Well August retail sales in Germany don't look any too happy (and here).
The German consumer showed no sign of springing into life last month, despite the strong growth in Europe’s largest economy, official figures showed on Friday.
Retail sales in German were unchanged in August after a revised 0.8 per cent fall in the previous month, according to the Federal Statistics Office.
Sluggish consumer spending has long been the Achilles’ heel of Germany’s economy, dragging down the eurozone’s overall performance. But the latest figures surprised analysts who had expected a rise on the back of one of the strongest German growth performances for years in the first six months of 2006, powered by the country’s industrial sector.
Bloomberg suggests that the last quarter may be stronger:
``Retail spending growth looks to have slowed noticeably in the third quarter, which will contribute to a slowdown in economic Growth,'' said Sandra Petcov, an economist at Lehman Brothers International in London. ``But we do expect spending to pick up in the fourth quarter ahead of the VAT increase.''
But isn't that just the point, if they pick-up before the rise, what will they do after it? Actually the 'disappointment' may come from the fact that people expected more bounce before the VAT rise, and not getting it makes next year look even more complicated.
Also, according to the FT, and tucked away at the bottom, unemployment in France seems to have risen ever so slightly:
"Separately, France reported an unexpected rise in unemployment in August. The jobless rate rose to 9.0 per cent in August from 8.9 per cent in July."
This is not deeply significant, but again it is hardly good news. The French economy is consistently outperforming the German one, and the whole prognosis there is different. France may slow, but I doubt they will have a recession in 2007.
Friday, September 29, 2006
Thursday, September 28, 2006
Italian Economy Watch Revamped
The Italian Economy Watch Blog has just been given a facelift. Almost literally, since we now have two new faces who are about to start posting. Below is the latest piece which I have just put up. Don't miss the part about Japanese debt which is worked into the middle section.
The Battle Is About To Commence
The FT this morning has a piece about the looming battle over next years budget:
Romano Prodi, Italy's prime minister, struggled on Wednesday to keep intact his planned deficit-cutting 2007 budget as moderates and leftwingers in his ruling coalition fought each other over his proposals to slash public spending.
Communists and other radicals insisted they would not endorse cuts in expenditure on schools and local government, while centrists voiced concern that the budget was drifting in the direction of higher taxes rather than spending cuts.
Bloomberg also covers the story.
As the FT also points out:
Italy's budget, due for cabinet approval on Friday, is the country's most important since it joined the eurozone in 1999, because the nation's public finances and international competitiveness have significantly deteriorated over the past eight years.
So 2007 is going to be a very hard road for Italy to travel. In some ways the moment of truth time is coming. Again the FT:
"Italy remains at risk of seeing its sovereign debt downgraded by credit rating agencies if its forthcoming budget is not rigorous enough."
Really it is very hard to just at this stage the importance of this threat. Much more than the credit rating agencies it is the response from the ECB which will be important if Italy fails to keep to the terms of the new version of the Stability and Growth Pact. Last year, we should remember, the ECB asserted that it would not accept government paper (bonds) in the future from any country which has not maintained at least an A- rating from one or more of the principal debt assesment agencies. So the threat may not be a hollow one, since if the ECB stop treating Italian paper at par, then this could easily, in and of itself, send Italy off on a default path.
These are not little issues.
Precisely for this reason I am rather sceptical that the ECB would be in any rush to actually carry out its threat. News from Japan though suggests that the climate may be changing. Japan, as is reasonably well known, also has a rapidly ageing population and a large government debt problem. In principle Japan was programmed to take some important steps (like Germany) to begin to correct the situation. The election of Shinzo Abe as prime minister has begun to put question marks over this process, and Standard and Poors have not been slow in reacting:
Japan may slow the pace of fiscal reforms under its new Prime Minister Shinzo Abe, ratings agency Standard & Poor's said on Wednesday, a day after he formed his new cabinet with a "no growth, no fiscal consolidation" policy.
The ratings agency questioned Abe's preference for growth policies over fiscal consolidation, saying his stance may lead to a deceleration of the pace of fiscal consolidation.
S&P currently has a positive outlook on Japan's rating.
But the direction of the sovereign rating depends largely on Abe's government's ability to pursue public sector reform pushed by his predecessor, the agency said.
"The two biggest constraints on the rating are Japan's fiscal position, which though improving remains weak, and its outstanding debt," said the report.
"Critical factors are therefore the pace of fiscal consolidation, the stability of the Japanese government bond market, and interest rates," it said.
Citing Japan's aim to achieve primary account balance in fiscal 2011 through spending cuts and revenue increases, the agency said how the new government meets the target is a major issue for the future direction of the sovereign rating.
So I would say that the issue of sovereign debt is now well up and over the radar, and that the agencies will be serious about downgrades.
The big problem is that EU institutions cried wolf for so long about the Stability and Growth pact that they have been left with a credibility problem. This has been doubly undesireable since it meant that during the relatively good years of 2002-2006 many countries were running deficits when they should have been aiming for balance or even - god forbid - surplus. Now the headwind may have changed, and may well be about to turn negative. The next two or three years ,may well be much harder than the last two or three.
I know that this view seems to go against the prevailing wisdom, but frankly many of the people making the 'euro growth engine call' simply haven't been thinking about the demographic dynamics of the situation. Claus Vistesen has been admirably covering all this, and a very useful point of entry is this post.
So the real question we are left with is what exactly is to be done? This is a very hard question, and I don't have any simple answers handy in my back pocket to pull out at the appropriate moment. Clearly Italy needs to move onto a sustainable fiscal path. It also needs to attach itself firmly to the EU Lisbon Reform agenda, and generate a consensus among the Italian population that the reforms are needed by getting across to the Italian people just why they are needed.
Naturally the political class in Italy isn't exactly an asset here.
Immigration undoubtedly forms another part of the picture, but this immigration (which is largely unskilled) needs to be coupled with an expanison of the high value services and new technology business sectors, so that a labour market environment can be created where the best of Italy's young talent can find work appropriate to their abilities, and thus help pull Italy out of this mess.
Over the summer I saw a film from the Italian director Paolo Virzì entitled Caterina va in città. The plot is summarised as follows:
When her father, Giancarlo (Sergio Castellitto) is transferred to Rome from the small country town of Montaldo Di Castro, Caterina (Alice Teghil), a 12 years old girl, discovers her new classmates, a totally new world, an ambient extremely divided politically. She starts developing her friendship with the "left side", represented by Margherita(Carolina Iaquaniello), and the right, Daniela (Federica Sbrenna) side of her class. She will lose herself, without knowing who she really is.
This is the problem I think, an ambient which is extremely divided politically where young Italians do not know 'who they really are'.
The Battle Is About To Commence
The FT this morning has a piece about the looming battle over next years budget:
Romano Prodi, Italy's prime minister, struggled on Wednesday to keep intact his planned deficit-cutting 2007 budget as moderates and leftwingers in his ruling coalition fought each other over his proposals to slash public spending.
Communists and other radicals insisted they would not endorse cuts in expenditure on schools and local government, while centrists voiced concern that the budget was drifting in the direction of higher taxes rather than spending cuts.
Bloomberg also covers the story.
As the FT also points out:
Italy's budget, due for cabinet approval on Friday, is the country's most important since it joined the eurozone in 1999, because the nation's public finances and international competitiveness have significantly deteriorated over the past eight years.
So 2007 is going to be a very hard road for Italy to travel. In some ways the moment of truth time is coming. Again the FT:
"Italy remains at risk of seeing its sovereign debt downgraded by credit rating agencies if its forthcoming budget is not rigorous enough."
Really it is very hard to just at this stage the importance of this threat. Much more than the credit rating agencies it is the response from the ECB which will be important if Italy fails to keep to the terms of the new version of the Stability and Growth Pact. Last year, we should remember, the ECB asserted that it would not accept government paper (bonds) in the future from any country which has not maintained at least an A- rating from one or more of the principal debt assesment agencies. So the threat may not be a hollow one, since if the ECB stop treating Italian paper at par, then this could easily, in and of itself, send Italy off on a default path.
These are not little issues.
Precisely for this reason I am rather sceptical that the ECB would be in any rush to actually carry out its threat. News from Japan though suggests that the climate may be changing. Japan, as is reasonably well known, also has a rapidly ageing population and a large government debt problem. In principle Japan was programmed to take some important steps (like Germany) to begin to correct the situation. The election of Shinzo Abe as prime minister has begun to put question marks over this process, and Standard and Poors have not been slow in reacting:
Japan may slow the pace of fiscal reforms under its new Prime Minister Shinzo Abe, ratings agency Standard & Poor's said on Wednesday, a day after he formed his new cabinet with a "no growth, no fiscal consolidation" policy.
The ratings agency questioned Abe's preference for growth policies over fiscal consolidation, saying his stance may lead to a deceleration of the pace of fiscal consolidation.
S&P currently has a positive outlook on Japan's rating.
But the direction of the sovereign rating depends largely on Abe's government's ability to pursue public sector reform pushed by his predecessor, the agency said.
"The two biggest constraints on the rating are Japan's fiscal position, which though improving remains weak, and its outstanding debt," said the report.
"Critical factors are therefore the pace of fiscal consolidation, the stability of the Japanese government bond market, and interest rates," it said.
Citing Japan's aim to achieve primary account balance in fiscal 2011 through spending cuts and revenue increases, the agency said how the new government meets the target is a major issue for the future direction of the sovereign rating.
So I would say that the issue of sovereign debt is now well up and over the radar, and that the agencies will be serious about downgrades.
The big problem is that EU institutions cried wolf for so long about the Stability and Growth pact that they have been left with a credibility problem. This has been doubly undesireable since it meant that during the relatively good years of 2002-2006 many countries were running deficits when they should have been aiming for balance or even - god forbid - surplus. Now the headwind may have changed, and may well be about to turn negative. The next two or three years ,may well be much harder than the last two or three.
I know that this view seems to go against the prevailing wisdom, but frankly many of the people making the 'euro growth engine call' simply haven't been thinking about the demographic dynamics of the situation. Claus Vistesen has been admirably covering all this, and a very useful point of entry is this post.
So the real question we are left with is what exactly is to be done? This is a very hard question, and I don't have any simple answers handy in my back pocket to pull out at the appropriate moment. Clearly Italy needs to move onto a sustainable fiscal path. It also needs to attach itself firmly to the EU Lisbon Reform agenda, and generate a consensus among the Italian population that the reforms are needed by getting across to the Italian people just why they are needed.
Naturally the political class in Italy isn't exactly an asset here.
Immigration undoubtedly forms another part of the picture, but this immigration (which is largely unskilled) needs to be coupled with an expanison of the high value services and new technology business sectors, so that a labour market environment can be created where the best of Italy's young talent can find work appropriate to their abilities, and thus help pull Italy out of this mess.
Over the summer I saw a film from the Italian director Paolo Virzì entitled Caterina va in città. The plot is summarised as follows:
When her father, Giancarlo (Sergio Castellitto) is transferred to Rome from the small country town of Montaldo Di Castro, Caterina (Alice Teghil), a 12 years old girl, discovers her new classmates, a totally new world, an ambient extremely divided politically. She starts developing her friendship with the "left side", represented by Margherita(Carolina Iaquaniello), and the right, Daniela (Federica Sbrenna) side of her class. She will lose herself, without knowing who she really is.
This is the problem I think, an ambient which is extremely divided politically where young Italians do not know 'who they really are'.
Monday, September 25, 2006
The Eurozone Is Slowing
Despite all the apparent optimism you can find round and about, the Eurozone is in fact slowing, the latest industrial output data from France seem to make this abundantly clear. What I find hard to understand is how so many people can have been wrong-footed on this. Claus Vistesen has a useful review of the arguments on the blogs, and New Economist has also been suitably cautious, but the rest seem to have missed the big picture. (Just as they have done with Japan really).
The worst offenders are definitely over at Morgan Stanley. Steven Roach leads the way, but Eric Chaney isn't far behind. And Brad Setser - and in particular his guest poster Charles Gottlieb of the Center for European Policy Studies (CEPS also seems to be way off target here) - seems to have fallen hook line and sinker.
Are we all putting our credibility on the line here gentlemen?
French Business Confidence Falls After Output Drops
French business confidence fell in September from a five-year high it reached in July, after industrial output declined.
Insee's index of sentiment among 2,000 manufacturers in Europe's third-largest economy dropped to 107 from 109 in July, the national statistics office said today in Paris. Economists expected the index to fall to 108, according to the median of 22 estimates in a Bloomberg News survey.
``This summer hasn't been that good, and things aren't as exuberant as they were in the first quarter,'' said Laurence Boone, a Paris-based economist with Barclays Capital. ``As we go towards the autumn, confidence is weakening.''
France's economy, which expanded at the fastest pace since 2001 in the second quarter, may be cooling as the cost of oil and the euro's gain against the dollar threaten purchasing power and exports. There already are signs growth in Europe has peaked after the European Central Bank raised its key interest rate four times since early December. Slower U.S. growth may also damp demand.
``According to entrepreneurs, past business has slowed down in the manufacturing sector,'' the report said, with orders from abroad thinning. Executives from the car industry remain the most pessimistic, the survey showed, after automobile production fell 1.4 percent in July.
French industrial production unexpectedly fell for a second month in July as manufacturing of cars and electronic equipment slumped, adding to evidence that economic growth may slow.
Incidentally, this Bloomberg piece is another classic example of how to get it wrong:
Europe, Japan Wean Themselves From Dependence on U.S. Consumers
Europe, Japan and emerging economies around the world are weaning themselves from dependence on the American consumer, and economists say it's just in time.
Demand in the world's largest economy is slowing as the U.S. housing market falters, a development that the International Monetary Fund on Sept. 14 called a key risk to global expansion. If so, it's a risk that the biggest exporting nations are better prepared to weather now than five years ago.
``Domestic demand in so many other parts of the world is picking up,'' says Jim O'Neill, head of global economic research at Goldman Sachs Group Inc. in London. ``If there ever was a good time for the U.S. to slow, this is it.''
Wishful thinking is not a substitute for sound economic analysis.
Difficult Times Ahead?
I have a post on Afoe about the dangers of contamination across Eastern Europe following the recent turbulence in Hungary.
Now one of the worries that must arise in these circumstances is whether a sudden downturn in some of these 'Lynx' economies could produce a haemorrage of you educated people outwards in search of work. If this were to happen this short-term crisis could have important long term supply-side consequences. Again, something else to watch for.
On this topic, the FT have details of an interview they had with Romanian Prime Minister Calin Tariceanu. Tariceanu is really at pains to re-assure Western Europeans (especially in the UK) that there will not be a sudden influx of Romanians after EU accession. My feeling is that the West Europeans have little to fear here (as he says the educated Romanians will head North, and the less educated ones will head South, and this doesn't seem to me to present any kind of problem). What he maybe should be considering is the impact of this on Romania itself: needless to say, in the current climate I think his growth expectations for the Romanian economy are way too high.
Romania dismisses EU emigration fears
Romania will win approval on Tuesday to join the European Union on January 1, but the country’s prime minister has denied that it will spark a massive wave of emigration from the Black Sea state.
Calin Tariceanu claims his country is in the middle of an economic boom that could see its gross domestic product double within 12 years, drawing migrant workers to Romania.
Speaking to the Financial Times, Mr Tariceanu also appealed to the British media and public – racked by a debate about the recent arrival of hundreds of thousands of migrant workers from Poland and other new EU member states – to remain calm: “People with higher educational levels might go to the UK but I don’t see too many.”
He said most poor Romanians would head to Italy and Spain, where they would have less trouble with the language, and only those with better schooling would go to the UK.
The worst offenders are definitely over at Morgan Stanley. Steven Roach leads the way, but Eric Chaney isn't far behind. And Brad Setser - and in particular his guest poster Charles Gottlieb of the Center for European Policy Studies (CEPS also seems to be way off target here) - seems to have fallen hook line and sinker.
Are we all putting our credibility on the line here gentlemen?
French Business Confidence Falls After Output Drops
French business confidence fell in September from a five-year high it reached in July, after industrial output declined.
Insee's index of sentiment among 2,000 manufacturers in Europe's third-largest economy dropped to 107 from 109 in July, the national statistics office said today in Paris. Economists expected the index to fall to 108, according to the median of 22 estimates in a Bloomberg News survey.
``This summer hasn't been that good, and things aren't as exuberant as they were in the first quarter,'' said Laurence Boone, a Paris-based economist with Barclays Capital. ``As we go towards the autumn, confidence is weakening.''
France's economy, which expanded at the fastest pace since 2001 in the second quarter, may be cooling as the cost of oil and the euro's gain against the dollar threaten purchasing power and exports. There already are signs growth in Europe has peaked after the European Central Bank raised its key interest rate four times since early December. Slower U.S. growth may also damp demand.
``According to entrepreneurs, past business has slowed down in the manufacturing sector,'' the report said, with orders from abroad thinning. Executives from the car industry remain the most pessimistic, the survey showed, after automobile production fell 1.4 percent in July.
French industrial production unexpectedly fell for a second month in July as manufacturing of cars and electronic equipment slumped, adding to evidence that economic growth may slow.
Incidentally, this Bloomberg piece is another classic example of how to get it wrong:
Europe, Japan Wean Themselves From Dependence on U.S. Consumers
Europe, Japan and emerging economies around the world are weaning themselves from dependence on the American consumer, and economists say it's just in time.
Demand in the world's largest economy is slowing as the U.S. housing market falters, a development that the International Monetary Fund on Sept. 14 called a key risk to global expansion. If so, it's a risk that the biggest exporting nations are better prepared to weather now than five years ago.
``Domestic demand in so many other parts of the world is picking up,'' says Jim O'Neill, head of global economic research at Goldman Sachs Group Inc. in London. ``If there ever was a good time for the U.S. to slow, this is it.''
Wishful thinking is not a substitute for sound economic analysis.
Difficult Times Ahead?
I have a post on Afoe about the dangers of contamination across Eastern Europe following the recent turbulence in Hungary.
Now one of the worries that must arise in these circumstances is whether a sudden downturn in some of these 'Lynx' economies could produce a haemorrage of you educated people outwards in search of work. If this were to happen this short-term crisis could have important long term supply-side consequences. Again, something else to watch for.
On this topic, the FT have details of an interview they had with Romanian Prime Minister Calin Tariceanu. Tariceanu is really at pains to re-assure Western Europeans (especially in the UK) that there will not be a sudden influx of Romanians after EU accession. My feeling is that the West Europeans have little to fear here (as he says the educated Romanians will head North, and the less educated ones will head South, and this doesn't seem to me to present any kind of problem). What he maybe should be considering is the impact of this on Romania itself: needless to say, in the current climate I think his growth expectations for the Romanian economy are way too high.
Romania dismisses EU emigration fears
Romania will win approval on Tuesday to join the European Union on January 1, but the country’s prime minister has denied that it will spark a massive wave of emigration from the Black Sea state.
Calin Tariceanu claims his country is in the middle of an economic boom that could see its gross domestic product double within 12 years, drawing migrant workers to Romania.
Speaking to the Financial Times, Mr Tariceanu also appealed to the British media and public – racked by a debate about the recent arrival of hundreds of thousands of migrant workers from Poland and other new EU member states – to remain calm: “People with higher educational levels might go to the UK but I don’t see too many.”
He said most poor Romanians would head to Italy and Spain, where they would have less trouble with the language, and only those with better schooling would go to the UK.
Friday, September 15, 2006
Italy and the Eurozone
John Kay had an article in the Financial Times earlier in the week, and this seems to have caused quite a ripple around the blogsphere (Eurozone Watch, Economonitor, Claus Vistesen at Alpha Sources). The article was about whether or not it was technically possible for Italy to leave the Eurozone. (Update: Sebastian has a fresh post over at Eurozone Watch Blog continuing the discussion).
John Kay's conclusion, and it is supported by a very reasoned commentary by Sebastien Dullien at Eurozone Watch Blog (welcome Sebastain and Daniela), is that there is no in-principle technical difficulty in exit. The most authoritative piece of work on this topic that I know of comes from Harvard International financial law specialist Hal Scott. The paper was written back in 1998, and was provocatively entitled "When the Euro Falls Apart". Despite the title the paper is a tightly reasoned piece of work whose main conclusion is that not only is euro-exit technically perfectly feasibe, in fact the mechanisms which would make this possible were incorporated from the start (in particular keeping independent central banks with their own reserves). I think those who were able to think clearly back then - and were able to use some emotional intelligence - were always aware that there were question marks over Italy's ability to go the distance.
So the problem is not a technical one. But as John Kay indicates it *is* a political one:
"But what of financial and commercial contracts made in euros before A-day but not yet completed?
The simple answer is that an agreement in euros stays in euros. But this is not politically feasible. Italians would not accept that their mortgages and credit-card debts, denominated in euros, would cost them one-third more to repay: and it would be absurd if the bank deposits of Italian residents were revalued by a similar amount.
The relevant principle of international law seems to be that debts are denominated in the currency of the place where they are to be paid. But in the modern world, that question often has no clear answer."
This then is going to be the question *when* Italy leaves (I say *when* since I have no doubt that she will, the demography makes that inevitable, and here, and here, and here). So it is perfectly coherent to argue that Italy can leave. This however is the moment when the debate normally veers off in a southerly direction - towards Argentina - and Argenitina seems, as usual, to generate more heat than light, since the argument tends to move away from Italy and its specific problems, towards a 'what really happened to Argentian debate" (welcome new blogger Felix), which is, of course interesting, but sometimes it is helpful to discuss just one thing at a time. So going round a rather more circuitous route, let's think for a moment about what just happened in Turkey and in Hungary. Two economies which were on an unsustainable external deficit course were brought back sharply into line by a sudden, large drop in the value of the local currency. Judging by posts and comments on this site we seem generally to be agreed that having such flexibility was a good thing, since it enabled these economies to correct and adapt before a big crisis (hard landing) situation built up.
So what about Italy? Well Italy as we know cannot go down this road, and Italy has, in fact, used the cheap finance made available by the eurozone not to reform, but to avoid reforming. This, at least, was the conclusion reached by two highly respected European economists (Romain Duval and Jørgen Elmeskov) in a widely quoted paper entitled The effects of EMU on Structural Reforms in Labour and Product Markets
So Italy is unable to correct, and the inbuilt problem is growing. The Italian economist Francesco Daveri (who is a specialist in technological change and ageing) makes the important point in this podcast for Radio Economics that Italian economic growth *peaked* in the 1950's at around 5% per annum. Since that time it has dropped steadily at the rate of about 1% per decade, and in the 1990s was at an annual rate of about 1% per annum. Following this trajectory, and what we already know, it is not unreasonable to imagine that this decade the Italian economy will flatline (an average of 0% growth) and possibly enter negative territory in the next one (say -1% pa 2010-2020). Of course this situation makes a complete nonesense of the neoclassical theory of 'steady state' growth, but that is a problem for that particular theory, it doesn't mean that what is happening isn't hapening (I have a post about this issue in the context of Germany, Japan and Italy on Demography Matters). So the question is, where does that leave the problem of Italian public debt currently running at 105 - 110% of GDP? Unsustainable, that's where it leaves it. And the only way for Italy really to get to grips with the situation is to recognise that it cannot resolve this problem and default. This default is unlikely to be possible inside the eurozone, and hence Italy will leave. This is a question of simple economics, not popularist politicians.
Which brings us to the last point before the last: won't this cause chaos? Well of course it will, this is why it would be better that people come to terms with this rationally rather than making it an emotive topic.
Now for the last point. John Kay rightly laments:
Any international bank or business should contemplate these issues. But the consequences of such contemplation are grave: in financial markets, actions to protect against a contingency make that contingency more likely. That is why a debate on the fragmentation of the eurozone is a debate that no one dares have.
And John Kay is right, debate on this topic will probably make default happen sooner. I remember the heartsearching Paul Krugman went through when it became obvious Argentina was going to default. Such situations pose special problems for those economists who can, to some extent, see what is happening. But my conclusion was in that case, and it remains the same today, that if something is unsustainable it is better to recognise this sooner rather than later: quite simply the damage is less. If Argentina had defaulted one year earlier, then the politics of the default transition would have been much easier. Basically, if you ask people to make a lot of sacrifices for a project that can't work you can hardly blame them if they are not in the mood for another round of sacrifices after it turns out that the earlier sacrifices were in vain. This is as true for the Italy of 2007 as it was for the Argentina of 2000. I think we would all do well to remember that.
John Kay's conclusion, and it is supported by a very reasoned commentary by Sebastien Dullien at Eurozone Watch Blog (welcome Sebastain and Daniela), is that there is no in-principle technical difficulty in exit. The most authoritative piece of work on this topic that I know of comes from Harvard International financial law specialist Hal Scott. The paper was written back in 1998, and was provocatively entitled "When the Euro Falls Apart". Despite the title the paper is a tightly reasoned piece of work whose main conclusion is that not only is euro-exit technically perfectly feasibe, in fact the mechanisms which would make this possible were incorporated from the start (in particular keeping independent central banks with their own reserves). I think those who were able to think clearly back then - and were able to use some emotional intelligence - were always aware that there were question marks over Italy's ability to go the distance.
So the problem is not a technical one. But as John Kay indicates it *is* a political one:
"But what of financial and commercial contracts made in euros before A-day but not yet completed?
The simple answer is that an agreement in euros stays in euros. But this is not politically feasible. Italians would not accept that their mortgages and credit-card debts, denominated in euros, would cost them one-third more to repay: and it would be absurd if the bank deposits of Italian residents were revalued by a similar amount.
The relevant principle of international law seems to be that debts are denominated in the currency of the place where they are to be paid. But in the modern world, that question often has no clear answer."
This then is going to be the question *when* Italy leaves (I say *when* since I have no doubt that she will, the demography makes that inevitable, and here, and here, and here). So it is perfectly coherent to argue that Italy can leave. This however is the moment when the debate normally veers off in a southerly direction - towards Argentina - and Argenitina seems, as usual, to generate more heat than light, since the argument tends to move away from Italy and its specific problems, towards a 'what really happened to Argentian debate" (welcome new blogger Felix), which is, of course interesting, but sometimes it is helpful to discuss just one thing at a time. So going round a rather more circuitous route, let's think for a moment about what just happened in Turkey and in Hungary. Two economies which were on an unsustainable external deficit course were brought back sharply into line by a sudden, large drop in the value of the local currency. Judging by posts and comments on this site we seem generally to be agreed that having such flexibility was a good thing, since it enabled these economies to correct and adapt before a big crisis (hard landing) situation built up.
So what about Italy? Well Italy as we know cannot go down this road, and Italy has, in fact, used the cheap finance made available by the eurozone not to reform, but to avoid reforming. This, at least, was the conclusion reached by two highly respected European economists (Romain Duval and Jørgen Elmeskov) in a widely quoted paper entitled The effects of EMU on Structural Reforms in Labour and Product Markets
So Italy is unable to correct, and the inbuilt problem is growing. The Italian economist Francesco Daveri (who is a specialist in technological change and ageing) makes the important point in this podcast for Radio Economics that Italian economic growth *peaked* in the 1950's at around 5% per annum. Since that time it has dropped steadily at the rate of about 1% per decade, and in the 1990s was at an annual rate of about 1% per annum. Following this trajectory, and what we already know, it is not unreasonable to imagine that this decade the Italian economy will flatline (an average of 0% growth) and possibly enter negative territory in the next one (say -1% pa 2010-2020). Of course this situation makes a complete nonesense of the neoclassical theory of 'steady state' growth, but that is a problem for that particular theory, it doesn't mean that what is happening isn't hapening (I have a post about this issue in the context of Germany, Japan and Italy on Demography Matters). So the question is, where does that leave the problem of Italian public debt currently running at 105 - 110% of GDP? Unsustainable, that's where it leaves it. And the only way for Italy really to get to grips with the situation is to recognise that it cannot resolve this problem and default. This default is unlikely to be possible inside the eurozone, and hence Italy will leave. This is a question of simple economics, not popularist politicians.
Which brings us to the last point before the last: won't this cause chaos? Well of course it will, this is why it would be better that people come to terms with this rationally rather than making it an emotive topic.
Now for the last point. John Kay rightly laments:
Any international bank or business should contemplate these issues. But the consequences of such contemplation are grave: in financial markets, actions to protect against a contingency make that contingency more likely. That is why a debate on the fragmentation of the eurozone is a debate that no one dares have.
And John Kay is right, debate on this topic will probably make default happen sooner. I remember the heartsearching Paul Krugman went through when it became obvious Argentina was going to default. Such situations pose special problems for those economists who can, to some extent, see what is happening. But my conclusion was in that case, and it remains the same today, that if something is unsustainable it is better to recognise this sooner rather than later: quite simply the damage is less. If Argentina had defaulted one year earlier, then the politics of the default transition would have been much easier. Basically, if you ask people to make a lot of sacrifices for a project that can't work you can hardly blame them if they are not in the mood for another round of sacrifices after it turns out that the earlier sacrifices were in vain. This is as true for the Italy of 2007 as it was for the Argentina of 2000. I think we would all do well to remember that.
Thursday, September 14, 2006
Eurozone Inflation
Oil, as is well known has been generally dropping in recent days, and are now somewhere around the lowest prices seen since last March. It is hard to know how much of the correction is due to the fact that it was previously over-valued, how much is due to the anticipation of a developing slowdown, and how much simply reflects relief that there were no serious hurricanes this year.
In any event the drift is down, although the thing which could upset the whole apple cart is an 'up the anti' in the argument about Iran's nuclear programme.
So it is hardly surprising to find that inflation in Eurozone countries is also taming somewhat. According to German the Federal Statistics Office in August German consumer prices rose 1.8 percent from a year earlier after increasing 2.1 percent in July. In France, the annual inflation rate in August fell to 2.1 percent after increasing 2.2 percent in July, according to the national statistics office Insee.
What I would say is that if oil prices hold either steady or drift down then we are unlikely to see any significant upsurge in inflation here in europe, especially with a high euro, and record imports fromChina. Which puts the ECB in a rather embarassing situation.
Certainly I think the idea of a surge in passing on costs is very unlikely, internal demand (even in France) just isn't sufficiently robust, so I think this argument is a mistake:
In any event the drift is down, although the thing which could upset the whole apple cart is an 'up the anti' in the argument about Iran's nuclear programme.
So it is hardly surprising to find that inflation in Eurozone countries is also taming somewhat. According to German the Federal Statistics Office in August German consumer prices rose 1.8 percent from a year earlier after increasing 2.1 percent in July. In France, the annual inflation rate in August fell to 2.1 percent after increasing 2.2 percent in July, according to the national statistics office Insee.
What I would say is that if oil prices hold either steady or drift down then we are unlikely to see any significant upsurge in inflation here in europe, especially with a high euro, and record imports fromChina. Which puts the ECB in a rather embarassing situation.
Certainly I think the idea of a surge in passing on costs is very unlikely, internal demand (even in France) just isn't sufficiently robust, so I think this argument is a mistake:
Euro-region inflation may accelerate in coming months as faster economic growth gives companies room to pass on rising costs and workers leeway to seek more pay. At least four European Central Bank council members signaled in the past week that interest rates may keep rising into 2007 to counter higher prices.
``Temporarily, we'll see an easing of inflation because of oil prices,'' said Rainer Guntermann, an economist at Dresdner Kleinwort in Frankfurt. ``The ECB realizes only too well that higher inflation rates need to be expected again next year. It's under pressure to continue normalizing interest rates.''
And on the central banking front, will they be embarassed at the end of the day if all this turns out to be completely off the mark:
ECB council member Nicholas Garganas said in an interview in Basel, Switzerland, on Sept. 11 that there's ``no evidence'' of easing inflation pressures with more signs of a ``greater pass- through of past oil price increases.'' His German counterpart Axel Weber said Sept. 5 that ``no decision has been taken to end the process of normalization at the end of the year.''``Obviously we are very worried'' that inflation is no longer expected to slow in 2007 on average,'' Garganas said. ``That is why we are strongly vigilant.''
Monday, September 11, 2006
The Eurozone and the US Downturn
Over at Afoe Mark Thoma had an interesting guest post last week on whether the eurozone will be affected by any possible downturn in the US. This same post was picked up by New Economist,as it is by Claus Vistesen at Alpha Sources.
Personally I think I think that Nouriel Roubini's view (which comes up in the post) that the rest of the world may not be able to decouple from the US is a mistake. In a sense the world already has decoupled. If you look at the fact that global growth this year is likely to be in the 5% region, while the US might grow say 3.5%, and Japan say 2.5% and the eurozone say 2.0%, then it is clear that someone somewhere else is now doing the heavy lifting. Most likely candidates are places like China, India, Brazil, Turkey and a string of other developing countries like Argentina and Chile who are to some extent riding the commodities boom generated by the aforementioned.
This is a sea-change from the 1995-2000 period, when US growth did account for a huge proportion of global GDP growth. I think this de-coupling will become even clearer after the next recession (which could be 2007 or 2008, we have no crystal balls, but I would pencil something in for 2007, especially if the collsion with Iran continues its course). The next upswing will surely be pulled by the new Growth Pandas (or if you like growth giant pandas).
The big issue is going to be how you square the circle on trade and capital flows.
Of course recognising that there are new growth engines at work isn't quite the same thing as saying that it doesn't matter to the rest of the world what happens in the US. Obviously if consumption in the US is sufficiently affected then this will be noticed in Germany, Japan and China.
One important point that isn't being noticed (or isn't being given sufficient importance) is that three of the G7 economies are going to have severe fiscal tightening in 2007 to accompany high oil prices and raised interest rates (Japan, Germany and Italy).
So the machine isn't going to be pulled in this direction. This tightening isn't, as Rogoff suggested frustrating, it is, unfortunately, entirely in the logic of things since these three economies have lived through the good times of this upswing with sustained fiscal deficits, and their budget liabilities with their aged populations mean that some time or another they have to change course. At least for the time being the plan is to change course in 2007 (this may, of course, be revised in the face of inclement weather).
But the big underlying issue is that these elderly economies cannot sustain strong internal demand, and can only live by trade exports and by the export of capital which is a spin off of the high savings rates. (In the case of Italy this is less clear, since the trade surplus has collapsed, but the gap is currently being made up by cheap finance from the eurosystem which goes to pay for Italian government spending).
Anyway, the real probem as I see it is this one. Most of the developing countries need to be export driven, and when they are not buying raw materials and equipment they will have an in-built tendency towards deficit during the development process. At the same time the elderly part of the G7 needs to run surpluses for quite other reasons. So this leaves us with very few countries to balance the books. The UK is undoubtedly one that can run a deficit, France could too, but the big big customer is undoubtedly the United States.
And this is the importance of the argument about housing, since if people stop recycling equity then demand for goods from abroad is likely to drop. This can then have a whole domino impact across the global economy, which far from encouraging investment in the US to take up the slack can have exactly the opposite effect as companies across the globe slash prices to offload unwanted excess output, thus discouraging further investment in the US. The recent surge in capital investment in Japan should fill one with a little foreboding in this regard. As should the recent marked fall in machine orders in Japan serve as a warning.
Personally I think I think that Nouriel Roubini's view (which comes up in the post) that the rest of the world may not be able to decouple from the US is a mistake. In a sense the world already has decoupled. If you look at the fact that global growth this year is likely to be in the 5% region, while the US might grow say 3.5%, and Japan say 2.5% and the eurozone say 2.0%, then it is clear that someone somewhere else is now doing the heavy lifting. Most likely candidates are places like China, India, Brazil, Turkey and a string of other developing countries like Argentina and Chile who are to some extent riding the commodities boom generated by the aforementioned.
This is a sea-change from the 1995-2000 period, when US growth did account for a huge proportion of global GDP growth. I think this de-coupling will become even clearer after the next recession (which could be 2007 or 2008, we have no crystal balls, but I would pencil something in for 2007, especially if the collsion with Iran continues its course). The next upswing will surely be pulled by the new Growth Pandas (or if you like growth giant pandas).
The big issue is going to be how you square the circle on trade and capital flows.
Of course recognising that there are new growth engines at work isn't quite the same thing as saying that it doesn't matter to the rest of the world what happens in the US. Obviously if consumption in the US is sufficiently affected then this will be noticed in Germany, Japan and China.
One important point that isn't being noticed (or isn't being given sufficient importance) is that three of the G7 economies are going to have severe fiscal tightening in 2007 to accompany high oil prices and raised interest rates (Japan, Germany and Italy).
So the machine isn't going to be pulled in this direction. This tightening isn't, as Rogoff suggested frustrating, it is, unfortunately, entirely in the logic of things since these three economies have lived through the good times of this upswing with sustained fiscal deficits, and their budget liabilities with their aged populations mean that some time or another they have to change course. At least for the time being the plan is to change course in 2007 (this may, of course, be revised in the face of inclement weather).
But the big underlying issue is that these elderly economies cannot sustain strong internal demand, and can only live by trade exports and by the export of capital which is a spin off of the high savings rates. (In the case of Italy this is less clear, since the trade surplus has collapsed, but the gap is currently being made up by cheap finance from the eurosystem which goes to pay for Italian government spending).
Anyway, the real probem as I see it is this one. Most of the developing countries need to be export driven, and when they are not buying raw materials and equipment they will have an in-built tendency towards deficit during the development process. At the same time the elderly part of the G7 needs to run surpluses for quite other reasons. So this leaves us with very few countries to balance the books. The UK is undoubtedly one that can run a deficit, France could too, but the big big customer is undoubtedly the United States.
And this is the importance of the argument about housing, since if people stop recycling equity then demand for goods from abroad is likely to drop. This can then have a whole domino impact across the global economy, which far from encouraging investment in the US to take up the slack can have exactly the opposite effect as companies across the globe slash prices to offload unwanted excess output, thus discouraging further investment in the US. The recent surge in capital investment in Japan should fill one with a little foreboding in this regard. As should the recent marked fall in machine orders in Japan serve as a warning.
Sunday, September 10, 2006
Back From A long Sleepy Summer
OK, I'm just dusting the rust off, since this blog is about to ramp up again after the extra-long sleepy summer. Actually I have been quite busy, but with non-Euro issues. Hence the silence here. Of course there won't be a post everyday. Maybe once a fortnight.
Firstly I'd like to welcome a new blog: Daniela Schwarzer and Sebastian Dullien over at Eurozone Watch Blog. Daniela has a post today about Mr Euro, Jean-Claude Juncker. But see this George Parker piece in the FT:
Jean-Claude Trichet, European Central Bank president, on Friday delivered a stiff warning to eurozone finance ministers to back off in an escalating dispute over the bank’s independence.
Mr Trichet pointed out that it was his signature on euro banknotes and that it was unlawful under the EU treaty for finance ministers to give instructions or try to influence the bank.
His comments came at a strained news conference in Helsinki with Jean-Claude Juncker, Luxembourg prime minister, who was on Friday given a second two-year term as political head of the eurozone.
Mr Juncker said he had only agreed to carry on chairing the eurogroup – the political arm of the single currency – after finance ministers supported his plan to have an “intensified dialogue” with the ECB.
As I say in a comment on Daniela's post. This is about the only topic I am currently in agreement with Trichet on: I simply don't see what he and Trichet have to talk about.
Meantime over at Afoe Mark Thoma has an interesting guest post on whether the eurozone will be affected by any possible downturn in the US. This same post is picked up by New Economist,as it is by Claus Vistesen at Alpha Sources.
Personally I think I think that Nouriel Roubini's view (which comes up in the post) that the rest of the world may not be able to decouple from the US is a mistake. In a sense the world already has. If you look at the fact that global growth this year is likely to be in the 5% region, while the US might grow say 3.5%, and Japan say 2.5% and the eurozone say 2.0%, then it is clear that someone somewhere else is now doing the heavy lifting. Most likely candidates are places like China, India, Brazil, Turkey and a string of other developing countries like Argentina and Chile who are to some extent riding the commodities boom generated by the aforementioned.
This is a sea-change from the 1995-2000 period, when US growth did account for a huge proportion of global GDP growth. I think this de-coupling will become even clearer after the next recession (which could be 2007 or 2008, we have no crystal balls, but I would pencil something in for 2007, especially if the collsion with Iran continues its course). The next upswing will surely be pulled by the new Growth Pandas (or if you like growth giant pandas).
The big issue is going to be how you square the circle on trade and capital flows.
One important point that isn't being noticed (or isn't being given sufficient importance) is that three of the G7 economies are going to have severe fiscal tightening in 2007 to accompany high oil prices and raised interest rates (Japan, Germany and Italy).
So the machine isn't going to be pulled in this direction. This tightening isn't, as Rogoff suggested frustrating, it is, unfortunately, entirely in the logic of things since these three economies have lived through the good times of this upswing with sustained fiscal deficits, and their budget liabilities with their aged populations mean that some time or another they have to change course. At least for the time being the plan is to change course in 2007 (this may, of course, be revised in the face of inclement weather).
But the big underlying issue is that these elderly economies cannot sustain strong internal demand, and can only live by trade exports and by the export of capital which is a spin off of the high savings rates. (In the case of Italy this is less clear, since the trade surplus has collapsed, but the gap is currently being made up by cheap finance from the eurosystem which goes to pay for Italian government spending).
Anyway, the real probem as I see it is this one. Most of the developing countries need to be export driven, and when they are not buying raw materials and equipment they will have an in-built tendency towards deficit during the development process. At the same time the elderly part of the G7 needs to run surpluses for quite other reasons. So this leaves us with very few countries to balance the books. The UK is undoubtedly one that can run a deficit, France could too, but the big big customer is undoubtedly the United States.
And this is the importance of the argument about housing, since if people stop recycling equity then demand for goods from abroad is likely to drop. This can then have a whole domino impact across the global economy, which far from encouraging investment in the US to take up the slack can have exactly the opposite effect as companies across the globe slash prices to offload unwanted excess output, thus discouraging further investment in the US. The recent surge in capital investment in Japan should fill one with a little foreboding in this regard.
Firstly I'd like to welcome a new blog: Daniela Schwarzer and Sebastian Dullien over at Eurozone Watch Blog. Daniela has a post today about Mr Euro, Jean-Claude Juncker. But see this George Parker piece in the FT:
Jean-Claude Trichet, European Central Bank president, on Friday delivered a stiff warning to eurozone finance ministers to back off in an escalating dispute over the bank’s independence.
Mr Trichet pointed out that it was his signature on euro banknotes and that it was unlawful under the EU treaty for finance ministers to give instructions or try to influence the bank.
His comments came at a strained news conference in Helsinki with Jean-Claude Juncker, Luxembourg prime minister, who was on Friday given a second two-year term as political head of the eurozone.
Mr Juncker said he had only agreed to carry on chairing the eurogroup – the political arm of the single currency – after finance ministers supported his plan to have an “intensified dialogue” with the ECB.
As I say in a comment on Daniela's post. This is about the only topic I am currently in agreement with Trichet on: I simply don't see what he and Trichet have to talk about.
Meantime over at Afoe Mark Thoma has an interesting guest post on whether the eurozone will be affected by any possible downturn in the US. This same post is picked up by New Economist,as it is by Claus Vistesen at Alpha Sources.
Personally I think I think that Nouriel Roubini's view (which comes up in the post) that the rest of the world may not be able to decouple from the US is a mistake. In a sense the world already has. If you look at the fact that global growth this year is likely to be in the 5% region, while the US might grow say 3.5%, and Japan say 2.5% and the eurozone say 2.0%, then it is clear that someone somewhere else is now doing the heavy lifting. Most likely candidates are places like China, India, Brazil, Turkey and a string of other developing countries like Argentina and Chile who are to some extent riding the commodities boom generated by the aforementioned.
This is a sea-change from the 1995-2000 period, when US growth did account for a huge proportion of global GDP growth. I think this de-coupling will become even clearer after the next recession (which could be 2007 or 2008, we have no crystal balls, but I would pencil something in for 2007, especially if the collsion with Iran continues its course). The next upswing will surely be pulled by the new Growth Pandas (or if you like growth giant pandas).
The big issue is going to be how you square the circle on trade and capital flows.
One important point that isn't being noticed (or isn't being given sufficient importance) is that three of the G7 economies are going to have severe fiscal tightening in 2007 to accompany high oil prices and raised interest rates (Japan, Germany and Italy).
So the machine isn't going to be pulled in this direction. This tightening isn't, as Rogoff suggested frustrating, it is, unfortunately, entirely in the logic of things since these three economies have lived through the good times of this upswing with sustained fiscal deficits, and their budget liabilities with their aged populations mean that some time or another they have to change course. At least for the time being the plan is to change course in 2007 (this may, of course, be revised in the face of inclement weather).
But the big underlying issue is that these elderly economies cannot sustain strong internal demand, and can only live by trade exports and by the export of capital which is a spin off of the high savings rates. (In the case of Italy this is less clear, since the trade surplus has collapsed, but the gap is currently being made up by cheap finance from the eurosystem which goes to pay for Italian government spending).
Anyway, the real probem as I see it is this one. Most of the developing countries need to be export driven, and when they are not buying raw materials and equipment they will have an in-built tendency towards deficit during the development process. At the same time the elderly part of the G7 needs to run surpluses for quite other reasons. So this leaves us with very few countries to balance the books. The UK is undoubtedly one that can run a deficit, France could too, but the big big customer is undoubtedly the United States.
And this is the importance of the argument about housing, since if people stop recycling equity then demand for goods from abroad is likely to drop. This can then have a whole domino impact across the global economy, which far from encouraging investment in the US to take up the slack can have exactly the opposite effect as companies across the globe slash prices to offload unwanted excess output, thus discouraging further investment in the US. The recent surge in capital investment in Japan should fill one with a little foreboding in this regard.
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