News N Economics

Rebecca Wilder is moving to the EconoMonitors

2011-09-26T07:00:00.000-04:00

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! (newsneconomics@gmail.com)

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

The European debt crisis in charts

2011-09-12T20:00:00.002-04:00

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

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

2011-09-05T12:56:00.043-04:00

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

Spanish consumers AND savers take a forced siesta

2011-09-01T21:13:00.002-04:00

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

Malicious ECB rate hikes

2011-08-23T15:35:00.015-04:00

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

2011-08-23T03:00:00.003-04:00

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.

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

2011-08-18T16:00:00.006-04:00

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 ö, 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?

Unbelievable.

Rebecca Wilder

Reference: Business cycle peak dates for chart above

Global slowdown underway - it's more than the Japanese supply chain disruptions

2011-08-15T08:12:00.014-04:00

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

A three day snapshot of U.S. equity markets

2011-08-08T18:15:00.007-04:00

This will affect consumer sentiment. Watch them scramble now.

Rebecca Wilder

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

2011-08-03T07:00:00.003-04:00

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

The euro area bond crisis in charts

2011-08-02T20:39:00.008-04:00

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

Global PMIs and Fed Policy: they're linked

2011-08-01T12:30:00.003-04:00

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

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

2011-07-30T10:25:00.010-04:00

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

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

2011-07-27T17:53:00.011-04:00

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

Economists are terrible forecasters - why trust them anyway?

2011-07-24T17:53:00.017-04:00

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

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

2011-07-22T16:52:00.020-04:00

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

Scary chart of the day: Ireland's bank run

2011-07-20T18:55:00.004-04:00

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

It's wrong to compare Italy to Japan

2011-07-19T07:46:00.013-04:00

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

What do Spain and Vietnam have in common?

2011-07-13T19:16:00.008-04:00

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.

Remarkable.

Rebecca Wilder

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

2011-07-11T04:00:00.002-04:00

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

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

2011-07-07T06:54:00.014-04:00

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.

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

2011-07-06T18:09:00.011-04:00

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

Retail Sales and Fiscal Policy in Europe

2011-06-30T19:08:00.010-04:00

In May retail sales in Spain fell 6.6% over the year and on a working-day adjusted basis. Retail sales in Spain haven't posted positive annual gains since June 2010. In its own right, this is horrendous.

Marshall Auerback is concerned, as he highlighted in an E-mail exchange:

These declines in retail sales in Spain have been accompanied by double digit declines in credit to households and significant declines in real estate collateral. Spanish home prices fell another 1.8% in the second quarter.

Finally the Spanish central bank has conceded that private consumption for the second quarter in Spain has been “rather weak”. Right now, with the celebration over the Greek parliament kicking the can down the road, signs of economic deterioration in the rest of Europe and especially in Spain do not matter. Someday they will.

My response to this was 'yes, we know that domestic demand it just horrendous'. But there's more: look at this data in a panel and note the deleterious nature of fiscal austerity amid the strong desire to save on the part of Spanish households. Marshall's right, this is 'economic deterioration', plain and simple.

(click to enlarge)
The chart illustrates the path of seasonally-adjusted real retail sales. The Italian and Spanish data are constructed as follows. Spanish real retail sales are released on a working-day but non-seasonally basis. I adjust the data for seasonal factors using the Census X12 ARMA method in Eviews. The Italian retail sales data are converted into a real series using the harmonised CPI, as released by Istat. The German and US data are available directly.

There's not a lot to explain here. As proxied by retail sales, the Spanish domestic consumer is imploding. Fiscal policy is driving retail sales through the ground, literally, amid a high household desire to save (recovering/deleveraging following a collapse in credit markets). The X12 adjustment may have issues - but there's no sampling error that can discredit this clear trend downward.

Spanning the previous six months, real retail sales in Italy and Spain - those countries actively engaged in fiscal tightening - dropped 2.0% and 3.3%, respectively, on a seasonally and working-day adjusted basis. In the US, where the government has yet to succumb, seasonally-adjusted real retail sales are up 0.9% over the same period.

Spanish consumers are essentially being squeezed by fiscal austerity. Notice that real retail sales in Spain appeared to stabilize spanning late 2009 through May 2010. The next leg down perfectly correlates with the outset of austerity in Europe.

The austerity will end eventually the easy way (as the German domestic economy is allowed to expand and inflation overshoot) or the hard way (missing deficit targets and being forced to choose between further deflationary austerity or leaving the Euro area). Randy Wray tells us the outcome.

Rebecca Wilder

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

2011-06-27T07:26:00.008-04:00

These jokers have no idea what they're doing.

The IMF has overshot the ex-post path of Greek nominal GDP in each and every one of their World Economic Outlook forecasts since April 2009. What do you want to wager that they're wrong about 2011, too? And now they want more fiscal austerity...

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

Just amazing.

Rebecca Wilder

Will someone please explain to me why the ECB is hiking in July

2011-06-24T08:03:00.011-04:00

I've gotta say, I have absolutely no idea why the ECB is hiking. If I look at key monetary variables (forget about the real economic data for a minute), they should be on hold.

(1) inflation expectations has dropped off precipitously across key countries in Europe, as measured by the 10-yr swap linker. One could argue that it's simply market sentiment and oil - which could very well bounce back - but the same measure of US inflation expectations is sticky at 2.7%. Chart 1 below.

2) key monetary variables, the annual growth in the money supply (M3) and lending to euro area residents have tapered off at levels not seen since 2003, with exception to recent history. On a 3-month annualized basis, growth rates have slowed markedly from peak levels earlier in Q1 2011 (MFI loans) and Q3 2010 (M3 growth). Charts 2 and 3 below.

(3) A cursory view of the history of ECB rate targets, US Fed rate targets, and the monetary variables suggests a high correlation between US Federal Reserve policy and Euro area monetary variables. In fact, on a 3-month annualized basis, MFI lending to Euro area residents has a 70% correlation to US Fed policy, a much greater correlation than with ECB policy (50%) - this same correlation is more balanced at the % Y/Y level. Chart 3 below.

(4) The money supply has a high correlation to ECB policy using either the Y/Y or the 3-month annualized growth measures. Money supply is a lagging indicator (one of the lengthier lagging indicators) - I would go so far as to deduce that this high correlation is further indication that the ECB is a 'reactive' bank.

It's going to be very tough for the ECB to eke out another 25 bps, let alone 50 bps by year end (the market is pricing in roughly 40 bps of hikes by year end). The economic (not this article) plus monetary data don't even support it.

Accompanying Charts

Rebecca Wilder

Little evidence of convergence across the Euro area 12 after adopting the euro

2011-06-22T12:05:00.002-04:00

Eurostat released measures of annual per-capita GDP expressed in Purchasing Power Standards for the European Union. Purchasing power standards corrects for price differentials in nominal income and is useful for cross-country comparison (Eurostat data).

Given the economic dispersion across Europe (a recent article highlighting this using Q1 GDP growth), I wanted to investigate 'convergence' among the Euro area 12 countries. Specifically, are the lower income countries benefiting from the single currency policy more so than the higher income countries and thereby 'catching-up' to the average?

The chart below illustrates the per-capita income bases across the Euro area 12 - those countries that adopted the single currency in 1999 plus Greece (they adopted in 2001).

The chart illustrates 2001 per-capita GDP measured in PPP euros across the Euro area 12 (now called average income). Luxembourg, Netherlands, and Ireland had the highest average incomes, while Spain, Portugal, and Greece had the lowest. If income disparities among the Euro area (12) countries were to converge over the following decade, then the lower income countries should grow more quickly than the higher income countries, and average income differentials should fall.

The chart below illustrates the average catch-up rates for the Euro area 12 (excluding Finland which averages 234% from 2001-2008, so distorts the chart) both before adopting the euro (1996-1999) and after (2001-2008). They are calculated as in Péter Halmai1 and Viktória Vásáry, Real convergence in the new Member States of the European Union (Shorter and longer term prospects).
Note: I did not include the years 2009 and 2010 to avoid distortions created by fiscal austerity in key countries. Furthermore, the year 2000 is omitted since Greece didn’t adopt the euro until 2001.

The catch-up rate is essentially the average annual rate of change of the difference between country average income and that of the Euro area (12). A positive number represents an average increase in this differential, while a negative number indicates a decline in the differential. For convergence, you would expect for these rates to be negative among the lower income countries and some of the higher income countries as well.

The discrete shift in convergence is quite striking. Basically, the Euro area went from generally converging before the formation of the Euro area, as illustrated by 6/11 shown negative catch-up rates spanning 1996-1999, to generally diverging, as illustrated by just 3/11 shown negative catch-up rates spanning the 2001-2008 post Euro area formation. Only Belgium and Spain demonstrate convergence across both time periods.

Following adopting the euro, the income differentials grew markedly in France, Italy, Germany, and Ireland, and often not for the better (i.e., the income differential widened). In Italy’s case, the income differential went from positive PPP700 in 1995 to –PPP2,400 in 2010 (not illustrated in chart); this differential turned for the worse in 2002.

According to this measure, there's little evidence of convergence. Here's a thought exercise: I'm one of the countries that are set to adopt the euro (see light blue countries here) - why would it be in my best interest to do so if history tells me that adopting the euro leads to rising income differentials?

Rebecca Wilder

Italy: a growing credit risk lurking in the shadows

2011-06-21T04:00:00.004-04:00

Markets and global economists are focused on Greece, where all the while there are growing non-Greek credit events lurking in the shadows. Specifically, recent news flow out of Italy ensures that the volatility in Europe will follow any near-term Greek resolution.

On Friday, Moody's placed Italy's Aa2 local and foreign currency bonds on negative outlook, citing a possible downgrade within 90 days. The drivers for the review are the following: (1) challenges to potential growth, (2) implementation risks surrounding fiscal consolidation efforts; and (3) risks posed by funding conditions for European sovereigns with high levels of debt.

Moody's states that the above are the 'main drivers' (no link); but how I've interpreted recent shifts in credit outlooks is that (2) above, via rising political risk, is the last straw. If the economic cyclical indicators become somewhat challenged, this would surely require further austerity measures in the case of European sovereigns; and if further austerity measures become less certain in expectation on rising political risk, then the country goes on 'review'.

The political risk has sharply increased in Italy as of late...

1. Local elections went against Berlusconi's coalition.
2. Then there was the vote against water privatization, further burdening Italian public finances.
3. And recently, previous political allies are pushing for tax cuts and new immigration rules.

...while Italy's cyclical outlook has worsened at the margin. In Q1 2011, Italy contributed just over 2% to Euro area quarterly GDP growth but is a massive 16% of of total GDP. Italy is lagging key core countries, like France and Germany.

And it's not just a relative decline. Italian GDP plunged 7% during the recession and recovered just 2% since its trough in Q2 2009: fall hard, rise slowly. When indexed to the GDP low in Q2 2009, imports have retraced the farthest with exports and gross fixed capital formation bouncing as well. But the real data are indexed to the cyclical lows following a 7% net decline in GDP. Better put, if I had indexed the data to before the recession, the recovery across GDP spending components would look much less buoyant.

I know that this is just one indicator; but higher frequency indicators are not looking good. Please see Edward Hugh's post at Roubini Global Economics for a nice review of Italian economic indicators.

Unless the economy picks up markedly, the government deficit is bound to surprise to the downside of official forecasts. Ultimately, this begs the question of how sustainable is Italy's debt burden, really? Is 189 basis points over German bunds (as of 6/20/11) a sufficient premium to warrant the credit risk?

Going forward, it wouldn't surprise me if Moody's did downgrade Italy unless the political situation improves markedly over the next 12 months. Italy's growth fundamentals are just too baked in for near-term change. (If you have a subscription to the Economist, please see the June 11-17th issue for a special report on Italy). Furthermore, I would expect the other rating agencies, S&P (A+u) and Fitch (AA-), to follow suit in either the outlook downgrade (S&P) or an outright rating downgrade (Fitch, possibly S&P).

Given Italy's high base of government debt, 119% of GDP in 2010, ratings downgrades that lead to shifts in real borrowing costs could have a profound impact on Italy's debt trajectory. Yes, this will be a problem in the world's third largest bond market - see the IMF GFSR 2009 data.

Greece is not the end game.

Rebecca Wilder

Is internal devaluation enough for Europe? Probably not, very unlikely...No

2011-06-17T11:45:00.025-04:00

The IMF produced an interesting paper, "Euro Area Export Performance and Competitiveness", that could have policy implications for the effectiveness of internal devaluation on intra-Euro area export demand. As I interpret Table 1, page 13, intra-Euro area exports are less sensitive to foreign demand (like German demand for Spanish exports, for example) and more sensitive to measures of 'competitiveness' than are extra-Euro area exports.

One could argue the following: these results demonstrate that internal devaluation has a better chance of working for trade within the Euro area than it would for other countries that aren't part of a single-currency union. The policy implication is that gained relative competitiveness via fiscal austerity in Spain, Greece, and Ireland has a fighting chance to produce a positive growth outcome. (If you want to skip to the end of this article, I present another interpretation of the results.)

We are seeing some evidence already of the link between internal devaluation and the rebalancing of trade within the Euro area (data link). The chart below illustrates the shift in the trade balances on a rolling 12-month basis and as a share of GDP across key Euro area countries (click to enlarge).

Generally, the healthy rebalancing is occurring on a trended basis. The intra-Euro area trade deficit is worsening in some of the core countries, like France and even Germany, and improving in key Periphery countries, most notably Spain and Greece. This is what is supposed to happen: capital moves away from the Periphery and into the core, eventually driving the trade flows to a healthier and more sustainable flux.

However, there's another way to read the results of Table 1 (page 13): the elasticities of real export volume with respect to the real exchange rate (i.e., measures of competitiveness, and however you measure it) are all less than one (except for one case). That means, for each 1% increase in relative competitiveness, export volume rises by less than 1% - and in some cases a lot less than 1%.

Simply put: the Periphery countries need an inordinate amount of internal devaluation and fiscal austerity to derive sufficient real export growth. Without the strong impetus to global demand, the necessary internal devaluation then becomes 'infernal'.

I haven't quantified this result; but the illustration above suggests that much more is needed. Furthermore, with global growth slowing - the IMF just today lowered its growth forecast - I'd say the Periphery countries will be showing some serious 'economic holes' in coming quarters.

Rebecca Wilder

Unemployment rate in Greece: seriously uncharted territory

2011-06-16T09:43:00.008-04:00

And you wonder why the Greek citizens are pushing back against austerity. Today the National Statistical Service of Greece released its quarterly labour force figures. From today's release (.pdf):

In the 1st Quarter of 2011 the number of employed amounted to 4,194,429 persons while the number of unemployed amounted to 792,601. The unemployment rate was 15.9% compared with 14.2% in the previous quarter, and 11.7% in the corresponding quarter of 2010

I'll first note that the period (.) at the end of 2010 was not in the release, i.e., even the presentation of the data lacks formality. However, the report doesn't need grammatical bells and whistles for one to see that the economy is disintegrating. According to the labour market, debt deflation, 'infernal devaluation' (as Marshall Auerback puts it) is taking its toll on the real economy.

The unemployment rate is (WAY) higher now than it was even before Greece joined the Euro area (2001).

The release also reports the female unemployment rate, which stood at 19.5% in Q1 2011 and up from 15.5% in Q1 2010. Furthermore, the aged 15-29 unemployment rate stood at 30.9% (35.8% for females) in Q1 2011, up from 22.3% in Q1 2010. Key parts of the labour force are being hit harder than others, i.e., young and female vs. males aged 30-44.

You wonder who's rioting? I bet its those younger citizens, 30% of the labour force, that are not working but WANT TO. This is a problem that's not going to disappear with more austerity.

Rebecca Wilder

The downgrade assault by the rating agencies continues - what are the implications for the EFSF?

2011-06-14T07:55:00.008-04:00

As the rating agencies trip over themselves to downgrade sovereign credit, Greece yesterday became the 'World’s Lowest Credit Rating by S&P'. This is largely meaningless for bond pricing, since Greece is already trading at very distressed levels - the curve is inverted, and the two year bond is trading at 26%. However, the downgrade of other Euro area countries could have broader implications for the EFSF (and then ESM) liquidity facility.

Ther are two reasons why ratings matter for the EFSF (European Financial Stability Facility):
(1) the 6 triple-A country guarantees facilitate the triple-A rating on the EFSF structure itself.
(2) countries that fall under the umbrella of the EFSF no longer contribute to the guarantee of the structure.

The table below illustrates the current EFSF guarantee structure (part of the credit enhancement to receive a triple-A rating) - details of which can be found here - and their associated foreign currency long-term ratings by the three major rating agencies.

The triple-A countries are highlighted in orange, of which Germany and France contribute the largest shares to the EFSF guarantee structure, 29.1% and 21.9%, respectively. Estonia, a member of the Euro area, is not part of the structure, at this time but will join soon.

Of the triple-A countries, France is perpetually the weak link, although it's been reaffirmed as stable by the three agencies. However, if France, for example, were to drop below triple-A, the entire structure would likely lose its AAA rating - this would be a problem for overall funding costs.

Greece, Ireland, and Portugal do not contribute, as they are currently under EFSF-funded programs. Before Portugal signed up for austerity (strict austerity is a condition for EFSF loans), it guaranteed 2.6% of the structure. So, as the countries fall under the blanket of the EFSF facility, they consequently fall out of the guarantee structure. The process leaves a hole to be filled by the remaining countries.

Having to cover 2.6% of the guarantee structure is not a big deal - but if Spain, Italy, or even Belgium - Belgium's rating was reaffirmed today by S&P - were to require loans, the burden would fall on fewer countries to cover the loss.

So, although Greece's downgrade is not a 'big deal', the downgrade of a triple-A country or a larger economy that leads to spread widening and perhaps EFSF lending would.

This is not over. Greece will likely get its funding needs covered through loans under the EFSF facility (and even voluntary debt rollover, however, I am skeptical about this prospect), but that will not be the end of the banking crisis.

Rebecca Wilder

Tabled policy options vs. CDS pricing in Europe: similar but not the same

2011-06-13T07:14:00.016-04:00

The discord in Europe across policy lines is growing. I thought it prudent to jot down a few notes regarding the different initiatives being tabled out there. The fact is, that betting on default, at this point, is essentially betting on the near-term outcome of an organic policy negotiation process. In my view, that's impossible, so market pricing cannot be predictive of the near- or even medium- term outcomes.

As illustrated above, a hard and possibly quite disorderly restructuring is being factored into credit default swap (CDS) pricing. The chart lists the 5-yr CDS-implied probability of default by included Euro area countries (a credit event that would trigger CDS payments - see 'credit event' under the ISDA glossary). The pricing is based on a 40% haircut to the bond principal, so we're talking a 'hard' debt restructuring. This may occur at some point, especially in the case of Greece, but a hard restructuring is not being negotiated at this time.

Over the near- to medium- term, policy makers are generally tabling the following options: (1) a Vienna Initiative part Deux, a type of voluntary rolling over of Periphery debt, (2) a debt swap now, and/or (3) extending Greek loans via the EFSF.

(1) Vienna Initiative part Deux. (see this working paper for information on the original meetings). This is what the ECB wants - a purely voluntary solution. It would involve (probably) an agreement among the banks and the ECB to A. not sell current Periphery (Greek) holdings, and B. buy new bonds by rolling over existing debt for a period of time (perhaps 5 years). All parties involved would be part of the negotiation process - German and Frence banks, the ECB, and Greek banks - and would involve no haircut to the Greek debt. Roubini writes of "The Nonsense of Purely 'Voluntary' Bail-Ins of Greece's Sovereign Bank Creditors".

(2)Debt Swap. This is what Schauble wants and involves more private-sector involvement up front. A debt swap would be more secure than a Vienna initiative part Deux, since the private sector exchange would occur at the outset of the agreement, rather than as the debt matures in the future. He offers that bond holders will eventually be made whole, but this option would likely trigger CDS contracts so is more contentious (see daily from Eurointelligence blog).

(3) A loan from the Euro area states via the EFSF. How big is this loan depends on (1) and (2).

Now that the economic cycle is mature, I think that policy makers finally realize that fiscal austerity only works when the following conditions are met:

A. Devaluation. Not an option in a single-currency union.
B. Strong global momentum. Has occured to date, although the pace of global economic activity is peetering out now (see Edward Hugh's report on April PMIs).
C. Loose monetary policy. There is clearly a tightening, rather than loosening, bias at the ECB.

So if a country cannot grow and pay its bills, default is likely. But voluntary debt re-profiling requires agreements among all interested parties. That seems like a stretch, given that the Heads of State (still) haven't fully resolved simpler issues at this point, like 'how' to increase the capacity of the EFSF to euro 440bn?

Rebecca Wilder

Rebecca's taking an indefinite break from blogging

2010-11-23T10:21:00.003-05:00

I started a new job in August 2010. It's a challenging, exciting, and thoroughly satisfying position, however, I am left with little to no time for my family. I have made the decision to cease commentary on News N Economics at this time.

I see this as an indefinite pause. Perhaps, though, at one point I may be able to dedicate time to my career and blogging simultaneously once again.

Thank you all for reading and providing feedback. It is the dedicated readership that keeps a blogger going.

Best regards, Rebecca

Japanese Q3 2010 GDP growth hit it out of the ballpark but set to fall flat next quarter

2010-11-15T05:51:00.008-05:00

The Japanese economy grew 3.9% at a seasonally-adjusted annualized rate in Q3 2010 and over 2X the pace in Q2 2010 (data here). According to Bloomberg, the headwinds to Q4 growth are household consumption and the yen:
Consumption, accounting for about 60 percent of GDP, led the gain as households stepped up purchases of fuel-efficient cars ahead of the expiration of a subsidy program and as smokers stocked up before an Oct. 1 tobacco-tax rise. The yen’s climb to a 15-year high will probably damp growth this quarter as companies from Sharp Corp. to Nikon Corp. cut profit forecasts.
To be sure, the surge in real GDP growth is unlikely sustainable; but it's not because of the yen's strength, per se. True, consumption growth is more likely to print on the lefthand, rather than the righthand, side of the 0-Axis. However, the yen on a trade-weighted basis and in real terms hovers at its historical average; hence, the currency poses less of a risk to growth.

The chart illustrates the contributions to non-annualized quarterly growth (not annualized, GDP grew near 1% in Q3) from each of the GDP components: private consumption (C), investment (I), inventory build (Inv), government consumption (G), and net exports (NX).

The Q3 pace of growth is almost certainly not sustainable and has a decent chance of turning negative in Q4 2010 for the following reasons. (See charts below text for illustration)

* The biggest contribution to Q3 growth came from consumer spending, +0.66%. Investment contributed positively, 0.11%, but has been trending downward. Key data points are inauspicious for consumer spending: the unemployment rate hovers stickily around 5% and October auto sales saw a 27% annual decline, as green auto subsidies expired.

* Although the JPY/USD has appreciated 14% since the middle of 2010, the real effective exchange rate, the economic driver of a country's trade balance, has been stable over the same period (see final chart below) and in line with its longer-term average. So while I don't expect net exports to turn negative, per se, any additional impetus to growth is unlikely to come from trade.

* Therefore, the key to growth is final domestic demand, and more specifically consumer spending. That's a stretch.

Rebecca Wilder

Ireland: the battle against "markets"

2010-11-12T05:49:00.018-05:00

Is it the sheer size of its contingent liabilities that is driving Irish spreads? Finance Minister Brian Lenihan thinks so via the Irish Independent:
"There is no doubt in my mind that while the announcement on the banking sector in September was not disbelieved by the markets, it wasn't fully believed either because there is a wait and see policy of seeing whether it is an accurate account of exposures in the banking system," the minister said.
Or is it German Chancellor Angela Merkel's recent rhetoric? According to the Irish Times, since her most recent statement on private haircuts, "All stakeholders must participate in the gains and losses of any particular situation", officials are readying the EFSF for possible tapping by the Irish government:
The Irish Times has established, however, that informal contacts are under way between Brussels, Berlin and other capitals to assess their readiness to activate the €750 billion rescue fund in the event of an application from Dublin.
The EU quashes this rumor.

Or is it that "markets" just don't buy the Irish fiscal austerity reduces the Irish budget deficit story? According to the Irish Independent, this is the opinion of Nobel laureate Joseph Stiglitz (mine, too, by the way):
“The austerity measures are weakening the economy, their approach to bank
resolution is disappointing,” Stiglitz, a Columbia University economics professor, said in an interview in Hong Kong today. “The prospect of success is very, very bleak” for the government’s plan to resolve the problem, he said.
What's driving spreads? (They've come off a bit today, but they're still just under 600 basis points over German bunds (as of 6am this morning).) Furthermore, the EU came out with a statement that reiterates the exclusion of outstanding debt on any new restructuring mechanisms:
..does not apply to any outstanding debt and any programme under current instruments. Any new mechanism would only come into effect after mid-2013 with no impact whatsoever on the current arrangements.
The answer is, it's probably a mix of the three above. Markets are starting to price in an insolvent government balance sheet, which will ultimately lead to default - some call Ireland's sovereign balance sheet insolvent but still liquid .

I side with Stiglitz, that ultimately its deficit reduction plan will reveal the axiom that is the three-sector financial balance: if you don't have a surge of external income, then the private sector and the public sector cannot simultaneously increase saving.

Exhibit A. The year of austerity - and even harsher and more front loaded austerity is on the way - has proven to squash growth prospects for the Irish economy compared to the average, which is the Euro area.

The chart illustratest the index of quarterly GDP, as reported by Eurostat. The Euro area data is current through Q3 2010 (only on a "flash" basis), while the Irish GDP figures are available through Q2 2010. These numbers are not annualized; but as of Q2 the Irish economy is running 11% below its Q1 2008 level of GDP, while in Q3 the Euro area as a whole is producing just 2.7% short of its Q1 2008 level.

But the Irish government is sticking to its plan. Recently the Central Bank of Ireland published its quarterly report, where it simultaneously downgraded the growth forecast AND announced that further action will be taken to bring the government deficit to 3% of GDP by 2014. Since then, the government announced deficit cuts that exceeded those originally planned by a factor of two. Seems fishy to me.

Rebecca Wilder

Eurozone rebalancing depends on German inflation

2010-11-09T21:58:00.001-05:00

The Federal Statistics Office reported that German consumer prices increased 0.2% on a seasonally-adjusted basis in October, translating into a 1.3% annual gain on a harmonized basis. German prices are very sticky, since the domestic economy doesn’t see the boom and bust cyclical behavior like that in other developed economies. However, inflation may headed north, especially if the trend in industrial prices (PPI), a +3.8% annual clip, is any leading indicator. (Click on chart to enlarge.)

Will German policymakers see the inflation for what it is? It’s a shift in relative prices to drive real German appreciation in order to rebalance current accounts across the region amid a fixed currency regime.

The Eurozone region is now characterized by current account imbalances, imbalances that are now being addressed through fiscal austerity measures. According to the IMF October 2010 World Economic Outlook, Germany will run the second largest current account surplus in the Eurozone as a percentage of GDP this year (second to Luxembourg), 6.1%, while Greece and Portugal will run the largest deficits, -10.8% and -10%, respectively. Among the bigger economies, Spain’s 2010 current account deficit sticks out at -5.2% of GDP. In fact, just 6 of the 16 Eurozone economies are expected to run current account surpluses in 2010.

If these fiscal austerity measures are to succeed in Europe, the hardest hit economies – Spain, Portugal, Ireland, Greece – must generate income externally via export growth. In order to gain export growth, competitiveness must be drawn upon in one of three ways (or a combination): (1) the nominal exchange rate depreciates in the debtor countries (CA deficit countries); (2) final goods prices fall in the debtor countries relative to the creditor countries; or (3) unit labor costs fall in the debtor countries relative to the creditor countries. Any combination of the three will shift the real exchange rate in favor of the debtor countries and drive export growth.

Since (1), depreciation of the nominal exchange rate, is clearly not an option in the single-currency Eurozone, it’s up to (2) and (3). I’ve talked about wage-cutting; and most of the fiscal austerity packages include some degree of public sector wage cuts, so I won't address that here. And point (2) has been addressed mostly via fiscal austerity dragging price pressures domestically, and leading to increased competitiveness. But point (2) can be seen from another light...

...it's all about relative prices, and inflation in Germany realtive to the debtor countries can establish competitiveness in debtor countries.

German inflation is important for two reasons.

First, it's all about relative prices (point 2 above), so competitiveness in Spain, for example, could similarly be generated if German inflation rises relative to that in Spain, holding Spanish inflation constant – even more so if Spain’s inflation rate is falling . In fact, a rather stark increase in German inflation is likely needed to generate a rebalancing effect when nominal depreciation is out of the question (as is the case for the Eurozone).

On to the second reason why German inflation is important: the ECB average inflation target.

The table to the left illustrates the compounded annual rate of inflation (CAGR) for each of the current member Eurozone economies since 2000. Germany has, on average, seen prices rise at a 1.7% annual rate, while Spain has seen prices rise at a 2.9% annual rate.

Amid fiscal austerity, German inflation is needed is to keep the ECB’s target average inflation rate– the average inflation rate is the weighted HICP across all of the Eurozone economies – around 2% while the much of the Eurozone experiences disinflation (or deflation).

Spanning 2000-2009, the Spanish economy contributed roughly 0.4% to the Euro area's average 2.1% annual inflation (based on the HICP country weight, which is 12.6% - see the Eurostat publication for links to the data). Greece contributed roughly 0.1%, on average, to overall inflation. Going forward, there will be a lot of inflation slack to be picked up as these economies contract further.

It’s gotta be Germany!

But will German policymakers and its massive export sector tolerate higher average annual inflation? Let’s say at roughly 3%, and for some time? I’m skeptical – so the outlook for the Eurozone, in my view, has just worsened.

Rebecca Wilder

By the way, I just told my German husband, Herr Wilder, about this article. You know what his response was? "Oh...Germans don't like inflation." Enough said.

German industrial production fell in September

2010-11-08T17:32:00.010-05:00

Today German industrial production surprised to the downside in September, falling 0.8% over the month on a seasonally-adjusted basis. The contraction brought the annual pace of growth to 7.9% over the year, down from a 10.7% clip in August.

It looks like my data mining is proving to be rather useful. The ratio of the Ifo expectations/current index, which tends to lead German IP growth by about 6 months, turned down in February 2010 - now so has the pace of annual industrial production growth. The implication is that the Q4 2010 rate of domestic activity is likely to be quite weak.
The chart illustrates the 6-month lead of the trend in Ifo expectations index minus the trend in Ifo current index and the annual growth rate of industrial production.

By my count (you'll have to trust me here), German data has surprised 9 times to the upside and 10 times to the downside this month (October through current). We'll see; but the scales are tipping to the downside.

Rebecca Wilder

According to bond markets, Ireland is not yet Greece

2010-11-05T10:00:00.006-04:00

A few articles regarding the bond crisis in Ireland:

The Irish Mess (IV)
ECB buying of Irish bonds 'vital' support
The world backs away from Ireland, Spain, Portugal
In keeping with Halloween, here's a scary one
EU leaders trigger another bond market crisis
Ireland fifth best place to live (a separate issue, of course)

Yves Smith's article (first link) is good, providing a network of associated links including one to Ambrose Evans-Pritchard. He states the following:

Yes, Ireland is fully-funded until April – and has another €12bn in pension reserves that could be tapped in extremis – but that is less reassuring than it looks. The spreads over German Bunds are mimicking the action seen in Greece in the final hours before the dam broke.

Ambrose Evans-Pritchard's article is well worth a read; but I'd like to talk about bond markets for just a bit. Yes, the probability of Irish default is increasingly being priced into bond markets; however, Irish bond market conditions have not yet reached those of Greece in May 2010 (the bailout announcement), nor are they really close...yet.

The Irish yield curve (proxied by the 10-year government bond yield minus the 3-year government bond yield, now the 3-10) is still positively sloped. (I choose the 3-10 because of the ESFS that is in place through 2013.)

This is important. See, when there is a binary outcome being priced into a sovereign bond market, default or no default, investors go straight to the long end of the term structure, and the yield curve inverts (negative slope). In a default situation, the longer end of the curve offers a higher expected return where the potential yield compression is much larger. That's what happened in Greece in May 2010, as the 10-yr bond yield reached 12.4% on May 7.

The two yield curves look "similar"; but Greece's yield curve turned negative, or near -500 basis points (bps) inverted - a basis point is the % * 100 - preceding the bailout. At the time, Irish spreads (chart above) dropped to 120 bps; but now the yield curve is even steeper, 170 bps as of 6am this morning.

The 3-yr Irish spread over German bunds is certainly coming under pressure, 492 bps (as of 6am today). But the front-end sell-off is nothing compared to that in Greece: spanning the period April 1 to May 1, 2010 (i.e. excluding the surge to 1700 bps), the 3-yr Greek spread over German bunds averaged 711 bps.

Further, the Irish debt profile is longer, on average, than that in Greece. The weighted average maturity on existing Irish debt is 6.1 years (starting in 2011), where that in Greece is a shorter 4.5 years.

The chart above illustrates the share of Irish and Greek debt by maturity date. 36% of Ireland's sovereign debt expires through 2015, just half the share of Greek sovereign debt maturing by the same year, 70%. Note, too, that according to Bloomberg, Greece has 3 times the debt outstanding of Ireland - a completely different game (for now).

Irish bonds are certainly under pressure. But Ireland being funded until the middle of next year is important, making the timing of its return to market critical.

In my view, though, the quintissential issue is the government's ability to finance its debt via domestic growth. Here's a great paragraph from an op-ed in the Irish Independent last week:

While interest rates charged to Ireland have been rising sharply, many large countries can borrow at very low rates, as little as three per cent. Many economists have been arguing recently that these countries should consider a further fiscal stimulus package. Instead most of them are committed to deficit reduction. This debate is one that we cannot join, unfortunately. These countries have a choice since it appears that they could borrow more if they chose to do so.

We cannot do that, nor can we devalue our exchange rate, since we do not have one. It is perfectly reasonable to ask how we got into this mess, to allocate blame and to demand retribution. But no amount of ranting can expand the limited range of choices available to the Government.

Ireland needs revenues to finance their debt. We'll see if the persistent fiscal austerity leads to growth - I'm totally skeptical.

Rebecca Wilder

This article is crossposted with Angry Bear blog.

G4 GDP, reaction ECB

2010-11-02T06:10:00.013-04:00

It's complicated. The ECB is currently juggling two objectives: perpetually assuaging bond investors in the face of a shaky financial system, and managing policy for an economy with a single currency and sovereign government issuers.

But is it really so complicated?

The chart above illustrates the peak (deemed 2008 Q1 here) to trough and recovery of GDP across the G4 (Eurozone, UK, US, and Japan). None of the G4 have returned to 2008 Q1 levels of production (pre-2008). Ironically, as the US Fed readies itself for QE2, the American economy has returned the farthest back up the "production path".

The German recession was deeper, but the rebound has been quick. Annual GDP growth in Q2 2010 was well above potential, 3.7% over the year, and the labor market continues to see gains. But German growth has not been sufficient-enough to bring neither its nor the Eurozone's level of GDP back to pre-2008 levels (as of Q2 2010).

To be sure, 2H 2010 GDP remains to be factored into the recovery in Germany and the Eurozone. Perhaps when all is said and done, Germany will recover smartly in 2H 2010 to generate the final 2.7% bump in GDP to return to pre-2008 levels before the 2011 fiscal austerity measures start to crimp export income. Thus, is the ECB holding pattern correct?

That remains to be seen. If the ECB continues to set policy as it has done so in the past, however, it'll take an economic slap in the face before the ECB reacts to real economic growth and eases further.

The chart illustrates the refi rate (ECB policy rate) at a 2-quarter lead to the annual pace of GDP growth. The relationship is strong and positive, with a correlation is 82%.

The relationship suggests that the ECB's reaction function actually follows economic growth trajectories, but at a two-quarter lag (roughly). For example, the ECB was raising rates into the third quarter of 2008 only to see GDP fall 2.1% at an annual clip in the fourth. It dropped the refi rate by 1.75% in Q4 2010.

The ECB targets inflation, not GDP growth; but the reaction function is roughly 2-quarters lagged to the disinflationary pressures that stem from recession (from my simple exercise, of course). In conclusion, if the ECB is going to react to GDP-induced disinflation signals (i.e., negative growth), then it could get a lot worse in the Eurozone before policy eases further: 1H 2011 is my bet.

Rebecca Wilder

Comparing the Fed, the ECB, and the BoE before policies diverge

2010-11-01T14:00:00.005-04:00

This commentary is crossposted with Angry Bear blog.

This week is G4 central bank week. The Federal Reserve Bank (Fed) announces its policy decision on November 3; the European Central Bank (ECB) and the Bank of England (BoE) will make policy announcements on November 4; and the Bank of Japan pushed forward its November 15-16 meeting to be held now on November 4-5.

At this juncture, G4 ex Japan monetary policy is likely to diverge sharply: the Fed is expected to announce an extension of its asset purchase program, while the ECB and BoE are not expected to increase theirs. In fact, the policy wedge between the three central banks is already wide. Despite the ECB's enacting its covered bond purchase program, the amount is small, roughly 1.4% of Eurozone GDP (see chart below), and the central bank is sterilizing the flow - sterilizing the operation means that the ECB performs equal and opposite monetary operations to reduce bank reserves by the amount of the bond purchase program.

The chart above illustrates the size of the bond purchase programs (assets sitting on the central bank balance sheet) as a share of 2010 GDP (IMF forecast). Ostensibly, and from a bank-lending point of view, Eurozone financial conditions appear to be "healthier" than those in the UK or US.

The chart above illustrates total bank lending in the Eurozone, UK, and the US; but this may change as austerity measures in some European countries infect the stronger economies via a tightly integrated trade relationship.

Policy is already much tighter in the ECB compared to its US and UK counterparts. This discrepancy is expected to diverge, as the Fed moves into QE2 mode this week.

Rebecca Wilder

Eurozone unemployment rate up in September

2010-10-29T07:50:00.013-04:00

Today Eurostat released the September unemployment rate figures for the European Union and the Eurozone. From the release:
The euro area1 (EA16) seasonally-adjusted2 unemployment rate3 was 10.1% in September 2010, compared with [downward revised] 10.0% in August4. It was 9.8% in September 2009. The EU27 unemployment rate was 9.6% in September 2010, unchanged compared with August4. It was 9.3% in September 2009.
The Eurozone unemployment rate has been above the EU (27) unemployment rate by an average 0.45% since the outset of 2007.

Across the Eurozone 16 countries, just 5 have seen their unemployment rates fall since October 2009 (I use the teilm020 table at Eurostat, which limits the time series to this time frame). Note that the unemployment rate in Italy rose over the month (8.1% to 8.3%), so unemployment rate is now unchanged since last year.

In the third quarter (the 3-month average ending in September 2010), the unemployment rate fell across 57% of the sample listed below (a highlight of the EU (27) countries plus Japan and the US). This is good, but the improvement is sluggish.

Rebecca Wilder

Unemployment rates in Europe: improving ever so slightly

2010-10-27T21:00:00.006-04:00

Based on internet searches that lead to my website, there's quite a bit of interest regarding unemployment across Europe. Usually, they are led to this post, which is quite dated.

Going forward, I plan to update the European employment trends as they are released on the Eurostat website. Generally this data is about one month lagged from the national statistics offices, since Eurostat harmonises the employment data for seasonalities and adheres to the International Labour Organisation (ILO) recommended definition . The current release is for August 2010; September will be released in two days.

The first notable shift is that the 3-month moving average ending in August of the unemployment rate (the average across three months) fell compared to that ending in May (a sort of proxy of quarters) across 52% of the sample illustrated in the chart below (many EU economies plus Japan and the US). The average percentage drop (not drop in percentage points) was fairly small, though, -3.5% over the two periods (i.e., the green dot hovers around the outside end of the blue bar). For the September release, we will see the quarterly shift in Q3.

In the Eurozone, the Eurozone 16 that is, the shift in the unemployment rate over the last year is down for just 5 economies: Finland, Italy, Germany, Malta, and Austria.

(Note: some of you may wonder why I compare October 2009 to August 2010. Well, that's the way that it is listed in table teilm020 at the Eurostat website. One can get a longer time series, but this is the table I will use going forward.)

So there you have it. The harmonised unemployment rates are generally screaming "weak" in Europe. Going forward, fiscal austerity is expected to directly pressure unemployment rates across those countries that are tightening. Also, a persistent strengthening of the currency (has yet to be determined) may play a role in key exporting industries, like Germany, where exporters hire large pools of labor.

Rebecca Wilder

Update: Click here for the September 2010 report.

A little perspective on the impact that a weaker USD will have on overall economic activity

2010-10-26T17:39:00.019-04:00

The Japanese yen, the Eurozone euro, and the British pound have appreciated 16%, 14%, and 9%, against the USD, respectively, since their 2010 lows. Some say that the "US wins" since the Fed's quantitative easing (QE2) will drive export growth via a weaker dollar. (Note that the Fed has not actually announced QE2, this is all just speculation.)

I'm not suggesting that the stated Fed policy will be to drive down the dollar. What I do know, however, is that the United States production model is not structurally positioned to enjoy the economic panacea that is a persistent debasement of the dollar, neither in the near- nor medium- term.

The bottom chart illustrates the export share in overall economic GDP, as forecasted by the European Commission (you can download this data at the Eurostat website). Notice that the US share of exports, expected to be just 12.3% in 2010, is minuscule compared to the export markets in Europe. So what I gather from a chart like this is that the weak dollar will hurt Europe much more than it will "help" the United States.

We need domestic policy to support full employment and the expansion of our export sector that will eventually arise. See Marshall Auerback's post this week at Credit Writedowns for a discussion on austerity, currency wars, and exchange rates.

Rebecca Wilder

A proxy for nominal aggregate demand and payroll growth: Treasury receipts are recovering...

2010-10-23T15:35:00.007-04:00

I present an update on aggregate demand using the highest frequency of economic data available, US Treasury tax receipts. Tax receipts serve as a proxy for nominal aggregate demand via a nominal indicator of private payroll growth.

US daily Treasury tax receipts are improving. (This chart has been modified since its original posting to enable reader to click to enlarge).

The chart illustrates the federal deposits of income and employment taxes that are recorded on a daily basis and presented here as the annual pace of the 30-day rolling sum. The red line illustrates the average annual growth rate spanning the period 2005-current.

Since roughly April of 2010, the annual pace of income and employment tax receipts has been above the average, 2.8%. In the third quarter, the annual pace of income and employment tax receipts remained around 4%, consistent with the second quarter pace. Hours and employment are improving, supporting wage gains and higher tax receipts. But more importantly, the pace of tax receipt growth has not faltered, demonstrating ongoing recovery in the labor market and consumer demand.

But it's not enough. The gains in tax receipts are likely a function of firms adding back hours instead of pumping up the work force. (see my previous post with links on the "hourless recovery").

The chart above illustrates the cyclical loss from recession and gains during the recovery of private net-jobs (payroll) and aggregate weekly hours (you can see the summary data from the September payroll report here).

Both series found a trough in the third quarter of 2009, which is consistent with the bottom in tax receipt growth (chart above). However, the hours index has recovered quicker than has its payroll counterpart (of course it fell farther, too). To date, both private hours and payroll are 7% short of their values at the peak of the economic cycle.

Receipts are growing, but not vigorously enough to indicate any shift in the current trajectory of payroll growth. Therefore, nominal aggregate demand remains weak. Furthermore, the still-nascent household deleveraging cycle is very likely moving at snail-speed (see this article for a discussion of the link between consumption growth, income growth, and deleveraging for today's commentary).

Rebecca Wilder

China's competitive devaluation

2010-10-20T14:00:00.010-04:00

This commentary is crossposted with Angry Bear blog.

China took the world by surprise on Tuesday by raising bank lending and deposit rates for the first time since 2007. The story is, that restrictive monetary policy (i.e., raising rates) is needed to curb excessive lending, with an eye on mitigating inflation pressures. See this Bloomberg article to the point.

While restrictive monetary policy is needed, raising rates is not the only tool available to policy makers: China could allow their currency (CNY) to appreciate. With support from the fiscal sector, a broad CNY appreciation would improve prospects for global growth ex China via import demand. Instead, the higher domestic rates may crimp domestic demand, perhaps reducing inflation, but contemporaneously lowering import demand.

In my view, China's move yesterday should be viewed as competitive devaluation: reducing domestic prices in order to capture a competive edge. The currency war, as so-called by Brazil’s finance minister, Guido Mantega, is afoot; and China just confirmed its participation.

Textbook economics says that a central bank cannot have it all: independent monetary policy, a fixed exchange rate, and open financial markets (the impossible trinity). China has a fixed exchange rate (currently, it's effectively pegged to the USD, see chart below) with tightly monitored capital markets. This means that the Chinese economy effectively matches the "easy monetary conditions" of its counterpart, the US. Monetary policy in China is too loose.

Going forward, further accommodative monetary policy in the US will likewise loosen policy further in China; inflation pressures will be even more robust. But, large-scale asset purchases on the part of the Fed will likewise weaken the USD, which is positive for US exports and negative for US import demand.

All in all, policy makers in China are looking at the USD move with tunnel vision. If the CNY maintians its current trajectory (effectively flat), then any shift in relative prices based on the recent (or future) rate hikes will reduce the CNY real exchange rate (all else equal, of course) - that's competitive domestic devaluation.

The table has already been set.

Chinese policy makers have slowed the nominal appreciation. Think about what could be if the CNY had maintained its 2005-2008 trajectory, where the CNY appreciated against the USD nearly 20%. Using the compounded annual growth rate (CAGR) over the same period, where the CNY gained 0.5% on a monthly basis against the USD, the month-end September CNY would be valued 11% higher against the USD than it is now.

They slowed real appreciation, too. The real appreciation of the CNY against its trading partners – the real exchange rate accounts for both nominal appreciation and price differentials across countries – slowed from an average 0.4% monthly gain spanning the period 2005-2008, as measured by the CAGR, to just 0.05% since then. (I use the JPMorgan real exchange rate index, but the BIS makes similar data available free of charge.)

The Chinese authorities are fully aware of the economic value of external demand (exports). The media will say that China’s trying to “cool” domestic inflation by raising domestic bank rates; but that’s not the full story. In my view, what they’re really trying to do is to “cool” domestic inflation in order to shift relative prices and depreciate the real exchange rate, all to gain a competitive advantage in global goods markets.

Rebecca Wilder

More on how the NY Times is wrong about the Japanese economy

2010-10-18T08:30:00.009-04:00

The NY Times writes Japan Goes From Dynamic to Disheartened. As highlighted by Dean Baker, this article grossly misrepresents the dynamics of the Japanese economy. I likewise read this article with some dismay, wondering was there any actual research done in preparation for this commentary?

First, the reporter draws conclusions on the aggregate economy through anecdotal accounts of Japanese businesses and households. Here's one example:

But his living standards slowly crumbled along with Japan’s overall economy. First, he was forced to reduce trips abroad and then eliminate them. Then he traded the Mercedes for a cheaper domestic model. Last year, he sold his condo — for a third of what he paid for it, and for less than what he still owed on the mortgage he took out 17 years ago.

As highlighted by Dean Baker, the Japanese standard of living, measured by real per-capita income listed in the IMF World Economic Outlook database, has grown markedly over the last two decades. Spanning the years 1990 to 2010 (f), Japanese real average income grew 17%, while that in the US grew 33%. The growth differential across the two countries is admitteldy large; but Japan's standard of living has not crumbled, rather grown.

The article is overly pessimistic about the effects of Japanese deflation on the standard of living. Spanning the years 1999 - 2010 (f), the period for which the Japanese economy experienced persistent annual deflation, real per-capita income in Japan grew neck and neck with that of the US: 9.7% in Japan, versus 10.4% in the US.

Even worse, the article barely touches (misses actually) on the fundamental economic problem in Japan: the shrinking labor force. Spanning 1999 - 2010 (f), real GDP in Japan grew at less than 1/2 the pace of that in the US, 10% in Japan versus 23% in the US. Deflation? I think not; it's a secular decline in employment.

The chart illustrates a measure of productivity, as real GDP normalized by the level of employment (also from the IMF World Economic Outlook database). During the period 1999 - 2010 (f), productivity growth in Japan's been roughly in line with that of the US, 14% and 17%, respectively.

Finally, in my view this is the most egregious NY Times error:

But the bubbles popped in the late 1980s and early 1990s, and Japan fell into a slow but relentless decline that neither enormous budget deficits nor a flood of easy money has reversed.

It wasn't that government deficits were not able to slow the decline - fiscal policy mistakes caused some of the decline.

Richard Koo, author of Balance Sheet Recession: Japan's Struggle with Uncharted Economics and its Global Implications and Chief Economist of Nomura Research Institute, who was interviewed for the NY Times article must be quite irked by the NY Times account of Japanese fiscal policy. Here's a presentation that Koo gave in 2008, where the title of slide 9 says it all: "Exhibit 9. Premature Fiscal Reforms in 1997 and 2001 Weakened Economy, Reduced Tax Revenue and Increased Deficit".

The government raised taxes in 1997 to see growth deline from 1.6% that year to -2% a year later.

Be careful what you read. Rebecca Wilder

Who's bringing home the dough?

2010-10-14T14:50:00.007-04:00

...Corporations. Since earnings season is now well underway, I decided to look at the breakdown of aggregate domestic income (gross domestic income). Corporate profits are up 44.7% since the outset of the US recovery, while wages and salary accruals are up just 0.9%.

The chart above illustrates the peak-trough losses (total loss), trough-Q2 2010 gains (total gain), and peak-Q2 (relative to peak) deviations of nominal gross domestic income, disaggregated by income type.

First up, wages and salaries (employer contributions for employee pension and insurance funds and of employer contributions for government social insurance) and private enterprises net of corporate profit incomes grew in sum spanning the recession (private enterprises net of corporate profits includes proprietor's income, which did fall). Furthermore, the drop in wage and salary accruals, -3.6%, was small compared to the drop in corporate profits, -18.1%.

Second, the corporate profit gains during the recovery massively outweigh the wage and salary gains over the same period, 44.7% versus 0.9%. Corporate profits are now 18.5% above the peak in 2007 IV, while wages and salaries hover 2.8% below.

The problem here is, that the deleveraging cycle is heavily weighted on the household sector (the workers at the corporations) - if corporate profit gains do not translate into hiring and wage gains, or even to further capital spending, economic growth will suffer going forward.

Better put, at the very minimum, the recent surge in corporate profits is not sustainable if firms do not distribute the gains to the real economy. Also, meager wage gains does make healthy deleveraging difficult for household sector. Therefore, the recent surge in gross domestic income (hence, it's spending counterpart, GDP) is not sustainable if corporate profits are not recycled.

Rebecca Wilder

Who's saving where? An application of the 3 Sector Financial Balances Map

2010-10-11T14:00:00.001-04:00

This commentary is crossposted with Angry Bear Blog.

Dean Baker finds gaping holes in deficit hawk rhetoric using the simple accounting identity that national saving must equal the current account (S-I = CA). If the domestic private-sector's desire to save is positive, then the only way for the public sector (i.e., government) to net save is for the economy as a whole to run a sizable current account surplus.

Singapore does just that. Spanning the years 2004-2009, the average current account surplus was near 21% of GDP, which enabled the government to run surpluses near 5% of GDP and the private sector to save 16% of GDP. Singapore is a net-saver in all sectors of the economy: private, public, and international. However, it's Singapore's huge current account surplus that allows the domestic sector to net save, and not all financial balances are created equally.

Let's use a slightly different version of Rob Parenteau's 3 Sector Financial Balances Map to illustrate that not all financial balances are created equally.

The chart illustrates the combination of private and public surpluses (or deficits) that prevail at each of three "zones" of the Balanced Current Account Line (BCAL). The BCAL zones are: CA > 0 to the right of the red line, CA < 0 to the left of the red line, and CA = 0 on the red line. The World Economic Report database, October 2010, is used to construct the average 3-Sector Financial Balances Map for the IMF's Advanced Economies spanning the years 2004-2009. (Note: Singapore, Norway, and Iceland are not illustrated because their respective sector financial balance points lie outside the normal range and distort the map.)

The public-sector financial balance (PubS) for each economy is the IMF's measure of general government net lending as a percentage of GDP. The domestic private-sector financial balance (PrivS) is the residual of the current account as a percentage of GDP less PubS such that the following identity holds:

PrivS + PubS = Current Account
(please see Rob's post for further detail on the sectoral balances approach)

In the chart, the four quadrants of public-sector and private-sector financial balances that account for the CBAL zones across the Advanced Economies are:

I. PubS > 0 (public-sector surplus) and PrivS < 0 (domestic private-sector, households and firms, deficit)
II. PubS < 0 and PrivS < 0
III. PubS > 0 and PrivS > 0
IV. PubS < 0 and PrivS > 0

The quintessential savers are listed in quadrant III and to the right of the BCAL: Sweden, Hong Kong, Luxembourg, and Singapore (not shown). The classic debtors are listed in quadrant II and to the left of the BCAL: Ireland, Spain, Portugal, Greece, and a couple of other Eurozone economies that are not labeled (Cyprus, Malta, and Slovak Republic). Finally, quadrants I and IV list economies that have positive saving in one of the domestic accounts: public (I) or private (IV).

The point is pretty clear: in order for the government to net-save, PubS > 0, either the private sector must dissave and/or the current account must be in surplus. It's that simple.

Notice that the financial balances of Spain, Portugal, Ireland, and Greece are in quadrant II and to the left of the CABL. These are averages, and the fiscal deficit worsened markedly in 2009 and 2010 as the private sector incentive to save surged. Currently, though, the fiscal adjustment requirements are huge (deep into quadrant II). For example, Spanish policymakers announced a deficit reduction path to take the PubS < 0 from 11.2% of GDP in 2009 to 9.3% in 2010, with a colossal further reduction of 4.9 percentage points to 4.4% of GDP in 2012.

Given that Spain, for example, is starting from a point of hefty private-sector deficits over the last five years, on average, the sole hope for a successful policy tightening lies with external demand growth (the current account). Spain needs massive export income in order to finance such reductions in the government deficits.

So who will succeed in reducing their public fiscal deficits? Pretty much any country with private surpluses has a fighting chance: Germany, France, the Netherlands, Belgium, the UK, and the US even (on the corporate side). The problem is, that policy makers can't just tell the private sector to start dissaving. Well, it can, but incentives may be needed.

All else equal, recent FOMC announcements furthered a dollar sell-off, and along with recent disinflation the economy has a fighting chance if policy does move toward austerity. But as Dean Baker suggests, more currency re-valuation is needed.

Rebecca Wilder

German industrial production: Hot or Not?

2010-10-07T16:01:00.009-04:00

Hot now, maybe not in six months.

In Germany, industrial production increased 1.7% in August, or 10.7% over the year. The monthly surge beat expectations 3-times over (0.5% on Bloomberg).

According to MarketWatch:

After two rather disappointing months in the German industry, concerns about
fading external demand and the sustainability of the German recovery surfaced.
Today's numbers should hush these concerns. Not only once, but for a longer
period. Looking ahead, all available evidence points to a further strengthening
of the German industry," said Carsten Brzeski, senior economist at ING in Belgium.

To be sure, this report is consistent with a slew of recent German statistics beating expectations: the unemployment rate dropped to a near 20-year low; consumer confidence continues its fearless ascent; annual inflation is on an upward trend (as opposed to a downward one); and factory orders are increasing at an average 2% monthly rate, far above the pre-recessionary average (0.5%).

In contrast, the Ifo business climate survey, which breaks down expected and current conditions, portends a precipitous decline in annual industrial production activity in the next six months (see chart below).

The chart illustrates the 6-month lead of the trend in Ifo expectations index minus the trend in Ifo current index and the annual growth rate of industrial production. The series are highly correlated, and the expectations/current Ifo peaked in February and fell precipitously thereafter. This suggests that the pace of German industrial production should slow markedly in coming months, and possibly turn negative.

This is just one indicator, and may be a truly spectacular bit of data mining on my part. However, as external demand slows, the German economy, with its 46% of GDP export share, is openly exposed to its drag.
Rebecca Wilder

Retraining workers won't work

2010-10-04T05:45:00.019-04:00

Update: one of our readers caught a mistake in the chart. I indexed the data to December 2008, or one year after the recession actually started in December 2007. The statistics that changed are formatted in bold, and the chart in the article has been updated. The analysis doesn't change at all, but the number of jobs lost during the recession is higher than those indicated in the original article.

From the NY Times, White House Plans Job Training Partnership (bold by me):

As part of efforts to address record-high levels of long-term unemployment, President Obama plans to announce a new national public-private partnership on Monday to help retrain workers for jobs that are in demand.

The national program is a response to frustrations from both workers and employers who complain that public retraining programs frequently do not provide students with employable skills. This new initiative is intended to help better align community college curriculums with the demands of local companies.

“The goal is to encourage community colleges and other training providers to work in close partnership with employers, to design a curriculum where they want to hire the people coming out of these programs right away,” said Austan Goolsbee, chairman of the President’s Council of Economic Advisers.

The White House has coined this program Skills for America's Future. The complication is, that lack of skills is not the problem for the 66% of the labor force aged 25 years and over without a bachelor's degree. The problem is the lack of jobs.

The chart illustrates the dynamics of employment by level of education through August 2010, as measured by the Bureau of Labor Statistics. Note that the data are indexed to the onset of the recession, December 2007, where 100 implies that employment is now at its pre-recession level.

The only category to recover employment in full is that requiring a Bachelor's degree or higher. Furthermore, no material change in employment for BA's (or higher) has occurred since about a year ago, as indexed employment hovers around 100. No new jobs.

The levels of employment for those workers with the lowest levels of educational attainment, 1. and 2., are 10.2% and 6.6% below pre-recession levels, respectively. That is over 3.5 million jobs.

The White House program is targeted at community college students, or education category 3., some college or associate degree in the chart above. Employment for workers with a community college degree sits over 3.2% below pre-recession levels, or 1.1 million jobs. Retraining workers will not raise the employment level further.

The government needs to "add jobs", not "retrain workers", and stimulate domestic aggregate demand.

Rebecca Wilder

The money quandary

2010-09-30T19:15:00.002-04:00

The Federal Reserve, the Bank of England, and the Bank of Japan are considering further quantitative easing. It's an explicit statement, as with the Federal Reserve and the Bank of England, or implied by the fact that the foreign exchange intervention will eventually be sterilized if the policy rule is not changed, as with the Bank of Japan. Why more easing?

In response to this question, BCA Research (article not available) presented a version of the quantity theory of money. They looked at the simple linear relationship between the average rate of money supply growth (M2) and nominal GDP growth (P*Y).

The chart is a reproduction of that in the BCA paper, but with a sample back to 1959 (they went back to the 1920's when M2 was not measured). The relationship illustrates the 5-yr compounded annual growth rate of money (M2) against that of nominal GDP, and has an R2 equal to 50% - okay, but not perfect.

Nevertheless, the implication is pretty simple: the current annual growth rate of M2, 2.8% in August 2010, corresponds to an average annual income growth just shy of 4%. Sitting beneath a behemoth pile of debt relative to income, 4% nominal GDP growth is unlikely provide sufficient nominal gains for households to deleverage quickly or "safely".

However, notice the 2000-2005 and 2005-2009 points, where the relationship between M2 and nominal GDP growth deviated away from the average "quantity theory" relationship. Would a broader measure of money account for the weak(ish) relationship in the chart above? Yes, partially. (Note: the relationship almost fully breaks down at an annual frequency.)

These days it's all about credit. I'm sitting in Cosi right now - bought a sandwich and charged the bill on my credit card. Actually, I prefer to use cards. But M2 doesn't account for this transaction as money if the balance is never paid in full. M2 is essentially currency, checking deposits, saving and small-denomination time deposits, and readily available retail money-market funds (see Federal Reserve release).

One can argue about the merits of including credit cards balances as "money", per se. However, the sharp reversal of revolving consumer credit, and likely through default (see the still growing chargeoff rates for credit card loans), would never be captured in M2. The hangover from the last decade of households using their homes as ATM's (i.e., home equity withdrawal) and running up credit card balances to serve as a medium of exchange is dragging nominal income growth via a sharp drop in aggregate demand.

The Federal Reserve discontinued its release of M3 in 2006, which among other things included bank repurchase agreements (repos). Including M3, rather than M2, in the estimation improves the the R2 over 30 percentage points (to 81%).

This is a very small sample, and removing the latest data point from the original estimation improves the R2 slightly to 64%; but clearly there's something going on here. I think that it's fair to say that we may be disappointed by the M2 implied average nominal GDP growth rate over the next 5 years (4%).

According to John Williams' Shadow Statistics website, M3 is still contracting at (roughly because I don't subscribe to the data) 4% over the year. The relationship in the second chart implies that nominal GDP will fall, on average, about 4.5% per year. Japan's nominal GDP never contracted more than 2.08% annually during its lost decade, but the implication is that "things" may not be as rosy as the M2 measure of money suggests.

Rebecca Wilder

Evaluating the "excess" in the US corporate financial balance

2010-09-19T09:53:00.030-04:00

In a NY Times op-ed, Rob Parenteau and Yves Smith reminded us that the private sector financial balance is a function of the household financial balance and the corporate financial balance. They concluded the following regarding excess corporate saving:

So instead of pursuing budget retrenchment, policymakers need to create incentives for corporations to reinvest their profits in business operations.

In my view, it's not that simple (not that passing this type policy would be easy at all). As I illustrate below, firms, like households, are in a deleveraging cycle, where corporate excess saving is likely to persist for some time. (Note: US total corporate financial balance, excess saving if the balance is positive, is roughly undistributed profits minus gross corporate domestic investment)

In their NY Times article, Rob and Yves cite a 2005 JP Morgan study, "Corporates are driving the global saving glut". In that study, JP Morgan argues that the global saving glut has been driven largely by G6 excess corporate saving, and to a lesser extent emerging economies. In the US, positive corporate excess saving persisted through the latest print, 2010 Q2.

The illustration above plots the total corporate financial balance as a percentage of GDP. I calculate the Total Corporate Financial Balance (TCFB) as in the JP Morgan study, which is the residual of the national accounting identity of the Current Account Balance minus the Household Financial Balance minus the Government Financial Balance. According to this measure, the TCFB was roughly +3% in 2010 Q2, or about +1% above the 2008-2010Q2 average (2.1%).

About the same time as JP Morgan published their research, the IMF and the OECD were wondering why global TCFBs were rising. Several factors are attributed the upward trend in the first half of the 2000's, including (this is not a complete list of factors):

Repurchase of stock shares relative to dividend payouts
The falling relative price of capital goods dragging nominal investment spending as a share of GDP (see Table 3.2 of the OECD publication)
The overhang of leverage build in the 1990's
Rising profits via falling taxes and low interest payments (especially in other OECD economies)

Although firms likely worked out much of the debt overhang from the 1990's, the debt accumulation spanning the second half of the 2000's was precipitous.

It's very unlikely that the excess corporate saving will fall anytime soon, as non-financial business leverage is high just as household leverage is high. Total non-financial business debt peaked in 2009 Q1 at 79.5% of GDP and is now trending downward, hitting 74.9% in 2010 Q2.

If history is any guide, then the "excessive" borrowing spanning 2005-2008 will take some time to repair. Spanning 2002 to 2004, the non-financial business sector dropped leverage 2.5% to 64%. If this 2-year period of de-leveraging indicates an "equilibrium" level of leverage, then non-financial businesses are likely to run consecutive financial surpluses (excess saving) in order to reduce debt levels by another 11 percentage points of GDP for a decade more.

If firms run excess saving balances, then they're not investing in future profitability via capital expenditures nor increasing marginal costs, like wages and hiring, relative to profit growth. So while it is true that some fiscal policy should be targeted directly at investment incentives (Rob Parenteau and Yves Smith article), these measures may prove less effective since the non-financial business sector's desire to "save" and repair balance sheets is high.

I leave you with one final chart to inspire more discussion: a breakdown of the total corporate financial balance into its two parts, financial-business and non-financial business.

The financial balances in illustration 2 are computed directly from the Flow of Funds Accounts, Table F.8, rather than taking the residual as calculated in illustration 1. Thus, the total corporate financial balance will not match that in illustration 1.

The point is simple: the small drop in excess saving in total corporate financial balance in illustration 1 is stemming from the financial side. The non-financial corporate sector continues to raise excess saving by investing retained earnings into liquid financial assets relative to capital investment.

Fiscal policy should be targeted at the high desired saving by the corporate and household sectors alike. The idea is to pull forward the deleveraging process by "helping" households and firms lower debt burden via direct liquidity transfers (lower taxes or subsidies, for example). Only then will healthy private-sector growth resume.

Rebecca Wilder

Harmonised unemployment rates: a tad scary

2010-09-15T05:37:00.011-04:00

Across the OECD, the unemployment rate was unchanged at 8.5% in July 2010.

The chart illustrates the harmonised unemployment rates for 28 economies in July spanning 2008-2010 (based on data availability, the comparison month is June for Chile, Netherlands, Norway, and Turkey, and May for the UK). The countries are ranked by the percentage change in the unemployment rate from 2008 to 2010, where Denmark is the highest, 115% increase, and Germany is the lowest, -4.2%.

The story in this chart is obvious: the slack in global economic activity remains extreme in much of the developed world. More growth it needed; but apparently, we're not going to get it.

The OECD released its index of composite leading indicators (CLI, where you can view the components of the index for each country here) for July. The pace of economic expansion is waning. (Click on chart to enlarge.)

From the release:

The CLI for the OECD area decreased by 0.1 point in July 2010. In Canada, France, Italy, the United Kingdom, China and India there are stronger signals of a slower pace of economic growth in coming months than was anticipated in last month’s release. Stronger signals that the expansion may lose momentum have emerged in Japan, the United States and Brazil. Tentative signals have also emerged that the expansion phases of Germany and Russia may soon peak.

According to the composite CLI, the OECD hit a cyclical trough in May 2009 (14 months before the July release). Since then, the unemployment rate has risen in 20 of the 28 listed economies.

The robust global restocking of inventories fueled world export income; but that cycle is now over (see the chart on page 8 of the OECD's interim forecast). Furthermore, expansionary policy, which underpinned domestic demand around the world, is tightening.

Policy will turn expansionary again in several of these economies. The faltering sum of income will drag global growth further until stabilizing policy kicks in.

Rebecca Wilder

Private-sector leverage says that it's not Bill Clinton

2010-09-12T09:27:00.013-04:00

What's your answer? "Thinking about the past few decades… to the best of your knowledge, which ONE of the following U.S. Presidents do you think did the best job of managing the economy?"

Bill Clinton
Ronald Reagan
Barack Obama
Lyndon B. Johnson
George W. Bush
Richard Nixon

That's question #11 of the the Allstate-National Journal Heartland poll. 42% of the 1201 adults polled last month answered Bill Clinton.

I wonder why near half of those polled think that Clinton did the best job of “managing the economy”. Using one simple metric, private-sector financial leverage (accumulated dissaving), Clinton ranks among the top three worst economic managers, behind George Bush (Jr.) and Ronald Reagan.

The chart illustrates private-sector leverage as a stock of debt to GDP indexed to the start of each Presidential term. Therefore, the numbers are not the debt ratios, rather the appreciation of the debt ratios since the onset of each President's term. The data are from the Fed's Flow of Funds Accounts.

The sector financial balances model of aggregate demand posits that fiscal policy must shift in order to normalize GDP amid deviations of the private-sector surplus (desire to save) and the current account (see Scott Fullwiler’s article on the sector financial balances model of aggregate demand, which references similar work by Bill Mitchell and Rob Parenteau; or you can see last week’s answers and discussion to Bill Mitchell’s quiz for a simple outline).

When the private sector is levering up, the public sector is not doing its job. Since the 1990’s, the private sector loaded up on debt (ran private-sector deficits) in order to maintain GDP closer to full employment in the face of shrinking government deficits relative to those of the current account (since 1991 the current account trended down as a % of GDP). Deregulation, of course, contributed as well.

According to this metric, Barack Obama ranks highest to date, thanks to the automatic stabilizers and the ARRA. But we’ll see what happens when 2011 rolls around: the waning stimulus will drag economic growth; the Congressional tides may turn; and the immediacy of the crisis continues to fade. Unless firms start to “dissave” and pass on profits to households via hiring and wage growth, we may be in for a rocky ride, since the household desire to save will hover at very high levels for years to come (see David Beckworth’s post on the growing mismatch between mortgage debt load and real estate valuations).

Rebecca Wilder

My absence explained

2010-09-07T19:39:00.002-04:00

Please hold on for just a bit more. I started a new position here in Boston and am waiting on compliance to clear my commentary online. I expect to be blogging regularly within the next week (or so).

Rebecca Wilder

Household leverage: what does the US have that the UK does not?

2010-08-23T12:05:00.023-04:00

Earlier this week I compared household saving rates across the US, UK, Canada, and Germany. My conclusion was pretty simple:

So generally, this simple analysis would suggest that Menzie Chinn's skepticism of a "status quo" of US consumer imports is worthy. But with the status quo firmly in place in Germany, the household saving data paint a foreboding picture - certainly for the Eurozone, but possibly for the global economy as well.

The financial circumstances of US and UK households are very similar despite their diverging saving rates over the last two quarters (see saving rate chart here): leverage is high.

The chart above illustrates the total stock of household loans/debt (including non-profit organizations, which is small relative to the "household") as a share of personal disposable income.

In the UK, household leverage peaked above that of the US at 161% of personal disposable income in Q1 2008, having fallen to 149% by Q1 2010. Furthermore, recent deleveraging by UK households has occurred through income gains, rather than paying down debt: spanning the period Q2 2009 to Q1 2010, the UK household stock of loans increased 1.2%, while disposable income grew 3.1% (you can download the data here).

Given the remaining leverage on balance, the divergence in household saving rates across the US and UK is probably not sustainable. The UK household saving rate is likely to increase, or at the very minimum, hold steady.

The problem is: that according to the sectoral balances approach, it's impossible for the government and the private sector to increase saving simultaneously unless the UK is running epic current account surpluses (it's not). Therefore, the £6.2billion in public "savings" may push UK households farther into the red. However, the more likely outcome is that UK public deficits rise amid shrinking aggregate demand (and with it, tax revenue) and the increasing household desire to save.

The punchline: the US household has something that the UK household does not: (still) expansionary fiscal policy ($26 billion in state aid and extending unemployment benefits, for example).

Rebecca Wilder

Household saving rates in the US, UK, and Germany: (possibly) light at the end of the tunnel

2010-08-20T09:45:00.002-04:00

Menzie Chinn at Econbrowser breaks down US import data by sector to argue the following (see entire article here):

What is clear is that consumer goods do not vary that much; now, part of auto and auto parts is going to satisfy consumer demand as well, and here we do have some evidence in support of the hypothesis of the consumer going back to his/her old ways of sucking in imports.
...
Consumption hardly seems resurgent, so attributing the increase in imports to consumers means that one is assuming a very high share of imports to incremental consumption -- something I'm not sure makes sense. So, I think the book is still open on whether the consumer is going to drive the US back into a rapidly expanding trade deficit.

Another way to look at this is by comparing global household saving rates. Specifically, I look at the household saving rates across the US (the world's largest economy in 2007, as measured in PPP dollars - download the data at the IMF World Economic Outlook database), UK (6th largest economy), Canada, and Germany (5th largest economy). The household saving ratio is calculated as gross household saving divided by personal disposable income, as reported in country National Accounts.

If the global economy is indeed "rebalancing", then relative to disposable income the big spenders (US, UK) raise saving, while the big savers (Germany) increase spending. In contrast, if the global economy is returning to the pre-crisis "status quo", then relative to disposable income household saving rate would:

fall in the US and UK
rise in Germany

(Using IMF data, here's a chart that I put together last year of consumption shares across economies to illustrate the big spenders and big savers.)

The German household saving rate is rising, while the UK households saving rate is falling. In the US, we're seeing the household saving rate stabilizing above pre-crisis levels, even increasing at the margin.

The table below lists average household savings rates for the pre- and post-crisis periods. Notably, the average US saving rate more than doubled to 4.8% since the previous 2005-2007 period, while that in the UK increased a much smaller 36% to 4.6%. Notably, German households increased average saving above an already elevated 10.6% average during the business cycle.

So generally, this simple analysis would suggest that Menzie Chinn's skepticism of a "status quo" of US consumer imports is worthy. But with the status quo firmly in place in Germany, the household saving data paint a foreboding picture - certainly for the Eurozone, but possibly for the global economy as well.

I'm in no way "blaming" this on the Germans - the banking system there will eventually contend with the crappy Greek and Portuguese assets they hold on balance. But didn't they learn their lesson? Relying on exports makes the economy highly susceptible to external demand shocks.

More on the UK vs US in my next post.

Rebecca Wilder

Note: Clearly, an analysis of this sort would require a much larger cross-section of household saving data. But differing measurement methodologies and data limitations make the comparison too arduous for a simple blog post. For example, Japan is not part of the analysis because only the expenditure approach to national income is available on a quarterly basis.

Nope, it's not enough for the weakest of the "Zone"

2010-08-17T15:19:00.020-04:00

Spanning the period April 14, 2010 to June 7, 2010, the euro lost 12.5% in value against the $US (this is not a trade-weighted measure of the currency value, but it'll do). As the currency tumbled, Q2 nominal export income grew quickly over the quarter for the top 5 economies in the Eurozone:

Germany, 6%
France, 4.6%
Italy, 8.3%
Spain, 0.8% (definitely the exception to the rule)
Netherlands, 7.2%

The export income is welcome in Italy's economy, one of the PIIGS countries (Portugal, Ireland, Italy, Greece, and Spain). But what about Greece, or the rest of the PIIGS countries that desperately need the external income?

Well, Greece actually did quite well in Q2: nominal export income was up 5.8% over the quarter compared to a 0.1% decline in Q1. Perfect - that's the point, right? Nominal depreciation begets external economic support via exports?

It's not enough. The problem is, that the external support generated by a euro depreciation is too evenly distributed across the "Zone". The result: those economies with both external and domestic demand posted record growth rates (i.e., Germany), while those with an overwhelming contraction in domestic demand posted further GDP declines amid reasonable external demand growth.

The chart below illustrates the pattern in GDP quarterly growth for Eurostat's reporting countries, ranked by Q2 2010 growth rates in order of smallest (Greece, -1.5%) to largest (Germany, +2.2%).

It should be noted here that the Eurostat data is a "Flash" report of Eurozone GDP only. The breakdown by spending category will not be reported until the second GDP release, which is scheduled for September 2, 2010. Therefore, the nominal export numbers, which are seasonally and working day adjusted through June 2010 (the volume indexes are only available through May 2010), proxy the strength of external demand.

The interesting thing is that export growth is likely strong enough to keep the third largest (as of Q2 2010) Eurozone economy, Italy, afloat for now. However, oncoming austerity measures (I searched for a list of announced European austerity measures, but only came up with this - do you know a credible source/link?) will drive the positive feedback loop: rising deficits - raise taxes/cut spending - cut domestic demand - taxable income falls - deficits rise.

Rebecca Wilder

Note: I included export data only, although the trade balance, which is exports minus imports, data tells a very similar story: widespread improvement in the trade balance.

The Fed didn't announce QE2

2010-08-12T18:08:00.018-04:00

Fortune published an op-ed piece by Keith R. McCullough at Hedgeye (h/t to my Mom). He argues (not very well, I might add) that QE2 is the doomsday scenario for "markets".

I'd like to point out the following (mostly because this is a common mistake): what the Fed announced is NOT QE2. Furthermore, the Fed's been considering investing options for months now, why the shock and awe treatment from markets?

Here are the FOMC's announced investment intentions:

...the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.

The Fed announcement is NOT a second version of quantitative easing (QE2). Quantitative easing is a "super" policy response, where the Fed grows its balance through reserve creation and the purchase of (usually) government assets.

The Fed is reinvesting the principal of maturing securities into longer-dated Treasuries from reserves already created. Therefore, the Fed is simply shifting the asset side of the balance sheet toward a Treasury-only portfolio. Reinvesting maturing Treasuries is regular practice for the Fed. No new quantitative easing.

The announcement should not have been a surprise; it wasn't to me. According to the FOMC minutes, the Fed has been considering investment options regarding the principal of the maturing securities for months now. From the June 22-23 FOMC minutes:

First, the Committee could consider halting all reinvestment of the proceeds of maturing securities. Such a strategy would shrink the size of the Federal Reserve's balance sheet and reduce the quantity of reserve balances in the banking system gradually over time. Second, the Committee could reinvest the proceeds of maturing securities only in new issues of Treasury securities with relatively short maturities--bills only, or bills as well as coupon issues with terms of three years or less. This strategy would maintain the size of the Federal Reserve's balance sheet but would reduce somewhat the average maturity of the portfolio and increase its liquidity.

The Committee decided to go with the second strategy, but in an altered form: reinvest the proceeds of maturing securities to maintain both the size of the balance sheet and the average maturity of the portfolio. And a few members favored the Fed's August announcement:

A few participants suggested selling MBS and using the proceeds to purchase Treasury securities of comparable duration, arguing that doing so would hasten the move toward a Treasury-securities-only portfolio without tightening financial conditions.

So you see, the FOMC announcement to buy longer-dated Treasuries is not QE2; is not a surprise; and for reasons that I did not describe here, doesn't portend economic collapse (see this policy brief, or the working paper, by Randy Wray and Yeva Nersisyan, where they refute the application of the Reinhart and Rogoff findings).

Rebecca Wilder

The compensationless recovery

2010-08-11T12:33:00.013-04:00

New York Times David Leonhardt argues that real wages are rising, so those resilient workers that remain employed will benefit from the bounce-back in "effective pay". The problem with this insight is twofold: first, the expansion phase of real hourly compensation, a broader measure of total earnings, is falling; and second, sitting atop a mountain of consumer and mortgage debt, the aggregate economy cannot afford a compensationless recovery.
From the NY Times:

But since this recent recession began in December 2007, real average hourly pay has risen nearly 5 percent. Some employers, especially state and local governments, have cut wages. But many more employers have continued to increase pay.

Something similar happened during the Great Depression, notes Bruce Judson of the Yale School of Management. Falling prices meant that workers who held their jobs received a surprisingly strong effective pay raise.

Rebecca: The referenced "real wages" are the real average hourly earnings figures for production and nonsupervisory workers, 80% of the total nonfarm payroll. The broader measure of total earnings is real hourly compensation (see Table A and get the data from the Fred database). Real hourly compensation measures compensation for all workers, including wages, 401k contributions, stock options, tips, and self-employed business owner compensation. (You can see a comparison of the earnings/compensation series in Exhibit 1 here.)

Since December 2007, real hourly compensation has increased just 1.3%. Furthermore, the index declined four consecutive quarters through Q2 2010, a first since 1979-1980. If the NBER dates the onset of the expansion at Q3 2009 (the first quarter of positive GDP growth in 2009), real hourly compensation will have dropped .7% through Q2 2010! That's pathetic compared to the average 2.5% gain during the first 4 quarters of expansion spanning the previous 10 recessions.

The table lists the gain/loss of real hourly compensation, measured by the BLS, during the recession and early recovery for the business cycle as dated by the NBER.

Here's how I see it: the problem is not that real hourly compensation is falling during the the recovery, per se, it's that real hourly compensation is falling during the recovery of a balance sheet recession.

In the context of wage and compensation growth, the NY Times article was misleading in its comparison of the Great Depression to the '07-'09 Great Recession. Mass default during the Great Depression wiped private-sector balance sheets clean, no debt. But not this time around. We're going to need a lot of income growth (the BLS measure of real hourly compensation includes measures of income at the BEA) to increase saving enough to deleverage the aggregate household balance sheet.

I'll say it again: we can't afford a jobless recovery. Specifically, we can't afford a compensationless recovery.

Rebecca Wilder

Policy stuck in the doldrums? Consumers think so

2010-07-29T10:20:00.010-04:00

Consumer confidence: that extremely coincident, but often cited as leading consumer spending, indicator of really just jobs growth during recovery has struck again, down near four points to 50.4 in July.

During the recovery phase of the business cycle, confidence is highly correlated with jobs growth. The chart below illustrates the recession and recovery path of consumer confidence since 1973. The 2007-2009 recovery in confidence - I mark the technical end of the recession at June 2009 but the exact month is not important- is tracking earlier "jobless recoveries": 1990-1991 and 2001.

The problem is, we can’t afford (economically, that is) a jobless recovery this time around!

Consumers are not feeling very good these days, with good reason! I like the way Dean Baker tersely puts it:

It is incredible that economists and economic reporters still focus on consumer confidence. Consumers are actually spending at a relatively high rate. (The savings rate is well below historic levels.) The problem is that they lost $8 trillion in housing wealth. The housing wealth effect on consumption is something that economists have known about for more than 60 years. It's too bad that they seem to have forgotten and so have the reporters who cover this issue.

The problem is not confidence. It is a lack of money. That is why consumers are not spending more and will not anytime soon regardless of how happy they are.

Rebecca: In my view, it's (more precisely) the lack of money during the recovery of a balance sheet recession (Richard Koo of Nomura developed this idea). In order to lower household leverage (i.e., pay down debt burden) the easy way, a significant increase in nominal income is needed, wage growth. And a significant increase in wage growth only occurs when the demand for labor is rising...precipitously. Only then will workers have enough pricing power (in aggregate) to demand sufficient wage gains in order to deleverage the safe way (not through default).

Recently, economists have been testing the theory that structural unemployment is rising (Economist.com post here). In my view, focusing on structural unemployment is just a policy excuse. It gives policymakers a reason to mitigate the large(r) policy impetus that is needed. Bad idea.

Richard Koo argues that structural unemployment is not rising:

When the deficit hawks manage to remove the fiscal stimulus while the private sector is still deleveraging, the economy collapses and re-enters the deflationary spiral. That weakness, in turn, prompts another fiscal stimulus, only to see it removed again by the deficit hawks once the economy stabilises. This unfortunate cycle can go on for years if the experience of post-1990 Japan is any guide. The net result is that the economy remains in the doldrums for years, and many unemployed workers will never find jobs in what appears to be structural unemployment even though there is nothing structural about their predicament. Japan took 15 years to come out of its balance sheet recession because of this unfortunate cycle where the necessary medicine was applied only intermittently.

Rebecca: Although this may appear to be a normal jobless recovery, recoveries from which consumers have prospered in the past through debt accumulation, it's not. Jobs growth is key to the deleveraging cycle; and with forecasts of the unemployment rate in the 8%-10% range through 2012, still 7% in 2013, the prospect of sufficient private-sector income generation looks very gloomy.

Rebecca Wilder

Another illustration of the struggling US labor market: teen employment

2010-07-27T15:14:00.002-04:00

This recession caused a severe disruption in the labor market for teen employment. The chart below illustrates the unemployment rate alongside the employment-to-population ratio for those aged 16-19 years.

The visual is quite striking: at the peak of the business cycle, December 2007, the difference between the employment-to-population ratio over the unemployment rate was roughly 17.3 percentage points (pps). In June 2010, however, the difference narrowed fully to -0.3 pps.

This is a growing problem for our youngest workers. In April, the OECD issued a press release (featuring related research) calling for government support for "youth" unemployment across the member countries:

The report’s message is that governments need to do much more to help young people. Some have benefitted from broader efforts to help the unemployed. But more policies are needed that target young people, especially those with poor education and skills. These “at-risk” youngsters now account for between three and four out of ten of all young people in the OECD and are at risk of long-term joblessness and reduced earnings.

Back in June, the LA Times argued that young workers in the US, workers aged 16-19, are being displaced by college graduates and other skilled workers; in better times, these workers would not take jobs normally filled by teenagers.

The recession has been particularly cruel to those aged 16-19. However, the chart above illustrates that the downward trend is both secular and cyclical, as the employment-to-population ratio has trended down since 2000.

At the turn of the century, the employment to population ratio for teens aged 16-19 years was 45% (average over the year), and just 35% in 2007. There’s a problem here. Workers aged 16-19 generally earn low hourly wages (unless they invented Facebook, of course); and in some cases, even the small monthly sum supports family income. And as the OECD report suggests, often young workers do not qualify for unemployment insurance when displaced.

The Federal Reserve’s latest Survey of Consumer Finance (2004-2007) indicates that much of the mean income growth is accumulating at the top 10% of the income distribution (Table 1). Spanning 2004-2007, the bottom 20% experienced 3.4% income growth, while the top 10% saw near 20% gains. And every bracket in between saw either negative or near-zero income growth.

Here’s the bigger picture: teen income is likely becoming increasingly important to the families at the bottom of the income distribution, while the jobs are becoming increasingly scarce. Without entry level jobs, aggregate work experience starts to decline, which translates into lower skill overall; and then productivity declines. Bad stuff.

Rebecca wilder

The answer is the domestic private sector

2010-07-19T20:10:00.015-04:00

Jim Hamilton used the Federal Reserve Flow of Funds data to present a question: who will buy “the additional $8 trillion in net new debt that would be issued over the next decade under the CBO's alternative fiscal scenario.”

I thought that the analysis was curious and too "partial". If one believes the deleveraging story, then domestic private saving is going to rise. The answer to his question seems pretty obvious…

Let’s say that consumption goes back back to the 1960’s-style 62% of GDP, then get ready for household Treasury accumulation. Spanning the decade of 1960, households held on average 30% of the Treasury's liabilities.

A simple example illustrates my point. If the Treasury’s book doubles to $16.5 trillion, and the household share of Treasury holdings rises to 30% – as of Q1 2010 the stock of Treasuries outstanding was just about $8.3 trillion (see L.209 here) – then households will accumulate over $4 trillion of those new Treasuries. That's just households, and holding all else equal (like financial funds and businesses).

So the answer is: the domestic private sector.

Rebecca Wilder

Quandary about the Fed outlook

2010-07-14T22:54:00.012-04:00

Paul Krugman beat me to this...but here's my take:

The FOMC members are asked to give their assessment of “the rate to which each variable would be expected to converge over time under appropriate monetary policy and in the absence of further shocks”. The 2012 forecast – the time frame that would provide enough of a buffer for the 1 year to 1.5 years lag in policy – includes persistently high unemployment and anemic headline and core inflation.

My quandary: all merits of monetary policy aside, doesn’t their forecast by definition imply inappropriate monetary policy? At the very minimum, it implies inappropriate fiscal policy.

Rebecca Wilder

Inflation expectations are jointly falling?

2010-07-13T09:19:00.008-04:00

As a global economic slowdown is very likely underway, inflation expectations are being watched closely.

David Beckworth comments on inflation expectations in the US using the Treasury Inflation-Protected Securities (TIPS) market (he commented previously on an alternate measure of inflation expectations at the Federal Reserve Bank of Cleveland). He argues that the aggregate demand effect is the dominant factor dragging US inflation expectations.

However, inflation expectations are falling globally. The chart above illustrates the 10-yr break-even expected inflation rates for the UK, Germany, Canada, Italy, and the US using their respective inflation-indexed bond markets (TIPS in the US). Notably, declining inflation expectations is not specific to the US.

Of interest, the onset of the downward trend across break-even inflation rates coincides with policy announcements in Europe:

the bailout of Greece, and
the European Financial Stability Facility (EFSF)

Inflation expectations in Italy has taken the biggest hit, falling 55 basis points since May 2 2010 (as of June 12, 2010). But the trend has been broad-based, hitting even "sticky" UK inflation expectations.

The chart illustrates the same 10-yr inflation expectations rates as in the first chart but indexed to the start of 2010 for comparison.

Market participants in the UK, Germany, Canada, Italy, and the US reacted similarly to the European policy measures. The most likely reason for the drop in Eurozone country inflation expectations - Germany and Italy - is the direct adverse impact on aggregate demand of fiscal austerity measures and the indirect impact via trade. In the UK, Canada, and the US, the decline in the euro will have lagged and adverse impacts on relative trade patterns.

However, beyond the adverse impact on expected export income, it does seem that markets over-reacted a bit in the UK, Canada, and the US. Because the UK, Canada, and the US have one thing that Germany and Italy don't: fully sovereign policy. Domestic policy, monetary and fiscal, can offset the effects of the European crisis.

Rebecca Wilder

Relative employment is shifting

2010-07-09T14:00:00.004-04:00

Today Statistics Canada released impressive June employment figures from its Labour Force Survey (LFS). In case you missed it, the April gains, +109,000 new jobs, set a record. And the June gains, +93,000, were nearly as spectacular. (Note: the unemployment rate for Canada in the chart to the left is through May, not June)

Canada’s labor market bounced back fully and then some. Spanning May 2008, when job loss became the norm as the global credit crunch started to take hold, to December 2009, 259k jobs were lost. However, this year through June 2010, the labour market added back 308k jobs, which is +50k new jobs during the expansion or roughly +500k in "US".

I’m afraid that the US labour market is a far different story. To regain employment lost since June 2008, 6.9 MILLION jobs need to be added back to the employment figures of the current population survey.

I digress. Every time I hear the Canadian statistics, I immediately multiply the statistic by 10 to control for the population differential; thus, +109,000 new jobs in Canada would be equivalent to roughly +1,090,000 in the US, all else equal. In translating the job gains into “U.S”, I understand the magnitude with more clarity – not very different form learning a new language by translating the words in your head.

Is +50k Canadian still equivalent (roughly) to +500k US? The short answer is pretty much – the 2009 US/CAN relative population was just over 9; but in thinking about relative population figures, I stumbled upon a rather remarkable relative employment figure between the US and Canada. The Canadian employment picture has become much much brighter than that in the US over the last decade.

The chart illustrates US employment relative to that in Canada, Germany, and Japan (Germany and Japan are there for comparison). As you can see, employment in the US relative to our neighbor to the North has dropped markedly. There is a secular downward trend in US employment relative to that in Canada.

And it’s not just a population issue. On a population-adjusted basis, the employment figures in Germany, Canada, and Japan are trending upward relative to that in the US - and for Canada, this is a secular trend rather than a cyclical phenomenon.

The US employment picture is fading compared to other developed nations. And remember, Japan and Germany saw near-zero annual population growth spanning the years 2000-2009.

Rebecca Wilder

Crib notes for G7 unemployment rates

2010-07-02T14:45:00.004-04:00

Unemployment rates across the G7 illustrate a broad-based labor recovery. Fantastic - now let's get to the underlying stories.

(Note: The US is the first to release the June 2010 figures. All other unemployment rates, except for the UK, are current as of May 2010.)

Germany, France, and Italy: Germany's labor market is ostensibly improving, as the unemployment rate continues its descent. However, don't be fooled by these statistics: the German government is subsidizing firms to drop hours in lieu of outright layoffs.

And across the Eurozone, fiscal tightening will drive unemployment rates up; look at what fiscal austerity got Ireland.

The United States: Spencer, as usual, gives his insightful take on the US employment release: not good. The real problem is that the US private sector is sitting on an iceberg of debt; and the only way to avoid the economic pain of large-scale default is by dropping leverage via nominal income (wages) growth.

Workers have NO pricing power. How can they when the employment to population ratio dropped 0.2% to 58.5% in June? Note that 58.5% is consistent with a 1970's-1980's style labor force with fewer females working. Wages are going nowhere until the labor market improves substantially, and the private sector can't do it atop the iceberg of debt. We need the government's help there.

UK: The pace of the labor market deterioration is slowing (not evident in the unemployment rate, which dates to just March, but more evident in the claimant count). However, the unemployment rate is expected to rise as the government's self-imposed austerity measures are put into play. Furthermore, look for weakening labor conditions to push further default amid big household leverage.

Canada: The labor market is strong as illustrated by the marked improvement in the employment figures. Expansionary policy was very likely too expansionary, and the Bank of Canada has initiated its tightening cycle. The economy is hot right now.

Update: A reader notes that April GDP was released a couple of days before this article published. Indeed the economy posted 0% economic gain in April - not hot over the month. However, the jobs picture remains solid on a month to month basis, as May 2010 employment gains were +25,000 and all (in net) in the "full time" category. Being a small-open economy, much of Canada's economic outlook depends on external factors, especially the outlook of the US economy.

Japan: The labor market is weak, as most industries posted job losses in May 2010 (access Japanese labor data here).

Rebecca Wilder

Yield curves in Japan and the US: similar but not the same

2010-06-29T14:29:00.011-04:00

Andy Harless presents the case for a double dip (second recession) - I would re-order #1 and #2 on that list - and that for a sustained recovery. #6 of Andy's case for a sustained recovery (he calls it Case Against a Second Dip) caught my attention, pointing me to an earlier Paul Krugman article about positively-sloped yield curves in a zero-bound policy environment.

In a related article, Krugman argues that a current policy of near-zero short-term rates precludes the lowering further of future short-term rates. Therefore, the steep yield curve reiterates that rates have nowhere to go but up rather than that the economy is expected to improve.

Reasonable; but it was Krugman's comparison to policy during Japan's lost decade that got the mental wheels rolling:

Indeed, if we look at Japan we find that the yield curve was positively sloped all the way through the lost decade. In 1999-2000, with the zero interest rate policy in effect, long rates averaged about 1.75 percent, not too far below current rates in the United States.

In my view, current Fed policy is generally more credible than policy undertaken by the Bank of Japan in the early 2000's. The fed funds target has been near-zero since December 2008; and the new reserve base (liquidity) peaked quickly since the onset of QE and has since remained in the banking system.

Therefore, it would stand to reason that as long as policy remains consistent and big (the latter on the fiscal side is the problem right now), the US yield curve can, in my view, be interpreted as an auspicious sign - all else equal, as they say - as compared to the positively-sloped one in Japan.

Monetary policy in Japan: 1998 - 2006

The Bank of Japan has a solid history of rescinding their own policy efforts. They did it earlier this year; but more importantly their policy announcements spanning the years 1999 to 2006 have on occasion been rather deceiving. Notice that the 2-10 yield curve never became inverted.

The shortened version of the timeline (illustrated in the chart above):

From Bernanke, Reinhart, and Sack (2004): "In April 1999, describing the stance of monetary policy as “super super expansionary,” then-Governor Hayami announced that the BOJ would keep the policy rate at zero “until deflationary concerns are dispelled,” with the latter phrase clearly indicating that the policy commitment was conditional."
In August 2000, The BoJ raises the overnight call rate to 0.25%, up from near-zero.
In February 2001 the BoJ lowers the overnight call rate to 0.15%.
In March 2001, the BoJ announces its quantitative easing strategy, initially targeting current account balances (essentially reserves) at 5 trillion yen and lowered the overnight call rate target to near-zero.
Until 2004, the BoJ raises the current account reserve target several times until it peaks at 30-35 trillion yen.
In March 2006, the BoJ exits QE.

I concur with Paul Krugman, that the deflation threat is very very real. I do not think that it is completely fair to compare the current US yield curve to that to early 2000's Japan.

To be sure, the likelihood of rates rising is the only possibility built into the US yield curve right now (no possibility of lower rates); but since the Fed is relatively more credible and consistent, the probability of rates rising is much higher compared to that in early 2000's Japan.

And the current US curve is steep! The chart below compares the dynamics of the 2-10 yield curve in Japan from its low in 1998 through 2006 to that in the US from its low in 2007 through June 24, 2010.

Rebecca Wilder

Reference for paper in final chart: Luc Laeven and Fabian Valencia (2008), Systemic Banking Crises: A New Database, IMF Working Paper WP/08/224.

Another blow to the US labor force

2010-06-26T12:00:00.004-04:00

The Senate voted down the American Workers, State, and Business Relief Act of 2010, 57 to 41 (see an earlier version of the CBO's estimate here for a breakdown of the Bill). The emergency extensions to weekly unemployment benefits will now expire, leaving many without government support as the labor market improves at snail speed.

Those who support the Bill claim that benefits prop up consumer spending. It is true, that unemployment benefits payments are more likely to be spent rather than saved. However, the latest version of the Bill allocated about $35 billion to benefits, just 0.34% of consumer spending in Q1 2010. Consequently, the direct impact on consumer spending of extending the benefits would have been small. (The provisions of the Bill in full would have quickened the recovery, according to David Resler at Nomura.)

Those who oppose the Bill claim that extending the benefits only increases the duration of unemployment - in May 2010 median duration was 23.2 weeks, its highest level since 1967. This is a weak argument when 7.4 million jobs, near 6% of the current payroll, have been lost since the onset of the recession (this is a cumulative number, which includes the gains since January 2010). The bulk of the unemployed would likely jump at an opportunity to work rather than live on benefits.

One way or another the government will plug the hole that is private spending. And the government will find this out the easy way (expansionary fiscal policy) or the hard way (perpetual deficits that result from weak private-sector tax revenue). Apparently it's going to be the hard way.

At 9.7% unemployment, isn't it obvious that Congress is not "spending" enough?

The chart illustrates the Nairu-implied level of unemployment (NAIRU, or the nonaccelerating inflation rate of unemployment) versus the measured rate of unemployment. The concept of NAIRU is limiting in that it inherently binds fiscal policy and is a theoretical notion at best; but it does present a baseline for comparison. The Nairu-implied level of unemployment is simply the CBO's estimate of NAIRU multiplied by the current labor force. Let's call points when the current level of unemployment is above the NAIRU-implied level as cyclical surplus of workers.

According to this measure of worker surplus, the state of the labor market is obvious: depressed. The NAIRU-implied level of unemployment is half of that currently measured by the BLS with a record wedge between the two. Furthermore, the cyclical surplus of workers in '82-'83 - the last time the unemployment rate peaked above 10% - was relatively mild compared to current conditions.

By failing to pass this Bill, the Senate reiterated its unwillingness to support the US labor market. Of course benefits are not the answer - we need a comprehensive jobs Bill to mitigate the consequences of such a depressed labor market. (There was a good article on the longer term unemployment problem at the Curious Capitalist some months back.)

Rebecca Wilder

GIIPS labour costs not moving in the "competitive" direction

2010-06-23T14:09:00.021-04:00

The GIIPS (Greece, Italy, Ireland, Portugal, and Spain) hope: exports. Fiscal austerity crimps the saving of the private sector. And provided the governments make good their plans to put on the fiscal straight-jacket, there’s no other impetus for growth except foreign demand. Financial crises are often accompanied by currency crises, i.e., Sweden 1991, which drives export growth if there is sufficient external demand. For Sweden, there was.

For the GIIPS, there is not. But worse yet, there's not a possibility of a currency crisis deep enough to drive sufficient external demand growth in Greece, Italy, Ireland, Portugal, and Spain. Therefore, it’s generally understood that the GIIPS will get the economic boost if internal competitiveness is restored. Put another way, in lieu of a domestic impetus to economic growth, "internal devaluation” (Marshall Auerback calls it “infernal devaluation”), i.e, dropping hourly labor costs and final goods prices through productivity gains and reform, is the only economic means to attract a sufficient boost of external income to grow the economy.

Well, internal labour cost devaluation has yet to materialize in the GIIPS or the Eurozone as a whole. According to last week’s Eurostat release of Q1 2010 quarterly labour costs for the European Union, labour costs are still very much rising:

The two main components of labour costs are wages & salaries and non-wage costs. In the euro area, wages & salaries per hour worked grew by 2.0% in the year up to the first quarter of 2010, and the non-wage component by 2.1%, compared with 1.6% and 2.0% respectively for the fourth quarter of 2009. In the EU27, hourly wages & salaries rose by 2.3% and the non-wage component by 1.9% in the year up to the first quarter of 2010, compared with 1.9% and 2.5% respectively for the previous quarter.

There is a lag associated with labor cost growth, especially in Europe. But over the last two years, the Eurozone 16 saw labour costs rise a cumulative 5.3%, which is on par with the previous two-year horizon, 5.7%; labour cost growth isn't even slowing.
(this chart was updated at 4:00pm on June 23)

The chart illustrates the two-year cumulative labour cost gains across the Eurozone 16 (seasonally and working-day adjusted) alongside the annual gains over the last year (working-day adjusted only). Note: country-level data for Ireland, Finland are not available. Furthermore, country-level data through Q1 2010 are not available for Belgium, Italy, and Greece, so Q4 2009 is used instead.

According to the measure of "labour costs", it appears that “competitiveness” is not improving markedly in any country across the Eurozone, especially in the GIIPS that need it. In contrast, US nonfarm business unit labor costs dropped 4.2% over the last two years.

To be sure, there are other measures of “infernal devaluation”, like final goods prices. But strictly speaking labour costs remain too sticky in the Eurozone to attract external demand sufficient enough to offset the drag that would stem from the announced fiscal tightening across Europe.

Rebecca Wilder

The hourless recovery

2010-06-16T16:30:00.001-04:00

There was an interesting blog post over at the Macroblog (Atlanta Fed) regarding productivity. John Robertson and Pedro Silos highlight the contributions to GDP growth from various factors, including productivity and employment. One of their findings:

As this chart shows, relatively high labor productivity growth during a recession is not a phenomenon isolated to the 2007–09 and 2001 recessions (for present purposes, the end of the most recent recession is identified with the trough in GDP in the second quarter of 2009). All recessions from WWII through 1970 also featured sizable growth in labor productivity.

The article focuses on the contribution of productivity gains to GDP growth during a recession and the early stages of the recovery. The authors do not comment on, however, a very interesting bit of their story: the “hourless” recovery. Lockhart speaks of this curtly in his speech - the focus of the macroblog article:

Current data on the use of part-time workers suggest that businesses have some scope to increase hours without hiring new full-time employees.

The precipitous drop in hours worked has differentiated this labor downturn from previous cycles (papers here and here). According to the BLS Q1 2010 productivity report, the recovery of the 2007-2009 recession has so far been “hourless”, which is consistent with the previous two cycles.

The chart illustrates the contributions to output growth from hours and productivity for the the first three quarters of recovery spanning the last six recessions. Note: the current recession has not officially been dated as having ended, but June or July 2009 is the "whisper" talk for now. I will simply call Q3 2009 as the onset of the recovery, since GDP grew that quarter.

The "hourless recovery" is underway: a cumulative 3.3% of output has been generated over the last three quarters (using the BLS productivity report) via a 0.9% drop in aggregate hours. I argued last year that adding back hours cannot generate sufficient output growth for sustainable "recovery"; however, productivity growth has been strong enough that the productive hours cycle has not even begun.

It’s likely that the large service sector is the drag that is driving the “hourless” recovery because manufacturing hours are red hot.

(The weekly hours series are indexed to 100 for comparison.

The chart illustrates average weekly hours of production and nonsupervisory workers in manufacturing and private industry payroll. Manufacturing weekly hours, 41.5 hours per week in May 2010, recovered 5% off the low of 39.4 hours in March 2009. Furthermore, May 2010 set a ten year record, breaking past levels not seen since July 2000 (not shown in chart but you can see it here). In contrast, total private weekly hours remain below pre-recession levels, just 1.5% off of the June 2009 low, 33.0 hours.

The BLS breaks down average weekly hours for all workers by industry since 2006. The service sector is the lion's share of the private payroll (~85%). Of the service sector payroll, 68% remains short of pre-recession weekly hours worked: trade, transportation, and utilities, professional and business services, and education and health services.

Adding hours still won’t provide a large growth impetus, as I argued here; however, the service industry has yet to see the burst in hours like in manufacturing. As such, I agree with the overall conclusions of the Robertson and Silos article:

Hence, it will probably take awhile to see how President Lockhart's forecast of continued modest employment growth pans out.

Rebecca Wilder

This article is crossposted with Angry Bear blog

I understand why Asia's worried about Europe

2010-06-13T07:30:00.017-04:00

On the forefront of the Chinese economic releases this week was the trade data, where headlines shouted +48.5% Y/Y export growth in May. This report didn’t go unnotic ed in Washington, as renewed obsessions with the Chinese peg against the US dollar fired up again.

But the Chinese release overshadowed the Philippines April trade report, which in my view, illustrates more transparently the slowdown in external demand that is likely underway across the region. In the Philippines merchandise exports increased 27.4% over the year in April, which was half the rate of the Bloomberg consensus and that in March, 42.7% and 43.8%, respectively.

A negative export growth trend has been established - explicitly in the Philippines and likely going forward in China (see Goldman Sachs report below). And these countries have strong trade ties with Europe - the Eurozone was 15% of 2009 world GDP (PPP value) according to the IMF.

Therefore, recent nominal appreciation of the Philippine peso and Chinese yuan against the euro, and expected real appreciation - Europe's self-imposed economic contraction stemming from harsh fiscal austerity measures will drag prices downward - may very well hamper the economic recovery for key Asian economies via the export channel.

Export growth in the Philippines has been slowing to top trading partners.

The chart illustrates the contribution to overall export growth from the Philippines six largest trading partners - together these countries account for roughly 50% of total exports. The contributions to the Philippines export income growth has been slowing or flat for some time to China, Singapore, and Germany. Slightly more worrisome is the Netherlands contribution having turned negative for two consecutive months.

The Netherlands and Germany account for roughly 13% of total export demand from the Philippines. The euro has depreciated 8% against the Philippine peso since April 2010 (through June 11 and see chart below), and the lagged effects of the nominal depreciation will continue to pass through to exports.

In China, though, a resurgence of export growth among its top trading partners bucks the trend seen in the Philippines.

The chart illustrates the contribution to overall export growth from China's six largest trading partners - again, these countries jointly demand roughly 50% of total Chinese exports. China’s May report was indeed strong: the US added a large +8.3pps to overall Chinese export growth in May, and Hong Kong contributed another robust +6.2pps of growth. In contrast to the Philippines April numbers, The Netherlands contribution to Chinese export growth remained strong, contributing 1.5pps in May.

Chinese exports are quite volatile in the beginning of the year. I suspect that Yu Song and Helen Qiao at Goldman Sachs are right, that export growth will initiate its trend downward starting in June:

“We believe the very strong exports growth in May is likely to be a temporary phenomenon, much like the very weak exports data recorded in March, and expect June data to show a visible normalisation,” said Yu Song and Helen Qiao at Goldman Sachs.

In their Goldman report (no link) Yu Song and Helen Qiao argued that the Chinese numbers remain clouded by the following distortions:

"The exports acceleration was likely to be partially induced by a potential cut to the export VAT rebate for some commodity exports: There have been a number of domestic news reports that this might happen soon as a part of the broader policy package to reduce pollution and energy consumption.
But it probably also reflected changes in the domestic economy: Our proprietary GS Commodity Price Index (GSPCC) (Bloomberg ticker: ALLX GSCP) suggest that the domestic prices of main commodities have been mostly trending down in May which might have encouraged more exports in this area.
Strong export activities might also be impacted by the Lunar New Year effects as many exporters resumed production after taking time off during the holiday season which often last for weeks. [although they say this cannot be validated until a further breakdown becomes available later this month]."

The recent nominal depreciation of the euro against the Chinese yuan and the Philippine peso, 11% and 8%, respectively, since April 1 2010, will pass through to both Chinese and Philippine exports at a lag. And further real depreciation - the nominal exchange rate adjusted for relative prices of goods and services - of the euro against the yuan and the peso is almost certain. Europe’s self-imposed fiscal austerity measures will crimp economic growth and deflation is bound to take over across Europe and relative to Asia.

As such, recent external shocks from Europe will likely show up Chinese and Philippine trade data in coming months. Doesn’t look good for Asia, especially for those economies like the Philippines and China for which exports provide a robust growth impetus.

We’re nowhere NEAR out of the woods yet.

Rebecca Wilder

European Propaganda

2010-06-10T16:30:00.009-04:00

Dan (as in Rdan) sent me a link to this article published at Eurostat, “Impact of the crisis on unemployment has so far been less pronounced in the EU than in the US”. The report states:

The unemployment rate in the EU27 has grown since the first quarter of 2008 as a result of the economic crisis. However, the increase has been smaller than in the US, where the rate has overtaken the EU27 despite having been much lower at the start of the crisis. On a more detailed level, similar patterns in the evolution of unemployment by gender and educational level during the crisis can be observed in the EU27 and the US.

Admittedly, the US unemployment rate has seen a much sharper upward trajectory than that of Europe (see chart below); but that is nothing new. Historically, the US labor market has been more flexible than the European labor market.

Alas, this report is nothing more than European propaganda; and in my view, it was written to assuage the public during a period of heightened political pressure. Pointing out that the US labor market is in worse shape perhaps makes European policymakers “feel” better.

It’s all a mirage, though (see chart below). And furthermore, the European labor market is sure to worsen markedly with fiscal austerity all the rage in Europe.

Back to the point: so why exactly is this propaganda? At 18% of the EU27’s employment in 2009 and 20% of nominal GDP, Germany’s labor policies skew the unemployment rate for the European Union as a whole. From the OECD 2010 Economic survey of Germany:

While the increase in the unemployment rate in the average OECD country was 3 percentage points, the German rate rose by only one half percentage point although the fall in German GDP was above average. This was primarily due to increased flexibility on the firm level that allowed a reduction in labour input by decreasing working hours instead of employment. In addition, the short-time working scheme, whereby the labour office replaces some of the lost income of employees if they work shorter hours, has been used extensively especially as this programme was made more generous during the crisis.

Point: The German government paid firms to hoard workers.

If you take out Germany from the EU27, you get a slightly different picture – one that is not as rosy as the Eurostat report suggests.

In the chart above, I illustrate the reconstructed unemployment rate for the EU27 ex-Germany alongside that for the US and Germany through April 2010 (using the Eurostat data, which is only available through April 2010 on the website although the May unemployment rate has been released).

Clearly, the EU27 unemployment rate is affected by Germany policy. In April the EU27 ex-Germany unemployment rate was 10.3%, which is 0.6% above that of the EU27 as a whole (including Germany). Furthermore, the EU27 ex-Germany unemployment rate surpassed that of the US, rather than the other way around as the report suggests, in January 2010.

Just thought that you should know.

Rebecca Wilder

China’s not the answer for the Eurozone

2010-06-09T08:00:00.009-04:00

“Go long whatever Chinese consumers buy and go short Chinese capital spending (construction) plays. Consistently, go long tech/short material stocks.”

That is the first sentence of a BCA Research report’s executive summary on China equity strategy (link not available). Rather than a global equity strategy, I’d like to put this into an economic growth context via trade…and with Europe.

Go long Eurozone economies selling to China? Is China the panacea for Eurozone growth? Short answer is no, but we'll attend to that later. Even if the euro wasn't selling off against the majors, China's domestic demand is robust and export income is flowing into the Eurozone - but to where?

The chart below illustrates the dynamics of annual export growth to China for the top 6 countries of the Eurozone measured by GDP in 2009: Germany, France, Italy, Spain, Netherlands, and Belgium. Presumably, the bulk of China’s export demand would flow to these countries.

Since the Eurozone's annual export growth to China bottomed out in May 2009, many of the Eurozone economies (some not shown in chart) have registered, on average, double-digit monthly export growth to China: Belgium 49% Y/Y, Germany 25%, Spain 16%, Greece 19%, Ireland 22%, Netherlands 39%, and Portugal 49%. Only Finland saw its monthly average export income drop over the same period, -10% Y/Y.

(A note of clarification: the statistics in the chart are monthly Y/Y growth rates, while the statistics in the paragraph above represent the average monthly Y/Y growth rate spanning the period May 2009 to March 2010. All of this data can be downloaded from Eurostat, EU27 Trade since 1995 by CN8).

But 75% of the Eurozone’s exports to China flow from just three countries: Germany, 54%, France, 11%, and Italy 10% (average Jan 2009 – Feb 2010 and see table below). This makes sense, given that Germany, France, and Italy are the three largest countries in the Eurozone.

However, compared to the size of their economies, Belgium and Germany are the true beneficiaries of China’s external demand, not Spain, France, nor Italy. And this trade data is truncated before the record decline of the euro.

The table above relates each country’s share of total Eurozone exports to China to its share of Eurozone GDP. I’d say that Belgium is doing quite well compared to its larger neighbors, +2.5% spread on a 3.8% share base. But Germany's out of this world, 26.9% spread on a 26.8% share base. Spain, France, and Italy are faring poorly, as their spreads are wide and negative.

China appears to be the panacea for just a handful of countries, most notably Germany and Belgium. But alas, it’s no panacea for the Eurozone, not even for Germany. Unfortunately, the Eurozone's fragile developed colleagues, the US and UK, are.

The shares illustrated in the chart are calculated for year 2009.

Markets anxiously await China’s every move; but according to the April 2010 IMF World Economic Outlook, China ran the largest current account surplus across the IMF member countries - $284 bn in 2008 – the 20th largest as a share of GDP. That kind of saving is NOT going to get the global economy back on its feet in full very quickly. China is not the answer for Europe.

The Eurozone, in particular, is paying close attention to non-Eurozone (16 countries adopted the euro as their currency) growth alternatives. I leave you with an excerpt from a nice FT article on Europe’s true woes – fiscal austerity measures - featuring the research of Wynne Godley and Rob Parenteau:

Many years ago, he [Wynne Godley] also criticised the institutional arrangements of the European Monetary Union. Writing in The Observer in August 1997, he noted that members of the eurozone were not only giving up their currencies but also their fiscal freedom. Within the union, a government could no longer draw cheques on its own central bank but must borrow in the open market. “This may prove excessively expensive or even impossible,” he warned.

He went on to caution that without a common European budget, there was a danger that “the budgetary restraint to which governments are individually committed will impart a disinflationary bias that locks Europe as a whole into a depression that it is powerless to lift”.

China is not the answer: not for Europe; not for the US; and not for the UK.

Rebecca Wilder

Rebecca on sabbatical for six weeks

2010-05-01T07:50:00.004-04:00

It's that time again! Some of you all may remember my sabbatical back in November 2009. Well, I must take 4-6 weeks again to prepare for a professional exam.

Will be back at the beginning of June. I wonder: what will bond markets in Europe look like then?

Rebecca Wilder