Global manufacturing activity is slowing across many regions due to multiple factors such as the Eurozone debt crisis, slowing growth in China, and quantitative easing measures running out of steam in developed economies. Japan continues to struggle with weak domestic demand and exports hindered by a strong yen. China is experiencing a slowdown driven by adjustments in its real estate sector and declining external demand. The recession in Europe is worsening and spreading from the periphery to core countries like Germany. Italy is also seeing its recession deepen.

1. Global Manufacturing Downturn Gathers Pace In July
July Monthly Manufacturing PMI Report Edward Hugh - Barcelona: July 2012

3. Manufacturing Visibly Slowing Across The Planet
We live in a globalised world. And what better illustration of this than the way in
which manufacturing activity is steadily slowing across the globe. In theory the
worsening conditions are a by-product of the Euro Debt Crisis, but in reality there
are a multitude of factors at work – the slowdown in China, exhaustion of a credit
boom in Brazil, a Japan which can’t export as much as it needs to due to the high
value of the Yen, a United States where the various rounds of quantitative easing
appear to have run out of steam.
We also live in a world which is structurally in transition. The developed countries
are overly in debt (especially when we consider health and pension liabilities
looking forward) and ageing excessively. The emerging economies are
experiencing a massive demographic, cultural and economic transition. The so
called “Arab Spring” is just one example of this. Risk is being re-evaluated, with
developed world risk rising, at the same time as risk perception of Emerging
Economies improves.
So the paths are crossing. Recessions in the developed world will now be more
frequent and the recoveries shallower, while EMs will experience substantial catch
up growth, while the recessions will be much more modest than previously.

4. Asia
Viewed as a continent, it is very hard to make generalitzacions about Asia. Japan is
among the oldest countries on the planet. Domestic demand is congenitally weak, and
exports struggle against the weight of an overvalued yen. The important point to notice
is that all last years predictions about Tsunami reconstruction bring a new lease of life to
the country have proven to be ill founded. All the associated damage has done is
produce more debt. And still the economy struggles to grow. This issue will doubtless
become worse after the government introduces the long promised increase in
consumption tax.
China is suffering from a real estate adjustment which influences internal demand, while
the global trade slowdown harms the export sector. In addition, the country’s potential
growth rate, after hitting double digits at one point, is now slowing steadily as China
steadily moves from emerging economy to mature economy status.
India continues to advance at rates which are not seen in most Asian economies these
days, but the country has an endemic inflation problem which remains unresolved, and
growth is also hampered by poor infrastructure and widespread corruption.
The semi developed economies like South Korea and Singapore still struggle to
overcome weak export demand, and even new emergers like Vietnam and Indonesia
remain challenged to find growth at this point.

6. Emerging Economies Hanging In the Balance
The key point to appreciate is that with “risk off” due to the European Debt Crisis,
even the Emerging Markets are unable to exploit their huge potential for growth.
Capital is no longer flowing in in the way it did after the various rounds of QE in
the US and even the LTROs in Europe. Investors are playing safe. In addition,
external demand is falling as one economy after another in the developed world
slides towards recession.
The China factor is also important. China’s economy is obviously slowing, and it
isn’t evident to me that it will bounce back any time soon.
Finally, it is important to stress that the BRIC concept was always far too general. It
is just based on population size and underdevelopment. The key factor is age
structure, and in this sense India and Brazil look very different from Russia and
China. Economic growth is partly about favourable demographics, and partly
about institutional quality. Some EMs increasingly have the latter, others never
will.
Still, it is impressive how some manufacturing sectors (like Indonesia and
Vietnam) are now evidently having a hard time of it, while others (India, Turkey)
are managing to keep their heads just above water.

7. My feeling on China is that we
won't see a hard crash landing, but
that with exports constantly
vulnerable to developed word
problems, and the construction
and property boom steadily
unwinding internally we will see a
much more protracted period of
slower growth than people are
expecting. I also think monetary
policy will be relatively ineffective
in rekindling property related
consumption activity in the short
term. Growth could easily fall into
the 4% to 6% annual range for a
time.

11. C.E.E.

16. Europe Sinking Into The Mire
ECB Action Depends On Requests For Help and EU Conditionality
As Europe’s leaders continue to fiddle around with the debt crisis, the economies of the
Euro Area sink deeper into the mire. The latest round of PMIs suggest that the recession is
extending into the third quarter with no let up in sight.
Certainly progress is being made in terms of the liquidity and capital needs of Euro Area
banks, and further moves to ease sovereign financing difficulties seem to be at hand, But
competitiveness issues are still a long way from finding solution. There is no evidence to
back the idea of a surge in German inflation, while VAT hikes in country’s like Spain
continue to damage their relative cost position.
The ECB has raised market expectations considerably in recent days. In the short run such
expectations have foundered on disappointment. In the longer run, however, the ECB is
likely to have few unbreachable limits to its freedom of action.
Movement by the EU and the ECB will require formal requests for aid and involve
conditionality. When this happens the most likely policy move with be SMP reactivation by
the ECB in the secondary market and EFSF purchases in the primary one.
Finally a reminder: it is important to remember the Greek problem has not gone away, it is
simply in limbo. The Troika have gone home for now, but they did leave a message, courtesy
of the Ramones, “see you in September”.

17. Euro Area

18. Europe’s Recession Worsens Entering Q3
Core Now Affected Along With The Periphery, Recession Risk in Germany
Germany’s economy seems to be
headed 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.
As Tim Moore, senior economist at Markit put it in his report, “July’s figures suggest that
the German economy has started the quarter on a weaker platform than at any time since
the 2008/09 recession”.
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 1.7% in July, compared with the 2.2%
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.

22. Italy’s Recession Deepens As Rescue Nears
Italy's national statistics office, ISTAT, issued
its preliminary Q2 GDP report this week,
estimating that gross domestic product fell
0.7 per cent quarter on quarter in the three
months to June, and fell 2.5 per cent below
the level of a year earlier. This makes Italy's
recession considerably deeper at this point
than Spain's. Confindustria, Italy’s main
business association, forecasts a 2.4 per
cent contraction for the whole of 2012, and
there may even be downside risks
here..Despite the shrinking economy, the
Italian treasury reported late on Monday
that tax revenues rose 4.3 per cent to
€191bn in the first half of this year
compared with the same period in 2011
thanks to the government’s austerity
measures. Given the substantial lack of
international competitiveness, the Italian
economy will struggle to find growth now
that fiscal support has been withdrawn.

23. The June EU summit decision to support funding costs of troubled periphery
countries applied to both Spain and Italy. Italy’s position is becoming ever
more precarious as the deepening recession drives up the debt to GDP level,
while at the same time support for the government lead by Mario Monti
weakens.
As with Spain, there will be nothing significant in the way of Italian bond
purchases until the Italian government asks for help and formally signs a
MoU. This moment seems farther away at this point than the Spanish bailout,
and as such there could be a temporary yield inversion whereby pressure on
Spanish bonds relaxes even as it intensifies on Italian ones.

25. Spanish Debt Sustainability
The main point to emerge from recent EU policy decisions is that the future of Spanish
sovereign debt is now very much tied to the evolution of the European debt crisis. If
the latter is adequately resolved Spanish debt may not even need restructuring,
although even with an adequate resolution some form of Private Sector Involvement
(PSI) at some point cannot be totally excluded.
The problem is that no one at this point knows, and there really is no way of knowing,
whether the crisis will be adequately resolved or not. We thus face a probability
distribution where the only possible outcomes are what would normally be
considered unlikely tail solutions - either the Euro Area fuses into one single
federation (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 attempt
to save the single currency. So obviously things like leveraging the ESM which are
currently excluded may well eventually become most probable. Even an eventual QE
programme 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 ECB
mandate, but as we have seen time and again during this crisis, mandates are
interpreted and reinterpreted as needs must, and the current ECB one may even
eventually be changed if the alternative is viewed as disaster.

26. So the Euro is unlikely to break apart as a result of institutional obstacles. If it
does eventually do so it will be because civil society (the electorate, citizens
in one form or another) refuse to continue with what they consider to be
either an excessively painful or unjust situation. Such a move could come
from the Core (as voters realise and become alarmed by the real cost to
them of sustaining the Euro), or from the periphery, as the sacrifices
demanded become unbearable, and political instability results.
Germany
It is important to understand that Germany is already into the “save the
euro” process in a way which makes it increasingly expensive for the country
to get itself out. Not only would debt obligations not be repaid in full
following any German exit, including those which come via the ECB Target2
clearing mechanism, but the country also depends on exports (it is an ageing
society where domestic demand is weak) which would make it hard to live
with an over-strong currency (look at Japan). So the German financial,
industrial and political leadership are likely to try to avoid this outcome at all
costs. The fundamental issue is then, how far can they get the rest of the
population to follow them?

27. Spain
It is important to stress that while recent progress has been made in Spain, the
country is not out of the woods by any means. The big danger with Spain was
always that Sovereign debt would approach 100% of GDP and then the need for a
large financial system bailout would suddenly appear. If resolving the needs of
the Spanish financial system was to have been carried out in the Irish manner,
then Sovereign debt would have become rapidly unsustainable.
Now that the EU has in principle agreed to directly inject money into Spain’s
banks, once the ESM is up and running and the Banking Union sufficiently
advanced, this danger recedes. Even if much more money than the initial 100
billion Euros down payment should eventually be needed, and I think it will be,
the same applies. Germany is now in the John Paul Getty position whereby having
someone owe you too much money means you have the problem.
Naturally, the whole banking union and ESM direct recapitalisation issue will need
careful monitoring, since it is the type of thing which may make German voters
nervous, and this could lead to delays and then even doubts about final
implementation. But if fully implemented it would be a game changer for Spain
and it is important to realise that.

28. Once you take the financial system out of the equation then the whole debt position
changes. There are lots of issues, like the FADE electricity fund, the regions, the public
companies etc, but they are all manageable within limits.
The two big problems looming are the low economic growth outlook and the mounting
pension liabilities. Despite the constant denials, lack of international competitiveness is
a major problem for Spain. Growth can only come at this point from exports, and the
sector is too small after so many years of neglect. In addition the reputational damage
being inflicted and the ongoing conversion risk will make it hard to attract the needed
FDI in the years to come. So I think we are facing a long drawn out process – maybe a
decade – when unemployment will be high, and public spending will be under constant
pressure, and the issue is whether the ordinary Spaniard is ready for this. I personally
have my doubts, and feel that before the time is up we will see cracks in the political
system.

29. The second main area of concern is the pensions system. The social security reserve
fund is effectively “non functional” since it mainly contains Spain Government Bonds
that could only be sold into the market at a loss. So, with the number of people
contributing to the system going steadily down, and the number of pensioners going
systematically up the system is now in permanent structural deficit, and the position is
getting worse. The EU is rumoured to be trying to press the Spanish government to
address this as part of the forthcoming bailout conditionality, but either way something
needs to be done. The number of people working and paying contributions isn’t going to
rebound any time soon, and the demands on the system will continue to grow. Hence
one day or another push will come to shove.

31. There are really two sides to the Irish
story. The country is keeping pace
with its bailout targets, but the real
economy is not recovering as
expected. This suggests two things.
In the first place the bailout targets
were excessively attainable, placing
far too much emphasisis on
achieving fiscal stability, and
insufficient on getting the economy
back 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.

33. Oh, I Believe In Miracles........
Never was a truer word spoken, even in jest.
When Mario Draghi clarified for the journalists who assembled before him at last
week’s ECB press conference what the expression "The euro is irreversible" actually
meant, he replied it "means we are not going back to the drachma, the lira" etc.
While some may have noted nothing remarkable in the statement, finding it
perhaps almost trite, or commonplace even, I thought to myself, "hmmm, now
that's an interesting choice of countries".
The conclusion which I for one drew from this observation was that he was trying to
tell us the ECB was not (for the moment at least) contemplating any move to cut off
Emergency Liquidity Assistance (ELA) access for the Greek banking system. I mean,
you would hardly boost the credibility of the institution you represent by saying no
one is going to a certain place and then in September sending someone directly
there.

34. And since shutting off access to Eurosystem backed ELA would be the only effective way
of driving a Greece that didn't want to go out of the Eurosystem, I also got the
impression that what we are going to see in September is likely to be some further
attempt to throw a lifeline to the struggling country, at least as far as the EU is
concerned. In terms of practicalities the latest round of cuts will be formally accepted,
and applauded, while money will be sent into the country, via the backdoor. Using
Francoise Hollande's EU growth stimulus programme, perhaps, be this in the form of EU
structural funds or long maturity low-interest loans from the European Investment
Bank.
Well, now that the some of the details of what was discussed at the ECB meeting have
started to be leaked to the press I am pleased to see that my initial hunch was not such
a bad one.
Mario was not making some sort of idle, throw away comment, for he knew of that
about which he spoke. In the proximate future Greece will not be going back to the
Drachma. Nor will it be introducing a second non-convertible currency, since it already
has the ability to generate resources on its own account a highly convertible one. Not
only are the ECB's Governing Council not planning to cut Greek banks off from the
Eurosystem, if a report this weekend in the German Newspaper Die Welt is to be
believed, they have even agreed to increase their credit limit.

35. Until last week the Bank of Greece was only authorised to accept Greek government T-Bills
up to a limit of 3 billion euros as collateral for accessing ELA. As of last Thursday, however,
that quantity has been increased to 7 billion euros, giving the government effectively
another 4 billion euros with which to pay employee salaries, pensions, etc. Greek banks buy
the T-Bills at government auctions, and take them to the national central bank to use as
collateral for borrowing, in much the same way commercial banks in Portugal, Spain, or Italy
use the ECB. The difficulty in the Greek case is the country's credit rating does not enable
the ECB to be used as counterparty in these financing operations.
Now I don't know how long it will take the mainstream Euro Crisis pundits to catch up with
what has been obvious to me (and among others Willem Buiter) for months now (over a
year in fact, at least since Ireland first started accessing ELA and de facto printing its own
euros). The reality is that despite the many evident parallels Greece is NOT Argentina. The
country can print its own Euros. Argentina could never print dollars, in fact it had to buy or
borrow them in order to keep pace with citizen demands for converting all the pesos it was
printing. Greek banks simply access German deposits via Target2 to cover their own lost
deposits as they move to Cyprus, as long as the collateral lasts that is. But then there is ELA.
In addition Greece can get direct access to fund transfers via the EU structural funds
programme, while Argentina never had any such bilateral relation with the US. Details don’t
solve the big picture problems, but they do matter here.

36. So while there is no denying the multitude of structural similarities with the
Argentina situation - macro imbalances, a structurally distorted economy, no relief
through devaluation due to the presence of a de facto peg, a very deep recession as
a consequence - there are a host of details which differ. Monetary Union is not
simply a currency peg, and this makes many of the key calculations about what to do
and when different.
Naturally, none of this is to say that the end of the story won't be the same, but we
aren't there yet, there is still some life in the process, and we can't rule out miracles
- not "miracle" recoveries of course, we are unlikely to see one of those, but
miraculous conversions of the Saul of Tarsus kind, one of which could just happen
one day when you least expect it somewhere along that Autobahn which runs
between Frankfurt and Berlin.

37. Americas

39. Africa