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

The Italian Economy Is Sliding

by Rebecca Wilder

The Italian Economy Is Sliding

Today I.Stat released the breakdown of Q1 2012 real GDP for the Italian economy. Weak external demand plus a precipitous drop in private sector spending dragged the headline real gross domestic product (GDP) 0.8% over the quarter (3.2% at an annualized rate). The highlights are the following:

  • Gross fixed capital formation (investment net of inventory formation) fell 3.6% over the quarter, or 13.7% at an annualized rate. This was the fastest quarterly rate of decline since Q1 2009 when GFCF fell 5% over the quarter.
  • Private consumption dropped 1.0% over the quarter, or 3.9% at an annualized rate
  • Imports fell 3.6%, or 13.6% at an annualized rate
  • Exports fell 0.6%, or 2.2% at an annualized rate
  • The only positive contribution to domestic spending was government consumption, which increased 0.4% over the quarter, or 1.4% at an annualized rate.

Italy’s real GDP is only 1.1% higher than its lowest point during the recession (Q2 2009). Furthermore, gross fixed capital formation has dropped at an increasing rate for four consecutive quarters. Hope for stabilization eludes, as the current business confidence survey continues its decent – IStat manufacturing confidence was 86.2 in May, which was the second lowest level since the outset of the EMU and well below the 100 average since 2000. Broadly speaking, the economy is imploding.

Don’t pin your hopes on exports. The contribution of exports to real GDP growth has dropped for two consecutive quarters, bucking a trend of positive contribution since the middle of 2009. The only reason that the net export contribution was positive in Q1 was due to the +1% contribution coming from a sharp decline in imports. This cannot be sustained, as the crisis of confidence has begun.
(Note: In the chart below, if real import growth is positive, then the contribution is negative; and if the real import growth is negative, then the contribution is positive.)

This is a product of failed policy at the Euro area level, and something needs to be done to break the positive feedback loop.


Rebecca Wilder


crossposted with   The Wilder View…Economonitors

ECB Rates Policy is Clogged in Key Periphery Markets

by Rebecca Wilder

ECB Rates Policy is Clogged in Key Periphery Markets

How the Euro area (EA) will grow, according to Mario Draghi:

The outlook for economic activity should be supported by foreign demand, the very low short-term interest rates in the euro area, and all the measures taken to foster the proper functioning of the euro area economy.

In this post, I address Draghi’s point that the ECB 1% refi rate will support economic activity through the lens of the mortgage market. Specifically, I find that the interest rate channel is clogged in the economies that are in most desperate need of lower rates: Spain, Portugal, and Italy.

Regarding ‘very low short-term interest rates’, what Draghi means is that the standard interest rate channel of monetary policy will stimulate domestic demand via increased spending by consumers and firms. If ECB policy is indeed passing through to retail credit (households and firms that borrow from banks to buy goods and services), then we should see evidence of this as falling interest rates to retail credit sectors, like those for consumer goods, home mortgage lending, loans for businesses, or even corporate credit rates to finance business investment.

In mortgage markets, the Euro area average borrowing rates are indeed falling. Banks started lowering mortgage borrowing rates, on average, in September 2011 in anticipation of ECB rate cuts that eventually occurred (again) in November 2011. Specifically, average Euro area mortgage rates are down roughly .25% since the local peak in August 2011.


But a closer look across mortgage markets shows a worrying trend for key periphery economies. The pass-through from ECB rate setting policy to mortgage borrowing costs is clogged in Spain, Portugal, and Italy, where mortgage rates have risen since the ECB cut the refi rate to 1%. Indeed, these are the economies that ‘need’ the stimulus to offset the fiscal consolidation.
Sure, mortgage rates are arguably low – but they’re not lower.

In Spain and Portugal, 91% and 99% of their respective new stock of mortgages sit on variable rate loans, so the pass through to the real economy should be rather quick IF mortgage rates declined (see Table below). True, Spain and Portugal are unlikely to experience any boom in real estate lending over the near term. However, had the ECB policy lowered mortgage rates, then disposable income would rise via lower monthly mortgage payments, thereby stimulating other sectors of the economy, all else equal.

In Italy, just 47% of the mortgage market is variable, so the immediate stimulus would be more muted compared to Spain and Portugal via disposable income. However, Italy didn’t experience a credit boom, so lending to firms and households could and should be warranted. But amid the fiscal consolidation and stressed debt markets, fewer borrowers are credit worthy AND mortgage rates have risen near 1% since EA mortgage rates peak on average in August 2011.

Core mortgage rates are falling, and this could create a positive stimulus for Spain, Portugal, and Italy down the road. But for now, the transmission mechanism, dropping the ECB refi rate to 1%, is not easing housing and mortgage financial conditions in those economies hit hardest by fiscal austerity.

Rebecca Wilder

Reference Table: reference for variable rate share of mortgage market

originally published at The Wilder View…Economonitors

Euro area credit: did the ECB wait too long?

by Rebecca Wilder

Euro area credit: did the ECB wait too long?

The ECB released its February report on monetary developments in the Euro area. This is an important report, since it will highlight whether or not the ECB’s LTRO is ‘working’, rather if the new liquidity is passing through to the real economy via new lending. On balance, it’s probably too early to tell, since there are long lags in monetary policy – however, early signs are not good for the real economy.

Ostensibly, the ECB LTRO did its job, as interbank credit has re-emerged in aggregate. Repo credit increased 4.2% over the year in February – this followed an 11.5% annual surge in January. Furthermore, short-term debt holdings jumped at a 21.3% annual pace. Banks and sovereigns have seen relief in the short-term credit markets, a product of long-term funding from the ECB.

But credit availability to the broader economy is more challenged. The chart below illustrates the working-day and seasonally adjusted lending by Monetary Financial Institutions (MFIs) to the household and non-financial corporate sectors. I use the 3-month/3-month average growth rate to illustrate the credit impetus over the LTRO period. In the three months ending in February, household lending fell 0.18% compared to the average spanning September through November 2011. The drop in quarterly lending did slow, but remains in decline. Loans to non-financial corporations fell a larger 0.82% in the three months ending in February. For non-financial corporations, the pace of decline quickened since the three months ending in January.


Across the Euro area, the charts below illustrate the contribution to annual growth in Euro area credit across the 17 EMU economies by sector: household (and nonprofit) and non-financial corporate. The usual suspects are seeing large declines in household and non-financial corporate lending, including Spain, Portugal, Greece, and Ireland. France is the bright spot across both sectors, contributing a large share (multiples of its GDP share) to household and non-financial corporate lending.
Chart Note: the Charts below illustrate the country-level contributions to the annual growth rate of Euro area Household and non-financial corporate loans in February 2012.


Household lending The contribution to annual EA credit growth from Irish households (consumer plus mortgages) has been negative for 40 consecutive months, or 13 consecutive months in Spain. Portuguese household loans dragged annual EA loan growth consecutively since September. The credit impetus is very negative in consumer and mortgage lending for these economies. A positive point is that German consumers are borrowing for credit consumption and home buying. German household lending contributed 0.32% to annual EA loan growth in February – this compares favorably to the 0.17% average contribution spanning 2004-2006.

Non-financial corporate lending By this metric the Spanish business sector is effectively imploding, as Spanish non-financial corporate lending dragged the pace of annual EA lending by 1.1% in February. The contribution from Spanish corporate lending has been negative for 32 months, and the pace of contraction has picked up some speed since September 2011 on an annual contribution basis.

The credit impetus remains reasonably strong in the core countries, at least on a Y/Y basis (with stark exception of the Dutch household sector). And to some extent, the drop-off in credit to the periphery was to be expected. However, with the domestic drag in periphery credit markets already underway, and limited upside potential to global demand for exports, one questions whether or not the the ECB waited too long (given the long lags in monetary policy).

Megan Greene highlights the risks to the Euro area. With these risks in mind, restrictive fiscal policy amid deteriorating labor markets makes the Euro area extremely vulnerable to external shocks.
Statistical reference: the Euro area aggregate statistical data links can be found here. The country level data can be found in the statistical warehouse tree here.

originally published at

Housing Bubbles: Less Frothy but Europe is Behind

by Rebecca Wilder

Housing Bubbles: Less Frothy but Europe is Behind

Wolfgang Muenchau’s article in the Financial Times, There is no Spanish siesta for the Eurozone, inspired me to update my post on housing bubbles around the world (really just Europe and the US). He argues that Spain’s bubble was much more extreme, and that the price adjustment is less mature compared to the others. I would add here that it’s European housing markets more broadly that look overvalued compared to that in the US, as measured by the price to rent ratio.

The chart below illustrates the housing bubble, as measured by the house price to rent ratio, in the US, Spain, the UK, and Ireland that is normalized to Q1 1997 and through Q1 2011. The price to rent ratio can be compared to a price to earnings or a price to dividend ratio in finance. It measures the relative value of the asset: the price of the asset (purchase price of a home) divided by its flow of fundamental value (rental income earned or the value of having a roof over your head). As the price-rent ratio falls, the market home values moves closer to fundamental value.


Spanning the years 2005 to Q4 2011 and indexed to 1997 Q1, home values peaked at roughly 1.7 times rent in the US, 1.8 times rent in Spain, and north of 2 time rent in Ireland and the UK. Since the peak, though, US home values have fallen to 1.0 times rent – a considerable reduction in asset prices toward fundamental value. In contrast, home values in Spain, the UK, and Ireland remain quite elevated to rents, 1.3 times, 1.6 times, and 1.4 times, respectively in Q4 2011. If 1.0 is deemed equilibrium, either home values in Spain, the UK, and Ireland must fall further and/or rents rise to normalize home values. That’s a tall order: rising rental values amid defficient and contracting domestic demand in Spain and possibly Ireland.

The UK has more of a fighting chance, given its relatively easy monetary policy, compared to Ireland and Spain, where more accommodative monetary policy is very lagged amid fiscal contraction. Without growth, though, default is probably the only answer left to normalize housing markets in Spain and Ireland.

originally published at The Wilder View…Economonitors

Does the US Corporate Saving Rate Portend a Lower Unemployment Rate?

by Rebecca Wilder

Does the US Corporate Saving Rate Portend a Lower Unemployment Rate? An interesting thing happened in Q4 2011: the corporate saving rate declined following two quarters of gains. Nominal net saving by the domestic business sector fell 3%, while nominal gross fixed investment and inventories surged 6% – the two pushed the saving rate down nearly 40 bps to 2.94% of GDP. The corporate saving rate (gross saving less gross investment) has been on a downward trend since the end of 2009, a welcomed trend by the labor market.

There’s a very strong correlation between the corporate saving rate and the unemployment rate, 80% according to a simple bivariate OLS regression. I’ve argued in the past that there is some causation to this relationship – but that’s not the point of this post. The point here is that the trend in corporate saving has fallen sufficiently to portend some material declines in the unemployment rate in coming quarters….ALL ELSE EQUAL. For example, a simple bivariate regression would forecast a 7.5% unemployment rate if the corporate saving rate falls another 30 bps to 2.6%.

The all else equal is important. The primary driver of this quarter’s decline in the corporate saving rate was the 6% increase in nominal investment spending, the largest quarterly gain since 2010 Q2. Amid relatively weak manufacturing orders and the expiration of the depreciation allowance, I expect that this momentum is unlikely to be matched in coming quarters. Will firms start drawing down nominal saving to finance new hires?

Better put: will the unemployment rate drop to meet the saving rate? Or will the saving rate rise to meet the unemployment rate?

Rebecca Wilder


originally published at The Wilder View..Economonitors

Euro Area GDP Report: Not Pretty

by Rebecca Wilder

Euro Area GDP Report: Not Pretty

Today Eurostat released the second estimate of Q4 2011 Gross Domestic Product. Real Euro area (EA) GDP declined 0.3% over the quarter (-1.3% on an annualized basis). In this release Eurostat provides a breakdown across region, spending categories, and industry, and is much more detailed than the preliminary flash estimate. It’s not pretty.
The expenditure side was very weak. Household and government consumption declined 0.4% and 0.2%, respectively, while gross capital formation tumbled 0.7%. Inventory depletion accounted for much of the reduction in investment and fixed investment deteriorated to a lesser degree. Exports fell 0.4%, while imports dropped a full 1.2%; therefore, net exports contributed +0.3% to overall GDP growth. The only positive contribution to GDP growth was imports – this type of technical growth is not sustainable.

As the chart below illustrates, exports has been a major driver of growth during this recovery. However, export demand is dropping off at the margin, and more weakness is expected. The level of new export orders (a component of the Markit PMI) fell for eight consecutive months through February.


So it it’s up to domestic demand to spur further recovery. I also have my doubts there, given that fiscal austerity pushed the unemployment rate to a historical high of 10.7% in January (rather vertically, I might add).

A second part of the EA GDP report was the disturbing minority of countries that posted positive growth: just three out of thirteen. French growth clearly added balance to the average, given its large weight in the index. However, there are plenty of things that can go wrong there with higher energy costs, the rising unemployment rate, and minimal business confidence.

Going forward, it’s either up or down again for the EA. With the tight fiscal and now tightening monetary policy, the economy surely faces a lot of headwinds – down again would be my bet.

originally published at The Wilder View…Economonitors

European Daily Catch: Retail Sales Stabilizing?

by Rebecca Wilder
European Daily Catch: Retail Sales Stabilizing?

Today’s real retail sales gave the ECB and EU heads of state another reason to keep their fingers crossed for stability of the Euro area economy (.pdf of release). In January, volume adjusted retail sales increased 0.3% in the Euro area (EA) and broke a 4-month trend downward. On a 3-month annualized basis, though, real retail sales are falling at a 2.2% pace. Therefore, on a trended basis the second derivative may be stabilizing but the first derivative remains conspicuously negative.


I suppose that the ECB and EU heads of state will take this month of reprieve to pat themselves on the back for policy well done. However, in looking at the cross section of the monthly gains, France was the primary driver of the regional improvement, +2.1% over the month. We’re not out of the woods yet.

Greece, Spain, and Italy haven’t reported for January, so we’ll have to wait on the over or under regarding revisions. I’ll take the under, however, given that Spanish and Italian service PMIs are in the low 40′s with the employment component a serious drag (.pdf of the Markit release).

originally published at The Wilder View…Economonitors

All of the Euro Area Usual Competitive Suspects in One Chart…But with a Twist

by Rebecca Wilder

All of the Euro Area Usual Competitive Suspects in One Chart…But with a Twist

The European Commission’s Economic and Financial Affairs initiated the Macroeconomic Imbalance Procedure (MIP) Scoreboard. The MIP Scorecard will be used to identify emerging or persistent macroeconomic imbalances in a country. In their inaugural release, the EC listed 12 EU countries in need of further review for potential imbalances (program countries are exempt from this review process).

The accompanying database of the factors in the MIP score is made available at Eurostat. This database is particularly exciting for a data geek like me. Included in the MIP database is an indicator that I’ve wanted to construct for some time: country level exports as a share of world exports. World export share is a much broader measure of competitiveness than the commonly reported export share of country GDP.

Belgium, which is one of the 12 countries on review for potential imbalances, has experienced an 0.5 ppt drop in world export share, 2.4% in 2002 to 1.9% in 2010. Seems like a big drop – but what does a 1.9% export share mean in terms of the size of the Belgian population in the Euro area 12 (EA 12)? In 2010, Belgium’s world export share was 2.2 times what it’s EA 12 population share implies – loss of competitiveness, yes, but still competitive.
The chart below illustrates the following: (country world export share as a share of EA 12 world export share)/(country share of EA 12 population). The data can be downloaded at Eurostat: export share, and population).


If the index level > 1, then the country has a greater share of the EA 12 world export share than that implied by its population as compared to that of the EA 12 – competitive; If the index level < 1, then the country has a smaller share of the EA 12 world export share than that implied by its population relative to that of the EA 12 - not competitive.
Some takeaways from this chart are:

  1. All the usual ‘competitive’ suspects are at the top: Ireland, Netherlands, Belgium, Austria, Germany, and Finland. These countries hold in excess of 1.2 to 3.1 times EA 12 world export share than their relative size in the EA 12.
  2. All of the usual ‘uncompetitive’ suspects are at the bottom: Greece, Portugal, Spain, Italy, and France. These countries hold anywhere from 30% to 70% less world export share of that in the EA 12 than their population share would imply.
  3. Ireland is the most competitive in this respect, and Greece is the least.
  4. Germany is more in the middle with just a 27% higher export share of the EA world export share than that implied by its population share….

That’s it for today. I’d like to hear your feedback.

Rebecca

originally oublished at The Wilder View…Economonitors

Does Latvia Give Us Any Clues?

by Rebecca Wilder

Does Latvia Give Us Any Clues?

Short answer: yes, as long as global trade growth is negligible.

Over the weekend I came across a December CEPR paper about the Latvian economy. Authors Mark Weisbrot and Rebecca Ray highlight the Latvian experience with internal devaluation, which may prove to be a case study for the current Eurozone model of internal devaluation by the program countries (Ireland, Portugal, and Greece). Weisbrot and Ray find the following (emphasis mine):

The paper also finds that Latvia’s net exports contributed little or nothing to the economic recovery over the past year and a half. This means that “internal devaluation” cannot have succeeded in bringing about the recovery. Rather, it appears that the recovery resulted from the government not adopting the fiscal tightening for 2010 that was prescribed by the IMF, and also from an expansionary monetary policy caused by rising inflation. The data contradict the notion that Latvia’s experience provides an example of successful internal devaluation.

Note: Internal devaluation is Europe’s favored prescription for any country seeking liquidity assistance; it refers to the process by which an EZ country that cannot devalue its currency reduces relative costs (wages) and prices by raising the unemployment rate in order to shift export income in favor of the deflating economy.

Internal devaluation didn’t work for Latvia, as evidenced by export demand. I wondered, though, how has real export demand performed for the current program countries, Ireland, Portugal, and Greece? Have these countries followed Latvia’s path?

To date, as regards to export income, internal devaluation appears to be working in Ireland and Portugal but not in Greece. For comparison to Latvia, I illustrate the path of real exports and imports spanning 2005Q1 through 2011Q3, as demonstrated for Latvia on page 14 of the CEPR paper.

Similar to Latvia’s experience, real import demand deteriorated in the face of fiscal austerity, especially in the case of Ireland and Greece. In contrast to Latvia’s experience, though, real exports in Ireland and Portugal are roughly 6% and 8%, respectively, above levels in 2007Q1. The Greek experience looks more like that of Latvia, as real imports and exports plummeted below pre-crisis levels, having yet to recover.

As I highlighted in a December post, relative unit labor costs have been cut in the case of all program countries, so internal devaluation is evident. (Note: the chart in the post illustrates the 4-q average Y/Y growth in nominal unit labor costs compared to the EA overall – it’s not intended to be a thorough examination of real exchange rates.) But has that been the driving force behind the export growth?

The resurgence in global trade has been an influential factor in the case of Ireland and Portugal. The chart above illustrates the Dutch estimate of world trade. Notably, there was a resurgence of trade spanning mid 2009 to Q1 2011, which support European exports broadly. It’s difficult, in this respect, to attribute all of the export success to internal devaluation.

Going forward, Ireland and Portugal are very likely slaves to global demand for exports. Prospects there are not looking too bright, given the slowdown in Asia.

Ultimately, I do think that Latvia serves as a warning for EA program countries. Internal devaluation is impossible for those countries with high private sector leverage without a burst of external demand. Unfortunately, the burst of external demand seems to have passed.
(Insert here a discussion of the 3-sector financial balances model, and why Ireland depends exclusively on generous export income to facilitate economic growth).

originally published at The Wilder View…Economonitors

Euro Area Portfolio Flows

by Rebecca Wilder

Euro Area Portfolio Flows

Today the ECB released the Euro area balance of payments for December. This is a statistical release that is worthy of only the biggest data geeks – but it is quite interesting, especially in forming relationships between FX and capital flows. I’ll demonstrate what’s been going on in EA bond, equity, and money markets in one just chart. The data come from the ECB, and can be seen in the Monthly Bulletin, Table 7.3.


The chart illustrates portfolio flows as the 3-month sum total flows in and out of Euro area bond, equity, and money markets, or portfolio investment. The red line plots the dynamics of investment flows by foreign residents in (positive) and out of (negative) the Euro area. The blue line plots the dynamics of investment flows by Euro area residents in (positive) and out of (negative) the Euro area.

When the blue line is positive, Euro area residents are bringing assets home, or repatriating capital. This is rare. When the red line is negative, foreign residents are moving capital out of the Euro area by selling euro assets. This is also rare. Both occurred in 2011.

Foreign investors reduced exposure to euro-denominated assets, -€78.9 billion in Q4, while Euro area investors brought assets back home, +€55.8 in Q4. Spanning 2011, foreign inflows into equity, bond, and money markets turned 180 degrees from +€183 net accumulation in the 3 months ending in June to -€78.9 in Q4.

For 2011 as a whole, foreigners accumulated similar amounts of euro-denominated assets as in 2008 (the last time the foreign flows turned negative), €233 billion versus €266 billion, respectively. In contrast, the repatriation flows did make a big 2011 dent compared to the 2008 comparable year of repatriation, +€60.2 billion of inflows for the year as a whole versus -€4.9 billion in 2008.
We’ll see if 2012 is a year of normalization – EA resident outflows and positive foreign inflows. Certainly recent actions by the ECB have helped to assuage foreign investors, as evidenced by the +€5.3 billion portfolio inflow in December 2011. The January release will be an interesting one!

Happy Presidents’ Day, Rebecca