MacroScope

The limits of austerity

With debate about the balance between growth and austerity well and truly breaking out into the open, flash euro zone PMIs – which have a strong correlation to future GDP — are likely to show why a bit of fiscal stimulus is sorely needed. Talk of a European Central Bank rate cut is growing, euro zone policymakers at the G20 last week began to ponder loosening up on debt-cutting in an attempt to foster some growth and European Commission President Jose Manuel Barroso added his voice to the debate yesterday, saying the austerity drive had reached its “natural limit”.

Crucially, we haven’t heard similar from Germany but something is afoot, starting with the certainty that the likes of Spain and France will get more time to meet their deficit targets when the Commission makes a ruling next month. Portugal has already been given more leeway and today its finance minister will spell out new spending cuts which are required after the constitutional court threw out Plan A.

It’s a coincidence, but an interesting one, that this debate – frequently voiced in private over many months – has gone public just as THE academic study from 2010 which asserted that as soon as debt exceeds 90 percent of GDP growth is crushed, has been called into question.

France continues to look like the poor cousin of northern Europe. It will also release an annual study of household income and wealth today. Its loss of economic clout is one factor behind the weakening of the French voice in comparison with Germany’s.

One of the saving graces for the likes of Germany has been the ability to export outside the euro zone so a Chinese slowdown would concentrate minds even further. Hey presto, today’s Chinese PMI showed growth in its huge manufacturing sector dipped in April and export orders contracted, a reflection of weakening global demand. Beijing will respond in policy terms if it has to but it is a worry.

Octogenarian rekindles Italian hope

 

The big euro zone development over the weekend was the re-election of ageing Italian President Giorgio Napolitano for a second term. The presumption is that to put himself through this again he must have got pretty serious expressions of intent from the warring political parties that they will strive for some form of grand coalition. That may have been made easier by the resignation of centre-left leader Bersani who was in danger of splitting his own caucus.

If that comes to pass it should push back the timing of fresh elections until next year at least, a welcome turn for markets which feared a new poll could result in an even more fractured outcome and put more power in the hands of the anti-establishment Five Star movement. All that means we should see a significant rally in Italian assets today. That should also benefit other peripheral euro zone bonds. Safe haven German Bund futures have already dipped at the open, Italian bond futures have leapt almost a full point and European stock futures are pointing upwards.

87-year-old Napolitano will address parliament later and could either rush through consultations with the parties or skip that step altogether since he’s already heard from them ad nauseam.

100-years of solitude in the euro zone

The euro zone slipped deeper into recession than economists expected in the fourth quarter of 2012 as Germany and France– the region’s two largest economies – shrank 0.6 percent and 0.3 percent respectively on a quarterly basis.

The data is a reminder of the plight still facing the euro zone as it struggles to shake off a three-year debt crisis, which the region has sought to fight with harsh, growth-crimping austerity.

The European Central Bank’s promise to buy the bonds of struggling sovereigns has spurred investors back into those markets and helped reduce borrowing costs. While one trillion euros of cheap funding made available to banks in late 2011 and early 2012 also gave investors greater confidence, the benefits of such policies have yet to translate into improvements in the real economy.

Brazil: Something’s got to give

How about living in a fast-growing economy with tame inflation, record-low interest rates, stable exchange rate and shrinking public debt. Sounds like paradise, doesn’t it? But Brazil may be starting to realize that this is also impossible.

Inflation hit the highest monthly reading in nearly eight years in January, rising 0.86 percent from December. It also came close to the top-end of the official target, accelerating to a rise of 6.15 percent in the 12 months through January.

That conflicts with key pillars of Brazil’s want-it-all economic policy. The central bank cut interest rates ten straight times through October 2012 to a record-low of 7.25 percent, saying Brazil no longer needed one of the world’s highest borrowing costs. The government also forced a currency depreciation of around 20 percent last year, aiming at boosting exports and stopping a flurry of cheap imports.

Trade entrails

An exercise in divination using the entrails of last week’s U.S. international trade report shows signs of a move with larger implications than just the gaping deficit that caught analysts wrong-footed: the possibility of a persistent burden on the American economy caused by Japanese and German imports, like in the 80s.

The U.S. trade deficit widened 16 percent in November to $48.7 billion, the Commerce Department said on Friday, above the $41.3 billion expected. The negative surprise prompted economists to cut hastily their U.S. gross domestic product estimates for the last quarter to a negligible rate. The stock market took a hit.

The disappointment was limited, however, as analysts attributed the bulky import bill behind the deficit increase to a resumption of merchandise flows into the U.S. after Hurricane Sandy paralyzed port activity in the East Coast the previous month. Some economists still on yuletide mode are, apparently, missing the big picture.

Britain’s budget conundrum

Budget statements from Britain and Ireland take top billing today with UK finance minister George Osborne cutting an increasingly lonely figure in policymaking circles as an advocate of cutting your way back to growth. While the economic policy room for manoeuvre is limited this is a huge political moment. With elections due in 2015, a feeling of recovery must be entrenched in the public’s mind well beforehand if the Conservatives are to entertain hopes of governing alone next time. So measures now and in the 2013 budget in the spring are the best opportunity to change the game.

Osborne has already said he is sticking to his austerity plan – and having made it the government’s central policy plank he has little choice although the opposition Labour party have staked out the opposite ground and hopes to capitalise. Even so, Osborne is likely to have to admit that he will miss his debt-cutting targets so that the pain will have to last for longer, well into the latter part of this decade.

As the euro zone has shown, without growth cutting debt is nigh on impossible. Osborne came into government in 2010 saying the austerity drive would be complete by the time of the 2015 election. He is expected to say today that it will stretch to 2018. Labour’s significant opinion poll lead is widely seen as “soft” but it might not be for long.

Hey, at least it beats the Mayan outlook

A panel of economic luminaries took the stage in Chicago this afternoon to join in a tradition repeated this time of the year in cities across the country, opining on the outlook for the coming year.

Raghuram Rajan, a finance professor at University of Chicago’s Booth School of Business, began with a joke involving 973 sheep and a dog, the butt of which was the intellectual capacity of economic forecasters. He went on to predict slow world growth ahead, highlighting the geopolitical risks from conflict in the Middle East and Asia, and the limits of fiscal and monetary policy to turn things around.

Carl Tannenbaum, Northern Trust’s chief economist, focused on the still-troubled housing market and risks posed by the failure of European political leaders to resolve their financial crisis (he observed that Americans frustrated by the deadlock in Washington over resolving the U.S. fiscal cliff have only to look across the Atlantic for comfort that things, certainly, could be worse).

Fiscal cliff could help U.S. avoid road to Japan – but probably won’t

The “fiscal cliff” is widely seen as a massive threat looming over a fragile U.S. recovery. But with a little imagination, it is not difficult to see how the combination of expiring tax cuts and spending reductions actually presents an opportunity for tilting the budget backdrop in a pro-growth direction, even if political paralysis makes this scenario rather unlikely.

For Steve Blitz, chief economist at ITG in New York, the cliff presents a unique chance for the United States to avoid sinking deeper in the direction of Japan’s growth-challenged economy by shifting incentives away from consumption and towards investment:

If current negotiations end up simply turning the “cliff” into a 10-year slide an opportunity to help the economy regain a dynamic growth path and close the gap with pre-recession trend GDP would, in our view, be lost and raise the odds that, in the coming years, U.S. economic performance looks more like Japan’s. […]

Roaring auto sector could charge up U.S. growth

photo

Economists love motor analogies, and for good reason: they are very useful in illustrating the ebb and flow of economies. In coming months, maybe even years, the help from the auto sector could become a lot more literal, argues Paul Dales, senior U.S. economist at Capital Economics in London. In particular, he expects rising sales following years of depressed consumer spending on vehicles in the wake of the Great Recession could add as much as 0.25 percentage point to U.S. gross domestic product growth per year over the next four years. Here’s why:

The rise in new vehicles sales in September, to 14.9 million from 14.5 million in August, was significant as the number of new vehicles being purchased is now higher than the number being scrapped. This comes after four years in which the total number of vehicles in operation has been declining.

That fall was because when the recession hit and credit seized up, both households and businesses had little choice but to run their existing vehicles for longer. It is possible that 10 million fewer new vehicles have been sold than would have been the case if there was no recession.

Latin America: the risks of being too attractive

Ironically, an increase of capital inflows to Latin America in the last few years due to unappealing ultralow yields in industrialized countries and the region’s relative economic success is posing a threat for development, according to a recent paper that provides wider background to BRIC criticism of the latest U.S. Federal Reserve´s quantitative easing.

The article, written by Argentine economists Roberto Frenkel and Martin Rapetti for the World Economic Review – an international journal of heterodox economics –  warns about the possibility of a Latin American variant of the so-called “Dutch Disease”. This is a situation where a country suddenly finds a new source of wealth that makes its currency more expensive, hurting local exports and causing traumatic de-industrialization.

“Our concern is that massive capital inflows to Latin America may have pernicious effects via an excessive appreciation of the real exchange rates, which could lead to a contraction in output and employment in tradable activities with negative effects on long-run growth”, says the paper.