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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

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

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

Angry Bear contributor now at Economonitor

Angry Bear contributor Rebecca Wilder has begun writing her own column, The Wilder View, at the internationally prestigious Economonitor (Nouriel Roubini).

The Wilder View at Economonitor

Europe: Why the One-Size-Fits-All Solution Won’t Work and

Linking sovereign risk to corporate credit spreads in Europe

…and is interviewed and quoted by Floyd Norris in the New York Times.

Government Debt Doesn’t Tell the Whole Story
New York Times by Floyd Norris

In Ireland, as in Spain, the government paid down debt while private sector grew,” said Rebecca Wilder, an economist and money manager whose blog at the …

You can follow her there in the sidebar feed for other blog contributions.

More Wilder on Europe today

by Rebecca Wilder

I present some basic statistics to highlight the problem in Europe. In short, there exists a deleterious positive feedback loop between overly leveraged banks and their sovereigns in key markets.

Exhibit 1: European Banks are overly levered. Spanning 2006 through the latest data point, key European banking systems – France, Germany, and Italy – increased leverage.

The chart above illustrates the ratio of bank assets to capital (see the IMF’s Financial Soundness Indicators for the data and description of ‘capital’). The countries are ranked by largest % drop in bank leverage spanning the period 2006 to current (Greece, Austria, and Belgium) to the largest % surge in leverage spanning the same period (France, Italy, and the UK). Note: the 2006 data is taken from the 2007 IMF Global Financial Stability Report.

The level of leverage is not strictly comparable across countries due to differences in national accounting, taxation, and supervisory regimes. However, while the US banks have delevered over the period, the big European banks – Germany, Italy, and France – have increased leverage. Assets need to be written down.

Exhibit 2. While leverage is too high, asset quality is dropping. The banks are increasing exposure to government loans and securities relative to traditional loans.

The chart illustrates the nominal stock of loans held on the bank balance sheets of the Monetary Financial Institutions in Europe. The data are from the ECB. Loans to governments and holdings of government securities are increasing more swiftly than traditional lending.

Exhibit 3. The asset quality of that rising stock of loans to the government sector is deteriorating…quickly. Italian and Spanish 10yr bonds are 1.5% and 1.2% higher, respectively, since the beginning of 2010, while German 10-yr yields are 1.5% lower.

The chart illustrates the 10-yr bonds across the euro area bond markets. The latest data point (today around 12pm) is listed in the legend.

Bond investors are clearly differentiating between the riskier bonds – Spain, Portugal, and Belgium – from the ‘core’ – Germany, Netherlands, Austria, Finland, and yes, France. Whether or not bond markets are right to regard Finland or France as ‘core’ is a different matter entirely. But the point is clear: bond markets are in crisis mode, and there’s a stark segmentation in yields across the region.

Cross border exposure dictates that some of these highly levered banking systems are exposed to the same government securities currently trading at distressed levels. A case in point is France with outsized exposure to Italy and Greece (see Table 9B). This is a helpful graphic by Thomson Reuters .

Rebecca Wilder originally at Newsneconomics

Spanish consumers AND savers take a forced siesta

by Rebecca Wilder

Recently we saw retail sales figures come out of Spain, Germany, France, and Italy. Across Europe, the seasonally-adjusted pattern of real retail sales is diverging.

The chart above illustrates the real seasonally-adjusted and working-day-adjusted (for Europe) level of retail sales across key countries in Europe and the US (for comparison). The raw data is indexed to 2007 for comparison. Euro area retail sales closely track those of Germany, so I’ll speak to Germany alone in this post. The final data point for sales in Italy, France, and the euro area is June 2011, while that for Spain, Germany, and the US is July 2011. Finally, Spain’s retail sales are released on a working-day but not seasonally adjusted basis. I adjust the figures for seasonal factors using a simple Census X12 ARIMA algorithm in EViews.

German and French consumers are hitting the retailers, while Italian and Spanish consumers are cutting back. In this post, I argued that the timing of the second drop in Spanish retail sales (following the recession) eerily coincides with the outset of fiscal austerity in Europe. US retail trade has outperformed that in Italy and Spain since the 2009 trough.

Spanish and US consumers have something in common: household saving rates fell in order to support retail shopping. In contrast to US consumers, though, Spanish consumers were forced to cut back both on retail spending AND savings. In Spain, there’s not enough income to increase retail spending and/or saving rates.

The chart illustrates household saving ratios (saving as a percentage of disposable income). Although the levels cannot be directly compared, since each are released in either gross or net form (net being gross ex depreciation), the trends are illustrative. Spanish saving plummeted since its peak in 2009. As of Q1 2011, the saving rate is already at the level forecasted by the OECD for all of 2011.

This is not going to end well. As the Spanish government struggles to meet its deficit target amid a battered economy, it does so at the cost of the domestic saving rate. Households will be forced to draw down saving further as a share of income in order to facilitate the government’s deficit objectives.

This deflationary policy is NOT sustainable.

Rebecca Wilder

Also published at Newsneconomics

Weak consumer confidence and real wage growth portend weak consumer spending

Yesterday the Conference Board released its measure of consumer confidence, which dropped to 44.5 in August. This brings the Conference Board measure of confidence in line with the Reuters/University of Michigan measure of consumer sentiment. Bloomberg summarizes the Conference Board results.

Confidence is important, since consumer spending accounts for the lion’s-share of aggregate spending. Consumer confidence measures are highly correlated with the annual growth in real personal consumption expenditures – the correlation coefficients are 75% and 67% for the University of Michigan Sentiment index and the Conference Board’s Confidence index, respectively.

(Chart axis identifcation amended…rdan)

Ultimately, though, it’s all about jobs and personal incomes.



READ MORE AFTER THE JUMP!

To date, while July real wages and salaries (deflated using the CPI) fell on the month, the 3-month average continues its ascent. Clearly the sluggish climb in real wages and salaries is not enough to spark a surge in confidence and spending. Neither will consumers draw down saving, as was the case over the last decade amid debt-financed consumption. In fact, saving is more likely to rise as a share of income than fall as the balance sheet repair process furthers.

Jobs and incomes will drive consumption.

To be sure, measures of confidence are “better” predictors of economic activity when the economy is fragile. We know that the economy is now much more fragile than previously thought. Weak confidence plus meager real wage and salary growth is, unfortunately, a harbinger of further ‘weak’ economic activity.

Malicious ECB rate hikes

by Rebecca Wilder

Lieblings quote of the day by Dean Baker:

“The ECB is run by a perverse cult that worships 2.0 percent inflation and is prepared to sacrifice almost all other economic goals to meet this target.”

The article goes on to argue that the ECB should increase its inflation target to 3-4% in order to facilitate positive wage growth in the debt deflationary economies like Spain. I’ve argued a similar point in the past.

However, I’d like to add that this “perverse cult” called the European Central Bank (ECB) raised its policy rate on April 13 – a point in time that correlates perfectly with a shift in trend across euro-area bond markets. Specifically, April 13 marks the upswing in risk premia on Italian, Spanish, and Belgian bonds relative to German bunds. Hmmm…policy mistake?



Now that’s just malicious.

Rebecca Wilder also posted at Newsneconomics

US economy in August: moving sideways

With the (roughly) 11% decline in US equities year-to-date, talk of a US recession has resurfaced. Through mid August, the high frequency economic indicators point to further weakness, rather than a double dip.

In my view, whether or not the US is IN a recession – defined as the coincident variables followed by the NBER (.xls) are turning downward – is really a moot point for a good chunk of the working-aged population. It probably ‘feels’ like the economy never exited recession to many.

As an aside, it would be difficult for the US economy to actually ENTER a contractionary phase right now, since the cyclical forces that normally drag the US into recession – inventories, auto sales, and housing – are at severely depressed levels. Confidence (or lack thereof) can reduce domestic spending and investment – it’s in this respect that the losses in equity equity markets are important. It takes time for shocks to work their way into the economic data. Nevertheless, high frequency indicators do not point to recession…for now.

Claims are elevated but ticked up last week. If claims do not fall back in coming weeks, the unemployment rate will rise again. This could indicate the outset of a contracting economy.



Weekly diesel production shows an increase in transportation activity (please see this post for an explanation of the data).



Read More After the Jump!



The demand for diesel (in real barrels per day) recovered, rising at a rate of roughly 15% annually for each of the weeks of July 29 and August 05. Annual growth declined to -3% in the week of August 12; but this series (even in annual growth rates) is highly volatile, and the 4 week moving average of annual growth decelerated only mildly, from 7% to 6%.

Finally, daily Treasury tax receipts are slowing but growth remains positive.

The chart illustrates the annual growth rate of the 30-day rolling sum of daily withholding receipts for income and employment tax payments. This series proxies the health of the labor market. Spanning the last three months, the annual growth rate decelerated to 4% (May 18 through August 18 this year compared to the same period last year) from 4.6% in the three months previous. There’s no indication of a contraction in tax receipt activity, but a further trend downward in the pace of tax receipt gains would turn some heads.

Nothing to indicate a contraction in the high-frequency data; but the deceleration is worrisome, given that consumers must ‘earn’ their consumption rather than ‘borrow’ for consumption. I don’t feel particularly positive about the state of the US economy. Neither does Mark Thoma.

Rebecca Wilder

Endogenous business cycle spending + tax receipts at record lows = deficit hysteria for the wrong reasons

Readers here will know more about the US federal government income statement than I. However, given the near ubiquitous deficit hysteria, I wanted to illustrate the truth about the budget deficit. The truth is, that deficit hysteria has been set in motion by A surge in government spending on items like unemployment compensation, food stamps, and other types of ‘support payments to persons for whom no current service is rendered’ AND low tax receipts. Yes, long-term reform is needed; but my general conclusion is that the deficit hysteria is sorely misplaced.

First things first, the fiscal deficit – receipts minus net outlays as a % of GDP – is big. In June 2011, the 12-month rolling sum of net receipts (the budget deficit) was roughly 8.5% of a rolling average of GDP. This is down from its 10.6% peak in February 2010, but the level of deficit spending clearly makes some nervous.

Why should they be nervous about the ‘level’ of the deficit? I don’t know, since recent ‘excess’ deficits are cyclically endogenous. The chart below illustrates the spending and tax receipt components of the US Treasury’s net borrowing (see Table 9 of the Monthly Treasury Statement). Weak tax receipts and big spending are driving the federal deficits (spending, as we will see below, has surged on items directly related to the business cycle).


READ MORE AFTER THE JUMP!

In June, the 12-month rolling sum of tax receipts – mostly corporate and individual income taxes and social insurance and retirement receipts – was 15.6%, which is up from its 14.5% cyclical low in January 2010. On the spending side, net outlays in June 2010 were a large 24.2% of GDP and down just slightly from the 25.3% peak in February 2010.

Deficit hysteria should be more appropriately placed as “lack of jobs and tax receipts hysteria”. At this point, the budget could just as easily worsen as it could improve, given the fragile state of the US economy (see Tim Duy’s recent post at Economist’s View).

Why the wrong hysteria?

Reason 1. Taxes. Some would love to increase taxes – but the fact of the matter is, that tax receipts remain well below their long-term average of 18% of GDP. Tax receipts will not improve without new jobs since individual income taxes account for near 50% of total receipts.

Reason 2. The spending has been on cyclical items.

The best time to ‘worry’ about government spending is NOT when the economy is barely moving.

The chart below illustrates the big ticket items of the monthly outlays – roughly 87% of total outlays. The broad spending components are listed in Table 9 of the Monthly Treasury Statement. The long-term average shares of total spending are indicated in the legend.


The items health, medicare, and income security (inc security) are all above their respective long-term averages. But spending on income security outlays is the only spending component to have broken its trend, i.e., surge. According to the GAO’s budget glossary (link here, .pdf), this item includes the following cyclical spending:

Support payments (including associated administrative expenses) to persons for whom no current service is rendered. Includes retirement, disability, unemployment, welfare, and similar programs, except for Social Security and income security for veterans, which are in other functions. Also includes the Food Stamp, Special Milk, and Child Nutrition programs (whether the benefits are in cash or in kind); both federal and trust fund unemployment compensation and workers’ compensation; public assistance cash payments; benefits to the elderly and to coal miners; and low- and moderate-income housing benefits.

It’s spending on unemployment and food stamps that’s driving spending at the margin.

The same deal exists with the ‘smaller ticket items’. Of these

OK – so deficit hysteria is about, but it’s misplaced. One could argue for more, not less, spending to get the jobs growth, hence tax receipts, up.

Rebecca Wilder