Relevant and even prescient commentary on news, politics and the economy.

The German euro is undervalued

I keep telling people that the German euro is undervalued, but some folks seem not to believe me. (See the comments section from this post last year for an example.) But this is a really big deal. The dominant narrative about the eurozone crisis is that fiscally irresponsible countries like Greece were bringing the once-proud currency to its knees, and weakening the European project to boot. Meanwhile, the virtuous Germans keep on cranking out trade surpluses and have to bail out Greece, Ireland, Portugal, and Spain. And it’s pretty clear that the Germans believe this version of events.

Never mind that Spain and Ireland, for two, had budget surpluses prior to the crisis, or that Spain’s economy is five times as large as Greece’s. What’s going on in Greece is supposedly the true explanation for the eurozone’s problems.

Let me challenge that narrative that with a simple thought experiment. Instead of one euro, let us reason as if each of the 18 eurozone members had its “own” “euro.” Let’s begin by thinking about what creates the value of the current 18-country euro. We might include interest rates, inflation rates, growth rates, and trade balance, among other things, and of course expectations for all these variables. What we need to remember is that the value of today’s euro represents the averaged effect of all these variables in all 18 countries, rather than reflecting the economic conditions of any one of them.

So the euro is currently worth about $1.25. It used to be higher; what is dragging it down? The simple answer is that conditions in Greece, Spain, Ireland, Portugal, and at time Italy have pulled its value down. As has often been noted, if Greece pulled out of the euro it would then devalue the drachma, becoming internationally competitive again without the need for the brutal austerity that has pushed its unemployment rate over 25%. The same is true for the other peripheral countries. By looking at what would happen to the drachma/punt/peseta/escudo, we can see that, for these countries, the euro is overvalued. Another way to say it is that the “Greek euro,” for example is overvalued.

So why isn’t the value of the euro lower than $1.25? The answer, of course, is that Germany, the Netherlands, Austria, Luxembourg, and so forth, are performing well and pushing the value of the euro upwards. These countries, by contrast, would see their currency values rise if the euro were suddenly abolished. For Germany, for instance, the euro is undervalued; an equivalent DM would rise in value.

U.S. officials constantly rail about the undervalued Chinese yuan and the huge bilateral trade deficit it creates for this country. But officials could (and to some extent do) say the same thing about Germany, which now has a larger trade surplus than the vastly larger Chinese economy. In fact, last year Morgan Stanley estimated that a stand-alone German euro would be worth $1.53, compared to the actual euro exchange rate then of $1.33.

With an undervalued currency, Germany gets a much larger trade surplus than it would have had otherwise, magnifying trade deficits in the United States and elsewhere. At the same time, it gets to pretend that this surplus is simply due to German thrift and virtue, rather than currency misalignment. It then points to its virtue as justification for doing nothing to increase domestic consumption, wages, or inflation, and for demanding austerity from the countries to which Paul Krugman rightly says Germany is exporting deflation.

Let me leave you with Krugman’s chart. You can see at a glance that Germany has throttled nominal wage growth and has inflation far below the European Central Bank’s announced target of just under 2%. When you combine its low inflation with an undervalued exchange rate (remember, low inflation should tend to raise the currency’s value), you come to realize that Germany is a huge part of the world economy’s problems today.

 

Credit OECD and IMF

Source: Paul Krugman

Cross-posted from Middle Class Political Economist.

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Chart for the day: Growing on Imports

by Rebecca Wilder
Chart for the day: Growing on Imports
Or should I say barely contracting on imports. In the traditional sense, growth in imports does not make a whole lot of sense. Normal economies import and export things, such that statistical agencies subtract the dollar amount of things that are made in other economies but consumed domestically (imports) out of their tally of spending on goods and services (GDP) in order to avoid double counting items. So if I spend $20 on candy at store in some resort town – $9 on taffy made in Monterey, California and $11 on chocolate made in Belgium – the government only counts the $9 candy made in Monterey as part of US GDP.

If imports is the sole positive growth contribution for GDP, that’s tantamount to production falling on goods and services but we don’t want to double-count the drop in spending of imported goods when calculating GDP, so it’s added back.

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Follow up to yesterday’s post: Euro area consumption and Investment in Q2 2013

by Rebecca Wilder 

Follow up to yesterday’s post: Euro area consumption and Investment in Q2 2013

Yesterday I illustrated the unsustainable accounting growth engine of imports occurring in the euro area (EA). Today I’ll present more of a forward looking analysis on private domestic demand within the euro area: consumption and investment. If current levels of real retail sales hold at the euro area level, then the contributions to growth in Q2 2013 will likely be ever so slightly healthier amid a pickup in private consumption.

Consumption Yesterday we received the May 2013 data on euro area real retail sales, of which the quarterly growth pattern (after revisions, which is very important because this index is heavily revised) has a 70% correlation with euro area real private consumption. A simple bivariate regression predicts that real consumption will grow 0.3% in the second quarter of 2013, holding all else equal and provided the level of real retail sales does not change in June. This would be a material increase from its meager 0.04% contribution to real GDP growth in Q1.

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Unhealthy developments across the euro area labour market

by Rebecca Wilder

Unhealthy developments across the euro area labour market

There are many ways to define rebalancing within the euro area: relative prices, trade, productivity, unit labor costs, etc. I’d argue that one could see it in the employment data as well, although it will take a long time to work its way through. Basically, Spaniards should move to Germany and vice versa to enjoy higher income and lower input costs, respectively, when looking for work or planning a business. Well, a lucky 5,000 young Spaniards will get the chance for apprenticeship in Germany thanks to a recent deal between Germany and Spain. But with 770,100 Spaniards aged 15-24 unemployed in Spain, 5,000 German jobs is not going to go very far. So what’s happened to date?

Eurostat released its annual detailed report of the labour force in Europe. I dug around a bit and found some interesting stats. The gist of what I found is the following: employment in the periphery markets has plummeted with no seeming end in site. Notably, 2012 employment levels in Portugal and Greece are 299,000 and 356,000 lower than their respective 2000 levels.

Note: Please click on all charts for a closer look.

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Unemployment Rates Across the Euro Area – Tough Times in Key Markets

by Rebecca Wilder

Unemployment Rates Across the Euro Area – Tough Times in Key Markets

Today Eurostat released its unemployment rate figures for the month of August. The Euro area unemployment rate held firm at 11.4% for the third consecutive month. Spain still has the highest unemployment rate in the euro area, 25.1%, and Greece is catching up quickly, 24.4% (in June, which is the latest data point).
The chart below illustrates the level of the unemployment rate and its month-month change for the euro area 12 countries.

The periphery are under performing the average, with Spain, Greece, Portugal, and Ireland leading the way. Internal devaluation, or driving up the unemployment rate to reduce relative prices with demand, is really taking its toll. Respectively, the unemployment rates in Spain, Greece, Portugal, and Ireland are 178.9 ppt, 234.2 ppt, 93.9 ppt, and 212.5 ppt above their pre-crisis minimums (loosely defined since January 2008) – a simple average of 179.9 ppt above the joint minimum for these four countries. The average euro area 17 unemployment rate is just 56.2 ppt above its 7.3% pre-crisis minimum. Hard days in the periphery, to be sure. Against this backdrop, weekend protests in Paris, Madrid, Lisbon, and Rome are not a surprise.
I further point out the troubling trend in the French labor market, as the new government presents its fresh austerity budget for 2013.

This budget is highly dependent on tax revenue and positive growth momentum, which is likely to disappoint amid such deterioration in domestic demand. See Ambrose Evans-Pritchard on the expected budget impact.

cross posted with The Wilder View…Economonitors

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It’s the Exchange Rate, Stupid

by Rebecca Wilder

It’s the Exchange Rate, Stupid

Eurostat released trade figures today, where the trade balance (exports less imports) surged €3.7 bn in the month of June (link to the .pdf release). The current figures imply a 2012 annualized trade balance of €66.9 bn, which is a meaningful boost to the -€7.4 bn deficit in 2011.

Eurostat breaks down the regional figures further into intra-Euro area (intra-EA) trade and extra-Euro area (extra-EA) trade.

Out of the EA 16, June intra-EA figures are available for just a few countries. Of those countries, the intra-EA trade balance improved in Portugal only, increasing by 0.26 ppt as a share of GDP on the month. From June 2011 to June 2012, where available, otherwise June 2011 to May 2012 (see Table above), the intra-EA rebalancing – i.e., roughly raising the balance of the net-importers and reducing the surplus of the net-exporters – has occurred to a certain degree. Net trade as a share of country GDP fell in Germany, and rose in Italy, Spain, Greece, and Portugal. France and Ireland worsened their positions, while the Netherlands increased its large trade surplus of 25.1% of GDP over the year.


Except in Portugal and Greece, the intra-EA ‘rebalancing’ is either not necessarily required due to the relatively low imbalances, Spain or Germany, or moving in the wrong direction, France or the Netherlands.
June extra-EA figures are available for all countries. With the help of the real depreciation of the trade-weighted euro over the month, the extra-EA trade balance improved in June across all EA 16 countries except for Ireland, where it fell by 0.2 ppt of GDP. Over the year through June, all countries except the Netherlands saw an improvement in the trade balance as a share of GDP (see Table above).

Given the strong positive momentum in extra-EA net trade and the sluggish shift in intra-EA net trade, I conclude that it’s the depreciation of the real exchange – the 12.7% nominal depreciation of the euro against the dollar, for example, and/or falling relative price levels with extra-EA economies – that’s the primary driver of the improving trade balances in key periphery markets. With the strong exception of Portugal, where the intra-EA balance improved by 2.6 ppt of GDP over the year, the internal (infernal) devaluation of repressing wages through high unemployment has mixed results at best.

Rebecca Wilder

Note: I understand the imbalances lie in the financial accounts as well but this post is dedicated to trade only.
A point on the data: all numbers are seasonally adjusted.

cross posted with The Wilder View…Economonitors

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Euro Area Retail Sales Portend Negative Quarter of Real Consumption

Euro Area Retail Sales Portend Negative Quarter of Real Consumption

by Rebecca Wilder

Today Eurostat released its June estimate of real retail sales for the Euro area. On a month/month basis, real retail sales increased at a rate of 0.1%. However, on a trended basis, the 3-month/3-month average growth rate was down 0.7% in the three months ending in June. Given that the 3-month trended pace of contraction quickened compared to Q1, real consumption is likely to detract from Q2 GDP growth (spending components released on August 23).

On a Y/Y growth basis, there’s a 96% correlation between real retail sales and real private consumption by households and non-profit institutions. Using a simple linear regression, the annual growth rate of consumption should stabilize somewhat in Q2 compared to Q1.
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Across the region, real retail sales in Ireland, Estonia, and Germany are the only reported countries to see growth through Q2.

Note: the chart below illustrates the 3-Month/3-Month growth rate through June 2012 (Q2/Q1).

On balance, Q2 domestic consumption spending in the Euro area is expected to be buoyed by Germany through June. The problem is, German retail sales growth have just a 38% correlation with real consumption growth, so the bump in retail sales won’t necessarily feed through to consumption at the aggregate level.
Euro area real consumption is still contracting. The question then becomes: will the pace of consumption contraction increase or decrease in coming quarters? We’ll have to watch leading indicators such as retail and consumer confidence, both of which deteriorated in July.


Rebecca Wilder

cross posted with The Wilder View…Economonitors

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Euro area troubles, banks, and sovereign debt connections

Economist Mark Blyth talks on Europe and rescuing the banks…

See 35 minutes in on context for LIBOR troubles. (70% of the special investment vehicles designed to pump and dump mortgages belong to European not American banks … Euro banks listed their periphery debt as Tier One Capital under Basel.)

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Euro Area Crisis Hits Confidence in the Core

by Rebecca Wilder

Euro Area Crisis Hits Confidence in the Core

France’s INSEE business confidence, Germany’s Ifo business climate, and theNational Bank of Belgium’s business survey demonstrate ongoing infection as the Euro area debt crisis hits business expectations in the core. Through July, business confidence in Germany and France continued to slide while that in Belgium rebounded, albeit from a low base.

Of note, the service industries in both Germany and Belgium may offer a “ray of hope” (the Ifo Institute puts it.), as these large economic sectors are perhaps stabilizing in the surveys.

Furthermore, consumer confidence in the Netherlands and Italy remain depressed. Notably, the July prints increased 8 and 1.1 points, respectively, over the month – is this the start of a trend, or rather a dead-cat bounce? If I were a betting girl, I’d go with the latter, given the weakness in labor markets and election cycles coming up (September in the Netherlands and TBA in Italy).

In Germany, the Ifo survey has deteriorated swiftly in recent months. This now brings this survey more in line with other business surveys, such as the German PMI, which had shown a more pronounced economic decline.

The Ifo Business Climate survey contains a wealth of information, but is generally dissected into assessment of the current business situation and expectations of the future business environment. The current environment survey, 111.6 in July, fell over the month but remains above the longer term average, 102. In contrast, expectations as regards the future business environment are falling swiftly. The Euro area crisis is impacting the business decision process.

Finally, as demonstrated in the Ifo Business Climate survey that highlighted its ‘significant deterioration’, the manufacturing base is leading the way down. In France and Germany, Markit Manufacturing PMIs hit the low 40s, 43.6 and 43.3, respectively in July. This implies a quickening of the pace of contraction across the French and German manufacturing bases with not much hope of near-term relief, neither from domestic nor foreign demand. The Dutch Statistical Agency, CBS, today reported further decline of Dutch manufacturing opinions in July, as manufacturers anticipate layoffs.

My only question becomes how much weakness is needed in the core (Germany) to get a(nother) significant response from the ECB?


Rebecca Wilder

cross posted with The Wilder View…Economonitors

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Euro Area Imbalances Are a Symptom of the Broader Global Imbalances

by Rebecca Wilder

Euro Area Imbalances Are a Symptom of the Broader Global Imbalances

Every year I travel to Germany to visit my in-laws, which is where I am now. Given the extra time on my hands, I’ve now mulled over a June 2012 NY Times opinion piece by Gunnar Beck. Beck displays an interesting medley of data in support of his view that Germany cannot afford to backstop the European Monetary Union (the single currency union referred to as the Euro area, or EA). Germany itself has been the loser, not the winner, of the single currency union. His comments are loosely based on the research of the Ifo Institute’s Hans-Werner Sinn.


Based on the ideas of Beck and Sinn, I start a short series on the benefits of membership in the EA, ex-post and ex-ante. The conclusion from this initial post: Some call the EA a microcosm of the world imbalances, i.e., Germany is to China as Spain is to the US. I disagree. I’d argue that the EA imbalances are a function of, rather than a mirror of, the broader global imbalances.

Let’s start by looking at the simple net trade statistics as rents derived by membership in the EA since 1999. I further Beck’s analysis on intra-EA trade (trade among the EA countries) for the original 1999 EA 11 economies. The 11 economies to meet the convergence criteria by 1999 were: Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland.

By definition, the trade balance is the difference between total exports and total imports, both of which are affected by relative prices and membership in the EA.

The chart below illustrates the change in the annual intra-EA trade balance as a share of GDP during the period 1999 to 2011. Spanning the years 1999-2011, intra-EA gains from the fixed exchange rate regime within the EA have been lopsided toward Spain, Portugal, and the Netherlands.

(Note: for consistency, I use the EA 17 economies as the ‘trading partner’ for the period in the chart below. Furthermore, notice that the axis points in both charts are equal for ease of comparison.)

Being a port economy, the Dutch trade ties to the EA are strong, and gains from EA trading partners have been robust, +11% of GDP spanning the years 1999-2011. Portugal and Spain have likewise benefited, however, their intra-EA net trade gains occurred exclusively since 2008. Of interest, Finland fares the worst, having seen a 5.1% (of GDP) decline in its net trade with EA partners. And Ireland, for all its praise (please see current account stats on Ireland here ), saw its intra-EA net trade decline by 5% of GDP while in the EA – admittedly, there’s been a 4.2% of GDP gain in net trade with the EA since 2008.

Who are the winners of intra-EA trade spanning the entirety of the Euro Area? As demonstrated above, not many countries. The gains from trade came primarily from net exports from developed economies outside the EA (while I do not include a country breakdown, the large net importers are the developed economies – see the IMF WEO database).

The chart above illustrates the change in the annual total trade balance (extra- plus intra-) of the EA 11 as a share of GDP spanning the period 1999 to 2011. Here, the gains from trade are a bit less lopsided and the ‘usual suspects’ are evident. Germany was the third best performing economy by this measure, where net trade increased an average of 2.8% of GDP over the period. The Netherlands benefited the most of the EA 11; but the improvement was based exclusively on intra-EA trade. Portugal experienced gains from net trade from the rest of the world and the EA, where the total trade balance improved by 3.2% of GDP (again, exclusively in the post 2008 period).

Of note, France performed poorly on both counts: intra- and total net trade, -3.2% and -4.9% of GDP, respectively. In contrast, Germany performed relatively well. Being the largest economies in the EA, and given that the absolute value of the total trade balances (either deficit or surplus) exceed that of their respective intra-EA balances, I hypothesize that the global imbalances exacerbated, even caused, the EA imbalances.

Thus, EA imbalances are not a microcosm of the broader global imbalances, rather a symptom of global trade policy.

Rebecca Wilder


crossposted with  The Wilder View…Economonitors

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