Monday, September 26, 2011

Rebecca Wilder is moving to the EconoMonitors

I've decided to migrate News N Economics over to my new blog, The Wilder View, on the Roubini EconoMonitors platform.

Really, I jumped at the opportunity to contribute as part of the EconoMonitors blogging network! Both the audience and the blogging community there are geared toward international macroeconomics and finance.

EconoMonitors, while it is a Roubini Global Economics Project, is free. All you have to do is change your RSS feed and you're good to go. There's no difference to any normal blogging site (like News N Economics). I'll continue to post all matters related to Europe and the global economy at The Wilder View, so it's really no different to what we've got here at News N Economics.

The only drawback from my readers' perspective is that you will no longer receive Emails of my latest posts. I would recommend that you follow me on Twitter as an alternative!

Here is the critical information:

New blog address: The Wilder View at the EconoMonitor platform.

New RSS feed for The Wilder View

And as always, please contact me via Email with any concerns, questions, or just salutations! (

Thank you for all of your support since 2007 at News N Economics! But it's not over - The Wilder View will be even better!

Rebecca Wilder

Monday, September 12, 2011

The European debt crisis in charts

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

Monday, September 5, 2011

The ECB data do not support the view that European banks are moving cash assets out of Europe and into the U.S.: it the Fed's QE2, that's all

Update: I modified this post since original publishing. I am sorry for that; but I came to some broader conclusions.

Kash Mansori published complimentary articles that received quite a bit of attention in the blogosphere. Using data published by the ECB and the Fed, Kash Mansori argued (here and then here) the following:
monetary financial institutions (MFIs) in Europe have been moving their deposits out of European banks. Where is that money going?

It looks like much of it is being placed with US banks instead. The following chart shows the total deposits at domestically chartered commercial banks in the US.
Clearly, something is going on -- the recent rise in deposits with US banks has been dramatic, with an above-trend increase in deposits of approximately $500 billion over the past 6 months.

I have a pretty simple problem with this analysis - the two posts span two different time periods, 1.5 years and 6 months.

In this post, Kash argues that deposits of monetary financial institutions (MFIs) with other MFIs declined by € 461 billion spanning the period January 2010 to July 2011 (using freely available ECB data), implying that they must be moving their cash somewhere else (bolded by yours truly):
with an above-trend increase in deposits of approximately $500 billion over the past 6 months.

Who is responsible for this sudden inflow of deposits into the US banking system? The answer is non-US banks, as illustrated in the following picture, which shows the cash assets of domestically chartered banks alongside the cash assets of foreign-owned banks in the US.
Rebecca: The problem is, that spanning the last six months MFI deposits with other MFIs (in Europe) has INCREASED by € 26.3 billion (see Table below).

Therefore, the 6-month increase in deposits and cash assets in foreign-related U.S. bank branches cannot be related to outflows in inter-MFI deposits in Europe. Yes "something else is going on".

In this post, I argued pretty simply that the ECB data on MFI (monetary financial institutions) deposits do not demonstrate that European banks are decreasing their cash holdings in Europe for the U.S. safe haven over the last six months. Therefore, the recent surge in the cash assets of foreign-related banks in the U.S. is not related to recent financial turmoil in Europe.

But why, nevertheless, has there been a surge in the cash assets of foreign-related banking institutions in the U.S. (i.e., Deutsche Bank offices located in the U.S., for example) since November 2010? There are two reasons, in my view. First, the surge in assets correlates perfectly with the outset of the Fed's second round of quantitative easing. But the surge in cash assets also correlates with increased net liabilities to foreign branches (illustrated below). In short: foreign banking institutions received easing reserves from the Fed AND sought the profit potential of a very steep U.S. yield curve.

The evidence

The second round of the Fed's quantitative easing program started November 2010. As illustrated below, a surge in the cash assets of foreign-related U.S. bank branches is starkly coincident with the outset of QE2 (Fed vault cash and reserves is filed under 'cash assets' in the H.8 Tables).

I cannot answer with certainty why cash assets of foreign-related US branches surged relative to the domestically chartered banks, since the level of detail is not so granular. However, I suspect that it has something to do with foreign banks making a conscious decision to transfer capital into their increasingly profitable U.S. branches.

Regarding foreign bank capital flows, the evidence of capital flows among foreign bank institutions and their U.S. branches is not in the ECB data, it's in the Fed's H.8 Table, pages 8 and 19, line 40. Line 40 shows that foreign-related bank branches in the U.S. increased their net-liabilities to offices located outside of the U.S. rather precipitously since November 2010. Better put: the head office diverted funds away from offices outside the U.S. and into affiliates within the U.S.

The chart illustrates net-foreign liabilities for both U.S. domestically chartered banks (red line) and foreign-related banks in the U.S. (blue line). For the foreign-related institutions with U.S. branches, a negative liability is effectively an asset or claim on its branches located outside the U.S. On the other hand, a positive number is a net liability, or the U.S. branch owes the foreign branch.

Net liabilities by foreign-related bank branches in the U.S. have risen sharply to branches outside the U.S. Not coincidentally, the series bottomed in November 2010, the month when the Fed initiated QE2. Since then, foreign-related banks increased net-liabilities to their local counterparts outside the U.S. by roughly $515 billion. In June 2011, the net liabilities to foreign branches by the foreign-related banks in the U.S. turned positive.

The head offices of foreign banking institutions are diverting capital to their U.S. branches relative to other foreign branches. Why would they do this? The yield curve is steep - and in banking world, a steep yield curve is highly profitable. The Fed's announcement of QE2 in November 2010 made funding in the U.S. very cheap, an input to bank earnings.

No ulterior motive - just profit seeking.

Rebecca Wilder

Thursday, September 1, 2011

Spanish consumers AND savers take a forced siesta

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

Tuesday, August 23, 2011

Malicious ECB rate hikes

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 "pervese 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

US economy in August: moving sideways

This piece was first written at Angry Bear blog.

by Rebecca Wilder

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).

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.

Thursday, August 18, 2011

G7 expansion? Not even close. Canada's in a league of its own

Disclaimer: I'm in Germany, and the keyboard takes some getting used to. Therefore, some of my posts in the coming week will be short and sweet (so that I don't include characters lik รถ, which is sure to turn some heads). Furthermore, blogger spellcheck doesn't work in English here.

The Q2 real GDP data across the G7 are now in, except for Canada who is always the last to release their statistics. We now know that the G7 expansion has been nothing short of pathetic. Why? Because among the G7, ONLY Canada - the G7 consists of the US, UK, Germany, France, Canada, Italy, and Japan - has fully regained its GDP lost during the recession (it had by Q3 2010 no less). Canada's in an expansion league of its own.

Hence, the G7 ex Canada remain in "recovery" mode through Q2 2011 and roughly 3.5 years since the previous cyclical peak (see table in reference of post).

(Note: I differentiate "recovery", or regaining output lost, from "expansion", or growing beyond the previous cyclical peak, in this post.)

The chart above illustrates real GDP (just "GDP" from here on out) across the G7 around the peak of each country's GDP during the last cyle, point 0. Only Canada has fully recovered its real GDP lost, having expanded to a level that is near 2% over its previous peak through Q1 2011.

A full business cycle can be measured as the bottom of a recession to the bottom of the next recession, or the trough to trough measure. In the US, the latest cycle lasted 91 months from the trough of the 2001 recession to the trough of the 2007-2009 recession. And here we are, 14 quarters since the peak in Q4 2007, of which GDP is 0,42% below. For comparison, GDP fully retraced the peaks previous to the 1981-82 and 1990-91 recessions in 7 and 6 quarters, respectively (by my quick count).

Even Germany, the wunderkind of euro area growth had not regained its GDP lost as of Q2 2011. And don't even get me started on Japan.

The ECB is tightening; US Congressional leaders are recklessly endangering the economy; and some euro area governments are pushing through even further fiscal spending cuts to calm market angst. This stinks of policy mistakes - and here in the US, we're patting ourselves on the back because the economic data do not scream recession yet?


Rebecca Wilder

Reference: Business cycle peak dates for chart above

Monday, August 15, 2011

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

Monday, August 8, 2011

A three day snapshot of U.S. equity markets

This will affect consumer sentiment. Watch them scramble now.

Rebecca Wilder

Wednesday, August 3, 2011

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

This article is crossposted with Angry Bear blog.

by Rebecca Wilder

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 big 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).

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 <5% of total spending items, energy, environment, and veterans have arguably broken trend. I would surmise that some of the 'veterans' spending is tied to the business cycle, given the timing of the surge.

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

Tuesday, August 2, 2011

The euro area bond crisis in charts

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.

(click to enlarge)

Let me cite Warren Buffet's interview with CNBC again when he said the following about euro area policy: “When you have 17 countries that all have the same currency, and the yields on their bonds are dramatically different, the situation is not solved.”

I'll say it again (some of this pricing is a couple of weeks old):
If the US States are any comparison, let’s see what a ‘divergence’ in pricing and risk should mean for a single-currency union. A AAA 10-yr Maryland municipal bond trades at 2.68%, while the worst (in pricing) of the States, Illinois, which is rated at A1/A+, trades at 3.98%. That’s a 130 bps risk premium for a 4 notch rating differential. Forget the ‘worst’ in Europe, Greece, because it’s about to go into default. Or even the next or next or next worst in European bond pricing (in order, these would be Ireland, Portugal, Spain, and Italy). But Belgium, an Aa1/AA+ country is trading at 145 bps over the AAA Germany and just one notch lower in rating, Aa2/AA+.

Something’s wrong here; bond markets are still in crisis mode.

Rebecca Wilder

Monday, August 1, 2011

Global PMIs and Fed Policy: they're linked

Today a host of global purchasing managers indices (PMIs) reiterated that the global economy is slowing....quickly.

Within 24 hours, China, the US, and the euro area all reported July PMIs falling toward the feared 50 (below which the manufacturing industry is contracting) - 50.7, 50.9, and 50.4, respectively. The UK PMI fell below 50 to 49.1 in July.

I would posit (and I believe that others have, too, like Edward Hugh) that this is directly related to Fed policy, specifically that of quantitative easing (QE).

The chart above illustrates the stated PMIs alongside the dates of a shift in the Federal Reserve's QE policy. The shorter bars indicate those dates when the Fed ended QE and announced that it would reinvest maturing proceeds. On the other hand, the full bars illustrate the outset of QE.

Falling PMIs correlate with the end of QE. New QE correlates with a rebound in global PMIs. Given this correlation and the latest GDP release, I expect that talk of QE anew to surface.

Rebecca Wilder

Saturday, July 30, 2011

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

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).

(click to enlarge)

The chart above illustrates the seasonally adjusted level of real retail sales for Germany, Spain, Italy, and the US. Since last year, Spain and Italy have seen a precipitous decline in real retail sales. This decline is especially coincident with the outset of fiscal austerity, as I highlighted in a post last month.

The only positive on this chart - US real retail sales have stalled and that in Italy and Spain are on a relentless trend of contraction - is Germany. Although there was a outstized gain in June, the 3-month/3-month annualized pace of growth is still negative, -1.5%. However, since auto sales are not included in this measure of retail sales, the surge is not just a Japan story. The point is, that it's possible there's consumer spending anew. If German consumers can push on their domestic economy and eventually seeping out to the Periphery via increased import demand, then there's hope for Europe after all. However, it's still way to early to tell if June will form a trend.

I have my doubts, though, as I'll highlight in a sequential post.

Rebecca Wilder

Wednesday, July 27, 2011

Credit growth in the euro area - seriously, where is it?

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? Meager. Spanning 2005 to June 2011, loans to euro area households grew at an average 5.5% annual pace, while that to non-financial businesses marked an average rate of 6.8%. According to this indicator, the ECB need not be 'vigilant' at all.

Perhaps it's one country, like Germany? One country that will eventually challenge the stability of prices and the financial system. (Nope, not through loans to the private sector.)

To investigate the dynamics of lending across the euro area, I illustrate the stock of private sector credit for the euro area 12 ex Luxembourg in the series of charts below (the data is available here). Each chart plots the level of loans to households and non-profit institutions (HH) alongside the level of loans to non-financial corporations (NFC). HH loans are generally made to households for consumption or for house purchase. NFC loans can be made for any number of reasons, but typically for investment spending.

Of note, the Periphery economies are generally deleveraging, but to varying degrees. Ireland is clearly experiencing the biggest credit crunch among the PIIGS (Portugal, Ireland, Italy, Greece, and Spain). Also, note that any media report alluding to a German spending and investment boom is just wrong. Credit growth to HH and NFC is literally non-existent. France and the Netherlands are problematic - strong macroprudential regulation is likely needed in these countries while real rates remain low (or negative).

Enjoy viewing the charts - I did. (Click to enlarge)

Rebecca Wilder

Sunday, July 24, 2011

Economists are terrible forecasters - why trust them anyway?

The herd that is 'consensus' clings to this hope that GDP will bounce back smartly in Q3 and Q4, where all the while some pretty miserable data and financial conditions are staring us in the face. On May 26 I worried about the 'soft patch'. On July 24, the data doesn't look too much better.

This week we get the Q2 GDP report from the Bureau of Economic Analysis, of which the mean growth forecast from 69 polled economists by Bloomberg is 1.8% Q/Q SAAR (Bloomberg terminal, no link). That may change as we near Friday (unlikely by much), but those same economists (on Bloomberg) are forecasting a 3.2% rebound in Q3.

Alas, after the huge forecast miss in the first half of the year, I no longer put much stock in what economists expect by way of GDP growth just one quarter ahead (some yes, but broadly no).

See, economists are generally terrible forecasters.

The chart illustrates the one-step-ahead quarterly GDP forecast of the Philadelphia Fed's Survey of Professional Forecasters (SFP) alongside the ex-post GDP growth rate (GNP prior to 1992 for continuity with the SFP data). You can download the GDP data here or here, and the historical SFP data here. As an example, 2011 q1 represents the SFP mean real GDP growth forecast (% Q/Q, SAAR) from the fourth quarter of 2010, 2.5%, and the actual q1 GDP growth rate, 1.9%.

They do okay looking broadly at the business cycle; but the SFP point-to-point forecast error is huge. In sum, the average forecast error is 0.3% on a Q/Q basis spanning the years 1968 to 2011. That means economists miss the next quarter forecast by an average of 0.3%. And they're really terrible recession forecasters: the average error is -2.1%. Spanning the historical expansion periods - of which we are in right now - the SFP miss was 0.8% on average.

On May 13 the SFP predicted a Q2 growth rate of 3.2% SAAR, where 1.8% is the Q2 forecast for Friday.

Economists completely underestimated the following factors in the first half of 2011:

(1) the adverse effects of rising oil prices in the first third of 2011,
(2) the supply disruption from the Japanese earthquakes, and
(3) the underlying weakness in the economy.

Remember David Altig's July 8 post on the implication of sub 2% GDP growth? Mark Thoma expanded on the commentary as well. Mark Thoma also points us to a Macroeconomic Advisers piece that forecasts a 'brief growth recession' if the US economy gets downgraded. S&P puts the probability of downgrade at 50%.

I don't trust economic forecasts. I'll take the under on Q3 and Q4, especially given the way the budget talks are going and recent high-frequency data is looking.

Rebecca Wilder

Friday, July 22, 2011

The latest Eurozone response: one step closer to the crisis point

Here on News N Economics, I’ve generally not commented on the politics of the sovereign debt crisis in Europe. Regular readers are well aware of my skeptical outlook on the growth prospects for countries forced into fiscal austerity amid piles of private-sector leverage, a slowing global recovery, and a central bank with a tightening bias. However, Tyler Cowen points us to various reactions (H/T RJS) – I’ll break my silence here and likewise comment on the latest Eurozone policy response.

The latest response to the Euro area banking, economic, and now fiscal crisis was heavy on promises and light on details and substance. Specifically, it outlines 16 different measures on 4 pages of text. The optimists – you know, the ‘glass half full types’ – see the ‘increased flexibility’ of the EFSF fund, or point 8. of the announcement, as a boon to the single-currency union. I see it as one step closer to the point where Eurozone policy makers will ultimately decide whether they're willing to institute a policy to keep the 17-country 'zone' together or let it fail.

Point 8. gives the European Financial Stability Fund (EFSF) the ability to do the following with ‘appropriate conditionality’: act on the basis of a precautionary programme; finance recapitalization of the banks for countries not in the EFSF programme; and purchase bonds on the secondary market (what the ECB was doing under its Security Markets Programme).

This is all fine and dandy; but these measures will do nothing to stem the contagion. Basically, the size of the EFSF is effectively too small to really make a difference, 323 billion euros remaining (note too that the 'full' EFSF lending capacity, 440 billion euros, has only been agreed upon, not yet ratified by all the governments at this time). If Ireland or Portugal were to need new assistance - this is not unlikely, in my view, given recent data coming out of Europe (H/T Credit Writedowns) - the remaining funds would quickly dissipate. Forget about Italy - it's too big. According to Bloomberg (not shown) 418 billion euros worth of Italian sovereign debt will mature through 2012.

The size needs to be bigger, yes, but this clinging to conditionality of fiscal austerity is the true weak link. “Strict”, “appropriate”, or “adequate” conditionality is a prerequisite for accessing the EFSF in any form. Conditionality for an autonomous sovereign government without autonomous monetary policy means fiscal austerity. And fiscal austerity for Europe means growth risk. And growth risk is now morphing into sovereign risk via weak domestic demand and rising fiscal deficits. There’s practically no way out except under fiscal union - or some version of it - and this must entail (literally) unconditional transfers.

It’s not a currency crisis, it’s a bond market crisis.

One can point to market reaction as testament that yesterday’s announcement was a successful response. Since July 18th (the day that bond investors started the long-standing tradition of “buying the rumor”) 10-yr yields across the Euro area fell precipitously: 171 bps in Portugal, 54 bps in Italy, 55 bps in Spain, 219 bps in Ireland, and a quick 353 bps in Greece. The biggest moves were in Ireland, Portugal, and Greece, where the curves shifted to reflect the lower borrowing costs and longer loan maturities. Furthermore, the euro gained 1.8% against the US dollar (+2.24% through yesterday).

It’s all about levels. Despite the quick drop in yields, today’s spread of 10-yr Periphery bonds over a like German bund reflects a substantial mismatch of risk: 815 bps for Portugal (that’s Portugal must pay 8.15% effective interest on a 10-yr bond above Germany’s 2.8% 10-yr borrowing cost), 262 bps for Italy, 296 bps in Spain, 907 bps in Ireland, and a completely unmanageable 1,187 bps for Greece. Note, Greece, Ireland, and Portugal do not pay these rates, since they are blanketed for now under an EFSF program or bilateral loans. Ironically, despite the clear crisis in bond markets, the euro is up 12.6% against the dollar in the last year.

A friend pointed me to a CNBC interview with Warren Buffett from July 7: This is what he said when asked about the Euro area: “When you have 17 countries that all have the same currency, and the yields on their bonds are dramatically different, the situation is not solved.

He’s right. If the US States are any comparison, let’s see what a ‘divergence’ in pricing and risk should mean for a single-currency union. A AAA 10-yr Maryland municipal bond trades at 2.68%, while the worst (in pricing) of the States, Illinois, which is rated at A1/A+, trades at 3.98%. That’s a 130 bps risk premium for a 4 notch rating differential. Forget the ‘worst’ in Europe, Greece, because it’s about to go into default. Or even the next or next or next worst in European bond pricing (in order, these would be Ireland, Portugal, Spain, and Italy). But Belgium, an Aa1/AA+ country is trading at 145 bps over the AAA Germany and just one notch lower in rating, Aa2/AA+. Something’s wrong here; bond markets are still in crisis mode.

This policy response is not a boon to the Eurozone, it’s just a step closer to the crisis point - the point where policy will determine whether the euro dies or survives.

Rebecca Wilder

Wednesday, July 20, 2011

Scary chart of the day: Ireland's bank run

I knew that the Irish deposit base was shrinking - I just didn't realize the severity of the situation. In sum, €21.4 bn in household and non-financial business deposits have been drawn down since their respective peaks.

Irish businesses in aggregate have been in a silent bank run since 2007, households since 2010. So how big is €21.4 bn? Roughly 14% of Irish GDP.

Rebecca Wilder

Tuesday, July 19, 2011

It's wrong to compare Italy to Japan

Reader Dilip pointed me to Paul Krugman's article over the weekend, Italy Versus Japan. In it, Krugman (via commenters) asks why Italian debt is trading at 5.7% on the 10yr, while that in Japan is trading at 1.1% (as of July 19, 2011).

The answer's pretty simple: just 7% of Japan's public debt is held outside its borders. Furthermore, near all of it is denominated in yen, a fiat currency that is funded by the Japanese government itself. On the other hand, Italy has quite a large share of external public debt, 43% of total public sector debt, and the sovereign has conceded monetary policy to the currency union. Simply put: Italy's constrained, Japan is not - and interest rates reflect this.

On a similar note, I often hear that 'Italy is very similar to Japan' in my business. The point is that while the government debt is high, the private sector balance is elevated, so that accounting requires the government to run large deficits and accumulate debt. This is true of both economies; but Japan's private sector surplus is multiple factors of that in Italy.

The sectoral balances in Japan and Italy

The Japanese private sector financial balance (the current account as a % of GDP less public sector net lending as a % of GDP) is seriously elevated, 11.7% of GDP in 2010 (mostly the business sector). Given that Japan runs current account surpluses, the level of deficit spending is somewhat less, 8.1% of GDP in 2010.

In stark contrast, Italy runs current account deficits, -3.3% of GDP in 2010, and the private sector financial balance is only slightly positive, +1.3% of GDP. This implies smaller but manageable public sector deficits on the order of 4.6% of 2010 GDP.

However, given that Italy does not have monetary sovereignty, the credit has become more 'risky' with rising current account deficits. Because for a given level of private sector saving, a higher current account deficit will by definition pressure government debt via increased public deficit spending. This dynamic will ultimately hinder the Italian sovereign's ability to refinance - we're seeing this now.

So while Italy does have a positive private sectoral balance, the economy's sectoral balance does not represent that in Japan. It's wrong to compare Italy to Japan.

Rebecca Wilder

Wednesday, July 13, 2011

What do Spain and Vietnam have in common?

What do Spain and Vietnam have in common?

Roughly a 25% chance of defaulting over the next 5 years. That's what the credit default swap market is telling us.

Vietnam's long-term rating is B1 by Moody's, BB- by S&P, and B+ by Fitch (not that these ratings really 'mean' anything). Spain's current rating is high investment grade - Aa2, AA, and AA+ by Moody's, S&P, and Fitch, respectively. Italy's is in good company as well, the low BBB camp (Croatia and Hungary, for example). Italy is currently rated mid- to low- A by all three rating agencies.

My model (not shown) rates Italy BBB and Spain BBB+ based on economic and structural fundamentals on a cross-section of 76 emerging and developed countries.

The chart above illustrates the shift in CDS pricing from 2 years ago (X-axis) to today (Y-axis). The red line is the 45-degree line. All sovereigns above the red line saw a point-to-point increase in CDS spreads spanning the last two years. There are a lot of European economies populating the upper-left area of the chart.

Is Europe going to end up with a few investment grade credits alongside a host of below-investment grade credits? Greece is roughly CCC by all three major rating agencies. At this time, Portugal and Ireland are below investment grade by Moody's only, Ba2 and Ba1, respectively. We'll see.

Finally, a bird's-eye view of CDS-land.


Rebecca Wilder

Monday, July 11, 2011

The US unemployment rate: European levels without the European safety net

This post is crossposted with Angry Bear blog, where it first appeared.

Jobs growth is a lagging indicator of economic activity, so the June report confirms that the US economy has been in a deep rut (Marshall Auerback calls it a 'fully-fledged New York City style pot hole'). Yes, the US economy is growing; but sub-2% really 'feels' like stagnation, if not recession for many. As always, Spencer provides a fantastic summary of the employment report here on AB: 'bad news', he says.

I call it abysmal, both relative to history and on a cross section. The chart below illustrates the unemployment rates across the G7 spanning 1995 to 2011.

Across the G7 economies, the level of the US unemployment rate is second only to France. This is true on a harmonized basis as well.The speed at which the US unemployment rate reached European levels was abrupt. Only the UK has seen such a swift deterioration in labor market conditions.

The chart above illustrates the same time series as in the first unemployment chart, but the rates are indexed to 2005 for comparability. France's high level of unemployment is structural. In contrast, the US level of unemployment is NOT, not even close.

The chart above illustrates the components of the OECD's indicators of employment protection. Also, see a short note by the Dallas Fed highlighting the differences between the French and US labor markets (and the 1994 OECD jobs study).

The French labor market is quite rigid, which leads to a structurally elevated unemployment rate and expansive unemployment compensation (see this follow up to the OECD 1994 jobs strategy report). The US Labor markets is much more fluid, which is why the unemployment rate has surged relative to comparable economies in Europe (see second chart).

European levels of unemployment without the European safety net.

The chart illustrates the maximum number of months that a worker can claim unemployment insurance for the year 2007. In normal times, French workers can collect benefits for up to 23 months by law, where the US worker collects for just 6 months. The tax and benefit policies data are updated infrequently, and listed on the OECD's website (excel file link).

Seriously, shouldn't Congress be focused on the depressed state of the US labor market, rather than a 'scaled back' version of deficit cutting? Addressing one will clearly impact the other - it goes both ways. Unfortunately, the government's pushing in the wrong direction (cutting deficits brings further unemployment rather reducing unemployment drops the deficits).

Rebecca Wilder

Thursday, July 7, 2011

Why you shouldn't get too excited about the 1.2% increase in German industrial production: ECB + global slowdown

Yesterday, I illustrated (and rather convincingly, in my view) that German factory orders are more of a harbinger of bad economic things to come rather than a strong report to get 'excited' about. Well, today I illustrate why you shouldn't get too excited about the 1.2% rise in working-day and seasonally adjusted German industrial activity in the month of May, as reported by the German Federal Statistical Agency.

Case 1: Industrial activity is set to slow, as illustrated by recent PMI trends.

The chart above illustrates the cyclical component of Industrial Production, filtered using the HP Filter (see reference at end of post), and the previous month's PMI survey. The correlation is 64%, so there's a clear signal from the PMI that stabilization of the cyclical IP is afoot. Better put: the trajectory of cyclical industrial activity is going to plateau.

So while IP remains robust, German industrial activity is unlikely to push Euro area GDP growth up and up for much longer.

So where's the German 'growth' machine going to come from? It must come from domestic demand, of course.

Case 2: Germany remains too reliant on exports and government spending to finance growth.

The table above illustrates spending components of German GDP since the previous cyclical peak. The German economy, as measured by GDP, was just 0.1% above its recent cyclical peak in Q1 2011. Domestic demand recovered somewhat, with consumption and government spending having surpassed the 2008 peak by 1.2% and 7.4%, respectively. Spending on machinery and equipment remains 5.4% below its previous peak. It's the government and trade that's driving domestic demand on a cumulative basis.

Here's the reason NOT to get excited about the industrial report: the ECB is trying to clamp down on domestic price pressures via higher interest rates. But Germany is an export machine, so the slowdown in global economic growth (see my post yesterday for one reasonably robust indicator) will do the ECB's job for them without rate hikes. The ECB's doubling down on policy in Germany when the Periphery are attempting to scrape themselves out of a fiscal austerity hole by way of exports to Germany.

Rebecca Wilder

BTW: Kurt Annen (German, ironically) provides a free HP Filter add-in for Excel. I coded this some time ago into Gauss, but did not want to spend time on it in Excel (VBA is a terrible language). Thanks Kurt.

Wednesday, July 6, 2011

Why you shouldn't get too excited about the 1.8% increase in German factory orders

German factory orders increased rather sharply in May, 1.8% in volumes and on a seasonally adjusted basis. The impetus to industrial orders growth on the month was primarily German factories buying capital goods, +2.4%.

Factory orders do lead economic activity, so German domestic demand is likely still plugging away. But that's as good as it gets - the report also reveals further evidence of a global economic slowdown.

While domestic orders surged 11.3% in May, orders from abroad (EMU countries plus extra-EMU countries) fell 5.8%. The three-month moving average of the index for German factory orders from abroad is now falling at the margin.

Of the new factory orders coming from outside Germany's borders, extra Euro-area orders fell a sharp -6.1% over the month (demand from the UK, the US, and presumably Asia). Factory orders from other Euro-area countries fell 5.4% in May.

The three month moving averages are stable to down for orders stemming from all sources except for within Germany. The implication is that Germany, which drove 50% of GDP growth in Q1 but holds just a 30% share, will further drive Euro-area economic activity into Q2 via robust investment spending. However, this report is consistent with a crystal clear slowdown in global demand.

This is not good for the outlook for Spain nor Italy. Note, too, that Italy's PMI is now in sub-50, i.e., contracting, territory across both the service and manufacturing industries.

Rebecca Wilder