MacroScope

The world’s second largest economy, Japan, and Europe’s largest, Germany, all of a sudden have a lot in common. 

Their most striking resemblance in recent weeks is the breathtaking speed of economic decline, with output ransacked by a collapse in world demand for high-quality manufactured goods and an overvalued currency.

The fundamental problem is simple and doesn’t take an economist’s model to explain. At this stage of the financial crisis, who wants to replace a fully-functional Audi they bought a few years ago? What’s wrong with the 2007-vintage Sony PlayStation connected to the two-year-old Bravia or Grundig flat-screen TV? And who in their right mind would want to import the stuff in bulk when the euro and the yen are so expensive?

It’s very simple, but somehow analysts remain nearly universally stunned.

News that German industrial production plunged by 4.6 percent in December, nearly double the Reuters consensus and the steepest decline since 1989, triggered much handwringing. “Really horrific”, one analyst gasped. “Pretty horrible”, another muttered. “Devastating”, another shrieked.

Those were more or less the same words used to describe the near-10 percent collapse in Japanese industrial production, driven by the same trouble from those same frugal global consumers. Compounded, of course, by even more thrifty domestic consumers, as in Germany.

"Confidence grows at the rate that a coconut tree grows, but confidence falls at the rate that the coconut falls," Montek Singh Ahluwalia, deputy chairman of India's Planning Commission, told a panel in Davos.

He also indicated that India's decision not to float its currency and to build up massive reserves was correct, noting that this gave it a cushion during the downturn.

"Floating (currencies) would be fine, if that was what was meant, but what they mean by floating is crashing upwards and crashing downwards."

Good session on the "Frugal American," an as yet undiscovered species that is coming to a global economy near you.

You know the general idea, a decade or so of living beyond their means, borrowing money against their rising house values to finance consumption is coming to a grinding halt. That's called a recession, but how long will this frugal thing last?

Ian Davis, the MD from consultants McKinsey & Co was blunt:

"Americans have no option but to be relatively more frugal over the next 10-20 years." This is irrespective of the crisis and is a structural issue due to overspending in the past and the huge host of baby boomers who are now moving into what they fondly hope will be their retirement years. Old people buy fewer ipods and ski boots apparently, and are less likely to remodel their kitchens and bathrooms. That is a problem for the global economy.

Alan Greenspan hasn't been chairman of the Fed for three years, but his policy mistakes keep paying dividends in the form of blame at this year's World Economic Forum in Davos.

Polish Finance Minister Jacek Rostowski yesterday:

"This was the failure of one of the key institutions in the world." During the Greenspan era he said they continually met downturns and distress with easing and "eliminated fear."

Ken Rosen of Berkeley, who was writing about the housing bubble in 2005 or so, is in the same camp:

If there's one thing you don't want to be, it's the next Iceland.

Since its currency, colossally indebted banking sector and economy collapsed in spectacular fashion in October, the country has become a byword for an economy that has truly hit the rocks.

Within weeks, banking problems and currency falls meant Hungary was being hyped as a "second Iceland", at least until a joint International Monetary Fund and European Union rescue package restored some stability.

Next to win the unwanted comparison was Ukraine.  Having lost at one stage half its value, the currency has somewhat stabilised -- although most foreign investors are very hesitant to hold Ukrainian assets again.  And like Iceland itself, Ukraine is now dependent on an IMF lifeline.

The terrible U.S. retail sales  racked up in December — called a “horror show” by ING — were all the more gruesome because of the sales on offer to customers in the run up to Christmas. Shops weren’t exactly giving things away, but their generosity knew few bounds.

Consider the experience of one visitor to a heaving handbag department in a Maryland Macy’s.
 
    Customer: “I would like to buy this handbag please. Oh dear, it appears to be the only one that is not on sale.”
    Salesman: “So it is. Tell you what, sir, I’ll give you 15 percent off anyway.”

Happy customer, happy new handbag recipient, unhappy sales figures.

Thanks are due to the World Economic Forum for clearly  explaining the interlinked web of misery currently facing the world.  Make what you will of the details in the graphic below -- and if you can, please do let us know! -- but the overall impact really does spell it all out.

This Vonnegutesque cat's cradle, incidently, comes from the forum's new report, Global Risks 2009, released ahead of its annual meeting in Davos between January 28 and February 1. It shows an interlinked world facing a monumental series of interlinked risk, some of which  investors are having to confront for the first time.  Sheana Tambourgi, head of WEF's global risk network, explains the report in this video:

The periphery economies of the euro zone are suddenly in the spotlight.  Credit rating agency Standard & Poor’s has cut its outlook on Ireland’s sovereign debt to negative. It worries that fiscal measures to recapitalise banks and boost the economy might not improve competitiveness, diversity and growth — all making it harder to manage debt.

Next came Greece. S&P basically put the country on watch with a negative bias. The global financial crisis has increased the risk of a difficult and long-lasting struggle to keep the Greek economy on track, it said.

All this is a long, long way from the unravelling of the euro zone — it just got a new member, Slovakia, after all. But the subject has been raised. Gary Dugan, chief investment officer of Merrill Lynch’s wealth management arm, told a group of reporters in London recently that he expected political calls to quit the currency to be heard in some member countries as the global recession bites. He added that it wouldn’t happen, but that the talk could weaken the euro.

Followers of the dismal science will note the passing of Sir Alan Walters on January 3. Walters was the controversial economist who advised Margaret Thatcher during what turned out — regardless of whether seen as good or bad — to be a revolution in matters both monetary and social.

Walters was one of the first British economists to challenge Keynesian orthodoxy and argue for a monetarist approach to tackling inflation. He may be best remembered, however, for his opposition to the pound joining the Exchange Rate Mechanism, out of which sterling famously crashed in 1992, and for partly prompting the resignation of Chancellor of the Exchequer Nigel Lawson who felt he had too much influence on Thatcher.

In an obituary, The Guardian newspaper concluded: “In the early days of Thatcher’s government, he was a valued member of the small group of outsiders who provided intellectual and academic support for its policies. His departure in 1989 was a symptom, rather than a cause, of the complete breakdown of trust between the prime minister and her chancellor.”

It's not often that economists turn their attention to military hardware, but Deutsche Bank has done just that in its latest world outlook. The subject is aircraft carriers and what it sees as the strange desire among a number of countries to build them.

Russia has suggested it may build up to six carriers, DB notes, while China plans one and Britain and France three between them. Like the true economists they are, DB first questions the need, saying such boats are vulnerable, make no sense for coastal defence and are for projecting offensive power over long distances. Then comes the cost:
  

"To build a serious aircraft carrier costs well above $5 billion. But then you need to build half a dozen escort vessels and the aircraft to produce a battle unit that will require upwards of 10,000 sailors. Since it is for distant power projection, to keep a single aircraft carrier group on constant deployment requires at least two and more likely three groups."