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

European Daily Catch: Unemployment and Retail

by Rebecca Wilder

European Daily Catch: Unemployment and Retail

Global labor reports prevailed today, but the US employment report took center stage. I’ll not comment on that report, so as to keep with my generally all things European theme here at The Wilder View. However, a quick sift through my feed reveals rather cynical takes: see Dean Baker’s comments here and here; Spencer’s take here; Jake’s eye candy here; and Ed Dolan’s more positive tone here.

In this post, I present a new series: European Daily Catch (EDC). In this series, I’ll illustrate a selection of the day’s European economic data releases that I find particularly interesting. We’ll start with two complimentary reports: the labor marekt and retail sales.

Bottom line: the divergence is at extreme levels. I expect 2012 to be the year of convergence rather than divergence. Something’s gotta give.

EDC 1. The variance in labour performance further widens in November. Unemployment rates across the EA 12 (excludes the new countries Slovenia, Slovakia, Malta, Cyprus, and Estonia) show 5 countries making new cyclical highs. Ireland, Greece, and Spain all mark unemployment rates that are 130% or more above their cyclical lows. Note the Netherlands is not consistent with core performance – while the unemployment rate is low, 4.9%, it continues to rise. The Netherlands is the first sign of convergence; more will come.

(Note: all data in this chart is for the month of November, except Greece which is current as of September.)

EDC 2. Next up is real and working-day adjusted retail sales. True, retail sales do not describe consumption patterns sufficiently well for some countries listed: the correlation between real retail sales and real consumption in Germany and France is 34% and 61%, respectively. However, for other countries, like Spain, the correlation is near 1, 92.5%.

The way that I read the illustration below is this: German and French real retail sales are stable to rising; that probably characterizes the best possible outcome for domestic consumer demand (just look at domestic orders for consumer manufactured goods in Germany- sorry not included here – or the French unemployment rate). In contrast, we know that domestic demand is falling precipitously in the 3rd and 4th largest EA countries, Italy and Spain. All else equal, core retail sales are likely to slip in 2012.

In both charts, I added the US performance for cross-regional comparison. The US performance provides positive contrast to the domestic catastrophe that fiscal austerity without growth brings.

Rebecca Wilder

Source data: There are too many sources to link to here. I used seasonal-adjusting techniques and multiple data sources. If, however, you would like to access this data, I’ll be happy to send it along. Just send me an Email request.

originally published at The Wilder View…Economonitors

Fractional Money Multipliers

by Rebecca Wilder

Fractional Money Multipliers

Money multipliers – the stock of money divided by a measure of base money (generally reserves plus currency in circulation) – are dwindling to fractions of what they used to be. FT Alphaville draws our attention to this fact on the Euro area (EA) using SocGen’s analysis. The money multiplier is a representation of base money (generally reserves plus currency in circulation) – are dwindling to fractions of what they used to be. FT Alphaville draws our attention to this fact on the Euro area (EA) using SocGen’s analysis. The money multiplier is a representation of how much credit is leaving the banking system via lending and growth (or inflation) enhancing monetary activities.

As FT Alphaville points out, the EA M3 multiplier is just over 3/4 its average 2007-2008 level, 7.67 vs 10.

But this is global! The US M2 money multiplier is a little over 2/5 the size of its average 2007-2008 level, 4.1 vs. 9.3. By this simple measure, I’d say that the US is in worse shape than is the EA.

Of note, my visual is a bit different from that in FT Alphaville.

Specifically, I don’t agree with SocGen’s estimates that the EA money multiplier drops in December to roughly 6. Given that December 2011 EA base money has been published, a 6.2 M3 multiplier implies that M3 dropped by 15% in 1 month. That’s unlikely.

To my readers: There’s a 92% probability that I’ll be serving on a grand jury for the next three months. Since I’ll need to keep up with all matters EA, I’ll probably be blogging at a higher frequency and in less depth (like this one).

Rebecca Wilder

Source data: The Federal Reserve publishes money supply and monetary base data, which can be easily downloaded at the St. Louis Fred database. ECB data can be found here and here.

Merry Christmas!

by Rebecca Wilder 

  Merry Christmas!

Here’s a nice little model I discussed in 2007: The Economics of Christmas! Hope that you enjoy; I do. (This commentary was written in my more ‘academic days’ when I was inundated with models of theoretical macro.  As you have no doubt noticed, I’ve gone the applied financial route since then.)


The economic model of Santa delivering presents and spreading the Christmas joy – Santa is a social planner!

In advanced economic theory, there are two types of models: the social planner model (very much like its political connotation) and the competitive equilibrium model (again, very much like its market connotation). The social planner seeks to maximize the welfare (happiness) of all agents in the economy. The competitive equilibrium model allows for markets (households + firms + government) to determine the allocation of goods and resources. In theory, and if certain conditions hold, both models yield the highest and same amount of welfare.

From a theoretical point of view, the economic representation of Santa Claus delivering gifts at Christmas is that of a social planner problem. See, Santa Claus is in charge of gift giving and not the markets. He allocates goods (presents and coal) according to who has been good and who has been bad in order to maximize the welfare of all children jointly. Those who have been good are blessed with many presents, while those who have been bad are given coal. The economy of Christmas is full of many individual economic agents (the children). Each child writes Santa Claus a note indicating the presents that he/she desires; the presents that give each child joy. This represents a utility function in economics, where utility (joy) is dependent on the consumption of goods and services (each child’s choice of presents). Finally, the total welfare of Christmas is the spread of Christmas joy.

Santa’s economic problem below the fold:
Santa is a social planner that chooses the allocation of presents and coal in order to maximize the joint Christmas joy of all the children, given several constraints.

  • Constraint 1: There is a goodness level for each child that is dependent on the child’s behavior over the past year; this level may be positive or negative. 
  • Constraint 2: Each child specifies only those presents that give him/her joy. 
  • Constraint 3: The total amount of presents demanded by the children cannot exceed the supply of presents that Santa Claus carries on his sleigh. 
  • Constraint 4: Santa’s workshop is subject to an availability of resources: elves (labor), toy-building machines (capital), blueprints for toys, coal, etc. 
  • Constraint 5: Santa’s workshop is subject to the available technology (they cannot make hover-craft skateboards yet) and the type of toy production in the workshop (perhaps the elves work in an assembly line). 
  • Constraint 6: The toy-building machines may be used this year or next year and are subject to a rate of depreciation (older machines are slower and less-efficient at toy production). 
  • Constraint 7: Santa only has one night to deliver all gifts on his magic sleigh. Solution to the problem: The optimal allocation of presents and coal is delivered across the world in one quick night. 

The globe is spread with the highest amount of Christmas joy. What will be your allocation? I’ve been good this year – I think that I’ll be rewarded with a very nice present. Merry Christmas and Happy Holidays!

originally published at The Wilder View…Economonitors

The Broad Sovereign Downgrade

by Rebecca Wilder

The Broad Sovereign Downgrade

Recently I’ve spent time thinking about global bond investors, especially those conservative investors that stick with the high-quality sovereigns. I’ve got news for them: the share of high-quality investment grade sovereigns – BBB- and above is investment grade – is shrinking. Some bullet points comparing ratings in December 2007 to December 2011:

  • From a sample of 76 emerging market (EM) and developed market (DM) economies, 23 sovereigns have been upgraded by S&P (I use S&P specifically, but the agencies usually move in lockstep at a lag). These upgrades span both EM and DM markets, but EM dominated with 19 upgrades overall..
  • The number of high-quality investment grade sovereigns – A- and above – fell by 6.
  • The AAA universe shrank by 2 economies – more is to come with imminent downgrades in Europe.

2007-2011 in charts: moving down in quality

…Vs. 2011

The Wilder View…Economonitors

EA Infernal Devaluation Progressing

by Rebecca Wilder

EA Infernal Devaluation Progressing

The EU answer to rebalancing portfolio and trade flows within the Euro area (EA) without currency devaluation is recession and deflation. They call this ‘internal devaluation’ – shifting relative prices by reducing domestic demand in the debtor countries, thereby shifting the terms of trade. Marshall Auerback calls it ‘infernaldevaluation’. Marshall’s right.

Today we got more evidence that infernal devaluation is progressing. EA unit labor costs (ULC) – average cost of labour per hour workers – increased 0.2% in the third quarter, slowing the annual pace from 3.1% to 2.7%. While the slowdown was to be expected, given the deterioration of domestic demand, the elevated level of growth in ULC suggests that wages in Europe are stickier than what is needed to effectively drive the terms of trade via internal devaluation. Better put: downward pressure in European wages moves more like molasses than water; it will take severe recessions in some of the debtor countries to drive relative prices down sufficient enough to feasibly shift the terms of trade.

The table below lists the average annual ULC gains/losses relative to the EA overall. Germany’s moving on par with the EA, averaging -0.05% (rounded to 0 in the Table) annual relative ULC growth. Germany should be seeing relative appreciation. Spain and Italy are seeing average annual relative depreciation, -0.6% and -0.3%, respectively, per quarter. This is consistent with what is ‘supposed to happen’ in Italy and Spain to shift relative capital and trade flows. However, Netherlands and Finland are matching pace, big exporters that theoretically should be turning importers. France is seeing relative appreciation, +2.2% average annual relative ULC gains; but they were already running CA deficits. Austria and Belgium experienced relative annual price gains, +0.65% and 0.99%, respectively; but they’re too small to matter. Greece and Ireland (Greek data is truncated at Q2 2011) successfully devalued. But at what cost? Their unemployment rates that are now multiples of what they were before the crisis.

As a point of reference, the average annual depreciation of US ULC relative to that of the EA is -2.1%. Not only are EA countries losing competitiveness to key developed players, the US for example, but they’re fighting a battle to the bottom within the EA. This is a lose-lose situation.

I hear through unnamed sources that Sarkozy and Merkel are planning (another) Summit next month – I cannot validate this through really anything except word of mouth. They’re meeting to discuss the impact of the contractionary austerity policies on EA economic growth. Duh.
The denial regarding the infernal impact of their deflationary policy is truly remarkable.

EA Spreads: Why Should the Trend Change?

By Rebecca Wilder 

EA Spreads: Why Should the Trend Change?

They changed the title; but originally the NY Times reported “Euro Zone Agrees to Reinforce Maastricht Rules“.  That’s exactly what EA policy makers agreed to last week – not much to bring home.

The real shift in policy came from the ECB. Ambrose Evans-Pritchard highlights the ECB’s actions as ensuring some sort of bank profitability, while at the same time defining the buyer of EA sovereign bonds. The banks will access funding from the ECB for up to 3 years at a very low and variable rate – currently the policy rate is 1% – and earn a higher return on their holdings of government debt (This morning, Italian 2-yr debt is trading at 6.05% – not bad). The banks will be ‘encouraged’ to buy government debt, thereby ensuring a funding source for the sovereigns. But this is not a business model, neither for the banks nor for the sovereigns.

Europe is headed toward recession – in fact, it’s probably already contracting – and EU policy makers agreed to explicitly enforce contractionary policy. Kevin O’Rourke calls it a Summit of Death, while Paul Krugman argues the impossibility of the grand internal devaluation experiment. I call it economic oppression coupled with zombie bank deleveraging – it is absolutely not in Spain’s best interest to be pushing sharp fiscal contraction while the private sector is itself deleveraging.

But alas, they’ve decided to put off the only credible solution, fiscal union, for another time. I suspect that global investors are going to see right through this simple fact. External investors will grow tired of the zombie deleveraging and recession, of which more selling will cheapen bonds further. Regarding bond spreads, why should this Summit lead to any different outcome than the ones before it? It shouldn’t.

Until EA policy makers make a concerted step toward fiscal union, the bond crisis will continue to evolve just as it has at each crossroad in the past. The european sovereign crisis will deteriorate further.

The chart above illustrates the average 10yr spread of the 9 bond markets listed over a like German bund alongside each major announcement date (see table below) through December 9. The trend has been up while volatile. Furthermore, no announcement to date has successfully stemmed the upward bias in bond spreads. EA policy makers consistently avoid the only truly credible answer: fiscal union.


The table below lists the dates and associated ECB/EU announcements used in the chart above.

Krugman, Roubini, and the Eurozone

Krugman highlights but provides no link to Nouriel Roubini’s address to the 2006 Davos meeting (direct link to Economonitors here).

What I would say is that this incident exemplified something that was going on all along the march to the eurodebacle. Serious discussion of the risks and possible downsides was simply not allowed. If you were an independent economist expressing even mild concerns about the project, you were labeled an enemy and shut out of the discussion.

and in the same op ed It’s Not About Welfare States (via truthout) reviews election rhetoric and disinformation on the economic crisis in Europe being mainly welfare oriented countries:

Whenever a disaster happens, people rush to claim it as vindication for whatever they believed before. And so it is with the euro.

As an aside, the interesting thing about the introduction of the euro from a political point of view is the way it cut across the ideological spectrum. It was hailed by the Wall Street Journal crowd, who saw it as a sort of milestone on the way back to gold, and by many on the British left, who saw it as a way to create an alliance of social democracies. It was criticized by Thatcherites, who wanted to be free to move Britain in an American direction, and by American liberals, who believed in the importance of discretionary monetary and fiscal policy.

But now that the thing is in trouble, people on the right are spinning this as a demonstration that … strong welfare states can’t work.

EA BoP Guide: CA and KA – EA too Dependent on Portfolio Inflows?

by Rebecca Wilder

EA BoP Guide: CA and KA – EA too Dependent on Portfolio Inflows?

This is part two of my multi-post commentary on the Euro area Balance of Payments (BoP). Yesterday, in part one, I compared the EA current account balance to its country-level cross section. Today’s post will be more instructive in nature, as I dig into the components of the EA current account (CA) and capital account (KA) balances.

My general conclusion is that the EA is highly dependent on foreign demand for EA assets in the identity of its international accounts.

As a note: remember the standard international finance identity: CA + KA + errors and omissions = 0, where CA + KA is generally referred to as the Balance of Payments. An international guide to the BoP can be found at the IMF website . Generally, the EA BoP statistics adhere to the IMF definitions.

The Current Account

The chart below illustrates the 3-month accumulated current account balance as the sum of its components: the goods balance (exports minus imports of goods), the service balance (exports minus imports of services), net foreign income, and unilateral transfers. The goods, services, and income balance is € 16.2 for the three months ending in September, which is more than offset by the unilateral transfer balance, -€ 28.1 billion.

The transfer debits are generally to and from other EU institutions and other non-EU and non G7 countries (see section 7.3, table 9), which reflects subsidies from the EA to EU budgets, remittance payments, and aid to developing economies. Given the stability in these outflows, this should be no cause for concern at this time. Of note, the goods balance shrunk spanning 2003 to current, while the service balance improved. In Q3 2011, the goods balance was just €1 billion, while the services balance was €15.

The trade and income balances balances generally fund the transfer outflows. However, recently the transfer balance has picked up (-€28.1 bn in the three months ending in September, which is up from -€19 or -€20 bn in the same month of 2004 and 2005). Given the dropoff in the trade and income balance, something is funding these unilateral outflows: the capital account.

The Capital Account

The chart below illustrates the 3-month accumulated capital account balance as a sum of its components: net portfolio flows (Port Inv – Bal, generally financial assets), foreign direct investment (FDI, or stickier capital flows), financial derivatives, ‘other investments’, and official reserves (ECB asset accumulation).

Since the crisis started, there’s been an stark inflow of foreign money (positive green bars) into the Euro area. It’s probably worth looking at this alongside the US TIC data to gauge interest in USD denominated assets for a proxy of global portfolio diversification – another post – I digress. The EA foreign direct investment is, and has generally been, negative. Foreign direct investment is long-term investment in other countries, including the retention of earnings for investment, equity investment, or long and short term loans. Most of the FDI is leaving the EA for the UK, ‘other EU countries (those not UK, Sweden, or Denmark, and “other countries” (likely EM countries in Asia and Latin America). You can see this information in section 7.3, Table 9. Official reserve asset accumulation is generally very small – one can barely see it in this illustration – and picks up in times of stress (like in 2008).

One interesting aspect of this data has been the persistently negative flows in ‘other investments’. Section 7.3, Tables 5-6 indicate this is driven by outflows in the banking sector (MFI’s). I’ll attend to this in another post; but there’s been a steady reduction to EA MFI’s via short-term loans.

The important feature of recent developments in the capital account is the sharp dropoff of the portfolio balance in September, just €31.5 bn over the last three months from €104.5 bn in the three months through August. This could be a one-off event; but the reduced foreign demand for EA assets could be problematic if a trend forms.

I would say that the EA BoP is not the most stable of all international flows. It’s now heavily dependent on portfolio flows – the green bars in the chart above – given the persistently negative foreign direct investment flows. Better put: the EA current account deficit is now funding through international asset flows into debt, equity, and lending markets. Given the deterioration of the sovereign debt crisis, I wouldn’t be surprised if these flows slowed further in coming months/quarters without a broad policy response from within Europe. Given the persistence of the transfer outflows, waning foreign demand for EA assets would pressure the currency downward if trade remains sluggish.

originally published at The Wilder View…Economonitors

EA Balance of Payments: the Current Account

by Rebecca Wilder

EA Balance of Payments: the Current Account

I’ve been doing quite a bit of research on the balance of payments flows within the Euro Area (EA). Given the complexity of the balance of payments, there are too many angles to tackle in one post. Therefore, spanning the next week I will dedicate my commentary to the EA balance of payments. In this post, we start with square one: the current account.

The Euro area (EA) current account

Often times I hear comparison of the EA sovereign debt crisis to past emerging market balance of payments crises. This is not correct, since the EA runs only mild current account deficits, -0.9% of total EA GDP as of Q2 2011 (Q3 data reported in December). There’s no need for a sharp revaluation of the euro to drive the balance of payments to its identity – remember, the current account (CA) + capital account (KA) + official reserves + errors/ommissions = 0.

The standard emerging market-style balance of payments crisis goes something like this: large current account deficits must be financed by foreign inflows of capital (financial account surpluses), so that the currency comes under pressure when foreigners lose confidence in said emerging market economy. As foreign capital flows start to reverse, the currency comes under pressure to balance the financial and current accounts. Under currency depreciation, relative costs rise (via imported goods), so the central bank ‘defends’ the level of the currency through FX intervention (they sell down FX reserves and buy the domestic currency). With the central bank’s stock of FX reserves depleting quickly, speculators can sell the domestic currency for much longer than the national central bank can buy up those assets. Eventually, the whole thing comes crashing down. The currency depreciates (quite materially in some cases) and brings the current account into balance.

The EA initial condition for a balance of payments crisis is just not there: the current account is, well, rather ‘balanced’. Within the EA, country-level current accounts are well out of balance. This is the central theme associated with the EA sovereign debt crisis: debtor countries are reliant on foreign inflows of capital from the credit countries to support current spending.

The chart above illustrates the 4-quarter moving average current account deficit (red)/surplus (green) as a % of national GDP ending in Q2 2011.

In the context of the standard balance of payments crisis, Greece and Portugal would/should have seen precipitous nominal FX depreciation by now. In contrast, the Netherlands or Germany would have seen significant appreciation. However, the single currency union prevents nominal depreciation, so the focus has been on real depreciation. The debtor countries are forced into a policy of internal devaluation (fiscal austerity, they call it) to shift relative prices and real exchange rates. This could work if global growth was going gangbusters, but it’s not.

These imbalances are no longer sustainable.

I’ll leave you with a link as to the direction we’ll be headed here on The Wilder View. Last month Thomas Mayer released a report titled Euroland’s hidden balance-of-payments crisis, which describes imbalances building in the EA financial flows. Next post we’ll look into the balance of payments flows within the EA.

originally published at The Wilder View…Economonitors

European Policy Makers Don’t Understand But Markets Do

By Rebecca Wilder

European Policy Makers Don’t Understand But Markets Do

So here we are: the Italian yield curve is flat at above 7%; the government institution is in question; and the ECB is using its SMP purchase program as a carrot to drive austerity implementation in and Berlusconi out. Some would argue that the ‘market is irrational’ – Italy faces a liquidity not solvency crisis. That’s the IMF’s line, and I don’t buy it.

See Italy’s situation is simple: given the Italian debt profile and initial conditions, the Italian sovereign should be able to stabilize its debt levels – even at 8% interest rate (borrowing costs) – PROVIDED (1) it grows, and (2) the sovereign increases its primary surplus (Italy is 1 of just 2 G7 countries expected to run a primary surplus in 2011, according to the IMF). The problem is, that (1) Italy’s contracting, and (2) a higher primary surplus is more likely than not going to aggravate the recession. Something has to change to break the link – this is where I encourage you to read Nouriel Roubini’s latest.

In my view, the market is behaving very rationally. The Troika (ECB+EU+IMF) adapted the standard IMF model to the European sovereign debt crisis as a means to regain market confidence amid a sovereign liquidity crisis. The plan is to enhance fiscal discipline and become more ‘competitive’ (usually that means coincident with currency devaluation).

So fiscal discipline + new competitiveness = market confidence. Right? Wrong.

Italy’s solvency is now under question amid current IMF-style bureaucratic policy in Europe. Why they haven’t figured out the following is beyond me: austerity and competitiveness gains only works if monetary policy is easy and/or the global economy is expanding, and that’s with nominal devaluation.

Either the IMF model will fail or the Euro area will

Here’s the problem with the IMF model:

1. None of the program countries are unequivocally more competitive. Devaluation would help here, but no Euro area (EA) economy can devalue unless they exit the EA.

The table below illustrates the gains in competitiveness by key EA markets since the beginning of the peak of the last cycle, Q1 2008. Competitiveness here is broadly measured by shifts in the real exchange rate, as calculated by relative prices, relative unit labor costs, and relative GDP deflators. The red cells highlight country real exchange rate gains/losses that undercut Germany.

Broadly speaking, no country except Ireland trumps Germany in two out of three measures of real depreciation. At best, the results on which country has indeed gained competitiveness against the 6th most competitive country in the world, Germany, is mixed. Furthermore, Europe as a whole is cutting labor costs, not just the program countries, and dragging domestic demand of the EA as a whole.

Ireland is the only country to have experienced broad depreciation across all three measures and against Germany. But I would argue this: they had further to go. The chart below illustrates the CPI-based real effective exchange rate. Spanning the period January 2007 to April 2008 (the peak), the Irish real exchange rate appreciated 10% against its major trading partners. As such, the 13.6% real depreciation since April 2008 is more reflective of mean reversion rather than competitiveness gains.

2. The second part of any IMF program (first, really) is controlling fiscal balances through ‘austerity’; but this is not possible if the private sector is simultaneously deleveraging and external demand is not sufficient. Spain and Ireland seem to be on track at this point – but they won’t be for long. The inevitable EA recession will increase the required ‘cuts’ to facilitate the reduced revenues; this is both logistically and nationalistically difficult. Global monetary easing is likely to help, but it’s too late for Europe.

Eventually the population will appeal to the economic malaise that is the disintegrating labor markets in program countries and fight against reform.

The divergence in economic performance is quickly turning into convergence, as the sovereign debt crisis inflicts the core economic performance. Shoot, even the ECB has acquiesced and is now calling for a ‘mild recession’.

Markets understand what policy makers in Europe do not: the European IMF-style model is not and cannot work under these conditions. Monetary policy is too tight, the global rebound has dissipated, and fiscal austerity is killing aggregate demand.

And here I get to my favorite quote of the day. From Bank of America’s Athanasios Vamvakidis (no link), a former IMF economist:

“In our view, there are two ways for a country to bolster market confidence in its economic policy: either through the intervention and support of an international institution, or through effective commitment to reform.”

Italy doesn’t need foreign capital, nor does it need effective commitment to reform. It needs a credible path of adjustment. And this involves all EA members, not just Italy. See Martin Wolf’s FT article from October 5, and Nouriel Roubini’s article today on EconoMonitor.

originally published at The Wilder View…Economonitors