Japan's Industry Reels Under The Slump In World Trade

Japan's economy certainly looks to be one of the worst case scenarios globally at the moment. Indeed, as Claus Vistesen puts it (in a very fine and thoroughly argued post - Engine Failure - that you can see here): "Final estimates from Q4 2008 suggested that Japan contracted at an annualized 12.1% which puts Japan in the dubious pole position of biggest GDP declines among industrialised economies."

This record breaking negative performance seems in danger, not only of being repeated, but even of being surpassed, in the current quarter, since Japanese industrial output slid for the fifth month in a row in February as falling exports gradually took their toll on the entire conomy, with production being down 38.4% year on year.

The seasonally adjusted Nomura/JMMA Japanese Manufacturing PMI (Purchasing Managers' Index) remained deeply entrenched in negative territory in March, posting a reading of 33.8. Up on February, but still well, well below the 50 contraction boundary reading. Despite rising for the second straight month, the headline index still signalled the fourth-sharpest deterioration in operating conditions recorded by the series to date.



In what should be seen as a very real and immediate warning survey respondents signalled that domestic demand and the employment outlook had deteriorated as clients postponed investment expenditure given the bleak economic outlook. Data also pointed to a sharp drop in new work received from abroad. This seems to imply that we will now get an ongoing series of "second round" effects, as investment is postponed, and consumers hang on to their money just in case they are not able to hang onto their job.

In another warning signal, average cost burdens declined at the fastest rate in just over seven years in March. Survey responses frequently linked the latest drop to lower prices for a wide range of raw materials amid low demand in global markets. March marked the fourth month running in which input prices have decreased. Japanese prices already seem to be well back in deflation territory.

So, despite the fact that Japanese Finance Minister Kaoru Yosano said last Friday that February's fall in the so called "core-core" consumer price index doesn't mean Japan is back in deflation, few are ready to accept his judgement. Indeed, if you look at the core-core line in the chart below, it is at least debateable whether the Japanese economy was ever out of it in the first place. But the present debate has really been set of by data that was released on Friday which showed a 0.1% on-year fall in the core-core index (that is the basic index with food and energy stripped out), while the core consumer price index (which only excludes food) was flat from a year earlier.


The average index reading over the quarter dropped from 36.6 in Q4 2008 to 31.7 in Q1 2009. It is hard to put a precise GDP number on what this means, but plunging global demand - the World Trade Organization said last week that global commerce may well shrink 9 percent this year - and weak consumption at home, may well mean Japan’s economy shrinking by anything between 3% and 4% per cent in the first quarter, extending the run of contraction to four quarters in a row.

Export Slump

Japan’s exports plunged a record 49.4 percent in February as deepening recessions elsewhere hit demand for Japanese products. Shipments to the U.S., which is still Japan’s biggest market, tumbled an unprecedented 58.4 percent from a year earlier, with automobile exports down a horrific 70.9 percent.



It is clear that Japanese companies cut inventories at an unprecedented pace in February so we may well now see some sort of increase in production in coming months.Inventories fell 4.2 percent, the biggest decrease since record-keeping began in 1953.

“The sharp adjustments in production and inventories are probably finished,”
said Sugiura, chief economist at Mizuho Research Institute in Tokyo. “But we
don’t expect a sharp rebound in production because exports are dropping very
significantly.”

This second monthly reduction means that Japan's inventories are now at their lowest level since August 2007. Asa result manufacturers forecast they would raise output 2.9 percent in March and 3.1 percent in April - but this is not what the March PMI shows, rather there is a continuing contraction, but at a slower pace as there are not so many inventories to run down now. Toyota now expects to have adjusted inventories to levels that reflect demand by April, according to its President Katsuaki Watanabe. Toyota cut global output a record 53 percent in February and led the 56 percent decline in Japan’s domestic vehicle production, the biggest drop since at least 1967.

Japan’s 12 car manufacturers produced 481,396 vehicles (according to the Japan Automobile Manufacturers Association), while car exports dropped 64 percent to 212,107 vehicles, with North American shipments falling 66 percent. As well as Toyota, Nissan, Mazda and Mitsubishi Motors all cut domestic production by at least 60 percent last month to trim inventory. Japan’s domestic car production has now posted record drops every month since November.

Hungary faces ‘painful crisis management’

From the financial times:


Hungary faces ‘painful crisis management’

By Thomas Escritt in Budapest

Published: March 30 2009 16:33 | Last updated: March 30 2009 16:33

Gordon Bajnai, the Hungarian economics minister who is set to become prime minister next week, promised a period of ”painful” crisis management at a press conference on Monday, as the country’s finance minister suggested the new leader may get less than a year to do his job.

Mr Bajnai said: ”It will be painful. Crisis management will demand sacrifices from every Hungarian family.” He is expected to announce spending cuts, which could include dramatic cutbacks to Hungary’s generous social safety net.

Mr Bajnai, a political independent who is a close ally of Ferenc Gyurcsany, the outgoing prime minister, was the fifth and final candidate floated after a week of increasingly chaotic and leak-strewn negotiations between the governing Socialist party and their liberal Free Democrat allies following the deeply unpopular prime minister’s announcement last week that he would stand aside.

Hungary, which turned to the International Monetary Fund for a €20bn bail-out last autumn, is sliding into a deep recession even as a heavy burden of public and private sector debt limits the country’s ability to spend its way through the downturn. The export-dependent economy is forecast to shrink by 4 per cent this year, while the debt burden remains large, despite Mr Gyurcsany’s achievement in shrinking the budget deficit from 9 per cent to 3 per cent over the past three years. The unemployment rate, currently at 9 per cent, is rising.

Parliament will vote on Mr Bajnai’s appointment on 14 April. Janos Veres, the finance minister, said he was confident the Socialists and Free Democrats could muster the majority needed to appoint him. ”This government must last long enough to prepare and pass in parliament a budget for 2010,” he told the Financial Times. Hungary passes its budget in December, while elections must be held by spring 2010 at the latest.

Japan’s output slides for fifth month

Japanese industrial output slid for the fifth month in a row in February as weak exports weighed on an economy mired in its worst recession since the second world war, but there were tentative signs of recovery.

Manufacturers said they expected output to rise in March and April and they reported a record fall in inventories in February, showing that rapid production cuts in response to the global financial crisis had helped reduce stockpiles of unsold goods.


Still, the government plans to map out a new stimulus package ahead of a G20 summit in London this week to support householders and the service sector to boost the economy, with unemployment forecast to rise and wages stagnant.

“Industrial production will probably bottom out in the second quarter and start rising in the third quarter,” said Kyohei Morita, chief economist at Barclays Capital.

“Manufacturers are bottoming out by cutting costs and jobs, which has a negative impact on households and nonmanufacturers. We need fiscal stimulus for these parts of the economy, and the government may announce something specific at the G20 meeting.”

Hit by plunging global demand and weak consumption at home, Japan’s economy is seen shrinking 2.5 per cent in the first quarter and 0.4 per cent in the second quarter, extending the run of contraction to five quarters in a row.

Highlighting the lack of confidence in the domestic and global economies, the Bank of Japan’s closely watched Tankan survey due on April 1 is expected to show sentiment among big manufacturers tumbled to the lowest since 1975.

Japanese companies cut inventories at an unprecedented pace in February and said they would increase production in coming months, indicating the worst of the country’s manufacturing slump may be over.

Inventories fell 4.2 percent last month, the biggest decrease since record-keeping began in 1953, the Trade Ministry said today in Tokyo. Factory output slid 9.4 percent from January, when it plunged a record 10.2 percent.

Production may rise for the first time since September after companies from Toyota Motor Corp. to Nissan Motor Co. burned off stockpiles by temporarily closing plants. Japan’s recession will linger “for the next few quarters” because global demand remains weak, said economist Tetsuro Sugiura.

“The sharp adjustments in production and inventories are probably finished,” said Sugiura, chief economist at Mizuho Research Institute in Tokyo. “But we don’t expect a sharp rebound in production because exports are dropping very significantly.”

The second monthly reduction in stockpiles brought them to the lowest level since August 2007, today’s report showed. Manufacturers said they’ll raise output 2.9 percent in March and 3.1 percent in April, ending a five-month losing streak.

Toyota expects to have adjusted inventories to levels that reflect demand by April, President Katsuaki Watanabe said last week. The carmaker, which cut global output a record 53 percent last month, plans to ease domestic production cuts from May, he said.

Nippon Steel, Nissan

Nippon Steel Corp. last month said production should improve next quarter because customers have used up their supplies. Nissan, Japan’s third-largest automaker, says it will raise domestic output next month.

“Production cuts may already be bottoming out,” said Shinichiro Kobayashi, a senior economist at Mitsubishi UFJ Research and Consulting Co. in Tokyo. “That that doesn’t necessarily mean overseas demand is already recovering.”

Exports plunged a record 49.4 percent in February from a year earlier as sales of cars and electronics dried up. The World Trade Organization said last week that global commerce will shrink 9 percent this year, the most since World War II.

Companies have been quicker to react to the drop in demand than in previous slumps, economists said. Manufacturers were reluctant to shed workers and shut plants after Japan’s stock and property bubbles burst in the early 1990s, contributing to the so-called lost decade of economic stagnation.

Learned Lesson

“As a result of that experience, Japanese managers have come to believe they need to adjust very quickly in order to avoid the excess inventories, capacity and debt of the past,” said Sugiura at Mizuho Research.

Japanese companies aren’t alone in slashing production to get rid of stockpiles. U.S. factory inventories have fallen every month since September; in December, they dropped by 1.9 percent, the biggest monthly decline in 62 years of record- keeping. A JPMorgan Chase & Co. index of global inventory growth is close to an 11-year low, economist David Hensley said in a March 11 note.

U.S.-based Caterpillar Inc., the world’s largest maker of construction equipment, has been allowing dealers to cancel orders as it cuts production. Renault SA, France’s second- biggest carmaker, said in January that “inventory management and reduction will remain a priority throughout 2009.”

“Companies have succeeded, as you can see in today’s data, at cutting inventories back,” said Richard Jerram, chief Japan economist at Macquarie Securities Ltd. in Tokyo. “They’re starting to move production back more into line with demand, which is still depressed but obviously going to be a stronger level than the January-February period.”

Toyota Motor Corp. led a 56 percent decline in Japan’s domestic vehicle production last month, the biggest drop since at least 1967, on slumping U.S. and European demand.

Local production at Japan’s 12 automakers fell to 481,396 vehicles from a year earlier, the Tokyo-based Japan Automobile Manufacturers Association said in a statement today. Exports dropped 64 percent to 212,107 vehicles, with North American shipments falling 66 percent. The output and export drops were the biggest since the group began tracking the data.

Toyota, Japan’s biggest automaker, Nissan Motor Co., Mazda Motor Corp. and Mitsubishi Motors Corp. each cut domestic production by at least 60 percent last month to trim inventory. The worst economic crisis since the Great Depression has sapped demand worldwide, sending February U.S. car sales to the lowest level since December 1981. Japan’s domestic auto production has posted record drops every month since November.

“There are now signs that after the large-scale cuts in production in the first quarter, inventory levels are coming down,” said Ashvin Chotai, managing director of Intelligence Automotive Asia Ltd., an automotive consulting company in London. “This will take pressure off further cuts, and hopefully to a slow recovery in the second half of the year.”

Toyota and Mazda, Japan’s two-biggest car exporters, plan to ease domestic production cuts that started last year after adjusting inventory. Toyota will relax the cutbacks from May, President Katsuaki Watanabe said last week. Mazda will resume production on Fridays at two of its four domestic plants for the first time in three months in April, it said on March 13.

U.S. Demand

If automakers fail to pare production cuts, it may threaten jobs. Nationwide March auto production needs to be half of last year’s rate to raise the fiscal year tally to 10 million, according to the automakers group. Automakers have said that annual production must top this level to safeguard employment. In the 11 months ended February, output totaled 9.44 million vehicles, down 12 percent from a year earlier.

Cars and light trucks sold at an annual pace of 9.12 million last month in the U.S., the biggest market for Japanese carmakers, a drop from 15.4 million a year earlier, according to Autodata Corp.

Toyota Production

Toyota’s domestic production last month plunged 64 percent to 141,127 the lowest level since the company began publishing tallies in 1976, it said March 24. Exports from Japan plunged 69 percent to 72,595.

Honda said production in Japan fell 48 percent to 54,748 vehicles. The drop was the biggest since it began releasing the figure in August 1996. Nissan, Japan’s third-largest automaker, reported a 69 percent fall in domestic production after exports slumped 78 percent. Nissan is cutting output by 64,000 vehicles in February and March.

Mazda, the largest car exporter after Toyota, built 60 percent fewer vehicles in Japan. Mitsubishi Motors, the maker of Pajero sport-utility vehicle, cut domestic production by 77 percent.

Japan’s five-year bonds rose, ending four days of losses, as a government report showing industrial output slid for a fifth month boosted demand for the relative safety of debt.

Five-year yields declined from a one-week high as stocks slipped after real-estate broker Azel Corp. filed for bankruptcy and an Obama administration official said General Motors Corp. and Chrysler LLC may face bankruptcy. The Bank of Japan’s Tankan survey due this week may show business sentiment dropped to the lowest level in 34 years, according to a Bloomberg News survey of economists.

“Incoming economic data will show the poor state of the Japanese economy,” said Akihiko Inoue, chief market analyst at Mizuho Securities Co., a unit of Japan’s second-largest banking group. “Weak economic fundamentals support the bond market.”

The yield on the benchmark five-year note fell half 1.5 basis points to 0.77 percent as of 4:37 p.m. at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The price of the 0.8 percent security due in March 2014 rose 0.072 yen to 100.143 yen. A basis point is 0.01 percentage point.

The yield on the benchmark 10-year note dropped half a basis point to 1.325 percent and 10-year bond futures for June delivery rose 0.09 to 138.30 at the afternoon close on the Tokyo Stock Exchange.

Industrial production slid 9.4 percent in February from the previous month, extending the longest losing streak since 2001, the Trade Ministry said in Tokyo. The Tankan sentiment index for large manufacturers slid to minus 55 in March, from minus 24 in December, according to the Bloomberg survey of 23 economists before the April 1 report.

‘More Tailwinds’

“If the headline number for large manufacturers slides to below a historical low, the bond market will see more tail- winds,” said Kazuhiko Sano, chief strategist in Tokyo at Nikko Citigroup Ltd., a unit of the second-largest U.S. bank. “Japanese investors may also try to buy bonds once the new fiscal year starts on April 1.”

The gain in bonds was tempered by concern the supply of debt will keep increasing as the government raises record amounts to fund spending to counter the recession.

Japanese Prime Minister Taro Aso is compiling a third stimulus package to add to the amount pledged since he took office six months ago. The Ministry of Finance said in December it plans to boost bond sales by 7 trillion yen ($71.3 billion) to 113.3 trillion yen in the financial year beginning April 1.

“There is the risk of debt sales increasing by an additional 10 trillion yen stemming from the compilation of new pump-priming measures,” said Eiji Dohke, chief strategist in Tokyo at UBS Securities Ltd. “We will maintain a ‘sell on rally’ recommendation for longer-maturity bonds.”

U.S. Carmakers

Japanese bonds are headed for the first quarterly loss since the three months to June 30, and U.S. Treasuries are set for their worst start to the year since 1996, as the governments of the world’s two biggest economies increase debt sales to fund measures to combat the global recession.

Demand for fixed-income assets also rose as the Nikkei 225 Stock Average slid 4.5 percent on concern the global financial turmoil will worsen.

General Motors Corp. and Chrysler LLC must overhaul their recovery plans with deeper concessions to justify further taxpayer aid, and bankruptcy may ultimately be their best chance, the Obama administration official said before details of the plan are released today. The administration also asked GM Chief Executive Officer Rick Wagoner to step down, according to the official who declined to be identified.

“We need to ascertain further developments on this delicate issue carefully, especially how stock markets react to it,” said Katsutoshi Inadome, a Tokyo-based strategist at Mitsubishi UFJ Securities Co., a unit of Japan’s largest banking group. If the Chapter 11 filing “leads to a stock decline, it should support bonds,” he said.

Japanese industrial production fell for a fifth month in February, the longest losing streak since 2001, as exports collapsed.

Factory output declined 9.4 percent from January, when it plummeted a record 10.2 percent, the Trade Ministry said today in Tokyo. Inventories fell an unprecedented 4.2 percent.

Companies surveyed said they will increase production in March and April as they begin to replenish stockpiles they managed to get rid of even as demand evaporated. Manufacturers worldwide are cutting inventories, a sign that output may pick up later this year, providing relief for a global economy that is contracting for the first time in six decades.

“Production cuts may already be bottoming out,” said Shinichiro Kobayashi, a senior economist at Mitsubishi UFJ Research and Consulting Co. in Tokyo. “We should remember that that doesn’t necessarily mean overseas demand is already recovering.”

The yen traded at 98.15 per dollar at 10:16 a.m. in Tokyo from 98.08 before the report was published. The currency is heading for its worst quarter since 2001 as the world’s second- largest economy deteriorates faster than the U.S. and Europe. The Nikkei 225 Stock Average fell 1.2 percent.

Japan’s exports plunged a record 49.4 percent in February from a year earlier as sales of cars and electronics dried up. Toyota Motor Corp., forecasting its first net loss in more than five decades, plans to cut thousands of jobs and slash domestic production by half this quarter.

Tankan Survey

Sentiment among the nation’s largest manufacturers has fallen to its lowest level in more than 30 years, economists predict the Bank of Japan’s Tankan survey will show on April 1. The country’s largest firms plan to cut investment by 12 percent next fiscal year, the biggest pullback since at least 1983, economists predict the survey will show.

Prime Minister Taro Aso is preparing his third stimulus package since October to counter the slump. Finance Minister Kaoru Yosano said on March 22 that a plan of as much as 20 trillion yen, double the total amount pledged since October, is “not out of line” as the economy heads for its worst recession since 1945.

“The longer this stretches out, the harder the domestic economy is going to be hit,” said Martin Schulz, senior economist at Fujitsu Research Institute in Tokyo. “The government really needs to come out with another package.”

Spending Billions

Governments around the world are spending billions of dollars to spur domestic demand as global trade seizes up. Economists say a Japanese recovery hinges on whether a combined $1.4 trillion of spending in the U.S. and China, the country’s two biggest markets, is enough to revive demand for its cars and electronics in the second half of the year.

There are signs a recovery may be stirring in the U.S., Japan’s biggest market. U.S. orders for durable goods rose in February for the first time in seven months. Inventories of long-lasting durable goods fell for a second month and new home sales increased for the first time since July.

In Japan, the drop in inventories adds to evidence that the worst of the manufacturing slump may be over. Companies said they would increase production 2.9 percent this month and 3.1 percent in April, today’s survey showed.

Nippon Steel Corp. said last month output should improve next quarter because customers have used up their stockpiles. Nissan Motor Co., Japan’s third-largest automaker, said on Feb. 26 it will raise domestic production next month.

“Companies have succeeded, as you can see in today’s data, at cutting inventories back,” Richard Jerram, chief Japan economist at Macquarie Securities Ltd. in Tokyo, said on Bloomberg Television. “They’re starting to move production back more into line with demand, which is still depressed but obviously going to be a stronger level than the January- February period.”

Two Graphs That Tell It All On Spain

The average interest rate in January 2009 was 5.64%, indicating growth of 10.2% in the interannual rate, and of 1.1% as compared with December 2008.

By institution, the average interest rate of Savings Bank mortgage loans was 5.72%, and the average term was 23 years. Regarding Banks, the average interest rate for mortgage loans was 5.63% and the average term was 20 years. 95.4% of the mortgages constituted in January used a variable interest rate, as opposed to the 4.6% that used a fixed rate. Within the variables, the Euribor was the reference interest rate most used in constituting mortgages, specifically in 87.4% of new contracts.





Bancos y cajas incrementan los tipos de interés para compensar la morosidad | El interés medio de las hipotecas es 5,64%, medio punto más que hace un año | La constitución de nuevas hipotecas ha descendido un 43% hasta febrero | La banca está siendo mucho más estricta y sólo concede el 80% del valor del piso.

Los compradores que acudieron en enero de este año a las entidades financieras para firmar una hipoteca nueva pagaron de media de tipo de interés un 10,2% más que los que formalizaron su contrato en el mismo mes hace justamente un año, pese a que el Euribor roza estos días el nivel más bajo de su historia. Previsiblemente, cerrará el mes a 1,91%.

Ese incremento del 10,2% representa medio punto más en el tipo medio del interés de los créditos hipotecarios, al pasar del 5,1% en enero del 2008 al 5,64% del mismo mes este ejercicio, según los datos ofrecidos ayer por el INE, que recogen las hipotecas constituidas a principios de año. Precisamente, el Euribor cerró por esas mismas fechas -el primer mes de este año- en 2,27%.

La clave de esta aparente contradicción radica en que pese a que el tipo de interés que fija el Banco Central Europeo ha descendido, las entidades financieras han incrementado sus márgenes tanto por una mayor prudencia (lo que ellos denominan prima de riesgo) como por el aumento de la morosidad, que compensan a costa de los nuevos clientes.

Por ejemplo, entidades como La Caixa ofrecían en su oficina del distrito de Las Tablas, en Madrid, préstamos a un interés del Euribor más 0,75% hace un año y ahora sus propuestas rondan el Euribor más 1,25%. Con todo, el precio definitivo dependerá del perfil de cada cliente. Es decir, a partir de factores como la edad, los rendimientos netos anuales, si cuenta con otro crédito hipotecario o no, o la vida del préstamo, entre otros. Incluso así, la política puede divergir en cada entidad en función de las ofertas que formulan.

El argumento que esgrime la mayor parte de las entidades financieras para defenderse de las críticas de la opinión pública es que la prima de riesgo de los clientes ahora es mucho más alta. Ayer, Miguel Martín, presidente de la Asociación Española de la Banca (AEB), manifestó que el hecho de que el tipo medio de las hipotecas actuales esté casi en el mismo nivel que hace un año pese a la caída del Euribor se debe al auge de la morosidad yal incremento de las provisiones que debe realizar la banca para cubrirse, informa Lalo Agustina.

Por otra parte, algunos profesionales del sector bancario explican que las entidades financieras están haciendo valoraciones mucho más estrictas del precio real de las viviendas y, por norma, no se arriesgan a financiar más del 80% del precio final, cuando en los años de bonanzas y alegría financiera, que fueron los mismos que los ejercicio del boom inmobiliario, se concedían créditos hipotecarios cuyo valor llegaba hasta el 120% del valor final del piso.

"Los márgenes de la banca son bastante más altos que estos años atrás para compensar las pérdidas por morosidad de clientes que tienen en sus actuales carteras, como créditos al promotor", explica Rafael Pampillón, profesor del Instituto de Empresa. Y pone un ejemplo muy gráfico: "Los bancos son como tiendas de alimentación que tienen algunas patatas podridas en su cesta y para compensar están poniendo precios más caros a la nueva cosecha, donde sí espera ganar y, así, costear las pérdidas de los impagos", sentencia. Para este experto, la banca no se ha convertido en una explotadora o avariciosa, "sino que compensa las patatas podridas con las buenas".

Otro de los temas más controvertidos se produce a la hora de revisar las hipotecas vigentes. "La gente actualiza el tipo de interés variable, en función de su contrato, pero lo normal es cada seis o doce meses", señala José Manuel Campa, profesor del Iese, quién añade: "La banca incrementa su margen cuando baja el Euribor, pero también disminuye su margen cuando sube el Euribor".

Por otra parte, el ritmo de constitución de las hipotecas en enero ha caído un 43,5% respecto a un año antes, hasta las 53.017, y redujo el capital prestado a 6.472,9 millones, un 51,7% menos. Además, el importe medio de las hipotecas constituidas sobre viviendas bajó por duodécimo mes consecutivo y se situó en 122.091 euros, con lo que acumula una caída interanual del 14,5%, según los datos facilitados ayer por el INE. En Catalunya el ritmo de concesión de hipotecas cayó en una proporción que ronda el 49%.

Euro-Zone PMI Holds Near Record-Low In March

The Euro-Zone PMI composite unexpectedly rose to 37.6 in March from a record low of 36.2 in the previous month, while the PMI reading for manufacturing and services rose to 34.0 and 40.1 respectively. Meanwhile, economic activity in German improved during the same period as the manufacturing PMI increased to 32.4 from 32.1




Barring some spectacular (and entirely improbable) turnaround in March it now seems likely that the Q1 GDP contraction will be worse than the Q4 2008 one. If we consider that the eurozone contracted by 0.2% in Q3 2008, and by 1.5% in Q4, then, in my humble opinion, the data we are seeing for this quarter are entirely consistent with a 2% quarterly contraction (or an annualised 8% rate of contraction). Not quite Japan territory yet, but not far behind. And for those who simply don't believe the PMIs can tell you so much, here is Markit's own chart, showing the strong underlying relationship between movements in GDP and the *flash* composite PMI. Pretty impressive I would say.

ECB explores expansion of economic armoury

From The Financial Times This Morning:


ECB explores expansion of economic armoury

By Ralph Atkins in Frankfurt

Published: March 26 2009 18:56 | Last updated: March 26 2009 18:56

The European Central Bank is actively exploring expanding its armoury to tackle the worst recession seen in continental Europe since the second world war. But it still seems some way from deploying the weapons being used in the US and UK.

ECB policymakers began their pre-meeting purdah on Thursday, a week ahead of their next policy meeting, having made clear there is “room for manoeuvre” to cut interest rates further. That makes possible, but not certain, a 25 or 50 basis point reduction in the main policy interest rate, currently at a record low of 1.5 per cent.


However, the days when central banks used only one instrument to steer an economy are over.

Lucas Papademos, ECB vice-president, heightened expectations that the central bank could soon start buying assets outright after noting in Brussels on Thursday that purchases of private debt securities could “reduce the cost of funding of the real economy, thus helping its recovery”.

Whether and when such a move is taken will depend on the outcome of soul-searching and debate within the ECB’s governing council. Comprising national central bank governors from the 16 eurozone countries and the six ECB executive board members, the council includes nine economic professors, some of whom – such as Athansasios Orphanides of Cyprus – have worked as academics in the US.

One lobby is hesitant to change substantially the way the ECB has operated since the collapse of Lehman Brothers last September paralysed financial markets.

The ECB’s assessment of eurozone prospects has remained broadly unchanged from last month, when it forecast gross domestic product could fall by up to 3.2 per cent this year. Deflation – persistent and general falls in prices – is still seen as unlikely, thanks to the eurozone’s economic rigidities.

Mr Papademos stressed the ECB’s current focus on what it calls “enhanced credit support” – its answer to “quantitative easing” – by which it provides banks with unlimited amounts of liquidity at fixed interest rates.

Banks play a much larger role in supplying finance to the economy than in the US, the argument goes, and the ECB’s assessment is that the “transmission channel” continues to function reasonably well.

A distinct possibility is that the ECB will next week extend the maximum maturity of the funds it lends from the current six months – perhaps to nine or 12 months.

More indicative of the way the debate is going will be what happens to its “deposit facility” interest rate, paid on sums deposited at the ECB overnight, and set at 100 basis points below the main policy rate.

Under “enhanced credit support”, the deposit facility rate has surreptitiously become an important benchmark for market interest rates.

But within the ECB there is resistance to a reduction from the current 0.5 per cent, on the grounds that it would mean, in effect, the ECB was operating a “zero interest rate” policy – a serious taboo for some council members.

Outright asset purchases, as at the US Federal Reserve or Bank of England, would take the ECB still further into new territory.

Conservatives on the council would worry about the political implications. Buying corporate debt could mean it having to favour particular countries or industries – for instance, car manufacturers.

Even worse for some, would be buying government bonds – which would blur the boundaries between central banks and governments and thus threaten the ECB’s cherished independence.

Japan's Exports Fall

Japan’s exports plunged a record 49.4 percent in February as deepening recessions in the U.S. and Europe sapped demand for the country’s cars and electronics.

Shipments to the U.S., the country’s biggest market, tumbled an unprecedented 58.4 percent from a year earlier, the Finance Ministry said today in Tokyo. Automobile exports tumbled 70.9 percent.

Japan - The Lost Quarter Century

Despite the fact that Japanese Finance Minister Kaoru Yosano said Friday that February's fall in the so called "core-core" consumer price index doesn't mean Japan is back in deflation, few are ready to accept his judgement. Data released on Friday showed a 0.1% on-year fall in the core-core index (that is the basic index with food and energy stripped out), while the core consumer price index (which only excludes food) was flat from a year earlier.



The preoccupying inflation news came on the same day we learnt that retail sales had retreated in February by the biggest margin in seven years in February, as growing concerns about jobs and wages had an obvious impact on Japanese shopping habits. Retail sales were down 5.8 percent from a year earlier (to 9.98 billion yen) — the sharpest decline since February 2002. The figure marks the sixth straight month that sales have fallen at retail outlets like department stores and supermarkets.

Business at department stores, which tend to reflect spending on luxury goods and premium items, was especially bleak in February, with sales down 11.5 percent from a year earlier.



And the reason why prices are falling, and workers are fearful for their jobs? Well just look at the export numbers : Japan’s exports plunged a record 49.4 percent in February as deepening recessions elsewhere hit demand for Japanese products. Shipments to the U.S., which is still Japan’s biggest market, tumbled an unprecedented 58.4 percent from a year earlier, with automobile exports down a horrific 70.9 percent.





So the massive contraction in industrial output that this decline in export business is producing is sending shock waves through the economy, and it is the pressure form all the excess capacity that is now forcing prices downwards. Nowhere is the process clearer in land and property values, long the key driver of the deflation process in Japan - and we learnt only this week that Japanese residential land prices fell 3.2 percent to a 24-year low last year - their lowest level since 1984. Overall property prices declined 3.5 percent, wiping out completely the recent two years of gain that followed the earlier 15-year slump.

And the decline in residential land values, which are about half of what they were at the height of the bubble in 1991, only looks set to continue as the recession deepens. So in property market terms at least, it isn't the lost decade anymore, we're now moving into the "lost quarter century".

We Won't Let Anyone Go Bust

A senior German lawmaker said euro zone states stood ready to come to the aid of financially fragile members of the currency bloc, sparking furious denials from European leaders that a specific rescue plan existed. Otto Bernhardt, a leading lawmaker in Angela Merkel's Christian Democrats (CDU), told Reuters in an interview late on Thursday: "There is a plan."

He added: "The finance ministers have agreed the procedures. The core point is: 'We won't let anyone go bust'." Speculation has grown in recent weeks that stronger members of the 16-nation euro zone, like Germany, could step in at some stage to help ailing partners. But officials have been reluctant to speak openly about how this aid would work for fear of aggravating problems in ailing euro economies like Ireland and Greece. Bernhardt's comments triggered a fierce response from political leaders around Europe.

The prime ministers of Italy, Ireland and Greece said no plan had been agreed to bail out euro zone countries and German Finance Minister Peer Steinbrueck also said he could not confirm the veracity of Bernhardt's remarks. Bernhardt also later contacted Reuters to qualify the comments he gave in the interview. He said in the conversation on Friday that although politicians were obliged to formulate a broad plan of action he knew of no blueprint to address a country in trouble now.
"My main point stands: A euro country cannot go bankrupt, because the currency would collapse," Bernhardt added.

In the Thursday interview, he said that of all the euro zone states, Ireland was in the "worst situation of all", followed by Greece. He made clear that any aid would come at a price. "We would look very closely at past sins," Bernhardt said. "We will not tolerate there being low-tax countries like Ireland for example. We will insist on a minimum corporate taxation rate."

Countries such as Ireland and Greece have been hit hard by a sharp economic downturn and are now being forced to pay hefty premiums over stronger bloc members to finance their debt, aggravating their financial troubles. Irish Prime Minister Brian Cowen dismissed the comments by Bernhardt, and Greek Prime Minister Costas Karamanlis denied the existence of such a plan. Italian Prime Minister Silvio Berlusconi said that while there was no plan to rescue weaker members, any euro zone country in trouble would be shown solidarity by other members.

Jean-Claude Juncker, Luxembourg Prime Minister and head of the Eurogroup finance ministers' forum, also said the euro zone would be able to respond immediately if one of its members risked a default. "If it ever did happen -- it won't happen -- the euro zone would be able to provide a response in a few hours," he said. Asked what the likelihood was that a euro member would need to be supported, Bernhardt had said: "It depends on how the international crisis develops. It could be that they (Ireland) can manage without getting credit." "But the chances we will need to help are greater than the chances that we will not need to help," he added.
Steinbrueck has acknowledged that Berlin stands ready to help weaker euro members but he again underlined on Friday that no euro zone country currently faced payment problems.

Bernhardt said in the Thursday interview that the danger for Germany of not helping would outweigh the cost of helping: "What is the alternative? We would otherwise lose our currency."

A senior German lawmaker said euro zone states stood ready to come to the aid of financially fragile members of the currency bloc, sparking furious denials from European leaders that a specific rescue plan existed.

Otto Bernhardt, a leading lawmaker in Angela Merkel's Christian Democrats (CDU), told Reuters in an interview late on Thursday: "There is a plan."

He added: "The finance ministers have agreed the procedures. The core point is: 'We won't let anyone go bust'."

Speculation has grown in recent weeks that stronger members of the 16-nation euro zone, like Germany, could step in at some stage to help ailing partners.

But officials have been reluctant to speak openly about how this aid would work for fear of aggravating problems in ailing euro economies like Ireland and Greece.

Bernhardt's comments triggered a fierce response from political leaders around Europe.

The prime ministers of Italy, Ireland and Greece said no plan had been agreed to bail out euro zone countries and German Finance Minister Peer Steinbrueck also said he could not confirm the veracity of Bernhardt's remarks.

Bernhardt also later contacted Reuters to qualify the comments he gave in the interview.

He said in the conversation on Friday that although politicians were obliged to formulate a broad plan of action he knew of no blueprint to address a country in trouble now.

"My main point stands: A euro country cannot go bankrupt, because the currency would collapse," Bernhardt added.

In the Thursday interview, he said that of all the euro zone states, Ireland was in the "worst situation of all", followed by Greece. He made clear that any aid would come at a price.

"We would look very closely at past sins," Bernhardt said. "We will not tolerate there being low-tax countries like Ireland for example. We will insist on a minimum corporate taxation rate."



BACKUP

Countries such as Ireland and Greece have been hit hard by a sharp economic downturn and are now being forced to pay hefty premiums over stronger bloc members to finance their debt, aggravating their financial troubles.

Irish Prime Minister Brian Cowen dismissed the comments by Bernhardt, and Greek Prime Minister Costas Karamanlis denied the existence of such a plan.

Italian Prime Minister Silvio Berlusconi said that while there was no plan to rescue weaker members, any euro zone country in trouble would be shown solidarity by other members.

Jean-Claude Juncker, Luxembourg Prime Minister and head of the Eurogroup finance ministers' forum, also said the euro zone would be able to respond immediately if one of its members risked a default.

"If it ever did happen -- it won't happen -- the euro zone would be able to provide a response in a few hours," he said.

Asked what the likelihood was that a euro member would need to be supported, Bernhardt had said: "It depends on how the international crisis develops. It could be that they (Ireland) can manage without getting credit."

"But the chances we will need to help are greater than the chances that we will not need to help," he added.

Steinbrueck has acknowledged that Berlin stands ready to help weaker euro members but he again underlined on Friday that no euro zone country currently faced payment problems.

Bernhardt said in the Thursday interview that the danger for Germany of not helping would outweigh the cost of helping: "What is the alternative? We would otherwise lose our currency."

Do They Have Parachutes In Bulgaria?

Someone was asking in comments yesterday about hard data to confirm the general impression that the economy is tanking. Well by accident I came across this little detail today: retail sales down 25.7% year on year in January. For an economy which has been driven by a consumer borrowing and lending boom, that is pretty dramatic evidence I would say.

Retail sales revenue in Bulgaria declined by 25.7% in January from the same month of last year, the National Statistical Institute (wwwo.nsi.bg) said in a statement. The slump was attributed to a sharp decrease in retail sales of larger consumer goods, although a decline is normal for the beginning of each year. A major 31.5% drop was reported in sales of vehicles and technical maintenance. Revenue generated by non-food sales went up by 3.0% year-on-year, the data showed. Revenue from food, beverages and cigarettes sales showed a minor increase of 0.5%

Update

Well I am finding more data, and I will keep adding it a bit at a time.

Bulgaria's industrial output fell by 19% in January 2009 month-on-month, after rising by a monthly 1.7% in December, preliminary data of the National Statistics Institute (NSI) showed on Tuesday. This is the fourth drop in a row, causing the index to go below the 2006 levels. The industrial output index is mainly determined by the indicators of the processing industry, which dropped by 21,4% in January, compared to December 2008. There is a 66,5% decrease in the production of metal goods, excluding machines and appliances. In the production of non-metal goods the drop is by 42,1%, and in the food processing industry by 24,8%.

As can be seen in the chart below, the output index is now somewhere round the level of summer 2006, and falling.











Sharp Current Account Contraction

According to the Bulgarian National Bank last week Bulgaria's current account deficit was EUR 439.7 M in January 2009, down from EUR 806.8 M in January 2008.

PM Sergey Stanishev said "the country's deficit has begun rapidly shrinking which means that the economy has unsurprisingly slowed down," Bulgarian National Radio reported.

The current and capital account deficit was EUR 288.7 M in January compared to EUR 806.2 M recorded in the previous year.And January's trade deficit was EUR 339.3 M, narrowing from EUR 607.8 million in 2008. All this is consistent with a very sharp and rapid contraction of the economy, as imports collapse and fund flows dry up, rather than any positive news on exports.




Moody's Affirms Baa3 Rating


Credit ratings agency Moody's affirmed on March 20 Bulgaria's Baa3 local and foreign currency ratings, with a stable outlook, but said that Bulgaria's economy faced tough times this year.

"Bulgaria is likely to experience a difficult recession in 2009 as the economy suffers from shrinking exports and slowing inflows of foreign capital," Moody's sovereign risk group analyst Kenneth Orchard said in a statement. "Nevertheless, many years of prudent fiscal policy and low debt mean that the government is well positioned to cope with the situation."

Having averaged Budget surpluses of 2.7 per cent of gross domestic product (GDP) since 2004, the Cabinet has strengthened its financial position, but the main threat did not come from the Government debt, which was a very low 14 per cent of GDP.

"Many years of strong domestic demand growth have left the Bulgarian economy with heightened vulnerabilities. Domestic credit, external debt and the current account deficit all increased at rapid rates from 2005 to 2008," the ratings agency said.

Although the banking sector was in good shape, with relatively high capital adequacy and liquidity ratios by international standards, it would not take long for the situation to worsen as the global crisis takes deeper roots in Eastern Europe.

"The decline in foreign financing will probably cause a sharp downward adjustment in the current account deficit, implying declining output and weak government revenue growth," Orchard said. "However, Moody's believes that low wages and a flexible labour market will ease the adjustment and ultimately allow Bulgaria to rebound when the regional economy improves."

Bulgaria's most pressing problem was the large debt accumulated by the private sector. "Moody's believes that a greater risk comes from the large amount of private sector external debt that must be re-financed in 2009," Orchard said.



"Short-term external debt totalled around 13 billion euro at the end of 2008, which is equivalent to 40 per cent of GDP. Much of this debt is likely to be rolled over, but automatic re-financing can no longer be assumed in the current financial environment."

The low Government debt was a safety net, because it allowed Bulgaria to borrow funds to support the private sector and the currency board without threatening the government's creditworthiness. The debt-to-GDP ratio could rise and still remain well below the EU average, Moody's said.

Big Ben Goes Shopping

The Almunia Syllogism

European Monetary Affairs Commissioner Joaquín Almunia recently, and possibly inadvertenly, recently stumbled on a very interesting argument. Here it is:

"Who is crazy enough to leave the euro area? Nobody," Almunia said. "The number of candidates to join the euro area increases. The number of candidates to leave the euro area is zero."

Reductio Ad Absurdum

Now you don't need a PhD in economics to understand what follows, although a little bit of basic logic would help. What we have here could be construed as a kind of syllogism (and from now on let's christen this one "The Almunia Syllogism"). The Almunia Syllogism has the following form:

a) Anyone leaving (or aiding and abetting the departure of someone from) the Eurozone is crazy
b) The EU Commission, The ECB and The National Leaders are not crazy
c) Therefore no one will leave, or be allowed to leave, the eurozone (at least under current conditions)

Q.E.D. We Will Have A United States Of Europe.

Well, ok, I do need to add a lettle lemma here to the effect that the only way to enforce (c) is to build the necessary architecture, and there is room for debate about this, since this lemma is neither proven, nor is it self evident, although my own opinion is that in the weeks and months to come its validity will become extraordinarily clear even to the most reticent among us. The thing about the lemma is that it focuses the debate. Those who do not agree need to be able to show how we can have (c) within the present architecture. ECB Executive Board member Lorenzo Bini Smaghi's attempt to argue that we can (for example, here)fails stupendously to convince in my opinion, and especially the extract I reproduce below(which exemplifies precisely the point those who want new achitecture are making).

For instance, for the period 2009-10, discretionary measures adopted in Germany total 3.5% of GDP, compared with 3.8%in the United States. In some European countries, such as Italy, the size of such stimulus measures is relatively limited owing to the high levels of debt, but in other countries the total fiscal stimulus is larger than in the United States.

The whole issue is that we need a mechanism to average out the stimulus, is that so hard to understand? Is this obscurantism, or simply stupidity?

A Literary Trope Not A Syllogism

The formal validity of the following statement is rather more questionable.

"Don't fear for this moment," he said. "We are equipped intellectually, politically and economically to face this crisis scenario. But by definition these kinds of things should not be explained in public."

The first phrase is an exhortation, one which I would agree with (but not for the same reasons), the second is an assertion whose truth content is, at least,questionable, while the third is an admission, one which would perhaps better not have been made, or a piece of advice, which the unfortunate Otto Bernhardt seems never to have received.

A senior German lawmaker said euro zone states stood ready to come to the aid of financially fragile members of the currency bloc, sparking furious denials from European leaders that a specific rescue plan existed. Otto Bernhardt, a leading lawmaker in Angela Merkel's Christian Democrats (CDU), told Reuters in an interview late on Thursday: "There is a plan."

and then Bloomberg let us know a bit more about the details of the plan.

The German Finance Ministry has no knowledge of a rescue fund organized by the European Central Bank for troubled euro-region members such as Ireland and Greece, spokeswoman Jeanette Schwamberger said.

Otto Bernhardt, finance spokesman for Chancellor Angela Merkel’s Christian Democratic Union, said in an interview with Reuters today that the ECB has a fund at its disposal to help troubled countries and can make money available at 24 hours’ notice.

Calls to relax eurozone rules rebuffed

From the FT this morning:

Calls to relax eurozone rules rebuffed
By Tony Barber in Brussels

Published: March 10 2009 08:48 | Last updated: March 10 2009 12:24

European Union countries hoping for milder terms on which to adopt the euro faced a rebuff on Tuesday from eurozone finance ministers, who said the credibility of Europe’s monetary union required sticking to EU rules.

“Given the current volatility of the situation, this would not be the right time to launch a debate on this,” said Jean-Claude Juncker, Luxembourg’s prime minister and head of the 16-nation eurozone finance ministers’ group.

The ministers’ decision is likely to be interpreted in some of the EU’s central and eastern European states, especially Hungary, as a sign that richer western European countries are failing to meet the challenge of helping their new democratic neighbours in the most difficult hour of their post-communist history.

Hungary last month raised the idea of shortening the two-year spell that a eurozone candidate country is obliged to spend in the EU’s exchange rate mechanism, known as ERM-2.

The proposal has won support from Thomas Mirow, president of the European Bank for Reconstruction and Development, who said last week the waiting time should be reduced on condition that a candidate country met all the EU’s rules on budgetary discipline.

The ERM-2’s purpose is to establish that a country’s currency is stable enough to justify eurozone membership.

But Hungary contends that the world financial crisis is so serious that some economically battered central and eastern European states need the protection offered by the eurozone sooner rather than later.

At an informal EU summit on March 1, Angela Merkel, Germany’s chancellor, suggested that she was open to reconsidering the ERM-2 process, but not to relaxing other tests for eurozone candidate countries on budget deficits, inflation, interest rates and public debt.

Mr Juncker said on Monday night that the eurozone finance ministers had agreed that careful adherence to the rules was essential, because the eurozone, unlike the US and other single-currency areas, lacked a central government and fiscal authority.

“We have a monetary union which doesn’t have a central state. It must be based on a set of rules. They are made up of the [EU’s governing] treaty and the stability and growth pact, and there is no question of changing the criteria or changing the amount of time that an aspirant must stay in the ERM-2, to bring it down from two years to one year,” Mr Juncker said.

“The credibility of monetary union is at stake,” he declared.

Mr Juncker was speaking after discussions during which EU policymakers confirmed that Romania was seeking a EU financial aid package similar to those arranged late last year for Hungary and Latvia, its fellow former communist member-states.

The EU recently doubled to €25bn the resources of a fund that helps non-eurozone EU countries address their balance of payments problems. Hungary and Latvia have both drawn on the fund.

But Mr Juncker made clear that eurozone finance ministers had no appetite for a much bigger, across-the-board financial aid package for central and eastern Europe, as proposed by Hungary.

“We refuse to accept that they represent one bloc. That has no longer applied since the fall of the Berlin Wall,” he said.

Trade and Shrinkage

From the FT this morning:

Explanation for trade plunge proves elusive
By Alan Beattie in Washington

Published: March 8 2009 23:31 | Last updated: March 8 2009 23:31

As world trade plunges, governments are looking for an explanation. Is it a fall in demand, a shortage of trade finance or protectionism? On the answer hangs the response they need to stop globalisation going into reverse.


International trade has long been more volatile than overall economic growth, partly because it is largely made up of manufactured goods that are subject to big swings in inventories and because imported consumer goods are often the first to be cut in a downturn.

But even allowing for the descent into recession, the speed of the collapse in trade has caused surprise. Trade has grown two to three times more quickly than the world economy in recent years, but countries with trade data for January show on average a 31 per cent fall over January 2008.

Protectionism is the easiest to eliminate. In spite of fears of another era of economic nationalism and a rise in emergency so-called anti-dumping duties, the use of such tariffs is low.

But there is confusion about the other possibilities.

The cost of trade credit, which finances goods while in transit, has surged in the past year. Participants say financing a shipment might have cost 60 basis points more than the London interbank offered rate a couple of years ago but now costs 400bp. Some developments, such as countries being unable to ship grain or resorting to barter, have been blamed on such shortages.

In particular, while some of the big providers of trade finance are still active, the smaller banks that used to buy trade finance assets from them in a secondary market have pulled in their horns. John Ahearn, head of trade finance at Citigroup, says: “Demand for finance has risen as a result of perceptions of higher risk at a time when a lot of capacity in the trade credit world has come offline and the secondary market has shrunk dramatically.” The World Bank, along with national export credit agencies, has announ­ced programmes of subsidy to trade finance.

But as the bank admits, the policy response has to contend with a lack of reliable figures. Data from Dealogic, the consultancy, suggest global trade finance shrank by 40 per cent in the last quarter of 2008, but those figures do not cover the bulk of such credit.

While commerce in low-value bulk commodities may have been hit by a shortage of trade finance, business that does not rely on such credit has also fallen.

About a third of global trade involves intra-company transfers. Simeon Djankov, chief economist for finance and the private sector at the World Bank, says research shows trade falling across the board. “The problems with demand swamp those of supply,” he says.

A general reassessment of risk among financial institutions and companies may have hurt smaller and poorer countries now cut out of global supply chains, but bank lending in trade finance has held up well compared with their activities elsewhere, he says. It might be easier politically to justify targeting government support on trade finance rather than boosting bank liquidity but the effect of such subsidy is unclear.

Mr Ahearn says an advantage of direct official support for liquidity in trade finance as opposed to pumping money into the financial system generally is that the result can be monitored.

“If governments come in and help recreate the secondary market and there is no demand for it, at least we will have ruled it out as one of the main reasons for the fall in trade,” he adds.

An L Of A Recession

Wolfgang Munchau in the FT:


An L of a recession – reform is the way out
By Wolfgang Münchau

Published: March 8 2009 18:15 | Last updated: March 8 2009 18:15

The US is dragging its feet over the financial sector. The European Union is doing the same, as well as failing to adopt policies that could shield it from an increasingly probable speculative attack. And judging by the state of preparations, the forthcoming Group of 20 summit is going to be a disaster.

So it looks like it is going to be an L – not a V or a U. I mean an L-shaped recession, one that starts with a steep decline, followed by very low growth for many years. In a V-type recession, the recovery is instant. In a U-type, it comes eventually. My guess is that we are currently somewhere in the middle of the vertical bit of the L, but it is the horizontal bit that is the scariest. History never repeats itself exactly, but we know from economic history that financial crises are surprisingly similar. This looks like Japan all over. Without financial restructuring, the economy is not going to recover. And Japan was lucky. It was surrounded by a booming global economy.

The best way to fight such a disaster is to restructure the banking system and provide short-term economic stimulus through monetary and fiscal policy. Speaking at a recent Aspen Italia conference in Rome, Martin Feldstein, a former economic adviser to Ronald Reagan and president of the National Bureau of Economic Research, estimated that US consumer spending would fall by $500bn (€395m, £355bn) annually, and construction spending by $250bn. Against this combined annual $750bn shortfall, the current stimulus package is woefully inadequate. In other words: we are looking at an L.

An L-shaped recession will make the adjustment of balance sheets even more painful. Unemployment will continue to rise. House prices will keep on falling. US consumers and banks will spend the next five or more years deleveraging, getting their respective balance sheets back in order. In that period, the US current-account deficit will fall sharply, as will that of the UK, Spain and several central and eastern European countries. This process can take a long time, and in an L-shaped recession it takes longer.

But the effect is also brutal on the rest of the world. The fall in current-account deficits will be partially compensated for by lower surpluses from oil and gas exporters, such as Middle Eastern countries and Russia. But the bulk of the adjustment would be borne by the world’s largest exporters: Germany, China and Japan. Globally, current-account deficits and surpluses add up to zero – minus some statistical reporting errors. You can do the maths. If the US stops buying German cars, Germany will eventually stop making them.

If we had a simple U-shaped recession, we would still have a painful recession in Germany and Japan, for example. But under a U-shaped scenario, both countries would be among the first to benefit from the recovery.

In an L-shaped recession, however, recession gives way to depression, despite the fact that both countries thought they had done their “homework”. If nobody can afford to run a large deficit for a long time – which is what an L recession effectively implies – the economic models of Germany and Japan will no longer work. Germany had a current-account surplus of more than 7 per cent last year. It is the world’s largest exporter. Exports constitute about 41 per cent of national gross domestic product – an extraordinary number, given the size of the country.

So what should these countries do? The right policy response would be to reduce the dependency on exports and undertake structural reforms that facilitate the shift towards non-tradable goods. These are not the same type of structural reforms as those of the past, involving cost-cutting and improving competitiveness. This is about flexibility and mobility.

Unfortunately, the opposite is happening. Germany is clinging to its export model like a drug addict. An example is the debate about the future of Opel, the European car manufacturing subsidiary of General Motors. Opel is unlikely to survive without help from the government. The proponents of a state bail-out of Opel argue that the company is systemically relevant. This argument is obviously wrong. There can be systemically relevant banks, but there can be no systemically relevant carmakers. But the answer is also revealing. What it means is that Opel is systemically relevant for the country’s export-oriented model. The bail-out adherents are clinging to an industrial structure that has no hope of survival in an L-shaped world.

To her credit, Angela Merkel, the German chancellor, seems reluctant to agree to the bail-out, as is her party. But pre-election politics will make a bail-out of some sort likely. It is terrible economics. The problem is not even the waste of taxpayers’ money. Combined with French car subsidies, such a decision will contribute to massive overcapacity in the sector and will slow down the economy’s adjustment to the export shock.

We are nowhere near a solution to the crisis. After committing errors of omission, global leaders are now producing errors of commission. The Americans dream about a return to a world of credit finance consumption while the Germans dream about assembly lines. In an L-shaped world, these are nightmares.

Slouching Towards Brusselfurt?

Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,

And what rough beast,
its hour come round at last,
Slouches towards Bethlehem to be born?
W.B. Yeats

Jack London's story White Fang, tells the tale of two men who trudge across the snow swept landscape of the Alaskan Frontier accompanying a sled-dog team hauling a dead man in a coffin. All along their problem-ridden route the two men are stalked by a staunch pack of starving wolves, headed by a sensual, seductive but mortally dangerous she wolf. Heeding instinctively the siren call of the she wolf, all the dogs are drawn, one by one, away from the warmth and safety of the communal campfire only to get themselves eaten and killed. Finally even one of the trekkers himself succumbs. Of course the coffin and its contents (which was the whole point of the expedition) are irretrievably lost, but not everything here is a negative, since in the process the she wolf mates with one of the luckless victims giving birth to a hybrid creature: White Fang.

This modern "half breed", of course, and in true Darwinian fashion, grows up even more savage, morose, solitary, and deadly than any of those who gave birth to him.

It isn't hard to see how this moving allegorically could be easily applied in its entirety to the process of European Economic and Political Unification, but in the short essay I embark on here I will meticulously avoid the temptation of attempting to offer deeper pschoanalytic interpretations, nor will I address the tricky little question of what might lie inside that irretrievably lost coffin. I will simply focus on the much more direct question of whether it is, at the end of the day such a good idea to let all those sled dogs wander off and out one at a time into the night, straight into the jaws of those ever so hungry wolves.

Severe Economic Recession

Hope they tell us, does spring eternal, but evidently some eternities are shorter than others, and all hope that Europe’s battered economies might be just about to turn themselves around must by now be in even shorter supply than the credit our companies and consumers are looking to find in the local branch of their favourite bank. The latest nail in the aforementioned coffin comes from the news that February's Purchasing Manager surveys, which provide us with one of the most accurate and valid short term indicators we have, showed a record low for the second month running. Thus, barring some spectacular (and entirely improbable) turnaround in March, it now seems almost a done deal that first quarter eurozone GDP will contract at a more rapid rate than even the one we saw in the last quarter of 2008. So, having fallen by 0.2% in the third quarter of last year, and by 1.5% in the fourth one, we may well see a further 2% drop in this one. Not quite Japan territory yet, but not far from it.


Post Bubble Blues In Spain and Ireland

Of course, there are not one, but many "Europe's", each, as Tolstoy would have it, "unhappy" in his or her own unique way. Spain, which is Europe’s fifth-biggest economy, entered its first recession in 15 years at the end of last year, and is now suffering (along with Ireland) the most severe of impacts following the blowout of a ten year housing bubble, a bubble which was fuelled for the most part by the negative interest rates which were served up under the ECB's "one size fits all" monetary policy. Forecasts for Spanish GDP growth in 2009 range from minus 3% to minus 5%, and unemployment looks set to reach around 5 million (or 20% of the working population) come December.

The Spanish government is still essentially in denial about the scale of the correction needed (especially given the need to bring the 10% of GDP current account deficit that was created back into balance), and is busy trying to spend its way out of trouble with the predictable negative consequence that the country's once solid fiscal surplus is now spiraling downwards into deficit at breathtaking speed (the deficit is forecast to reach a minimum of 6% of GDP this year). And the result of all this was not hard to foresee, as credit rating agency Standard & Poor’s announced last month that it was cutting Spain’s AAA long-term sovereign rating to AA+. Predictably, the yield spread between 10 year Spanish bonds and German Bunds rose to a record 122 on the news.

At the same time it was not so long ago that Ireland's economy was experiencing a boom of such proportions it came to be known as the "Celtic tiger." But that was then, in the world as we knew it before the arrival of the "US subprime turmoil". Now things have changed, almost beyond recognition. The EU Commission forecasts a 5% contraction in GDP this year, unemployment is widely expected to hit the11 percent level, and house prices have plummeted. As a result the Irish fiscal deficit is expected to rise to 9.4% in 2009, after hitting 6.3% in 2008, the EU Commission has opened an excess deficit procedure, and the country is being threatened with losing its AAA debt rating by Fitch Ratings.

The situation is so severe that the Irish Prime Minister was only recently forced to issue strenuous denials that he was threatening the unions with bringing in the IMF if they did not agree to immediate wage reductions in the public sector. As a result of the crisis the cost of insuring against a default on Irish sovereign debt has risen steadily, with credit-default swaps on Irish government debt hitting a record 396 basis points in the middle of February.


Meltdown In The East?


But the EU is not only facing new problems with former growth stars inside the tent (growth in Italy and Portugal remained decidedly lacklustre even after the creation of the eurozone), there are also important and growing issues arising among the EU's most recent members, those still waiting patiently in line at the entry point to the monetary union's ticket holder's enclosure.

Only two weeks ago World Bank president, Robert Zoellick, felt himself forced to make an urgent call for a European Union-led and co-ordinated global support programme for the economies of Central and Eastern Europe. As Zoellick himself said, “It’s 20 years after Europe was united in 1989 – what a tragedy if you allow Europe to split again.”

Eastern Europe's economies, and their banking systems, are now starting to feel the chill winds of the global financial crisis and recession. But the situation in Eastern Europe is very different from that in the West, and their economies and credit ratings evidently can’t support such dramatic increases in their debt levels. Thus, in the case of those countries having a significant home-banking presence, like Latvia’s Parex, or Hungary’s OTP, the support of external organisations (the IMF, the World Bank, the EU) becomes rapidly necessary when the bank in question starts to have liquidity problems. Then, as a direct result of the consequent bailout the country's debt to GDP ratio starts to rise in a way which then places even subsequent eurozone membership in jeopardy. Latvia’s Debt/GDP is, for example set to rise from around 12% of GDP in 2007 to over 55% in 2010, even on the best case scenario. With a 10% plus GDP contraction already in the works for 2009, it is clear that Latvia’s debt to GDP will rise beyond the critical 60% level. Hungary’s debt/GDP is already above, and rising. If we don’t do something soon, these two countries at least are being launched off towards a self perpetuating process of indebtedness which only has one end point: sovereign default.

And while Latvia and Hungary may be the current worst case scenarios, the list of walking wounded is growing by the day.


In fact Robert Zoellick is far from being a lone voice crying in the wilderness about the current level of risk to the countries in the East, and indeed precisely those EU banks who have been most active in emerging Europe are now busily trying to convince EU regulators, the European Central Bank and Brussels itself to coordinate new measures to counter the impact of the financial crisis confronting the region.

While Storm Clouds Gather In the North

And now, with some ten countries out there (to one degree or another, and despite the cries of "we're different") desperately looking for help from the East, 5 (including Austria) about to do so from the South, and two more (if we include the UK and along with Ireland) from the West, news has come in that one last group of battle weary combatants have finally made their way through to the hastily erected field hospitals in Frankfurt and Brussels - the Scandinavian countries - since it emerged last week that Sweden is in the middle of a much more serious recession than previously thought. Official figures for the fourth quarter of last year revealed that gross domestic product contracted 2.4 per cent quarter-on-quarter in the final three months of last year, equivalent to an annualised decline of 9.3 per cent. Denmark’s economy, on the other hand contracted by 3.9 per cent year-on-year in the fourth quarter, making this already the worst recession in three decades.Denmark is in the middle of a housing bust and the economy contracted as households spent less and the global financial crisis sapped demand for the country’s exports. Finnish output also slumped, by 1.3 percent, the most in 17 years, in the fourth quarter. Certainly the situation is less severe in the North, but in addition to the home grown recession Sweden's troubled banking sector now labours under the growing weight of debt defaults in the Baltic's and other parts of the CEE.

Severe Contraction In Germany

So with the periphery down (if not positively out for the count), all eyes have been turning to the centre, and it has fallen to Germany's Finance Minister - Peer Steinbrüeck - to face the cameras on an almost daily basis to answer the barrage of press questions about how equipped the EU is to handle all the looming bailouts, as if reaching for the German chequebook was the magic remedy to cure all ills. Unfortunately nothing could be further from the truth. Germany's banking sector has been bruised and battered itself over the months, first in the US sub-prime turmoil, then in Ireland and now in the East. While Germany’s export driven-economy has suffered the impact of recession after recession among its main customers. The economic slump in the final quarter of 2008 proved worse than feared, with the country posting the sharpest fall in gross domestic product since the country was reunified in the early 1990s.

And there is evidently worse to come, since the Germany private sector shrank in February at its fastest rate in more than a decade according to Purchasing Managers survey data - with the composite PMI falling to 36.3 from 38.0 in January, the lowest level registered since the series began in January 1998. The neutral point between expansion and contraction on these diffusion indexes is fifty, and a reading around 36 is compatible with an annualised contraction rate in the region of 10%.

Deflation Threat

And to top it all the eurozone looks like it is headed rapidly into negative price change territory, or deflation, since the headline HICP inflation fell back significantly more than expected in January - to 1.1 per cent. This was the lowest level registered since July 1999, and a sharp drop from the 1.6 percent rate registered in December. On a month-to-month basis, prices dropped 0.8 percent. And if we come to look at the "core" inflation rate - that is consumer inflation without the volatile elements of food, energy, alcohol and tobacco, we find that it dropped by a very large 1.3% month on month in January. Indeed if we look at the core inflation rate over the last six months, the index has only risen 0.1% (or an annual rate of 0.2%). This gives us a much more accurate reading on where inflation actually is at this point in time, and where it is headed. If things continue like this, then the eurozone as a whole is headed straight into deflation, for sure, especially when the force of the economic contraction and the size of the consequent output gap are taken into account.


Problem Surfeit Or Architectural Deficit?

What is not totally clear at this point is whether the European Union is "overdetermined" (in terms of the problem set it faces) or "underdetermined" (in terms of the available instruments and institutional structures it disposes of for handling it). The Financial Times eurozone correspondent Wolfgang Munchau has been complaining bitterly of late - and with good reason - about the extraordinary narrow-mindedness of Europe’s economic and political leadership in the face of the current crisis, which reaches, as we have seen from Ireland in the West to Hungary in the East, and from Greece in the South to Sweden in the North. But more than narrow mindedness what we are faced with is innocence and inability to react, and frankly I am not sure which is worst. I say “innocence” because it is by now abundantly clear that many of Europe's leaders simply haven’t yet grasped the severity of the problems the continent faces (especially in Spain, or even Germany itself, let alone in the East), and I say inability to react, since we have always and forever been moving too little and too late. The initial response to the banking crisis last October was one clear example (where we saw a landshift-style volte face in the space of only one week) and the way we are now confronting the need to live up to the promises then made about guaranteeing the banking sector in individual countries which start to get into difficulty, and in particular the “systemic” banks, would be another.

The apparent confusion which currently reigns over at the ECB about whether or not the eurozone can operate some sort of US/Japanese style quantitative easing - the bank is at the present time "researching" its alternatives - would be a third.

But as our leaders are busy contemplating whether or how to bail-out entire nations, rather than simply individual banks, European government budget commitments steadily mount-up while their sovereign debt ratings start to buckle under the weight of a growing and deepening European recession.

As I keep flagging, sovereign bond and CDS spreads keep widening, and the gap between the interest rates Greece, Austria, Italy, Ireland and Spain must pay investors to borrow for 10 years and the rate charged Germany has risen to the widest since before they adopted the euro. Credit-default swaps on Ireland rose to a record on February 16, climbing to 378.4 points, while Greek credit-default swaps hit 270 points. The yield difference, or spread, between 10-year Austrian securities and benchmark German bunds has been rising substantially of late, and hit 137 points on Feb. 18, and Austria now has a higher default risk than those Mediterranean “laggards” like Italy, Portugal and Spain, at least according to credit-default swap prices as quoted by CMA Datavision. Austrian swaps were trading at 253.3 basis points on March 3, compared with 17.5 points 12 months ago.

Now ten years bad craftsmanship cannot be put straight in a day, but we are going to have to try. There is a path through to the sunlight, and we need to follow it, even if sometimes its hard to discern whether what we see before us is the light at the end of the tunnel, or the Brussel-Frankfurt express headed straight towards us.

The EU needs to remedy its institutional deficiencies in order to address its crisis overload problem. Fortunately there are remedies available. In the first place EU (rather than exclusively national) bonds can be created and these will effectively give us a central treasury. In the second place, and given the deflation problem, the ECB can now follow the Bank of England and enter a further stage of quantitative easing, expand its balance sheet and buying the EU bonds in the primary market, as the BoE is set to do with Gilts and as the BoJ did in the early years of this century. Thirdly, the rules of the Maastricht treaty can be rewritten to give rapid access to the eurozone to the highly vulnerable countries of the East, and, lastly, we can write a new pact, one with teeth to give us the ability to see through the deep seated structural reforms that so many of our economies badly need. Most importantly of all, the arrival of deflation is not only a threat, it is also a challenge, and one we can rise to. Money may not be the be all and end all of everything, but having it sometimes helps, and having the power, nay the need, to print money can give Europe's central administration one hell of a lot of clout should it need to use it. As Economy and Finance Commissioner Almunia said only last week "you would have to be crazy to want to leave the eurozone right now". Well that sure is one hell of a lot of leverage to have over people, if you know how to use it.

So while the first argument in favour of EU bonds may be an entirely pragmatic one, namely that it doesn’t make sense for subsidiary components of EU Inc. to be paying more to borrow their money when the credit guarantee of the parent entity can get it for them far cheaper, the longer term argument is that the ability to issue such bonds may well enable the EU Commission to become something it has long dreamed of becoming - an internal credit rating agency for EU national debt, since in the mid term the whole system of EU bonds can only work if it is backed by a very strong Lisbon type reform pact for those countries who apply to make use of the facility. This is what now needs to be worked on.

And how do we know that that there won’t be yet another round of backsliding on all this? Well we don’t, this is the risk we just have to take, but sometimes you do need to simply cross your fingers and jump, since the burning building behind you looks none to attractive either. But what we do know is that since there will now be a mechanism whereby the bad behaviour of the few really can penalise the many financially, then there really will be some meaningful incentive to generate a pact, this time, that really has teeth to stop that penalisation taking place.

The deficiencies in the institutional architecture to support the eurozone have long been known, and in particular the absence of a common treasury. The road to establishing the zone in the first place was tiresome, tortuous and long, the road to cleaning up the mess which has arisen as a result of these deficiencies will need to be nasty, brutish and short, or otherwise this is just what the life of the zone itself may well turn out to become.