Sunday, August 30, 2009
While the present focus of most press attention is on the fact that GDP in Germany and Japan nudged upwards between April and June (over Q1), we should never forget that this increase follows substantial falls in output. Japan’s real GDP fell at a record pace in Q4 2008 and Q1 2009 (annualized declines of 13.5% and 14.2%, respectively), and German GDP fell by a quarterly 3.5 percent in Q1 and an annual 6.7% - making for the fourth consecutive quarter of negative growth. In both cases the fall in output was accompanied by only a much more moderate decline in employment.
Part of the explanation for this lies in the fact that both countries have very substantial stimulus and employment protection programmes in place, and these to some extent mask the extent of the slump. At the same time both countries are now facing elections, and deteriorating gross debt to GDP positions. It is therefore highly likely that the positive stimulus programmes will wane somewhat after October, and the problem is to know just how far the labour markets can deteriorate further in these countries as a result. Fortunately Nomura (for Japan) and Societe Generale (for Germany) have this week produced timely studies which help us get a better picture.
The news coming out of Japan at the moment is almost uniformly bad. The unemployment rate is now at a record high, data showed today, raising even more doubts about the sustainability of the economic recovery there piling pressure on embattled Prime Minister Taro Aso just two days ahead of an election which he looks set to lose.
The jobless rate rose to a worse than expected 5.7 per cent in July, up from 5.4 per cent in June. By Spanish or Latvian standards this may seem very tame, but if you take into account the extent of government subsidised "hidden unemployment" the true underlying rate may be nearer 12 or 13%.
And adding insult to injury for Aso, Japanese core consumer prices fell at the fastest annual pace on record in again in July, potentially putting pressure on a reluctant Bank of Japan to rein in deepening deflation. Core consumer prices - the bank of Japan's preferred measure - which exclude volatile fresh food prices but include oil costs, fell 2.2% in the year to July.
Average monthly Japanese household spending fell in July by a price adjusted 2.0 percent from a year earlier to 285,078 yen, down for the first time in three months,
Also, Japan’s July exports fell 1.3 per cent on a seasonally adjusted basis from June, amid concerns about the sustainability of the country’s recovery. Provisional data out today showed that shipments in July fell 36.5 per cent b...y value year on year, outpacing the 35.7 per cent decline in June.
Japanese exports slid in July at a faster annual rate than June, raising fears the effects of global stimulus measures are starting to decline..meanwhile average salaries keep falling and unemployment keeps rising as Japan sinks deeper and deeper into deflation.
Under the scheme, as a rule the government provides two thirds of the wages paid by businesses in such circumstances. As of June 2009, some 2.383mn workers had applied for employment adjustment subsidies for 2009 onward (see chart). Although only 1.891mn had been approved as of June, Nomura expect this figure to grow closer to the number of applicants.
Nomura found that when indexing the number of those employed and real GDP to the output peak of Q4 2007 the result showed a considerable gap. Based on a simple calculation and assuming this gap to represent the amount of “hidden underemployment”, they arrive at a figure for “hidden jobless” in Q1 2009 of 4.7m. This is far higher than the June unemployment figure of 3.48m. If the hidden jobless are included together with the registered “unemployed”, they calculate that the unemployment rate would leap from 5.4% to 12.2%.
This chart shows estimates made by Nomura of the hidden jobless during past economic downturns. In the majority of cases the number of hidden jobless did not rise at all or employment fell more than GDP, suggesting that employment adjustments
were quite swift. Comparatively substantial numbers of hidden jobless rose in Q4 1973, triggered by the first oil shock and in Q2 1997, due to the Asian currency crisis, financial system concerns and a consumption tax hike. The number of hidden jobless, estimated at about 4.7m in Q1 2009, is well above the figures associated with these two downturns, according to Nomura.
However, as Nomura point out, even if the difficult labour market conditions are not fully reflected in the unemployment figures, a deterioration in adjusted labor supply-demand could easily lead to major declines in wages even while companies keep the number of hidden jobless down, thanks to government support. In fact, according to Nomura it would be hard to explain the fact that the decline in wages (total cash earnings of full-time employees) in H1 2009, at 4.7% y-o-y, was far bigger than the equivalent declines in annual average wages of 2.3% in 2002 and 0.4% in 2003, when unemployment also reached new highs, if you don't take the hidden jobless factor into account (see chart). Pressure on wages and household income could thus become a serious impediment to any genuine fully fledged economic recovery.
As of June 2009, payments under the government's subsidy scheme for employment adjustment totalled ¥101.14bn. If the number of approvals grows to meet the number of applicants, Nomura estimate total payments will increase to ¥127.42bn, placing some additional strain on fiscal finances. We think that dividing the cost of the hidden jobless and in-house unemployed between companies, households and government would be a major policy challenge for the new administration when it takes office in September. Given the seriousness of the social and political problems that result from sharp rises in unemployment, we think that while the next Japanese government may strengthen the employment adjustment subsidy scheme by, for example, further relaxing its terms and conditions, it is unlikely to try to limit the number of eligible cases by tightening conditions.
Despite the huge number of hidden jobless, however, Nomura think the unemployment rate is unlikely to rise much beyond 6.0%, largely because the government has established a subsidy scheme for employment adjustment.
The Ministry of Health, Labour and Welfare says that the aim of the scheme is to prevent unemployment by partly subsidizing wages for companies in trouble. This includes wages of staff that may be temporarily transferred and providing allowances if a business temporarily shuts down. Businesses that temporarily transfer employees (or place staff in training programs) or shut down operations after having been forced to scale back for economic reasons, or other factors such as industry realignment, for example, are also eligible.
The German job machine ran out of steam last autumn, and since that time has been adding jobs at an ever slower pace. Now it has turned negative, and less Germans are employed every month than they were a year earlier.
German unemployment rose again in July. The number of people out of work increased 52,000 to 3.46 million on an unadjusted basis. The seasonally adjusted total actually fell by 6,000, according to the statistics office due to statistical changes. Without the impact of the changes, the office estimates unemployment rose by 30,000. German unemployment began to increase in November after falling steadily for more than three years. The seasonally adjusted jobless rate was unchanged at 8.3 percent in July.
Societe Generale, take the German case, and point out that while official unemployment in Germany has in fact only risen moderately in the current recession. The unemployment rate (using the ILO measure) has risen by just 0.6ppt from its 7.1% low in Q4 2008, while in the euro area as a whole, the rate is up by 2.2ppt to 9.4% from its March 2008 low of 7.2%. As they say, it is also quite clear that this relative stability owes much to the widely-used practice of so called short-time working (Kurzarbeit).
The Societe Generale interpretation is broadly supported by survey evidence which suggests that the rate of contraction in employment has eased, pointing to a slower increase in unemployment in coming months. For example, the employment component of the PMI surveys in manufacturing has risen to 37.9 in July from a low of 32.9 in April, and in the services sector to 49.0 from a low of 45.2 in May. Employment intentions (in the European Commission survey) have also come off the lows in all sectors, but remain in negative territory, implying further job losses. That tallies with the recent evidence from official unemployment data, which have unemployment up by an average of 8,000 per month in May-July, a big shift downward from the average monthly increases of nearly 60,000 in Q1. That degree of improvement will, according to Societe Generale not be sustained, but they do not expect to see a return to the pace of unemployment gains witnessed earlier this year. Of course, as SocGen point out, company employment intentions could easily deteriorate again if growth expectations get revised down, but for the nearer term, the evidence suggests that unemployment in Germany will rise at slower rates than observed earlier this year.
They also point out that this short-time working arrangement has a "sell by" date, and can't run forever, hence there is widespread concern that a major increase in unemployment in Germany is merely a matter of time. Socgen then go on to ask themselves how wellfounded these concerns actually are, and take the view, that they are not as justified as they seem.
First of all, they note that German legislation has already extended the period for which companies can run short-time working from 18 to 24 months. Looking at the evolution of the numbers on short-time working they find that the vast majority of companies only resorted to the programme in the very recent past, so that the 24 month limit will not bite until late-2010. Until the turn of the year 2008/09, the recourse to short-time working was very small indeed; aside from the seasonal increases in the first quarters of 2007 and 2008, the numbers were small at around 50K. To put that in context, that is 0.1% of the labour force and equivalent to the monthly gains in unemployment that were recorded this year. Since then, the numbers have indeed exploded: by March of this year (latest available data), there were 1.3m workers with shortened hours, and according to official estimates, that has probably risen to around 1.4m more recently. These are clearly big numbers, amounting to about 3% of the labour force. If they were added to unemployment figures, total unemployment would rise to the previous historic peaks of around 5m. However, given that this increase only began in the final two months of 2008, these schemes could easily run for another 18 months, at least as far as the administrative rules are concerned. Whether the German fiscal position will allow this once the new government is installed is another question entirely.
Monday, August 24, 2009
By Paul Day
MADRID, Aug 14 (Reuters) - Spain has little chance of meeting its oft-repeated promise to cut its budget deficit to European Union limits by 2012, but economists believe the government is right to pay lip service to the target.
As a massive public works scheme, designed to stop the Spanish economy slipping into a coma, threatens to push the deficit close to 12 percent of GDP in 2009, the government has tried to reassure debt markets that it will swiftly return to fiscal prudence.
"When we make a promise, we like to keep it," said Economy Secretary Jose Manuel Campa last week, asked whether the country would really rein in the deficit to the 3 percent of gross domestic product limit, called for by Europe's Stability Pact, within three years.
"This goal is linked to cyclical (economic development) and we expect cyclical growth of above 2 percent in 2012. A deficit of 3 percent is consistent with this," Campa said.
But therein lies a fallacy, economists say. If Spain withdraws fiscal stimulus (to cut the deficit) while it still lacks a motor of growth to replace the subsiding construction industry, it can't hope to grow above 2 percent.
On top of that, 2012 is an election year in Spain, a period seldom associated with spending cuts.
"The bottom line is all the European countries have got to pay lip service to these rules, but it's a nonsense," says economist at Commerzbank Peter Dixon.
"When you have the situation that we are in now, allowing the deficit to rise is the least worst option."
WORST CASE SCENARIO FADES
Over the last month, credit rating agencies Fitch and Moody's have expressed doubt that Spain's deficit target is achievable while at the same time restating the country's top triple-A sovereign-debt rating.
For Moody's, this marked a more optimistic attitude towards Spain, where recent data, including second quarter GDP and unemployment, has shown some improvement thanks to one of the worlds' largest stimulus plans in relative terms.
In January, Moody's had tagged Spain as "vulnerable" amid fears surrounding the global economy and the local housing market. It now believes such worries have dissipated.
"Moody's immediate concerns in this regard have been largely allayed," Moody's said in its press note in July.
"Although there is a good chance that the government will fail to get the deficit down to 3 percent of GDP by 2012 ... it should be able to do so roughly a year or so later."
Markets, so far, seem unconcerned by the speed with which Spain's public debt is rising.
The government says that its debt as a proportion of GDP will jump by 15 percentage points to 60 percent by the end of 2010.
Yet the spread on 10-year bonos against German bunds dropped to around 42 basis points last week, the lowest level since the time of the collapse of Lehman Brothers.
"The deficit's high, but debt in relation to GDP is expected to rise to around only 70 percent (over the next few years), which is relatively low compared to other European countries," said economist at Capital Economics Ben May.
"We certainly feel the fears of a Spanish default at the start of the year were overblown. The decline in bond yields has shown this worry is unfounded," said May.
Nonetheless, while markets are expected to be tolerant of Spain's actual fiscal performance, they still expect the government to talk the talk.
"A 3 percent deficit by 2012 would be difficult, but it doesn't really matter (if they meet it). What's important is the trend," said Standard and Poor's Senior Director of Sovereign and Public Finance, Myriam Fernandez.
DON'T TURN OFF LIFE SUPPORT
Spain is especially vulnerable to a sudden withdrawal of state-support because the downturn has been largely due to domestic, structural failings and, as such, it won't find immediate relief from a global recovery.
Aggressive moves by the government to counter the downturn over the last six months, including around 15 billion euros ($21.40 billion) of infrastructure projects and tax breaks, has helped stem lay offs and encouraged talk of the green shoots of recovery.
Pull this life-support away too soon and the ailing economy could relapse.
"Public finances should be geared toward the medium term but tighten too quickly and you won't get what you're hoping for. A double dip recession could easily occur if you tighten too early," said economist at BNP Paribas Dominic Bryant.
Thursday, August 13, 2009
As is evident the reality which lies behind the current crisis in the EU10 is complex, and has its origin in a variety of causes. But one key factor has undoubtedly been the decisions the various countries took when thinking about their monetary policy and currency regimes. The case of the legendary euro "peggers" - the three Baltic countries and Bulgaria - has been receiving plenty of media attention on late, and two of the remaining six (Slovenia and Slovakia) are now members of the Eurozone, but what of the other four, Romania, Hungary, Poland and The Czech Republic? What can be learnt from the experience of these countries in the present crisis.
Well, one convenient way of thinking about what just happened could be to use Nobel Economist Paul Krugman’s Eternal Triangle” model (see his summary here), which postulates that when it comes to tensions within the strategic trio formed by exchange rate policy, monetary policy, and international liquidity flows, maintaining control over any one implies a loss of control in one of the other two.
In the case of the Central Europe "four", Poland and the Czech Republic opted for maintaining their grip on monetary policy, thus accepting the need for their currency to "freefloat" and move according to the ebbs and flows of market sentiment. As it turns out this decision has served them remarkably well, since the real appreciation in their currencies which accompanied the good times helped take some of the sting out of inflation, while their ability to rapidly reduce interest rates into the downturn has lead to currency depreciation, helping to sustain exports and avoid deflation related issues.
The other two countries (Hungary and Romania), to a greater or lesser degree prioritised currency stability, and as a result had to sacrifice a lot of control over monetary policy, in the process exposing themselves the risk of much more violent swings in market sentiment when it comes to capital flows. Having been pushed by the logic of their currency decision towards tolerating higher inflation, they have seen the competitiveness of their home industries gradually undermined, and as a consequence found themselves pushed into large current account deficits for just as long the market was prepared to support them, and into sharp domestic contractions once they were no longer disposed so to do.
A second problem which stems from this "initial decision" has been the tendency for households in the latter two countries to overload themselves with unhedged forex loans, a move which stems to some considerable extent from the currency question, since in order to stabilise the currency, the central banks have had to maintain higher than desireable interest rates, which only reinforced the attractiveness of borrowing in forex, which in turn produced lock-in at the central bank, since it could then no longer afford to let the currency slide due to the balance sheet impact on households. Significantly the forex borrowing problem is much less in Poland than it is in Hungary or Romania, and in the Czech Republic it is nearly non-existent.
The third consequence of the decision to loosen control on domestic monetary policy has been the need to tolerate higher than desireable inflation, a necessity which was also accompanied by a predisposition which had its origin in the erroneous belief that the lions share of the wage differential between West and Eastern Europe is an “unfair” reflection of the region’s earlier history, and essentially a market distortion. The result has been, since 2005, a steady increase in unit wage costs with an accompanying loss of competitiveness, and an increasing dependence on external borrowing to fuel domestic consumption.
So, if we look at the current state of economic play in the four countries, we find two of them (Hungary and Romania) undergoing very severe economic contractions, to the extent that in both cases the IMF has been called in. At the same time they still have higher than desireable inflation and interest rates. In the other two countries the contraction is milder, the financial instability weaker, and both inflation and deomestic interest rates much lower. Really, looked at in this light, I think there can be little doubt who made the best decision.
Here for comparative purposes are charts illustrating the varying degrees of economic contraction, inflation, and interest rates. GDP contraction rates actually present a little problem at the moment, since one of the relevant countries - Poland - still has to report. However Michal Boni, chief adviser to the Prime Minister, told the newspaper Dziennik this week that the economy expanded at an annual rate of between 0.5% and 1% in Q1. So lets take the lower bound as good, it is still an expansion.
The economy in the Czech Republic contracted by an estimated 4.9% year on year in the second quarter.
The Hungarian economy contracted by an estimated 7.4% year on year in Q2.
While the Romanian economy contracted by an estimated 8.8% year on year.
Poland's CPI rose by an annual 4.2% in July.
The CPI in the Czech Republic rose by an annual 0.3% in July.
Romania's CPI rose by an annual 5.1% in July.
Polands CPI rose by an annual 5.1% in July.
The benchmark central bank interest rate in Poland is currently 3.5%.
The benchmark central bank interest rate in the Czech Republic is currently 1.25%.
The benchmark central bank interest rate in Romania is currently 8.5%.
The benchmark central bank interest rate in Hungary is currently 9.5%.