains optimistic about Germany's ability of maintaining its current financial boom.

Experts are predicting that economic growth will slip this year. They cite the financial crisis, high oil and gas prices and the expensive euro.

But the German economy is currently quite robust -- perhaps even more robust than many experts think. The surprisingly strong jump in economic activity during the first quarter is evidence of this. While gross domestic product increased by only 0.3 percent in October, November and December, it rose by 1.5 percent in the first three months of 2008.

Domestic markets get attention

For years, business activity has been fuelled by ever increasing export records. But now, focus has shifted to domestic markets. There were few impulses from abroad that spurred the German economy during the first quarter. The rising prices of key imports crude oil and gas, but also the expensive euro, which put the breaks on German exports, played a decisive role.

Little reason for pessimism

But the German economy is still on track for growth. Even in the first quarter, personal consumption rose after many weak years. Employment was up 1.8 percent compared to spring 2007 and the rise in wages in some sectors promises the biggest increase in buying power in years. That will boost consumption. The German economy is powering ahead, propelled by its own strength.

The indicators suggest that the German government is on the safe side with its growth prediction of 1.7 percent. Some economic experts are already speaking of 2 percent or more.

Compared to other countries in the EU, Germany is proving to be the bloc's economic engine and is powering through the current financial crisis quite well. While the German economy grew by 1.5 percent in the first quarter, the EU reported an average growth rate of only 0.7 percent.

Certainly German analyst and investor sentiment rose sharply in August to its highest level in over three years. The ZEW economic think tank's closely-watched monthly survey, said rising industrial orders and a pick-up in exports had brightened the outlook for Germany. The Mannheim-based institute's economic expectations index for Germany rose to 56.1 in August from 39.5 in July, taking the indicator to its highest level since April 2006.

But we should never forget that while German exports swang back to solid growth in June, surging by 7 per cent in June, optimism was also boosted by a 4.5 per cent rise in industrial orders in June - powered almost entirely by export orders - they are still significantly down on the level they attained one year ago.

While industrial production output numbers for June, tempered hopes for a further rebound, since they fell back 0.1 per cent compared with the May’s figures which showed a 4.3 per cent rise over April.

And in terms of domestic consumption it really is difficult to see any powering ahead in German retail sales, since while the rate of decline may have eased somewhat in July as only a marginal drop was shown in month-on-month sales (the index rose from 46.0 in June to 49.8) the index has now been registering contraction since sales began falling in June of last year. And I doubt things are going to get much better on this front anytime soon.

Oh, and one last little detail. Germany's economy is not - as Frank Atkins again had it in last Friday's FT - offering a ray of hope for the global economy, since Germany is running a current account and trade surplus, which is to say that, on aggregate it is actually draining demand from the rest of the world, rather like those famous energy inefficient solar panels, it uses up more energy producing itself than it actually supplies.

Thursday, August 13, 2009

Germany's Economy Returns To (Timid) Growth In Q2

The German economy, Europe’s largest, unexpectedly returned to growth in the second quarter, technically bringing an end to its worst recession since World War II. The euro climbed 0.2 percent to $1.4248 on release of the report.

But don't get carried away just yet, since while gross domestic product rose a seasonally adjusted 0.3 percent from the first quarter, when it plunged 3.5 percent, the most since quarterly data were first compiled in 1970, compared with Q1 2008 Compared with the second quarter of 2008, the price-adjusted GDP product was down 7.1%, while after adjustment for calendar variations, economic performance decreased 5.9% on a year earlier as the quarter had three working days less than the same period of the previous year.

Household and government final consumption together with capital formation in construction (government infrastructure spending) all exerted a positive impact compared with the previous quarter. As price-adjusted imports declined far more sharply than exports (that is the trade surplus rose), the balance of exports and imports also had a positive effect on GDP growth. However, declining inventories continued a negative effect on growth, and this suggests that optimism is not that ebullient, since otherwise people would be stocking up getting ready to sell.

Employment continued to fall, and there were 40.2 million people in employment in Q2, which was a decrease of 25,000 persons or 0.1% on a year earlier.

The Federal Statistical Office will release detailed results for the second quarter of 2009 on 25 August 2009, and we will be able to see the complete picture a little better then.

PMIs Still Show Contraction

Germany's private sector contracted at its slowest pace in 11 months in July and was close to breaking through into growth.

Final figures for the Markit purchasing managers index (PMI) showed the headline composite measure of business activity rising five index points to 49.0 in July from 44.0 in June -- closing in on the 50 level that separates contraction from expansion.

The composite index covers both Germany's manufacturing and service sectors. The headline PMI for the service sector rose to 48.1 in July from 45.2, just below the flash estimate of 48.4.

However, it is clear there will be a before and after the German elections (next month) here, and my forecast is for a further contraction, possibly 0.5% q-o-q in Q3 (looking at the PMIs) as the impact of the stimulus wanes, and exports get stuck more or less around the present level. A long hard road lies ahead.

Germany's battered industrial sector contracted at its slowest pace in 10 months in July, and orders and output grew for the first time since last summer. The Markit purchasing managers' index (PMI) of activity in the German manufacturing sector rose for a sixth month running and by the biggest amount in the survey's history to hit 45.7. This is still, however some considerable distance from the 50 expansion threshold.

Exports Rebound

German exports swang backin to solid growth in June, surging by 7 per cent in June, optimism was also boosted by a 4.5 per cent rise in industrial orders in June - powered almost entirely by export orders.

On the other hand, industrial production output numbers for June, tempered hopes for a further rebound, since they fell back 0.1 per cent compared with the May’s figures which were revised up to show a 4.3 per cent rise in production over April. The strongest performing sectors in recent months have been those producing investment goods and “intermediate” products, shipped for completion elsewhere.

Consumer and Business Confidence On The Rise

German IFO business climate came in at 87.3, higher than the 86.6 expected and the 85.9 reading in June. IFO economists continue to be optimistic as the economy is gradually stabilizing. The expectations component rose for the eighth consecutive month to 90.4 from 89.5 in June. The current assessment component also increased to 84.3 from 82.4 and above market forecast of 82.8.

Consumer confidence also continued it upward trend in August with the GFK forward looking indicator forecasting a value of 3.5 points for August 2009, following a revised value of 3.0 points in July. Over a longer term comparison however, the consumer climate is still at a very low level.

German investor confidence on the other hand fell back in July, although since the impression has been that investors may have been getting ahead of themselves, then this correction is not entirely unexpected. The ZEW index of investor and analyst expectations, which aims to predict economic activity six months ahead, declined to 39.5 from 44.8 in June.

As Retail Sales Continue To Fall Domestic Demand Remains Weak

Domestic demand remains very weak, and retail sales dropped for a secondconsecutive month in June as rising unemployment prompted consumers to cut back their spending. Sales, adjusted for inflation and seasonal factors, decreased 1.8 percent from May when they fell 1.3 percent. From a year earlier, sales decreased 1.6 percent. As can be seen in the chart, German retail sales have been in decline since 2006.

Employment Falls And Unemployment On The Rise

The German job machine ran out of steam last autumn, and since that time has been adding jobs at an ever slower pace. Now it has turned negative, and less Germans are employed every month than they were a year earlier.

German unemployment rose again in July. The number of people out of work increased 52,000 to 3.46 million on an unadjusted basis. The seasonally adjusted total actually fell by 6,000, according to the statistics office due to statistical changes. Without the impact of the changes, the office estimates unemployment rose by 30,000. German unemployment began to increase in November after falling steadily for more than three years. The seasonally adjusted jobless rate was unchanged at 8.3 percent in July.

And Deflationary Pressures Mount

The German consumer price index declined by 0.5% in July 2009 over July 2008, raising new deflation concerns. Germany as a whole has never seen such a low inflation rate has not been seen since German reunification, while for the former territory of the Federal Republic, a similar rate was registered in spring 1987. In the preceding months of June and May 2009, the rates of price increase were +0.1% and ± 0.0%, respectively. Compared to June 2009, the consumer price index remained unchanged (±0.0%).

The harmonised consumer price index (HICP) for Germany, which is calculated for European purposes, declined 0.7% in July 2009 over July 2008.

The index of producer prices for industrial products (domestic sales) for Germany fell by 4.6% in June 2009 from the corresponding month of the preceding year. This was the lowest year-on-year-rate since December 1968 (–5.0%). In May 2009, the annual rate of change was –3.6%. Despite the fact that much of this fall in prices is due to falling food and energy costs, the ongoing excess capacity in the economy, and the mounting unemployment will maintain the deflationary pressure. My view: Germany has entered deflation, and it is far from clear when she will leave.

In fact the German economy will never recover on the back of domestic demand, which is weak, and tends to lag behind movements in exports and in GDP. So really a full fledged German recovery must await recovery elsewhere, and in the meantime we are left with simply marking time.

Bottom line, this is as much of a statistical recovery as anything else at this point. After the election the new German government will need to address fiscal deficit concerns, undermining the fragile growth, and my current forecast is for a further 0.5% contraction in the third quarter, and a 7% fall in 2009 as compared with 2008.