Global Output Continues Its Rise As Asian Manufacturing Surges Ahead

Global manufacturing industry ended 2009 on what seems to be a fairly positive footing, with the JPMorgan Global Manufacturing PMI posting a comfortable 55.0 in December, up from 53.7 in November, significantly above that critical 50 growth/contraction dividing line. December's was the highest reading for 44 months, and the headline Global PMI has now remained in expansion territory for each of the past six months. So this is not a fluke, and growth is being sustained, even if it is not evenly distributed, and is far from being that much hoped for "V" recovery. But of course, what happens to all of this as the stimulus is gradually withdrawn?


December data also continued to reflect an ongoing expansion in international trade volumes, with growth of new export orders being the fastest in almost two years. The latest increase came from a broad-base, with only Australia, Brazil, Greece, Russia and Spain reporting declines.

The employment situation also continued to improve, and at 50.2 the Global Manufacturing Employment Index signalled the first (ever-so-slight) increase in staffing levels since March 2008. The rise in manufacturing employment was, however, largely concentrated in emerging markets (particularly China, Taiwan and South Korea) and the US. Staffing levels fell in all of the West-European nations covered by the survey, although the rates of decline were slower than in November.

Strong Growth In Asia

One thing is clear at the present time, and that is that economic growth in Asia is powering ahead at a faster pace than in other regions - and is being led by China and India. The PMI reports for China, South Korea, Taiwan and India all suggest the presence of a widespread recovery. Japan improved for the first month in four, although Japanese exports do seem very China dependent. Australia was the outlier in Asia, with conditions deteriorating from November and the PMI falling back to from 51.2 last month to the present 48.5.

The China HSBC Manufacturing PMI rose to 56.1 in December, up from 55.7 a month earlier – the second fastest rise yet recorded by the survey, which dates back to 2004. The HSBC PMI data also signalled that prices charged by Chinese manufacturers were rising at the fastest rate since July 2008, bouyed by rising raw material costs as well as strong demand.



The India Manufacturing PMI, rose from 53 to 55.6 , its highest level since May, when it hit 55.7, the strongest performance of 2009. The positive result was helped by a big rise in the sub-index for new orders, which rose to 60.1, the highest for the year, from 54.6 in November.



The India PMI has now been above the neutral level of 50 for nine consecutive months, indicating a sustained period of expansion, following a five-month period when it suggested that output was contracting. HSBC said the detailed December survey data suggested that growth was the strongest for 15 months, driven by better economic conditions and business investment. Demand from both domestic and foreign buyers was higher than in November, although the home market remained the principal driver of new business expansion.

The South Korea manufacturing PMI edged up slightly in December to 52.8 from 52.6 in November, indicating a continued expansion of the economy, although the pace appeared to be slowing. The sub-index for total new orders fell from 54.1 to 52.9, and the index for new export orders declined from 52.4 to 50.7. However, both remain in positive territory.



In Taiwan, the manufacturing PMI moved upwards for the ninth successive month, reaching 58.7 from 58.4 in November. The index showed strong demand in both export and domestic markets, although the rate of increase in new orders edged downwards.


Diversity In The Eurozone

In Europe, the situation was more uneven, and characterised by the marked disparities between the performances of the big-4 Eurozone economies. While the French recovery remains robust, the German one continues to look lacklustre. Italy just managed to keep its head above water for the second month running, while the Spanish manufacturing sector remained firmly in recession territory. Greece and Ireland continued to struggle to gain momentum, while in the East Hungary and Russia failed to pass the critical 50 level.

The Eurozone Manufacturing PMI posted 51.6, up from 51.2 in November, the highest level since March 2008, but still well below the global level of 55.



As usual, France lead the way again, with the headline PMI recording 54.7, up marginally from 54.4 in November. Output was raised in response to a further increase in incoming new orders, the sixth in successive months. The domestic market remained the principal driver of growth, although export sales rose at an accelerated pace. Anecdotal evidence suggested that improving market demand and restocking at clients had contributed to the latest increase in new work.
Higher new orders placed pressure on firms’ capacity, leading to a further rise in backlogs of work during December. The rate of growth of outstanding business was robust and the strongest in three years. If the US is no longer the global consumer of the last resort, France is certainly in the process of becoming the European one.



In Germany the final headline PMI registered 52.7 in December, up from 52.4 in November, to indicate the strongest overall improvement in operating conditions since May 2008. However, the final PMI was slightly lower than the earlier flash reading for December (53.1), while the rise in the PMI since November largely reflected slower rates of job shedding and inventory reduction.

As far as I can see, you can read four things here into this December German reading: i)the situation in German manufacturing has improved since May; ii) but not very much (since 52.7 is not a very high absolute reading); iii) he final reading came in slightly v lower than the flash - that could indicate deceleration as the month went one, the good profile is having a higher final reading than the flash one; iv) the improvement came from a slowing down in job shedding (which may suggest increased optimism for the future, retaining staff etc), but not from an increase in output.Conclusion, German manufacturing continues to move forward, but the road is a lot longer and a lot harder than many were expecting. There is no sharp rebound here, nor are we likely to see one.



Italy continued to more or less move sideways. At 50.8, up from 50.1 in November, the seasonally adjusted Markit/ADACI Purchasing Managers’ Index only served to underline the fragility of the recovery in Italy, and how easily Italian manufacturing could fall back into contraction. On the other hand Italian manufacturers recorded a solid rise in new export orders during December. The increase in new business from abroad was faster than that recorded for overall new orders, suggesting that demand growth was stronger across export markets than in Italy.



Outside the Eurozone, Swedish industry continued to be the stellar performer with the PMI climbing up to 58.2 points, from 56.o in November, according to data from Swedbank/Silf. This was the highest level over the last year and indeed the highest of any country included in the JPMorgan poll.A strong inflow of orders accounted for the largest positive contribution to the rise in the PMI. The order sub-index rose 5.8 points, with domestic orders rising and export orders falling. Increased orders also lead to higher production plans for the next six month, pushing the production sub-index up close to the 60-point level, while time of delivery continued to increase, yet another sign of stronger economy. Meanwhile, fewer companies reported cutting staff and the employment sub-index rose to 49.5 points.


Eastern Europe

No Strong Performers In The East

Business conditions in Russia’s manufacturing sector deteriorated yet again in December, suggesting that domestic inflation and the rise in the ruble was continuing to take its toll on manufacturing competitiveness. Output was only marginally higher than in November, and new orders fell for the second month running. Meanwhile, manufacturers continued to shed staff and cut inventories. Input and output prices both rose on the month but, in both cases, the rates of inflation remained historically weak. The headline seasonally adjusted Russian Manufacturing PMI posted a second consecutive reading below the 50.0 no-change mark in December, indicating an overall deterioration in manufacturing business conditions.

The index declined to 48.8, from 49.1, its lowest level since July. Contributing to the downward movement in the index were slightly steeper falls in new orders and stocks of purchases, and a slower lengthening of suppliers’ delivery times.



Output in Poland continued to rise, while the Czech Republic just managed to keep its head above the 50 mark. Unsurprisingly, Hungarian manufacturing continued to contract, though at a slightly slower rate than in November.



The rate of expansion also slowed in Turkey,and the headline index posted a measly 50.6 in December, indicating only a marginal improvement of business conditions in the Turkish manufacturing sector. The rate of expansion fell back from November and reached the lowest recorded in the current eight-month period of growth. Incoming new business received by Turkish manufacturers only increased marginally in December.

Labour market conditions remain difficult, and employment only increased slightly in December. Staffing levels have now risen for seven successive months, but the latest increase was the weakest since July. On the other hand input prices rose substantially in December, and faster than they did in November.




And Dynamic Growth In Both The US And Brazil


In the Americas, both Brazil and the United States showed strong growth - in the US case the reading was a four year high. The Brazilian manufacturing sector continued to expand at a robust pace, and the seasonally adjusted Brazil Manufacturing PMI hit 55.8 in December, up from 55.5 in November - its highest level since November 2007. Output rose for the sixth time in seven months, and at the fastest rate since October 2007. Unfinished business and employment both increased during the latest survey period, pointing to the existence of capacity pressures in Brazil’s manufacturing industry. Staffing numbers expanded at a robust rate that was the fastest for seventeen months.



The U.S. manufacturing sector expanded in December for the fifth straight month, according to the Institute for Supply Management report. The ISM manufacturing index rose to 55.9% from 53.6% in November. It was the highest since April 2006. In December, nine of 18 industrial sectors were growing, led by apparel, petroleum, electronics and machinery. Manufacturing is benefiting from the need to restock inventories, according to Norbert Ore, chairman of the ISM's survey committee.

"Overall, the recovery in manufacturing is continuing, but there are still some industries mired in the downturn as evidenced by the seven industries still in decline," Ore said. Construction materials, chemicals and plastics are declining. The new orders index rose to 65.5% in December from 60.3% in November. It was the highest since December 2004. The employment index rose to 52% from 50.8% in November. The production index rose to 61.8% from 59.9% in November. The supplier delivery index rose to 56.6% from 55.7%.

That "Staggering" Greek Deficit Continues To Stagger Onwards and Upwards

Only a few short weeks ago the financial and economic world declared itself staggered to learn that the 2009 Greek fiscal deficit was going to come in at 12.7% (mind you, as the conservative Dutch newspaper NRC Handelsblad pointed out, there was plenty of evidence of what was coming available long before for those who really wanted to look into the matter). Well, now get ready to be staggered again, since according to a spate of articles that have started appearing in the Greek press, the number which only so very recently had us all reeling in shock may be on its way up again, if only by "a few tenths of a percentage point". How many "tenths of a percentage point?" Well at this stage this isn't exactly clear. On 28 December the web portal Capital.gr reported (in Greek, but try Google translator):

“Temporary (cash) data from the flow of government revenues have fallen quite substantially when compared to those of the last quarter of 2008,... not only data for October-November, but the first indications for December show that the delay in the flow of public tax income (mainly) is important. The Treasury has also begun to "mumble" about the possibility that the deficit in 2009 is going "to close a few decimals above the anticipated 12.7 %...". How many decimals? This is unknown at present, although the General Accounting Office (YPOIK) displayed some optimism that the gap will not exceed 0.1% - 0.2% of GDP (ie the deficit will remain below 13%) even if some do not hesitate to speak of a deficit of over 13% of GDP.”

So it definitely looks like the deficit is likely to be signed off at something over 13%, but according to this article (Greek again, I'm afraid) from "Ta Nea online" on 2 January, speculation is still rife that the breach in the 13% mark could be substantial, and that the final figure may even be as high as 14.5%. If it fear was confirmed, it should not really catch is completely by surprise, since it could well be that now that spending is not accelerating as it was before revenue may be contracting very fast (for a simple illustration of how diminishing stimulus - let alone negative stimulus - works, see this post by Paul Krugman), and with both GDP and prices falling (systematic deflation), the deficit as a % of GDP can easily shoot up. Then again, there are reasons why it might be politically convenient to "book-in" a larger deficit in 2009, in order to make next years cuts look a lot bigger than they actually are (you start from a higher base), so who really knows. Will the true Greek 2009 fiscal deficit please stand up!

The more interesting dimension in the Ta Nea article is all the potential for intrigue it goes into. Evidently, nothing here is ever what it seems to be, and the article speculates that there are those in Pasok (the Greek socialist party) who are wheeling out and using the threat of declaring a 14.5% deficit as a bludgeon with which to try and moral-blackmail Brussels. The thinking seems to go that Brussels cannot afford to let Athens go to the wall at this point, so they would not want to see the kind of pandemonium which might break out if the markets cottoned on to a deficit of this magnitude. On the other hand key people in the governing party don't want to accept the kind of deep reforms the Commission is talking about in the Greek case, so they want to trade a smaller budget deficit for a bigger proportion of one-off measures. But then there are even more wheels within wheels, since it seems Brussels is adamant that it wants to present the reform package as a largely "made in Greece" affair, while those in Greece want to sell the package to their voters as being imposed by Brussels, so there are those who think the 14.5% deficit menace is being cooked up simply to make the Commission furious and get it to read the trems of the riot act out in public. Naturally, protagonists of this viewpoint should remember that old Greek saying, "whom the gods would destroy they first drive mad", so they need to be careful. And as the other old English saying goes, playing around with primed bombs is a decidedly dangerous thing to do. Definitely not recommened.

Structural Reforms AND Internal Devaluation

The Greek parliament passed a 2010 austerity budget just before Christmas aimed at reining in the country's soaring deficit by cutting public spending by 10 percent and cracking down on tax evasion. The budget is the government's response to growing pressure after the three main credit ratings agencies all downgraded Greece’s debt. Prime Minister Papandreou has vowed to bring the deficit to below 9.4 percent next year, but doubts remain as to whether the need for fundamental reform has been accepted, or whether Greek politicians are simply looking to apply some cosmetics and ride out the storm. In theory the 2010 budget aims to cut the 2009 deficit to 9.1% of GDP in 2010 through a combination of spending cuts (€8 billion are currently planned) ) and tax increases.

However, the budget has already been criticized by both the EU and the ratings agencies for relying too much on one-off measures, and too little on permanent reforms like cutting the public sector wage bill or stamping out widespread tax evasion. Moody's decision to cut its sovereign debt rating for Greece to A2 from A1 was widely interpreted as a mini victory for the Greek administration, but it could easily turn into a Pyrrhic one if the measures taken fail to convince. As Moody's stressed

"A further downgrade will depend on the Greek government's plan being followed through - as demonstrated, for instance, by a sustained increase in tax revenues and/or the effectiveness in reining in expenditure."

Finance Minister George Papaconstantinou stressed the government's commitment to far-reaching changes: "With this budget we begin our program of restructuring the economy...and cleaning up public finances," he said. But with Greece already under heightened EU budget supervision, what is needed at this point is something more than mere words, and the government will have to move quickly to convince both Europe's leaders and the financial markets that it is serious about reform.

A key moment is bound to come in mid-January when the government is due to present the EU Commission with its three-year stability and growth timetable outlining the government's medium-term plan to bring the deficit below an EU-mandated ceiling of 3% of GDP by 2013. The government has already pledged itself to introduce sweeping tax reform to boost government revenues, overhaul Greece's deficit-ridden pension system and outline plans for some €2.5 billion in privatizations, and it is presumeably the sum total of all these that is leading to those tensions in the governing party Pasok.

Aside from the fact that these measures are all very unpopular with the party's traditional electors, another problem arises. Most of the measures so far referred to are what could be referred to as "structural reforms", and these are very badly needed to lift Greece's long run growth rate slightly, and ensure fiscal sustainability in the face of a rapidly ageing population. But Greece has another problem - it's enormous current account deficit.




This deficit is largely a product of the large goods trade deficit, itself a reflection of the substantial loss of competitiveness that has characterised Greek industry during the years of the Euro-driven boom. Now the imbalances that this has all produced need to be corrected, and this correction needs to happen simultaneously with the fiscal correction. What this means is that in addition to the structural reforms Greece also needs to carry out what is known as an "internal devaluation", in order to make domestic industry more competitive in both the import and export sectors. And here comes the catch, since this devaluation will mean that GDP will fall even faster than otherwise, as prices also fall. Which means that the fiscal deficit will tend to be higher, and the debt to GDP level will rise even more rapidly than envisaged in the EU Commission forecasts - a process we have seen only to clearly in Latvia lately. And as many people continually point out, such processes are inherently difficult to carry through due to the political and social tensions they engender.

Just how serious this kind of problem this can become was highlighted in a Bloomberg article only today, where they point out that Japanese gross domestic product shrank to an annualized 471 trillion yen (or $5 trillion) in the third quarter of 2009. If you don't correct for changes in prices this takes Japan GDP back to levels not seen since 1991. As Paul Sheard, global chief economist at Nomura Securities International, points out, this tumble is unprecedented among developed economies since the 1930s. What's more, as a result of the ongoing economic contraction, the Finance Ministry now projects tax revenue in 2010 will drop to a quarter-century low.

More than a fifth of Japanese are over 65, according to the National Institute of Population and Social Security Research. The nation’s population began shrinking in 2006 from 127.8 million, and will drop by 3.2 percent in the coming decade, the Tokyo-based, state-sponsored institute estimates.

Japan faces the biggest fiscal gap among the Group of 20 advanced and emerging nations during the coming five years, according to a Nov. 3 report by the International Monetary Fund in Washington. Its deficit will remain as high as 8 percent of gross domestic product in 2014, compared with 6.7 percent in the U.S. and a balanced budget in Germany. Japan’s debt is projected to be 246 percent of GDP that year, compared with 108 percent for the U.S. and 89 percent for Germany, according to the IMF report.

Now Greece can't have exactly the same problem as Japan for a number of reasons. In the first place Japan currently runs a massive current account surplus, while Greece has an equally huge deficit. Further, Greece has no equivalent of the Bank of Japan, since it has no direct channel of influence over the ECB in Frankfurt (which evidently is responsible to a whole group of countries). But even more to the point, as part of a currency union there is an obvious limit to the deflation process, as the fall in prices would eventually restore competitiveness with the other euro area countries (which is where the root of the problem lies). But in the meantime the level of debt to GDP could be lead to rise even more sharply than currently anticipated, and even if the ECB should prove willing to support such a high debt to GDP level, it would still pose serious taxation and growth issues for Greek society.

So the bottom line here is that nothing is going to be easy. Greece now has a hard road to travel, and will need all the institutional support she can muster. Which is why it is high time Greek political leaders realised that this time there really is nowhere to hide, and that all the old games and tricks simply won't work now. They are playing with the future of others, would that they were capable of realising this.

Ten New Year Questions For Paul Krugman

I have an interview with Paul Krugman in today's edition of La Vanguardia (in Spanish). Below I reproduce the English original. As will be evident, there are many topics about which Paul and I are far from being in complete agreement. But on one topic we are in complete harmony: the diffficult situation which now faces Spain, the need for internal devaluation, and the threat which continuing inaction on the part of Spain's current leaders represents for the future of the entire Eurozone.

One

Edward Hugh: In your NYT article "How Did Economists Get It All So Wrong", you state what I imagine for many is the obvious, that few economists saw our current crisis coming. The Spanish economist Luis Garicano even made himself famous for a day because he was asked by the Queen of England the very question I would now like to put to you: could you briefly explain to a Spanish public why you think this was?

Paul Krugman: I think that what happened was a combination of two things. First, the academic side of economics fell too much in love with beautiful mathematical models, which created a bias toward assuming perfect markets. (Perfect markets lead to nice math; imperfect markets are a lot messier). Second, the same forces that lead to financial bubbles – prolonged good news tends to silence the skeptics – also applied to economists. Those who rationalized the way things were going gained credibility until the day things fell apart.


Two

E.H. : The late Sir Karl Popper used to contrast what he regarded as science with ideologies like Marxism and Psychoanalysis, because there seemed to be no way whatever of consenually agreeing with their practitioners a series of simple tests which would enable their theories to be falsified. Some critics of neoclassical economics - including Popper's heir Imre Lakatos - have expressed similar frustrations. Do you think we economists are, as a profession, up to the challenge of formulating testable hypotheses in such a way that the public at large might come to have more confidence in what we are up to, or are we a lost cause?

P.K.: I really don’t think that’s a helpful way to pose this question. Economics is about modeling complex systems, and as such the models are always less than fully accurate. What economists do need, however, is some demonstrated ability to get big things right. They had that after the Great Depression, when Keynesian economics clearly made sense of both the depression and the wartime recovery. But now the profession needs to get back on track.


Three

E.H.: Comparing the types and levels of indebtedness in the United States as between 1929 and 2007 one factor immediately stands out, the importance in modern times of the financial sector. You have repeatedly drawn attention to this phenomenon, and to how the unbridled growth of the institutions associated with it inevitably sowed the seeds of the problem which eventually came. Is there a road back? Can we reduce the strategic importance of this sector in developed economies and still generate meaningful economic growth?

P.K.: We grew fine for 30 years after World War II with a much smaller financial sector. I think if we tax and regulate the sector, we can replace it with other, more productive uses of resources – everything from manufacturing to health care.

Four

E.H.: Another of the distinguishing characteristics of the global economy over the last decade has been the development of large and sustained imbalances, with the US-China one being only the most publicly visible. Here in Europe we also have strong and notable differences between export driven economies like the German and the Swedish ones and many of those in the South and East which have evolved models based on consumer and corporate indebtedness and import dependence. Do you think we have the policy tools available to address such issues, and if so, where do we start?

P.K.: On the domestic side in advanced countries, financial reform should help reduce debt reliance. As for the developing country capital surpluses, that’s heading for a big confrontation. In the end, either China in particular increases domestic spending, or there will be some kind of at least threatened trade war.

Five

E.H.: One of the standard pieces of economic observation about countries recovering from financial crises is that their recoveries are export driven. This has now almost attained the status of a stylised fact. But as you starkly ask, at a time when the financial crisis is generalised across all developed economies - whether because those who borrowed the money now have difficulty paying back, or those who leant it now struggle to recover the money owed them - to which new planet are we all going to export? Maybe we don't need to look so far afield. Many developing economies badly need cheap and responsible credit lines, and access to state-of-the-art technologies. Do you think there is room for some sort of New Marshall Plan initiative, to generate a win-win dynamic for all of us?

P.K.: Um, no. Not realistically as a political matter. We’ll be lucky if we can get the surplus developing countries to spend on themselves. My guess is that our best hope for recovery lies in environmental investment: taking on climate change could, in terms of the macroeconomic impact, be the functional equivalent of a major new technology.

Six

E.H.: Last December you publicly warned of a burgeoning economic crisis on Europe's outer frontiers. Indeed you even went so far as to state that the center of the present crisis had "moved from the U.S. housing market to the European periphery" - and by periphery here I take it you mean countries like Ireland, Spain, Greece, Romania, Bulgaria, Hungary and the Baltics. With hindsight, and looking at how Europe sovereign debt, with Greece in the forefront, has suddenly become the "plat du jour" for the financial markets, this seems to have been extraordinarily perceptive. What was it about the situation on Europe's periphery that attracted your attention at such an early stage?

P.K.: Numbers, numbers, numbers. Those huge current account deficits practically screamed “bubble”. In general, it’s been amazing how useful even very rough measures of imbalance have been at predicting crisis, in everything from U.S. housing to Latvia. And that makes it even more amazing how few people recognized the warning signs.

Seven

E.H.: One of the most significant recent monetary initiatives - the Euro - is now nearly ten years old. On its fifth birthday Ben Bernanke described it as a "great experiment", do you think this description still fits the case, or is it now possible to start to draw some tentative conclusions?

P.K.: It’s still very much an experiment. We’re only seeing the real downside now, as the eurozone tries to cope with the unwinding of large internal imbalances. Until we see how that goes, the judgment on the euro will remain in doubt.

Eight

E.H.: A number of Eurozone economies are currently in some difficulty due to their high general level of indebtedness and a loss of price competitiveness which makes exporting their way out of their problems quite hard. This issue becomes even larger given that these economies no longer have a currency to devalue, In a speech earlier this year in Argentina you said that Spain now had no alternative but to carry out a systematic reduction of prices and wages in order to restore competitiveness. For a Spanish public which is far from convinced that this is the case, could you briefly explain why this is so?

P.K.: Put it this way: for a number of years Spain could pay its way within the eurozone by selling assets, mainly real estate, as the inflow of capital financed a huge housing boom. That allowed Spanish wages to rise relative to those in other European countries. But now the housing boom has gone bust, and the big inflows of money are over. So Spain needs to compete in producing real stuff, such as manufactured goods. And it won’t be able to do that unless it has a major gain in productivity through wage reductions.

Nine

E.H.: In the Latvian context the expression "internal devaluation" has been advanced to describe this kind of wage and price correction process. The expression has a very attractive feel about it, but as you recently pointed out in your NYT blog (The Pain In Spain) the changes involved are far from easy to implement, with consequences which are normally none too pleasant for those on the receiving end. Indeed they bear a striking resemblance to what used to be called wage and price deflation in the 1930s. Have we really advanced so little in all these years, or are there now more sophistocated policy instruments available to public authorities to implement such changes in a way that parallels the monetary policy improvements which we have seen in action during the present crisis?

P.K.: I wish I had some clever suggestions. But the essentials of economics change much less than the façade. The truth is that Spain is very much in the same situation as gold-standard countries in the 1930s; in some ways worse, because it lacks the option of using trade policy as a substitute for devaluation. So deflation it must be.

Ten

E.H.: Finally, as one decade draws to a close, and another opens, are there any grounds for optimism? You often speak of the return of depression economics, is what we once called the "modern growth era" now decidedly over, or are we simply passing through an interlude, with a new dawn out there waiting for us, somewhere just over the horizon?


P.K.: We will recover eventually. And we have learned some things since the Depression, which was why this hasn’t been nearly as bad. Overall, leadership is better – I’m especially relieved that we have smart, well-intentioned people running my own country, which is a major improvement. So sure, things will improve. But it’s going to be a hard slog.