Welcome to the global slowdown

May 24, 2011

James Saft is a Reuters columnist. The opinions expressed are his own.

HUNTSVILLE, Ala. — With QE2 set to end in five weeks and with Greece rolling downhill towards default, the world is not best placed to withstand a weakening economy.

That, however, is exactly what looks to be happening, as Asian demand is hit by a cooling China and a struggling Japan.

Let’s take a look at the evidence:

Japan’s economy shrank by 0.9 percent in the three months to March, battered by the earthquake, tsunami and ongoing nuclear fiasco.

The preliminary HSBC/Markit purchasing managers’ index for China fell to 51.1 in May from a final reading of 51.8 in April, holding in expansionary territory above 50 but amidst growing evidence that China is coming off the boil. Chinese demand for raw materials and semi-finished products has been one of the global economy’s principal supports, but now a monetary policy tightening campaign may be gaining traction.

The Chicago Fed national index, derived itself from 85 economic indicators, came in at negative 0.45 in April compared to 0.32 in March. There are numerous signals of an industrial slowdown in the U.S., while the housing market continues to weaken, threatening financial stability and consumer spending.

Finally, in Europe the euro zone composite flash PMI, an indicator combining service sector and manufacturing purchasing, fell to 55.4 from 57.8. More worryingly, the headline manufacturing index had its biggest fall since Lehman Brothers failed, falling by 3.1 points to 54.8.

“All in all it seems to us that the odds are high that a domestic and global economic slowdown is already in place.  In the U.S. the slowdown is happening with only weeks to go before the end of QE2, a program that has been a major prop for even the tepid recovery we’ve undergone so far,” said Charlie Minter of fund managers Comstock Partners in a note to clients.

“For the stock market nothing seems to matter until, suddenly, it does.”

It has begun to matter recently to the stock market, which has fallen in recent sessions after a sustained rally. The bond market has already figured this out; since mid-April U.S. 10-year yields are down more than 12 percent to 3.12 percent. Given that the U.S. debt market faces a debt showdown and the end of QE2, both factors which should theoretically send yields higher, this slide in yields shows real doubts about future growth.

CRUEL SUMMER

It is worth noting that the euro zone’s woes were not this time concentrated in the weak peripheral states; this time Germany got whacked too. That may well reflect the wrench thrown into production from Japanese plant closings, which in itself will self-correct. It is also likely reflecting a slowdown in demand for German products from China. If you believe that Chinese demand was artificially boosted by very easy credit, and that Chinese demand in turn was driving global growth, then this is an indicator of a very busy and volatile summer in financial markets.

Global markets have ignored, more or less, the euro zone’s issues for more than a year, but did so in a very supportive atmosphere. The Federal Reserve was buying up Treasuries, sending cash into risk markets in waves, while China continued to grow at a blistering pace. It may be that China is important not just because its slowdown affects demand, but because it lets investors focus on the actual prospects in the euro zone.

Will Germany and France be as willing to foot the bill for Greece if their own manufacturing bases begin to shrink? It is possible but a lot less likely.

Meanwhile the crisis both builds and spreads, with a dispute over debt reprofiling (a sort of doe-eyed default) between the European Central Bank and European officials and a fantasy plan by Greece to raise 15 billion euros through asset sales.

Greece may turn out to be a minor worry; Belgium and Italy have been threatened with credit downgrades by Fitch.

So what happens from here? A palatable outcome would be a gentle decline in economic momentum followed by a strong second half. This makes absorbing the impact from Europe easier, and makes it easier for Europe to come to terms with itself.

A less likely, perhaps, but still possible scenario is that the manufacturing slowdown gains speeds just as Europe faces a contagion from the periphery, either to parts of the core, to the banking system of the core, or both.

At this point the Federal Reserve will have an ugly choice; does it extend and expand quantitative easing to support the newly weakening economy, or does it sit tight, brace for the recession and hope something else will turn up?

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

8 comments

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Two years of brutal austerity in the face of severe recession doesn’t seem to be restoring anyone’s confidence in European markets, which was the main rationale for anti-stimulus thinking in the first place. What a shock.

The US stimulus in ’09 was too small, yet it did halt the free-fall of bankruptcies and job losses. The markets hit bottom in March ’09 and have nearly recovered their previous value, even exceeding it in many cases.

The TARP program not only rescued several key industries, e.g. Financial, Insurance, Auto, etc., but because those industries were not only saved from destruction, but are now actually growing, the Govt. stands to make a profit on the money spent! (With the exception of Fannie and Freddie, of course–although that could change too if the housing crisis ever ends, which it should seeing as how shelter from the elements is basic need.)

Europe has only a few choices to get out of this mess, none of which it has the political will to make anyway. But here goes nothing:

1) Europe needs to either drop the Euro or truly empower a centralized bank to manage the currency. Neither will happen of course. The inability of individual countries to manage their currencies takes the most effective tools a government has for rescuing its economy out of the toolbox.

2) Europe needs to restructure the debt burdens for Greece, Portugal, Spain, Ireland, and whoever the next victim may be, so that these economies have a chance to grow again. Smothering that growth ensures default. Disdain among Germans for the self-imposed suffering of the Greeks and the non-self imposed suffering of the other tottering economies guarantees that defaults will happen, and they will spread. Like a plague, Germany may be the last to be infected but they will not be able to stay healthy themselves if their neighbors start to fall ill.

So you will see more of the same. Drastic austerity measures further eroding growth and fanning the flames of instability. The Third Act will be the anchor weight of the Euro, dragging each country down in succession until the momentum crushes even the stronger economies. None of this will help the global economy, perhaps triggering another global depression or at least another recession.

Remember the Marshall Plan? That was the single biggest stimulus ever in history. It allowed Europe to recover from the wreckage of WW2 and have the strength to resist conquest by the USSR. Eventually, the stimulus was ended as the fragile economies of Western Europe became strong and able to fly on their own. Within only a couple decades, European economies were back in great shape, generating vast revenues and rising standards of living for people who’d known only want for most of their lives.

Sadly, by the time Europeans realize the need for such economic stimulus, there may be no one left to provide it.

Posted by BajaArizona | Report as abusive

In my above post I did not mention the need for reform of financial regulations. Here is a case where the US is lagging behind Europe, and there are lessons we can learn from across the Atlantic as well.

Again, it comes down to political will. Obama has accomplished an enormous amount of reform in a very short time against a rock solid united opposition unwilling to compromise on any issue. Now that the Republicans control half the legislative branch, comprehensive financial reform is out of reach, at least for the next two years. Unlikely as it seemed 6 months ago, I think there is a chance in two years for Democrats to retake control of both chambers of Congress AND keep Obama in the White House. Until/if that happens, we’ll just be lucky to keep The Repubs from destroying the fragile recovery. True reform is not possible in the near-term, unfortunately. So Goldman Sachs and their ilk have at least two more years to loot our country. Perhaps there will be something left to reform when the pendulum swings back to the Democrats.

The latest Repub attack? They wish to cut food and nutritional supplements to poor pregnant women and their infants. W.I.C. (Women Infants and Children) is one of the most successful programs in our nation’s history. The terrible impact of malnutrition in the womb and during infancy remains with a person for their entire lives. The impact on society at large is enormous. WIC uses a fraction of a fraction of total federal spending. Another GOP priority? Tax breaks for oil companies and the ultra-rich.

I don’t know if they are just ultra cruel or actually insane.

Posted by BajaArizona | Report as abusive

It is stunning to see someone like a previous commenter try to make a case that all of the failed attempts to revive the US and global economies will eventually work if we just double down enough on the monetary and fiscal roulette wheel. I’m not going to devote an hour or two to rebut every fallacy contained therein. I’m too busy trading to fall for that bait.
Be it sufficient to say that there is another catastrophe in the making. It is a debt debacle — the Mother of All Bubbles. There was never any true resolution to the debt crisis that began in the mortgage industry and that brought on the recent recession. They just kicked the can with more debt, socializing the losses, and more Fed monetary mayhem with QE1 and QE2.
And more of the same is only going to deepen and worsen the price we eventually pay. More debt and more socialist policies are not going to improve the results when the consequences soon hit the fan. A bond market conflagration and a vicious sell-off will eventually bring a crushing end to our extend and pretend insanity.
We can not defy the laws of sound economics forever! More of the same with overspending and overindebtedness will only ultimately make things worse!
It’s time to take our monetary and fiscal medicine instead of demanding another round of economic heroin to makes ourselves feel better for a day. The music is soon ending in the game of musical chairs. It’s time to face that reality instead of living in the dream world where endless debt can solve every problem! It can’t, and it won’t!
This article eloquently makes a case for what may soon be the next phase of a crisis that was never resolved, but just delayed!

Posted by sbenard | Report as abusive

[...] Welcome to the Global Slowdown – Reuters [...]

The banks have systematically looted the country with their schemes and games. Our Congress is weak as they cannot even stop taking money for making asinine decisions. Our leadership in the executive branch are busy pretending they are doing a good job. You cannot use economics to fix this problem. It takes common sense decisions and a willingness to make changes. Mr Obama, you are not FDR. To be another FDR you must seek guidance outside of your cronies, write your own speeches, and have a heart.

Posted by fred5407 | Report as abusive

Economic pain causes fear and fear causes anger and anger clouds peoples ability to think–never too strong to begin with. So they extrapolate personal solutions to whole economies. Running a country is nothing like running a household. What you know about debt and budgeting for yourself is not applicable to the global economy. Although I wish it were so.

Posted by BajaArizona | Report as abusive

BajaArizona is weak on history and on recent events, so I would have doubts about any advice he may proffer.

The Marshall Plan spent less per year than the US had prior to its beginning. Marshall deserves more credit for undoing the dimwitted policy of crushing German industry under the heel of the victors. Contrary to the comment, Europe surpassed its previous wealth (it was never poor) within a few years, not decades.

Obama’s stimulus, although approaching a trillion dollars, was “too small” and yet it halted the free-fall” of bankruptcies and job losses. Bankruptcies continued to rise in 2009 and 2010. Job losses were projected by the Obama Administration to reach 8.5% in 2009 without the stimulus, and 9.0% in 2010. With the stimulus, job losses were much worse, reaching 10% in 2009 (not the 8% peak predicted by the Administration).

As for his comment “Running a country is nothing like running a household” perhaps he should know that the word “economics” comes from Greek “managing a household.” The similarities exceed the differences — we can live it up and keep up appearances as long as we are able to borrow from others. If we use the money wisely, we can pay everyone back and live well. If we don’t, maybe not.

As for castigating the Republicans on such matters as financial regulation, the Democrats had both houses of Congress and the White House and did nothing — not even ending the tax breaks for the rich. Don’t hold out hope that they will prove the sheriff able to corral Goldman Sachs. The campaign of partisans to blame the other side is part of the puppet show to distract us from the real looters. They are politicians and their cronies.

Posted by fredricwilliams | Report as abusive

well…there are some basic things people are overlooking .It is not really related to specific administration or rule or country specific . These are simple and very much differ from any previous cases in the history .

a)After WWII there were demands among people for basic needs (foods ,home ,car etc.) and there was an urge for advancement of life and there was tremendous scope for improving life .The scope was created by technology . Situation is much more different now . Little scope with a very less urge . As technology is touching a limit . So , until and unless we are getting interested about interglacial life,next level of development or demand growth is not in the horizon.

b) The second one is rapid automation in various goods and services we use . This phenomenon decreases need for human being to produce their need .Less number of people can produce far more . There comes the unemployment and income inequality . Some change in policy could handle this problem .

c) Third one is , scarcity of resources we use .The world is getting sold-out . And mother nature is shutting the shop(no more coal,oil, gas,minerals etc. ) . While we can struggle over providing alternative energy related problem , solution for material related issue will dominate in future and till date there is no significant technological breakthrough in this field as of now.

d)Over luxury of super rich in and over population of some countries creating some social and economic stress .

e)The last one may sound new but it is reality .This is generation problem .Much of world’s resources are controlled/handled by old baby-boomers of 70′s and 80′s . The newer generation have almost nothing to control but work for the earlier generation .So , it is a battle of generations,too .

Well …history says problem is inevitable .So , lets see how all parameters works out in future .

Posted by atanu2531 | Report as abusive

well…there are some basic things people are overlooking .It is not really related to specific administration or rule or country specific . These are simple and very much differ from any previous cases in the history .

a)After WWII there were demands among people for basic needs (foods ,home ,car etc.) and there was an urge for advancement of life and there was tremendous scope for improving life .The scope was created by technology . Situation is much more different now . Little scope with a very less urge . As technology is touching a limit . So , until and unless we are getting interested about interglacial life,next level of development or demand growth is not in the horizon.

b) The second one is rapid automation in various goods and services we use . This phenomenon decreases need for human being to produce their need .Less number of people can produce far more . There comes the unemployment and income inequality . Some change in policy could handle this problem .

c) Third one is , scarcity of resources we use .The world is getting sold-out . And mother nature is shutting the shop(no more coal,oil, gas,minerals etc. ) . While we can struggle over providing alternative energy related problem , solution for material related issue will dominate in future and till date there is no significant technological breakthrough in this field as of now.

d)Over luxury of super rich in and over population of some countries creating some social and economic stress .

e)The last one may sound new but it is reality .This is generation problem .Much of world’s resources are controlled/handled by old baby-boomers of 70′s and 80′s . The newer generation have almost nothing to control but work for the earlier generation .So , it is a battle of generations,too .

Well …history says problem is inevitable .So , lets see how all parameters works out in future .

Posted by atanu2531 | Report as abusive