More Bad News From Germany


Well just to round off the week late Friday afternoon, another ominous piece of data from the German front:

Concern over the fragile health of the German economy, the largest in the eurozone, mounted on Friday after industrial output fell faster than expected, casting further doubt on official growth forecasts.Industrial production fell by 1.1 per cent month-on-month in March after a meagre rise of 0.2 per cent in February, the economics ministry said. The steep fall followed a sharp drop in orders for March. Economists said the decline confirmed their view that GDP growth in the first quarter was just 0.2 per cent. The economy ground to a halt in the final quarter of 2002 and is expected to weaken in the second quarter of this year. The German government, which has forecast gross domestic product growth for this year of 0.75 per cent, will release first quarter GDP figures next week. Most economists believe the GDP forecast will prove too optimistic.
Source: Financial Times
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Complicated Brain Gymnastics

Seeing the damage that was clearly being done, another of the savants, Otmar Issing, has emerged from the closet to clarify: the key phrase 'close to - but below - 2% should give a 'sufficient margin to guard' against the deflation risk. Of course, the fact that this 2% is an aggregate (of somewhat dubious propriety), and that some countries (Germany, Italy...) are already significantly below that magic number and falling, this detail does not seem to merit too much attention.

The threat of deflation in Europe prompted the European Central Bank on Thursday to soften its inflation objective and redefine its monetary policy strategy. In a move that economists said raised the likelihood of lower interest rates in the future, the ECB said it would aim in future for an inflation rate of "close to - but below - 2 per cent".Its previous formal objective had been simply to keep inflation at 2 per cent or less...............

The ECB took no action on interest rates as a result of its new strategy, leaving its main rate unchanged at 2.5 per cent. The decision to leave rates on hold was widely expected, but the steep rise in the euro to a four year high against the dollar had fuelled hopes that the downward pressure on inflation might encourage the ECB to cut rates. Ken Wattret of BNP Paribas said: "I think the ECB view is that deflation may be a problem, but not in the euro area. I get the impression that the ECB has not really taken in the implications of the rise in the euro." The euro hit a four-year high of $1.1506 on Thursday, up 1.25 per cent from Wednesday's New York close, before falling back in late trading.

Mr Issing said the changes to the ECB's strategy would not lead to a change in policy, insisting that past rate decisions would not have been any different if the clarification had been in place earlier. Nevertheless, economists said the change represented a significant shift for the longer term and could lead to a bias in favour of lower rates. David Walton of Goldman Sachs said the review would bring the ECB's declared strategy into line with its interest rate decisions. "I think they should be commended because they've used this as an opportunity to formalise in words what they've been doing in practice," he said. "They will be aiming at inflation of close to 2 per cent, but you can't keep inflation precisely at that level."
Source: Financial Times
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Euro Rise: Not Significant,...........But a Problem For Business?


This is Pedro Solbes' appreciation of the situation as the common currency seems to continue its upward climb without restraint. As I indicated yesterday, probably the main legacy of the war is that no-one would believe the ECB had the capacity to stop the dollar's fall if that fall were being pushed by a deflation consciouss US government. So maybe the best policy they can see is put up and shut up. The question is one of credibility, and right now Brussels and Frankfurt have very little indeed. Even so, what is a problem for business today will reach the rest of us tomorrow. It's the complete bankruptcy of the thing that gets to me. While everyone is busy congratulating the Fed on seeing the danger coming, on 'letting us in on the conversation', on preparing the 'unconventional tools', the ECB is still in denial: we are still talking about a further reduction in inflation being beneficial and liable to promote growth. It seems that the time the ECB spokesmen don't use excelling themselves Byzantime obscurantism, they seem to idle away testing the limits of absolute folly.

I am not, in principle, convinced as to the workability of the euro. But if I was, then I would be looking to see a serious effort made to make it work. This would involve a real call to arms from the Central Bank and the Commission. It would involve an open recognition that the flagship, the titanic of the fleet, was in danger, and that its was hands-on-the-pumps time all round. This is the time to show that level of mutual solidarity that is considered so necessary to make the euro work. The smaller, peripheral economies need to be prepared for sacrifices (or did they think it was all about drawing down money from the structural funds?). Maybe near zero interest rates would provoke dangerous inflation in Spain, Greece and Portugal, but if Germany sinks into the deflation mire, and the 'unconventional tools' come out, the damage is going to be far, far worse. Or are we not prepared to think about the unthinkable?

The euro hit a record high against the yen in Asian trade on Friday as its appeal as a yield earner, after the ECB kept eurozone interest rates on hold, gathered momentum. The single currency rose as high as Y135.26 against the yen, after closing at Y133.57 over night in New York.In early European trade the single currency was at Y134.83. Against the dollar the single currency hit a new four-year high of $1.1537 before falling back to stand at $1.1505 after closing at $1.1451 in New York on Thursday. Gains for the euro were, in part, fuelled by comments after the European Central Bank's rate decision by governor Wim Duisenberg. Mr Duisenberg said that the ECB was not alarmed and that current levels were not excessive.Pedro Solbes, the EU's monetary affairs commissioner, echoed Mr Duisenberg's comments overnight, saying that the level of the euro was not significant. He voiced concerns however, that the currency's rapid rise was a problem for businesses.
Source: Financial Times
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The Man with Feet of Clay Does it Again

This could be one for the record books, 45 minutes after Duisenberg described himself as 'comfortable' with the euro's recent rise the currency broke the $1.11 level and shot up to $1.14, to be closely followed by next months German unemployment figure if things continue this way. Won't he ever learn that if you've got nothing useful to say it's better to keep your mouth wide shut.

The euro jumped to new highs against the dollar on Thursday after Wim Duisenberg, head of the European Central Bank, signalled his ease with the currency's recent strong rally. Earlier, the bank decided to hold interest rates steady.At a press conference following the bank's policy meeting, Mr Duisenberg said the euro was now trading around its historical average and that its current levels were therefore not excessive.The single currency leapt to a high of $1.1486 against the dollar, breaking decisively through its previous high of $1.1437, as Mr Duisenberg made the comments. The euro was at $1.136 ahead of the decision.Mr Duisenberg struck a relatively hawkish note at the conference giving further support to the euro. The bank head said current monetary policy was conducive to stability in the medium term and that the ending of war had removed many of the downside risks to the economy. Economists had expected a more dovish speech to prepare the market for a rate cut at the ECB's next meeting in June.
Source: Financial Times
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Nero Fiddles...................

The European Central Bank and the Bank of England kept interest rates unchanged as policy makers wait for signs that rate cuts this year are sufficient to spur an economic recovery. The ECB left its benchmark rate at a 3 1/2 year low of 2.5 percent. The U.K. central bank kept its rate at 3.75 percent, the lowest since 1955. Most economists surveyed by Bloomberg News expect lower rates next month. Lucas Papademos, the ECB's vice president, is among officials to predict growth in the dozen euro nations will rebound in the second half. In Britain, the pound's 8 percent slide against the euro this year may help manufacturers struggling to recover from the worst slump in a decade, by making exports less expensive. ``Rate cuts have been postponed, but only postponed'' said Holger Schmieding, an economist at Bank of America in London and former adviser to the International Monetary Fund. ``For the Bank of England the currency move means there's little harm in waiting. The ECB has missed an opportunity'' to cut rates. Stocks extended their decline. The Dow Jones Stoxx 50 Index fell 1.7 percent to 2298.5 at 1:51 p.m. in Frankfurt. The yield on the 3 percent German government note dropped 2 basis points to 2.25 percent. A basis point is 0.01 percent.
Source: Bloomberg
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............................While Rome Burns

Germany was facing the threat of another recession on Wednesday after manufacturing orders fell sharply and unemployment climbed for the 13th successive month. The steep 3.9 per cent month-on-month drop in orders for March, far more than the most pessimistic forecasts, and the jump in unemployment to its highest April level since unification put paid to lingering hopes of an upturn. The numbers even fuelled concern that the fragile German economy, the largest in the eurozone and the third-largest in the world, could slide into recession for the second time in as many years. Germany saw a shallow recession, technically two successive quarters of contraction, at the end of 2001. Economists said the figures were "catastrophic" and would exert more pressure on the European Central Bank to cut interest rates when it meets in Frankfurt today. Bank officials have so far played down market hopes of a cut in its primary interest rate.

But Europe's economy was "on its back. . . there has been no Baghdad bounce. . . no postwar rebound," said Ken Wattret of BNP Paribas. "The ECB seems to be biding its time - but you should never say never in an environment like this." Economists said the weakness of the eurozone and the relentless rise of the euro argued for a cut. The ECB last cut rates in March by a quarter-point to 2.5 per cent. The fall in orders, an important but volatile indicator of future economic developments, was led by a 5.6 per cent drop in domestic demand, the second-biggest decline since the data series began in January 1991.Foreign orders fell 2 per cent after falling 4.2 per cent in February, raising fears that the surging euro is curbing export growth. Jacques Cailloux of Barclays Capital said Europe's largest economy was "now flirting" with renewed contraction. "Falling domestic and external demand is a lethal combination for the economy." Many analysts expect the German economy to contract in the second quarter after marginal growth in the first.

Last week the Berlin government cut its gross domestic product growth forecast for 2003 to 0.75 per cent from 1 per cent. But most market economists think even that is over-optimistic.The bleak outlook was reinforced by a 44,000 rise in seasonally-adjusted unemployment to 4.46m, roughly 10.7 per cent of the workforce and a sharp rise in insolvencies for January. Some economists fear unadjusted unemployment could reach 5m by the winter. Government officials said the latest jobless figures highlighted the urgency of reforms needed to cut crippling non-wage labour costs and improve German competitiveness. But Chancellor Gerhard Schröder's plans to cut unemployment benefit and loosen job protection face stiff opposition from leftwingers in his Social Democratic party and the trade unions.The federal statistical office said insolvencies soared by 42 per cent year-on-year in January to 8,158. Company insolvencies rose by 19.2 per cent.
Source: Financial Times
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No Comment

Print Any Amount of Money


The following quote from an investment strategist in today's FT may bear thinking about:

"The euro is strengthening because the US seems prepared to print any amount of money to avert deflation whereas the European Central Bank seems unwilling to do anything," said Kit Juckes, chief strategist at Royal Bank of Scotland financial markets. Despite the strength of the euro, the majority of economists expect the European Central Bank to keep rates on hold at today's meeting.

Now the interesting thing is the logic here. People are buying euros because the US "seems prepared to buy any amount of money". So why are they prepared to spend any amount of money, to have a big party, to fight more wars? No, silly, to fight deflation. And is this a good thing to do, I mean the Europeans don't seem worried about it? No, no, it's a good thing to do, it's just that the Europeans don't take the problem seriously enough, they haven't learnt the 'lessons from Japan', they aren't acting agressively, they're busy fighting last years problem, inflation. So if the US avoids deflation, will that be good for the dollar? Oh, yes, definitely yes, the economy will grow, earnings will grow, consumption will grow, there will be more jobs, yes definately a dollar plus this. And the euro, if the ECB's appeasmanet policy with the deflation menace continues, will this be euro positive. Well............

I think the important thing here is to distinguish between the short and the medium term. Short-term people are buying euros, and European bonds, not principally for the interest rate differential, but because of the US policy of lowering the dollar in relation to the euro, and because this policy convinces them that the dollar will have to fall, and this adds to the momentum. At the same time the absence of any evident willingness to resist from Frankfurt and Brussels only encourages this process. But once we look out to the medium term (say 18 months to two years) process can only unwind. It can only unwind since the relative economic strengths of the two regions can only change in the direction of US positive. The only serious 'runner' as an argument against this is Steven Roach's forlorn hope that the pressure will force reform on Europe and Japan. To this I have only to things to say. Firstly, even were this argument a good one, things can only get worse before they get better. The 'remedies' being proposed - solving the bad-loan problem in Japan, and cutting back the social security system in Germany - ar not going to be consumption and investment positive in either case. An secondly, the argument is ill founded. If the underlying problem is a demographic transition, then all the currency pressure in the world won't get to the heart of the matter. For that we need 'unconventional tools' of the institutional kind: like - eg - immigration.

So why will the dollar continue it's rise short term. Now here things get really interesting. Remember all those silly 'conspiracy' theories about the war and petro dollars. Well, that's what they were 'silly'. But if we step back and thing about things a little, the war has had an impact here. The 'battle of the titans' between the central bankers is very much a no-contest one these days. If the US wants the dollar down, the dollar will come down. This is very different from, say, the late 80's. Now why does everyone imagine the US can get its way here (and thus why do the markets act on that supposition)? Well they have just won a war haven't they? Everyone is talking about the monopolar world, the pax Americana, now aren't they? So what self-respecting global super power, in the moment of its 'supreme' power (and just before, incidentally, its rapidly growing young rival, China, enters stage left to confuse the picture) would allow itself to be pushed around on a 'mere detail' like currency policy. So this is all about credibility and enforcement. The current US strength is undeniable, and this is the trump card. Now, what was the war about? I really have no idea: I think only hisory will tell us, and maybe not even then. But the consequences are plain to see. Was this a policy objective. I doubt it, even I don't think they have such a good grasp of the economic realities of things in the White House. Remember, you read it first in Bonobo Land.

The euro on Wednesday rose to its highest level against the pound since the European currency was launched in January 1999, adding to the strains on the Continent's exporters and intensifying pressure on the European Central Bank to cut interest rates. The move - which took the euro to £0.714 - reflected broad strength in Europe's currency, as global investors warmed to the appeal of European bonds. Although the euro eased slightly against the dollar yesterday, it has risen by 4 per cent over the past 2 weeks. Indications on Tuesday that the Federal Reserve may be prepared to ease monetary policy further to stave off the risk of falling prices have further increased investors' appetite for the euro."The euro is strengthening because the US seems prepared to print any amount of money to avert deflation whereas the European Central Bank seems unwilling to do anything," said Kit Juckes, chief strategist at Royal Bank of Scotland financial markets. Despite the strength of the euro, the majority of economists expect the European Central Bank to keep rates on hold at today's meeting.


The ECB has long been criticised for its failure to respond quickly to deteriorating economic growth in the eurozone. But economists said the ECB's inflation fighting zeal now made the euro particularly attractive. "We are back in a world where cross-border bond flows are larger than equity flows," said Avinash Persaud, head of global research at State Street, the Boston-based investment bank. "Two years ago the ECB was being criticised for reluctance to cut rates and now it is being rewarded for the same behaviour." Analysts said that many European companies had been taken by surprise by the speed of the euro's rise and had not yet done enough to insulate themselves from currency strength.The strength of the euro may be given added impetus from European exporters seeking to hedge themselves against a further appreciation of the currency. Since this usually involves buying the euro forward, it should assist the euro's rise. Volkswagen AG said yesterday that its profits had tumbled by more than two-thirds in the first quarter, dented by a weak dollar and spending on new models.
Source: Financial Times
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Up and Up She Goes


The euro continues its seemingly inexorable rise. This should surprise no-one since it is only a continuation of what has been happening for a year now. This time it seems people are starting to get nervous in Frankfurt and Brussels. What started off as a good thing, now could become a serious problem. Reading Greenspan yesterday it's clear that the US Treasury are likely to continue to encourage the dollar decline, which only leaves us with one question: now that the euro luminaries are waking-up to the problem, what do they propose to do about it? Oh yes, and going back to the petro-dollar theories, it's curious to note that the euro continues to rise despite the US having won the war in Iraq, and the oil markets being presumabley more dollarised than ever. One more duff theory out of the window?

The European Central Bank on Tuesday came under mounting pressure to cut interest rates as the euro surged to four-year highs and shrinking eurozone output continued to hold back recovery. The euro charged to $1.1358, up more than 8 per cent on the dollar since the beginning of the year, spreading alarm among exporters and prompting warnings that the soaring single currency could dent eurozone growth prospects. The euro's rise since December has wiped out the benefits of the ECB's quarter-point cut in rates in March as exporters face increasing competition for their goods. European stock markets have shrugged off the rise in the euro as investors have recovered their appetite for risk, pushing the French and German share indices through 3,000 for the first time since mid-January. London's FTSE-100 index of leading shares broke through 4,000 for the first time in four months to close up 1.4 per cent at 4,006.40.The case for another cut to boost sagging confidence when the ECB meets at its monthly governing council in Frankfurt tomorrow is now "overwhelming", economists said on Tuesday. ECB officials have played down prospects for any loosening, signalling rates are likely to remain at 2.5 per cent.......

ECB officials insisted the rising euro was "not a cause for concern at this time". But fears it may further depress already weak activity deepened when the Reuters/NTC Research purchasing managers' survey showed the dominant services sector shrinking for the third month running. The purchasing managers index for services remained stuck at 47.7 in April, well below the 50 mark that separates contraction from expansion. It was the lowest level since November 2001 and followed a sharp fall in the manufacturing index............

On the eurozone data, economists said the services and manufacturing surveys combined suggested the economy contracted in April despite a glimmer of hope from the expectations component of the index, which rose to a seven- month high."First quarter GDP growth was weak . . . the second quarter was probably negative," said Robert Prior of HSBC. He said the outlook "was all the more worrying" because the surveys were taken after the end of the Iraq war when activity should have been recovering.......
With the rising euro increasing the downside risks to growth, many economists believe the ECB might opt to cut rates by half-a-point in June when it will have updated its economic projections.The bank last cut rates in March when its growth forecast was revised down sharply to 1 per cent. But even that is looking increasingly optimistic, say economist, in the face of a strong euro and continued global weakness.
Source: Financial Times
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Eurozone Growth Worries Continue


According to the Financial Times there has been no 'Baghdad bounce' and growth expectations in the eurozone economies look as negative as ever. With the ECB meeting later this week a reduction in interest rates would be the logical thing, but the consensus seems to be 'no change'. Still we can always live in hope.

Manufacturing in the eurozone contracted at a faster pace in April, failing to get a lift from the end of the war in Iraq, a survey indicated on Friday. The Reuters/NTC purchasing managers' index for the eurozone fell from 48.4 in March to 47.8 in April. A score of 50 distinguishes expansion from contraction. The survey said the decline - which was worse than analysts' predictions - signalled the second consecutive month of deteriorating business conditions, at the fastest rate since January 2002. "The fall in the PMI reflected declines in order books, production, employment and stocks of purchases," it said. "The data suggest that no immediate bounce-back in growth was evident following the earlier-than-expected end to the war." Economists said the unexpectedly poor figures showed that an upturn in the eurozone economy was still some way off. They also showed that the 12-nation bloc was "crying out" for further interest rate relief, said one. The European Central Bank is expected to keep rates on hold at 2.50 per cent when it meets next week. But with domestic demand weak and a surging euro curbing exports, pressure is mounting for monetary easing sooner rather than later.
Source: Financial Times
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On the Euro and its Value


Frans has written from Holland picking me up on some of my arguments, especially about the 'internet conspiracy' and petrodollars stuff I wrote: I cite his argument in detail because I think it reflects a lot of thinking here in Europe on this topic, and I think it's more interesting to try and debate these things out in the open.

First of all you quote Stephen Jen explaining that “the Asian dollars are in fact more important than the petro ones - he estimates by a factor of ten to one.” I won’t argue this (of course not) but why is this important? I mean, it is a very interesting and important subject but from the point of view of the eurozone, Britain or the OPEC it’s something they have to accept as a fact: it can neither be influenced nor will it affect the considerations on whether to pursuit oil pricing or oil billing in euros.

Which brings me to European government strategy. “It is I suspect a widely held belief here in Europe that a significant part of contemporary American prosperity is based on the fact that the rest of the world is prepared to subsidise US consumption by holding dollar denominated assets. This, like most theories, is partly true.”

The arguments you use to exemplify the superior “performance of many of the leading US corporations” surprise me. As far as I know Amazon made no profits at all during long long years. Google and Yahoo may be very famous and politically interesting (I think of China’s regime attempting to influence the search-results of the engines) but seem to me economically of little significance. Google still has less than 1000 employees. If I was a shareholder I think I would prefer Nokia above Amazon (and what about Linux?).

Firstly about OPEC. What I was trying to say was that the quantities of petro-money involved in externally deposited funds are not as important as is often assumed. The Asian money in the US seems to be much more important, as does the European funding going into the US economy. Without this, as Stephen Roach continually points out, the US deficit would be unsustainable. But if all these Europeans, Japanese, Chinese etc are investing in the US it must be for some reason. Certainly it is not for the recent performance of the equity markets, so why is it?

There is no easy answer to this but I tried to suggest that one of the factors involved was the expectation of better general relative performance of the US economy (an expectation which seems to me to be reasonably well grounded) and in particular I wanted to make the point that this expectation is based on the way in which US labour markets have adapted to the new economic reality, and the way in which the US enterprise has been able to obtain productivity benefits from the ICT revolution which, to date, its European equivalent seems to have been unable to equal.

My mention of Google, (Blogger?), Amazon, Yahoo etc is meant as an illustration of this. The EU seems to be based on the idea that big is beautiful. This I don’t accept. I prefer the recently floated notion of 'small components loosely joined'. The European strategy seems to be based on the prowess of large ‘National Champions’, all too often former monopolies, and thus seems to have been unable to generate the kind of youthful vigour and initiative which for me are represented by the above mentioned names. You talk of Nokia, but this seems is a good case in point. Nokia seems to have become so locked-in to the GSM-UTMS transition that it has all but missed-out on the booming WCDMA market in the third world. And why is it so focused on the GMS-UMTS transition? Because some years ago the European Commission thought in its wisdom that if it could only adopt uniform standards from above, then it could steer the technology where it wanted. The whole approach seems to miss the user driven component in technology. And this is the reason I pick these companies, since the problem is about a whole attitude towards and relation with technology, and part of the European problem is reflected in your response. Put another way Deutsche Telecom, Phillips, Nokia, Vivendi etc represent very much the past (as do Disney, Coca Cola, McDonalds, Levi Strauss, and, who knows, AOL-Time Warner), and it's to the future we should be looking.

So I think that it is by addressing this problem, the problem of risk taking and corporate culture that Europe needs to change, not by trying to get, on the free and easy, a piece of the dollar 'action'. If Europe could make that change then in fact the euro would naturally follow a rising trajectory, and more entities would be holding euros in anticipation of its rising value. I also think Europe needs to be seen to react differently to its demography problem. The EU needs to face up to the fact that is a union of ageing societies. This reality needs to be recognised via a different approach to the question of national identity, and to the question of who is welcome in Europe. In this context the whole issue of Turkish membership has been badly mishandled in my view. Europe needs to cease being an agglomeration of distinct nationalities (often at rhetorical war with each other) and reach out to change it’s geographic and ethnic identity. As a metaphor for the radical switch that is needed I have floated the idea of India becoming a candidate country. This is only a metaphor, to try and make people think what the problem would be, and thus perhaps reflect on what prejudices they might have.

Finally on OPEC. I think that if the Europeans really want to be seen as favouring a different world to the one which appears to be being promoted by the present US administration, then it should reflect long and hard on the idea of enjoying favoured relations with OPEC. We should, for starters, reflect on just why it is that these funds are sitting around in this way in European and US bank accounts in the first place. It is hard not to come to the conclusion that no worse fate can become a nation than to discover oil. It seems more of a curse than a boon. When we look at Russia, Nigeria, Venezuela etc this view can only be confirmed. This money shouldn’t be languishing in overseas bank accounts, but should be being invested in profitable projects which can promote balanced economic development in the countries concerned. Remember the day will come when we’re all off oil (at least for energy purposes).

May Day Holiday


I'm off for a long weekend in the country today, so blogging could be a bit slow - mind you looking at the stats this morning it looks like I'm not the only one. It's strange, I don't think it's often commented on, but everyone running a blog or site must know one of the world's best guarded secrets: most surfing takes place at work. The weekend numbers and visit patterns are always down and different. In fact things normally start to tail off on Friday afternoons.........Oh yeah, I got it, all that surfing makes us so open, so modern, we have to be an extra asset for any company clever enough to employ us, right.

I'm going down to an obscure part of Valencia, to stay in the village where my wife's parents came from. Very Spanish this, the family and the village (cada burro en su pueblo!). Apart from the contact with nature, they do have geat oranges, and we always bring back olive oil, which is again one of the great secrets of Spanish life. My wife's parents hail from an obscure Sierra, lost in the mountains with no running water and no electricity (sometimes this serves as my retreat in summer), but everybody who didn't emmigrate in the 50's moved down to the nearest village years ago. These days my visits have an unusual twist since a zone which once saw massive emmigration has now become home for a new wave of immigrants. This time from Eastern Europe, from Bulgaria. This is unusual in a European context, since most migration is urban (more like an earlier generation of Mexicans who went to work in the fields of California. god, this takes me back to Pete Seeger and Arloe Guthrie, I do feel old). It is also unusual since the Eastern European immigrants who are arriving in Spain are relatively well educated: teachers, dentists, lab technicians, translators, and a lot more besides. Nowadays they spent their lives in the world of agriculture. You all know what garlic is, right. Well have you ever thought how they extract the heads. Well in an economy where the Harrod-Balassa-Samuelson effect was working as predicted you would probably do this with a machine. But I am in Spain, and with the wages paid to the newcomes it's perfectly feasible (in the black economy of course, but then a big part of the Spanish boom is based on this) to have a university graduate sitting at a bench cutting them out manually. I don't know if you can imagine this, but after 10 hours of engaging in this activity they emerge covered in a white dust from head to foot. And get this, the best part is that the garlic isn't even local. It comes in in a big truck from another Spanish region, gets processed, and then leaves in another one, heading probably for the big market here in Barcelona, and then into my kitchen. This is economics at work, all you need is a space and some very cheap, very desparate labour. It may be sound economics, but it isn't very attractive.

What has attracted my attention in all this is the way the migration concentrates. The village has 5,000 inhabitants, and of these 1,000 are immigrants, of which 975 (approx) are Bulgarians, and all of this in the last 3 years. And now they are 'spilling over' into every other village in sight. It feels like Bulgaria is emptying itself out into the Spanish province of Valencia. Now those of you who know something about network theory will see where I'm going here. This concentration is unusual in such a small community, but is representative enough of a broader phenomenon. So how does this 'small world' work. This has attracted my attention, and I have put together a small group at the university to try and do some research into the topic. At the moment we're still looking for funding, but I'm confident we can do something. So, those of you who know that my respect for Cavalli Sforza stems, in part, from his ability to get out of the office when needed, won't be surprised to learn that I'm revelling in the thought of playing accidental anthropologist in the summer.

Meantime I do also plan to have a good break, I may have a very healthy respect for American economic institutions, but I am a European at heart. And we Europeans do, as is notorious, place a very high value on our leisure time........... Talking of which, Valencia is also famous for it's Paellas, and this afternoon they're preparing a monster one: yum, yum!

Germany: Surprise, What Surprise?


According to the Financial Times, the slump in Germany's Ifo index was sharp and unexpected. Well if you'd been watching developments in Germany carefully it shouldn't have been (eg Germany's Difficult Road To Reform or Germany: Finally Biting the Bullet? ). The whole point is not that it confounded post-Iraq war expectations, but rather that these expectations were always overly inflated and out of touch with reality (see eg this morning's post ), based as they were on a political and not an economic analysis of the problem. My feeling is that this may mark the begining of some extremely bad data from Germany since, as I have been arguing, whatever the merits or otherwise of the proposed reforms (see links above) the short term consequences will be all negative. Only on an extremely optimistic reading of an extremely questionable version of expectations theory could you read it any other way. And the 'early' ECB rate cut, September perhaps????

A sharp and unexpected slump in Germany's keenly-watched Ifo index highlighted the fragility of Germany's growth prospects on Monday, lending urgency to chancellor Gerhard Schröder's calls for structural reforms to help lift the eurozone's largest economy out of stagnation. The fall in Germany's most important economic indicator, which confounded expectations for a post-Iraq rally, comes amid much uncertainty over Mr Schröder's ability to push through a reform programme that is seen as key to fostering the country's long-term economic revival. The proposed Agenda 2010 measures - including relaxed job protection rules and cuts in jobless benefits - have drawn opposition from a group of rebel left-wingers within the chancellor's own Social Democrat party, who argue the measures risk damaging the weakest elements of society. Mr Schröder on Monday upped pressure on the rebels to fall in line when, in a veiled threat to resign, he warned that a major dilution of the measures he outlined last month would force him to take consequences."

Analysts said the surprise fall in the Ifo index may strengthen the chancellor's hand in arguing for speedy and full implementation of the programme. The Ifo institute's business climate index for western Germany fell from 88.1 in March to 86.6, taking it to its lowest level since December 2001, when the German economy was in recession.The forward-looking component of the index, measuring expectations for the next six months, was especially weak, falling to 94.9 from 97.2 the previous month, heralding little improvement in coming months."There are still no signs of better days for German business sentiment," Hans-Werner Sinn, president of the Munich-based institute said. Contrary to analysts' expectations, the fall of Baghdad on April 9 had had little impact on Ifo's monthly survey of 7,000 companies.The fall in the index, also regarded as a barometer for eurozone growth, follows downbeat Italian and Belgian sentiment indicators last week, and boosts analysts' belief the ECB will act to cut borrowing costs soon.
Source: Financial Times
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A Grim Message For Europe


That's the economists view of the latest OECD Survey. They also endorse the 'should've cut sooner and harder' view of the ECB.

As the OECD points out, the gap between America and Europe is widening, with the euro area as a whole registering significantly poorer performance in the past few years. There is no prospect of an early reversal, at least in part because European economies have left themselves with very little room for maneouvre—and because what scope they do have remains largely unused.

It does not help that the European Central Bank (ECB) has been slow to reduce interest rates. The OECD reckons that there is scope to cut rates by another half of a percentage point: the IMF also said further cuts should be considered. In Europe, monetary policy is the main instrument of economic stimulus because the much-derided stability and growth pact has left no scope for fiscal relaxation. The budget-deficit limits set by the pact were intended to underpin monetary union, but they have already been breached. For the euro area as a whole, the budget deficit should have fallen to 0.3% by last year, and be set to disappear altogether in 2003. Instead, the deficit across the zone reached 2.3% in 2002, and is not now expected to return to balance until 2006 or thereabouts. France and Germany are finding it particularly difficult to meet the pact’s targets.

The OECD does not share the view of those who argue that the stability pact is pointless because it is damaging short-term recovery. Instead, it points out that the medium-term outlook makes curbing fiscal deficits necessary—not just to preserve the pact’s credibility “but because of the age-related spending pressures that are about to intensify over the next few years”. Without new measures, the OECD reckons the three biggest euro-area economies—Germany, France and Italy—will make little headway in bringing down their deficits. The report makes little attempt to disguise the OECD’s view that governments have mainly themselves to blame, for squandering the surpluses in the boom years.

It’s a grim message for Europe, especially when contrasted with the somewhat better short-term outlook for America, where the OECD expects a modest but steady recovery this year, accelerating in 2004. However, even that might turn out be optimistic in the light of the Federal Reserve’s latest survey of economic conditions across America, widely known as the “beige book”, published on April 23rd. This shows a “lacklustre” economy, with several parts of America growing even more slowly than earlier in the year.
Source: The Economist
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OECD Joins the Call for Sharp ECB Rate Cut


I'm afraid I'm not a special OECD fan, and in the comparison with Rogoffs IMF facelift there is 'ni color' as we say here in Spain. Nor am I willing to cite advice from Jeam-Phillipe Cotis since, frankly my dear, he may not have a clue. (Obviously there are exceptions to prove every rule, and Bessanini, Scarpetta, Scherer et al do a fine job). Also note the 'unexpectedly protracted' comment about the downturn: it depends on who you read doesn't it ? (Maybe the OECD people need to get into collaborative filtering). However it is interesting to note the growing consensus that something should be done to try to stop the big ship from sinking. Those in the little boats need to mind the backwash!

The eurozone needs a significant cut in interest rates "the sooner the better" to stimulate economic recovery, the Organisation for Economic Cooperation and Development said on Thursday. The Paris-based group of the world's 30 richest nations warned of slowing eurozone growth and said there was a clear case for a cut of 0.5 percentage points off the current interest rate of 2.5 per cent. The European Central Bank meets in two weeks.In its twice-yearly economic outlook published on Thursday, the OECD cut sharply its forecasts for eurozone growth this year while raising its expectations for the US in 2004.

The OECD indicated US interest rates were "well-adapted" to the economic situation but appeared worried about inflationary pressure in Britain, where it said short-term interest rates would need to rise next year. . World economic recovery would be "progressive if unspectacular" having been "unexpectedly protracted" and marked by failing confidence, the OECD said.
Source: Financial Times
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Sock it to 'em Marty


Harvard professor and president of the US National Bureau of Economic Research Marty Feldstein has a timely piece on the pitfalls of the euro in today's Financial Times. While I may not go along with him in everything he says - I'm not sure he has the endebtedness minefield that lies behind the growth and stability pact too clear for example - he has at least been saying this from the begining. I wonder how many more will jump on the bandwagon this year as the problems become more and more apparent. My guess, for what it's worth, is that Britain won't join, ever. Sweden, I don't know, it may be a close call, and it depends how things pan out as the year goes on. The enlargement countries, if they've got any sense they won't since they would lose their competitive edge inside the Union, also by the time their turn to decide comes the difficulties involved will probably be pretty plain to see.

As Gordon Brown, the chancellor of the exchequer, considers whether adopting the euro would be in Britain's interest, he should look carefully at the experience of Germany. Membership in the monetary union has weakened the German economy and is preventing it from escaping its current slump. Although Germany also suffers from a variety of structural problems, it is the euro that raised its unemployment rate over the past year to 10.6 per cent. The German example shows that Britain's decision about adopting the euro is not a question of whether the time to do so is now right. Adopting the euro is a permanent commitment with permanent consequences. My judgment is that it would not be in Britain's long-term economic interest to accept the constraints of the single currency.

Here are the facts. Germany's gross domestic product rose only 0.5 per cent last year, the lowest of all the leading European countries, and ended the year in decline. Germany also has the lowest inflation rate, just 1.2 per cent. Because the single currency means that all eurozone countries have the same nominal interest rate, Germany's real interest rate is the highest in the eurozone. This is a very dangerous situation in which the high real interest rate weakens the economy and causes inflation to fall further. As the inflation rate falls, the real interest rate rises, creating the potential for a dangerous downward economic spiral.

If the German economy were not constrained by the single currency, natural market forces would cause interest rates to decline, thereby boosting all kinds of interest-sensitive spending. Weak demand in Germany would also cause the D-mark to decline relative to its trading partners, boosting exports and helping producers to compete with imports from the rest of the world. Instead, German manufacturing has been weakened by the sharp rise of the euro over the past year. In addition to these automatic market responses, an independent Bundesbank would probably have responded to the weak economy and declining inflation by temporarily lowering short-term interest rates. This is now impossible. The European Central Bank must make monetary policy for Europe as a whole, an area in which inflation is now above the 2 per cent target ceiling. The Stability and Growth Pact also prevents Germany from using a temporary fiscal stimulus to increase growth and bring down unemployment. Although persistent deficits are harmful in the long term, a temporary rise in the fiscal deficit could in principle provide the stimulus needed to rekindle growth. But the eurozone countries have had to constrain themselves from running deficits because of the potential danger to the common currency.

As an American who has long been sceptical about the economic effects of the euro, I am often asked why a single currency should be good for a large continental economy such as the US and yet not for Europe. The answer is that the US economy has three basic features that make it possible to have a single currency without the harmful effects that now arise in Europe. First, American employees move within the country when demand is relatively weak in a particular region, facilitated by a common language and a culture that regards moving across the country as perfectly normal. Germans are not leaving Germany in large numbers for areas of Europe with faster growth or lower unemployment. Second, wages are much more flexible in the US than in Europe, reducing the decline in regional employment that occurs when demand falls. And third, the US has a federal fiscal system that directly offsets about 40 per cent of the relative decline in any state's gross domestic product by a lower outflow of taxes to Washington and a higher inflow of transfer payments. European fiscal systems are still largely national.

Germany did not decide to embark on the single currency after a careful evaluation of its economic costs and benefits. Helmut Kohl led Germany into the single currency in order to create a stronger political union in continental Europe, a political union that would have common economic, social, defence and foreign policies. The euro would be a symbol of that solidarity and a mechanism for centralising economic power.
Source: Financial Times
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