The Global Manufacturing Recession Tightens Its Grip In AugustAugust Monthly Manufacturing PMI Report Edward Hugh - Barcelona: August 2012
Europe’s Debt Crisis Transformed into GlobalManufacturing CrunchThe pattern we have seen in recent months - whereby international tradeproblems drag the global economy down with diminishing export orders leadingto a reduced pace of manufacturing output - consolidated itself further thismonth, with manufacturing conditions deteriorating notably in Japan, China andthe United States.In Europe, which has been the epicentre of the problem, conditions continued todeteriorate, although somewhat more slowly than in July. Core countriescontinued to be affected, while the deterioration in Italy suggested the country isundergoing a deeper recession than previously anticipated.Globally, there were few bright spots. Ireland’s manufacturing sector continues togrow slowly, as does the Indonesian one. Russia struggles along, India continues togrow but at well under half the pace seen six months ago, conditions in Turkeyremain stable (just) while economic activity in Brazil barely turns over.It also seems we will see little change before the end of the year as export orderbooks continue to shrink.
More QE Likely In The US and Japan A much weaker than expected US employment report for August has finally tipped the balance in favour of more active easing steps by the Fed next week. In addition to strengthening accommodation language, it is highly probable the FOMC will announce a new round of QE, or unsterilized asset purchases. As can be seen in the PMI Composite below, each round of QE has been followed by a surge in global economic activity as demand for risk assets in the Emerging Economies is boosted. Equally it should be noted that each wave of activity has been weaker.The Bank of Japan is also expressingincreasing concern about thedamage being inflicted by a high yenon exports. In the event ofcontinuing economic weaknessintervention by the central bankwould seem likely.
AsiaViewed as a continent, it is very hard to make generalitzacions about Asia. Japan isamong the oldest countries on the planet. Domestic demand is congenitally weak, andexports struggle against the weight of an overvalued yen. The important point to noticeis that all last years predictions about Tsunami reconstruction bring a new lease of life tothe country have proven to be ill founded. All the associated damage has done isproduce more debt. And still the economy struggles to grow. This issue will doubtlessbecome worse after the government introduces the long promised increase inconsumption tax.China is suffering from a real estate adjustment which influences internal demand, whilethe global trade slowdown harms the export sector. In addition, the country’s potentialgrowth rate, after hitting double digits at one point, is now slowing steadily as Chinasteadily moves from emerging economy to mature economy status.India continues to advance at rates which are not seen in most Asian economies thesedays, but the country has an endemic inflation problem which remains unresolved, andgrowth is also hampered by poor infrastructure and widespread corruption.The semi developed economies like South Korea and Singapore still struggle toovercome weak export demand, and even new emergers like Vietnam and Indonesiaremain challenged to find growth at this point.
Emerging Economies Hold The KeyMost of the strategic emerging economies – Brazil, Turkey, India, Indonesia – arestruggling to find growth at the moment, despite their undoubted growthpotential. This situation is unlikely to last forever, and especially if there is moreQE (or talk of it) in the US and continuing stabilisation in the Euro debt crisis.The most probable outcome is that we will start to see a return to growth in theEMs as the year draws to a close, and this will work its way through to exportdemand in the developed economies. Pent up demand is there, it just isn’t in thedeveloped world.
Developments in China seem to be a particular cause for concern in terms of growth prospects for 2013. Internal demand is not responding to the current stimulus, while exports are hit by weak demand in both Europe and Japan.Chinas August export growth was higherthan July’s 1 per cent but far below thedouble-digit growth rates China’s export-driven economy has become accustomedto over the past decadeMuch of theweakness came from crisis-hitEurope, China’s biggest tradingpartner, with exports to the EU falling12.7 per cent in August from a yearearlier. Exports to Japan alsodisappointed, registering a decline of 6.7per cent in August, while shipments tothe US rebounded with 3 per centgrowth, compared with an increase ofjust 0.6 per cent in July.
Central and Eastern Europe Russia’s economy continues to struggle, but the energy and commodity factor to rely on the country should be able to avoid an outright recession unless we see a Lehman type event, which seems unlikely in the near future. Other parts of Eastern Europe seem much more problematic, and there are clear signs of growing export dependence across the region. The Czech Republic has been stuck in recession for a year now, and Hungary has now joined it there. Beyond Hungary government debt is not a problem, but if the Euro Area continues to be unable to find growth then those countries dependent on customers there may be tempted to use fiscal policy to plug the gap. In which case sovereign debt could soon become a problem.
ECB To The Eurozone RescueBut No Bond Purchases Without Strict ConditionalityThe announcement by the ECB of a bond buying programme – to be called OutrightMonetary Transactions (OMT) - for countries on the Euro Area periphery who ask for abailout from Europe’s leaders marks a new stage in the Euro crisis. The unlimitedquantity of short term bonds the ECB is prepared to buy will undoubtedly bring downborrowing costs and avoid pressure on country spreads for those involved.Nonetheless many questions remain. Most importantly relating to the conditionalityattached to the activation of the ECB purchases. Mario Draghi left no doubt thatcountries eligible for OMT operations would need to apply to the EU for a relevantprogramme. This will involve signing a Memorandum of Understanding (MoU) andaccepting Troika supervision of the implementation of the terms of the MoU. Draghiexplicitly mentioned the IMF, and Christine Lagarde has since expressed enthusiasm forIMF involvement. IMF financial involvement in the form of a precautionary credit line(one of the two modalities of programme mentioned by Draghi) has neither beenconfirmed nor denied.The situation is complicated, however, by the fact that neither of the two principalcandidates for receiving OMT seem in any hurry to ask for the relevant EUprogramme, although Spain seems nearer to doing so than Italy.
At first sight the involvement of the ECB in containing interest rates meansthat the acute stage of the Euro government financing crisis has come to anend. Mario Draghi stressed the quantity of purchases would be unlimited, andin the case of a central bank unlimited really can mean unlimited. So despitethe fact that the bank did not specify any specific interest rate target, it surelyhas the power to impose one should it chose to do so. Naturally it is unlikelythis target rate will be made public, although what it is will doubtless becomethe source of much speculation.Of course, stress could still arise on the spreads of other countries (Belgium orFrance, for example) but once Spanish and Italian bonds are being liberallypurchased, the logical next move would not be individual country programmesbut all-out QE as a first step on the road to full fiscal union. Once you havecrossed the Rubicon there does not seem to be any going back, especiallyafter you have gotten in so deep it is hard to see how you can get out again.
Naturally this move does not solve all the Euro Area problems – it is simply onemore step. In particular growth issues remain the principal concern. France isthe latest country to announce a major set of austerity issues for 2013, andgiven the likely weakness in the external environment growth in the commoncurrency zone will be meagre at best, and several countries beyond Greece –Portugal, Italy, Spain – seem at risk to continuing deep recessions.In this context the principal risk seems to be that voters will not back theirpolitical leaders, and will adopt attitudes which put continuation of theEurozone in doubt. This radicalisation of views is not only occurring in southernEurope, the process is visible in the core countries too, with one group ofpeople getting increasingly tired of making sacrifices, and the other groupgetting tired of what they perceive as continually being asked to pay for thefailure of others.
Europe’s Recession Worsens As Q3 ProgressesCore Now Affected Along With The Periphery, Recession Risk Grows in Germany Germany’s economy seems to be headed steadily back into recession. With export growth already weakened by the impact of austerity measures on the periphery, the slowdown in Chinese consumption seems to have acted as some kind of killer app.The current situation highlights just how dependent the German economy is on exports, and in thissense on the rest of the Euro Area. The core has as much interest in finding solutions to the debtproblem as does the periphery. Still No Sign Of German Inflation Despite steady loosening in monetary policy at the ECB, and 3% growth in GDP in 2011, there is no real sign of domestic demand driven inflation in Germany. Inter-annual inflation in Germany was only 2% in August, compared with the 2.7% registered in credit crunch driven Spain. Fears of (or hopes for) a substantial surge in German inflation as the ECB moves towards some form of QE are greatly exaggerated. Social engineering isn’t that easy.
Italy’s Recession Deepens As Rescue Nears The Italian economy shrank by 0.8% between April and June, slightly more than previously estimated. A bigger drop in investment and consumer spending accounted for the downward revision from the 0.7% contraction estimated last month. Compared with the previous quarter, domestic consumption fell by 0.7%, while investment dropped by 2.3%. The Italian economy - the eurozones third largest - has now contracted for the past four quarters as the government has implemented a series of drastic spending cuts designed to cut its debt levels, which currently stand at more than 120% of the countrys annual economic output.It is hard to disagee with Simon Johnson when he says:While Draghi’s policies “may temporarily help stabilize” the crisis, “Europeaneconomies have to turn themselves around, they have to get back on a growthtrack, that’s not what we’re seeing right now.”
The ECB’s decision to purchase short term bonds from troubled periphery countriesapplies just as much to Italy as it does to Spain and Italy, even though the politicaldynamics of accepting the offer look daunting. Italy’s position is becoming ever moreprecarious as the deepening recession drives up the debt to GDP level, while at thesame time support for the government lead by Mario Monti weakens.As with Spain, there will be nothing significant in the way of Italian bond purchasesuntil the Italian government asks for help and formally signs a MoU. This momentseems farther away at this point than the Spanish bailout, and as such there couldbe a temporary yield inversion whereby pressure on Spanish bonds relaxes even asit intensifies on Italian ones.
Spanish Debt SustainabilityThe main point to emerge from recent EU policy decisions is that the future of Spanishsovereign debt is now very much tied to the evolution of the European debt crisis. Ifthe latter is adequately resolved Spanish debt may not even needrestructuring, although even with an adequate resolution some form of Private SectorInvolvement (PSI) at some point cannot be totally excluded.The problem is that no one at this point knows, and there really is no way ofknowing, whether the crisis will be adequately resolved or not. We thus face aprobability distribution where the only possible outcomes are what would normally beconsidered unlikely tail solutions - either the Euro Area fuses into one singlefederation (like the USA) or it splinters apart. There really is no middle way.Institutionally it is to be anticipated that no stone will remain unturned in the attemptto save the single currency. So obviously things like leveraging the ESM which arecurrently excluded may well eventually become most probable. Even an eventual QEprogramme of the sort we have seen in the UK, the US or Japan cannot be excluded.At present directly buying sovereign bonds in the primary market is not within the ECBmandate, but as we have seen time and again during this crisis, mandates areinterpreted and reinterpreted as needs must, and the current ECB one may eveneventually be changed if the alternative is viewed as disaster.
There are really two sides to the Irishstory. The country is keeping pacewith its bailout targets, but the realeconomy is not recovering asexpected. This suggests two things.In the first place the bailout targetswere excessively attainable, placingfar too much emphasisis onachieving fiscal stability, andinsufficient on getting the economyback on a sustainable path. The housing market is still stuck in a bad place, unemployment is too high, and mortgages are increasingly not being paid. Young educated Irish are leaving, making problems worse.
Greece Uses It’s “Wiggle Room”The economic crisis in Greece continues unabated, and there really does seem tobe no end in sight. Nevertheless the Troika are back in down, and Greek leadersare practicing their wiggle. Maybe they haven’t much scope for it, but AngelaMerkel’s admission that a Greek exit from the Euro could precipitate a Lehmantype situation has given the Greek government some bargaining space. It’s not clear what the agreement will be, but markets and almost everyone else are taking it for granted that there will be one. This is a far cry from the panic mood which prevailed before the recent elections. But methinks we are being too complacent. Some sort of patched up job may be possible now, but what happens when we get to next spring, or even though to autumn 2013. Greece’s growth problems have not been fixed, and the Greeks can only take so much for so long.