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The Euro Area Precedent for Policy Failure

by Rebecca Wilder

The Euro Area Precedent for Policy Failure

Last weekend, a leaked Troika report (Troika = ECB + EC + IMF) revealed that European policy makers now comprehend that the Greek policy prescription is not working (bold by yours truly):

The growth and fiscal policy adjustments assumed under the program individually have precedent in other countries’ experience, but experience to date under the program suggests that Greece will not be able to set a new precedent by realizing at the same time and from very weak initial conditions a large internal devaluation, fiscal adjustment, and privatization program.

Rob Parenteau and Marshall Auerback sum up the implications of this point (1 A.):

On the first page of the document is not only a pretty open and blatant admission that expansionary fiscal consolidation (EFC) has proven to be a contradiction in terms, at least in Greece, but there is also a serious policy incompatibility problem, at least over the intermediate term horizon, with efforts at internal devaluation (ID) – that is, attempting nominal domestic private income deflation in order to improve trade prospects when one has a fixed exchange rate constraint.

I agree with Rob and Marshall – the grand plan does not work. Greece will (of course) not be able to set a new precedent of public sector and private sector deleveraging amid weakening external demand and a fixed exchange rate. However, I’d like to focus here on the ‘precedent in other countries’ experience’. What precedent?

One might point to Canada’s mid-1990s budget initiative that dropped program spending from 16.8% of GDP in 1993-1994 to 12.1% in 1999-2000 as a candidate for precedent. Marshall Auerback and Stephen Gordon refuted this claim as applicable to current conditions. However, we now have economic data available with which to compare the Canadian austerity experience to that of the Euro area.

What’s happened in Europe over the last year: Divergence. Since the middle of 2010, fiscal austerity and a drive for internal devaluation to ‘increase competitiveness (whatever that is) slashed GDP growth on a quarterly basis for all countries under the European Financial Stability Facility (EFSF) program – Greece, Ireland, and Portugal – while nonprogram countries enjoyed the economic benefits associated with a robust global recovery (through 2010). Note: fiscal austerity and ‘reform’ are pre-conditions to accessing funding at the EFSF. Not coincidentally, since Q1 2010, no Euro area countries have contracted except program countries (rounding to the nearest tenth) through Q2 2011.

The chart above illustrates the major Euro area (EA) economic (EA 12 less Luxembourg) recoveries since the peak in EA real GDP, Q1 2008. The legend lists the latest Q2 2011 reading as an index to the Q1 2008 EA peak – the difference over 100 represents the accumulated growth in real GDP. Only Belgium, Austria, and Germany retraced, or fully recovered, the lost EA real GDP. EA economic activity is 2% below pre-recession levels. Notably, Ireland, Greece, and Portugal are struggling amid tight financial conditions and the crimping of domestic demand (internal devaluation).

Since austerity and raising the primary balance is a  condition for EFSF funding access, a contracting economy is to be expected, right?

Wrong – in fact, the Canadian economy experienced no real GDP contraction spanning the years 1994-2000 when the structural fiscal balance turned from a 6.9% deficit to a 1.5% surplus. All the while, GDP maintained a 4% average annual growth rate and did not contract on a quarterly basis (after revisions). Admittedly, the Canadian economy did not grow in Q2 1995 and Q3 1995, but improved smartly thereafter.

I point you again to Marshall Auerback and Stephen Gordon for the whys. But basically, easy monetary policy, depreciation of the currency, and robust US demand fostered the fiscal shift in Canada. None of these conditions exist in the Euro area, so those program (austerity) countries – Ireland, Greece, and Portugal – suffer contraction.

As an aside, some may point to Ireland as a success story, since it posted two consecutive quarters of reasonably strong growth in the first half of 2011. Sure, Ireland eventually grew – it is a very open economy, so has an innate ability to generate net export income. But importantly, look how far the economy fell (see first chart). The economy saw 10.7% in accumulated contraction spanning Q1 2008 to Q4 2010 – the 3.5% rebound spanning the first half of 2011 pales in magnitude. I point you to Edward Hugh’s commentary for a sobering read on Ireland.

Finally, I leave you with a potent illustration of what not to do when it comes to fiscal austerity: Portugal vs. France.

Portugal was doing all right – better than France, even – until they ran into 2010 financial stability problems that forced the government to start ‘cutting’. Portugal started to contract in Q4 2010, applied for funding in April 2011, and contracted thereafter. Economic Intelligence Unit sees Portugal contracting throughout 2012 (no link). The Euro area prescription for austerity is tantamount to economic collapse amid a fixed exchange rate and meager global growth prospects.

The EA policy plan for fiscal austerity is setting a precedent, all right, a precedent for policy failure.

Originally published atThe Wilder View…Economonitors

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Don’t Hold Out for a Lasting German Economic Rebound

by Rebecca Wilder

German industry is plugging away. Ending in August, the 3-month average of the seasonally- and calendar-day adjusted volume of industrial production (excluding construction) maintained a quick 8.3% annualized pace. Even if this core measure of industrial activity falls another 1% in September, the Q3 quarterly annualized pace would be 10.5% – a robust acceleration from Q2 (6.3%). This suggests that the German economy quickened in Q3 – does that mean it’s all clear for the Euro area?

I think not.

According to The Wilder View Leading Economic Indicator (TWV-LEI), the annual pace of German manufacturing is set to slow quickly, if not contract, by the end of this year. (I constructed my own indicator since the OECD indicators are generally lagged by two months.) In September, five of the seven components that drive the index confirm a sharp deterioration in economic activity (the final two indicators have not been released yet). This downward trend in TWV-LEI for Germany has been in play since August 2010 and is yet to be fully reflected in industrial production (IP); that will change.

The chart above illustrates The Wilder View’s leading indicator for Germany (TWV-LEI, Germany). TWV-LEI is a composite of the following variables: PMI manufacturing, Ifo business climate index, manufacturing orders, employment opportunities index, inflation expectations, consumer confidence, and the terms of trade. I’ve found that these indices have the highest correlation with current economic activity, which is measured by industrial production. The r^2 of a simple univariate regression of annual industrial production growth on the 5-month ahead leading indicator (annual growth) reveals an 81% correlation – Implied IP is the fitted dynamics of this univariate regression. Unless leading surveys improve dramatically, I expect the German economy to soften much further in coming months.

Using the 1993-2011 time series, the precipitous drop in the TWV-LEI portends a sharp slowdown in German industrial activity, even contraction by December 2011. The implication is that German economic activity, while accelerating in Q3, is likely to contract in Q4.

The policy ramification is clear: It’s going to get a lot more difficult to sell a‘comprehensive solution’ if the leading Euro area economy is in recession.

originally published at The Wilder View …Economonitors

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This ‘Competitiveness’ Thing Is a Scam

By Rebecca Wilder

This ‘Competitiveness’ Thing Is a Scam

What is ‘competitiveness’? It’s an important part of the euro area leaders’ negotiated terms in the July 21st Summit announcement by the European Heads of State. The first paragraph, #4, and #11 of the announcement all refer to this issue of ‘competitiveness’:

We also reaffirm our determination to reinforce convergence, competitiveness and governance in the euro area.

create a Task Force which will work with the Greek authorities to target the structural funds on competitiveness and growth, job creation and training.

All euro area Member States will adhere strictly to the agreed fiscal targets, improve competitiveness and address macro-economic imbalances.

It’s not totally clear what they mean by ‘competitiveness.’ However, I note that they separate the term ‘competitiveness’ from ‘macro-economic imbalances’. Current account imbalances across the region should be included in addressing ’macro-economic imbalances’.
Therefore, it’s bigger than the OECD definition of international competitiveness measure of a country’s advantage or disadvantage in selling its products in international markets.

See, ‘competitiveness’ is an elusive concept that is often associated with relative price movements, real exchange rates, or openness to international trade. But if we look at a May 2011 speech given by German Finance Minister, Wolfgang Schäuble, what he (and by association, the Germans) thinks of ‘competitiveness becomes more clear (h/t Marshall Auerback and bold by yours truly):

“All Eurozone governments need not only convincingly demonstrate their commitment to fiscal consolidation but also to increasing competitiveness to restore confidence of markets as well as their citizens.

Besides, one does not resolve one’s own problems of competitiveness by asking others to become less competitive and one cannot permanently close the gap between expenditure and income by asking others for more money.

the Eurozone has to put additional emphasis on strengthening the competitiveness of all its members. Consumption developments, bubbles in housing markets and the accumulation of external and internal debt in some Member States deepened the impact of the crisis and constrained the capacity to respond. This is why a new procedure for detecting and correcting economic imbalances will be introduced. This procedure will concentrate on curing the root causes of macroeconomic deficits by forcing Member States to ensure a high level of competitiveness.

Competitiveness is about strong macro-prudential policy, infrastructure, efficiency and income gains, saving, etc. Schäuble used the word ‘comopetitiveness’ 14 times in this speech – it’s an important part of his (and perhaps more broadly Germany’s) vision of the euro area’s structural construct. After reading the speech, you realize ‘competitiveness’ isn’t just about international trade and exports, it’s about the efficiency of an economy as a whole.

Now we’re on to something. The World Economic Forum measures competitiveness as a composite of various factors that describe institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, market size, business sophistication, and innovation (.pdf link here, and composite technicals listed on .pdf page 49). The chart below illustrates the rankings of the euro area 12 and the USA (for comparison) as measured by the percentage of countries that rank below it across 142 developing and developed economies (.pdf page 15).

(Click to enlarge chart)

In 2011-2012, Germany ranks #6 out of 142 countries, where 95 of the 142 countries are less competitive than Germany. Also ranked below Germany is every euro area economy except Finland. So when a German finance minister says that he wants economies to increase competitiveness, he’s effectively saying that he wants economies to be more German. From the bottom up, countries should reform their education, financial markets, business sophistication, innovation, etc., all the while emulating those institutions in Germany.

Better put: being asked to increase competitiveness is really a scam to get these economies to become more ‘German’. If I were Italy or Spain or even Ireland (who by the way is very open but less ‘competitive’ according to this measure), I’d have a problem with that.

originally published at The Wilder View…EconoMonitor

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Global slowdown underway – it’s more than the Japanese supply chain disruptions

by Rebecca Wilder

Global slowdown underway – it’s more than the Japanese supply chain disruptions

The global economic rebound is slowing markedly. With a tightening bias in emerging markets and a US recovery that continues to disappoint, external demand for any country that ‘needs it’ – those countries mired in fiscal austerity without monetary autonomy, i.e. euro area countries – is decelerating precipitously.

Exhibit 1: import demand for manufactured goods from 22.5% of the world (see chart at the end of this post) is slowing quickly, even contracting.



The chart illustrates the growth of import demand for manufactured goods from the US (12.8% of world import demand in 2011) and China (9.7% of world import demand in 2011) on a 3-month over 3-month annualized and seasonally adjusted basis. Spanning April through June 2011 compared to January through March 2011, US imports for manufactured goods slowed to a 4.9% annualized clip, while Chinese manufacturing imports contracted at a 22.9% annualized pace. US import demand growth peaked at 36.9% in March 2011 (again, on the same 3M/3M SAAR basis), while Chinese import demand growth peaked a bit earlier at 108.2% in January 2011.



One may argue that the sharp slowdown (US) and deceleration (China) of manufacturing imports is a product of supply chain disruptions stemming from the Japanese earthquake and ensuing tsunami. Let’s take a look.

Exhibit 2: Japanese distortions started to ease in April and May, leading global imports by roughly 1 month.



The chart above illustrates the dynamics of the Japanese industrial sector before and after the earthquake. Industrial production started to recover in April 2011 and hit a month/month peak of +6.2% growth in May. The sector has all but recovered, and should have been reflected in the US and Chinese import data as positive momentum by June- it hasn’t. In June, the seasonally adjusted import demand decelerated to a 0.6% pace in the US, while that in China contracted 4.3%.

In contrast, we saw the easing of supply chain disruptions in the US domestic industrial production stats. In the US (not shown, but you can get the IP data here), production of motor vehicles and parts fell 6.6% in April, which has improved sequentially through June (-2% M/M). This should be reflected in import demand (first chart), but the opposite’s occurred. In fact, import demand has worsened, while the supply chain disruptions improved. Better put: there’s weakness in global demand that is unrelated to Japanese supply chain disruptions.

Global growth is slowing – according to import demand of manufactured goods by the US and China, it’s slowing rather quickly. Where will this be felt? In Europe, of course. Germany derives near 50% of GDP from export demand, and imports roughly 45% of its goods and services from within the euro area (data here). The PIIGS countries – Portugal, Ireland, Italy, Greece, and Spain – necessitate strong external demand from the core countries (Germany and France) and from outside the euro area in order to successfully deleverage amid sharp fiscal retrenchment. Unless the German consumer really starts spending, the global industrial sector is unlikely to drive demand sufficiently enough in Europe.

Rebecca Wilder

Reference: dynamics of US and Chinese shares of world import demand

….

Crossposted at Newsneconomics

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Wilder on ‘The euro area bond crisis in charts’

by Rebecca Wilder

Edward Harrison draws our attention to the euro area bond crisis: Spain, Italy, Belgium yields now under attack. I’d like to add to this thread by offering some illustrations of the polarizing of bond markets that’s coincident with the euro area bond crisis. (Notice I do not say currency crisis because it’s really the bond markets that are seething – the euro area, hence the currency, is thought to be relatively secure for now.)

(click to enlarge)


Spain, Italy, and Belgium are breaking away from the ‘core’, Germany, Austria, Netherlands, Finland, and France. But if you look really hard, France is showing a fair bit of stress too; it’s underperforming the other core countries.

This is ironic. By attempting to stem broader contagion by ring-fencing Greece, Ireland, and Italy, euro area policy makers focused market attention on those countries too big to quickly ring-fence, i.e., Italy and Spain.

(The complete post is at Newsneconomics)

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Wilder on ‘Real retail sales in Europe: will German consumers save the day? Maybe, perhaps’

After the US report on Q2… Angry Bear and credit market weakness in the eurozone, Rebecca takes a look at the retail side of the economy:

Retail sales in Germany and Spain were reported last week for the month of June. On a working-day and not-seasonally adjusted basis, real retail sales fell 7.0% on the year in Spain. In contrast, working-day and seasonally adjusted real retail sales surged over the month in Germany, 6.3%, and posted a 2.6% annual gain.
But the Spanish data is better than the non-seasonal numbers would suggest. In fact, accounting for seasonal factors as in the manner done by the Federal Statistical Office of Germany, Spanish real retail sales posted a monthly gain, 1.2% in June. Don’t get too giddy on me – the Spanish data looks awful in a small panel (time series and cross section).

The rest of the post is here: Real retail sales in Europe: will German consumers save the day? Maybe, perhaps

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Wilder’s news on Euro area credit markets

Rebecca takes note of credit growth in many of the Euro countries and notes indications of continued deteriorating macro economies in Newsneconomics:

Today the ECB released details on monetary aggregates for the euro area. According to the statement on the asset side of the consolidated balance sheet of the euro area monetary financial institutions (MFIs):

the annual growth rate of total credit granted to euro area residents decreased to 2.6% in June 2011, from 3.1% in the previous month. The annual growth rate of credit extended to general government decreased to 4.6% in June, from 5.7% in May, while the annual growth rate of credit extended to the private sector decreased to 2.2% in June, from 2.5% in the previous month

Weak credit growth is entirely consistent with the deteriorating pace of the macroeconomy (see Edward Hugh’s post here). How does 2.2% annual credit growth compare to history?

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These jokers have no idea what they’re doing

by Rebecca Wilder

What do you want to wager that the IMF’s a bit overly optimistic on the outlook for Greek nominal GDP?

Monday, June 27, 2011

Newsneconomics

These jokers have no idea what they’re doing.
The IMF has overshot the ex-post path of Greek nominal GDP in each and every one of their World Economic Outlook forecasts since April 2009. What do you want to wager that they’re wrong about 2011, too? And now they want more fiscal austerity…

The French are devising a plan to compel bondholers to rollover Greek debt by enhancing the bonds. The new bond rate would be equal to Greece’s current borrowing rate on the EU/IMF/EFSF programs plus a variable factor linked to ‘an indicator such as GDP’.
Just amazing.
Rebecca Wilder

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Financial Services Intermediation

Traditionally, non-commercial banking (i.e., everything except savings deposits and consumer loans) was about one of two things:

  1. Tax arbitrage or
  2. Regulatory arbitrage

    The rest is window dressing; that is, it was basic financial intermediation, usually for the purpose of helping Corporate and/or High Net Worth clients.*

    That was until the late 1990s and the Noughts, when the third level came to liquidity-prominence:

  3. Credit rating arbitrage

The third is the most chimerical of all, becausemdash;unless you’re selling to or buying from the company that is involved (which has correlation issues, as I noted long ago)—neither party (in theory) has control over the outcome of events. It’s asymmetric information on both sides: not so much gambling against the house as shooting craps in the alley, not certain whether there is a bobby down the block.

All of which is an indirect way of saying: Go Read Kash Mansori. Especially if you think US institutions are managing better than the EU is. (Hint: it may be true on the governance level, but the financial institutions’s exposure appears to tell another story.)

*Think corporate deposits, lines of credit, commercial loans, IPOs that are often used in part to pay off debt, and the like. Normal course of business options, with the selection influenced by tax or regulatory considerations.

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Simon Johnson has an excellent post

by Mike Kimel

An excellent post by Simon Johnson.

The managing director of the IMF is the impresario of any bailout. The big decisions must be negotiated with all significant stakeholders but this still leaves enormous scope for discretion.

If Ms. Lagarde becomes managing director she can directly influence the terms of IMF involvement – and based on her negotiating position to date within the eurozone, we can presume she will lean towards more money, easier terms, and above all no losses for the banks that made foolish loans.

Increasingly it looks like the eurozone leadership, under French guidance, will go for the Full Bailout option, in which all Greek debt is bought up by the IMF, by the European Central Bank, and by other eurozone entities. This debt will be held to maturity – and any creditor who did not yet sell will be made whole (those who already sold at a loss are out of luck).

This course of action will be expensive, in terms of nominal outlays and in real risk-adjusted terms, because whatever terms Greece gets must also be offered to Ireland and Portugal. The IMF may need to raise more capital or – more likely – tap its credit lines from member governments.

Also…

The French want to sway decision-making at the IMF in order to use US, Japanese, and poorer countries’ money to conceal from their own electorate that the eurozone structure has led all its members into serious fiscal jeopardy – some borrowed heavily, while others let their banks lend irresponsibly and thus created a large contingent liability.

The best way to hide the true cost is to have other people’s taxpayers foot the bill, preferably with the least possible transparency. There is a lot at stake for eurozone politicians. Ms. Lagarde will run the IMF.

The George Bush/Barack Obama bail-out policy writ larger…

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