Posts Tagged ‘eurozone’

file9961251406222Oil has fallen again in recent weeks. This week, West Texas Intermediate oil has been hovering at just a dollar or two above the year low. Meanwhile, a report from the National Institute of Economics and Social Research (NIESR) has predicted that 2015 will be the worst year for the global economy since 2008. It shouldn’t be like that. With oil as cheap as it is, the economy should be booming.  So this all begs the question, “why?” Is there some rather worrying underlying reason for the weakness in the global economy?

At the time of writing (6 August 2015, 6.45 am) West Texas Intermediate oil is trading at $45.17. To put that in context, just over a year ago it was trading at $104. Brent crude oil is just shy of $50. One day, black gold will probably go back over $100. Maybe, one day it will even pass the 2008 peak, when it went close to $150, but this day is not likely to be any time soon.   The oil cycle moves slowly. Investment in oil has dropped drastically, new projects have been shelved. It will be several years before these developments show up in rising oil prices, though.

There are winners and losers from cheaper oil. Apologies if this sounds like a lesson from the University of the Bleeding Obvious, but cheaper oil benefits its consumers and hits its producers. So in theory the effect of falling oil prices on the global economy should be neutral. It is just that on the whole, oil consumers have a much lower savings ratio that oil producers. A fall in the oil price distributes income from high savers to high spenders. Given that we are in a time when there is a chronic shortage of demand worldwide, this should be good news.

As an aside, there is another not commonly understood potential side effect of cheaper oil. Ask yourself this question, why are interest rates so low? That is to say, what is the real reason? Forget central bankers, they move with the tide. The main reason why rates are so low is because worldwide there is a shortage of demand and a savings glut.  Back in the noughties this savings glut funded consumer spending in the West, creating a bubble which burst in 2008. Since then it has been funding surging government debt, and maybe sharp rises in debt in emerging markets.  McKinsey has said that global debt has risen by $57 trillion since 2007. The savings glut made this possible. There are many reason for this, and many of these reasons have not gone away. But at least one driver of low interest rates, the rise in savings coming out of oil producers, has gone into reverse.  

Returning to the global economy in 2015, earlier this week NIESR projected that “The world economy will grow by 3 per cent in 2015 – the slowest rate since the crisis – and 3.5 per cent in 2016.” So that is odd. The price of oil has fallen by a half, and the global economy is weak. Something is wrong.

There are two ways looking at this. You can look at individual countries, one at a time, or you can look for some deeper underlying cause.

The US has a bad start to the year because of an exceptionally cold winter in the north east of the country. This had a knock-on effect worldwide. The UK, it appears, got caught up in it all with falling exports to the US dragging down on growth.  

By its standards, the Eurozone had a good first half of this year, this despite Greek woe. But then again, this is the Eurozone, and the key phrase here is “by its standards.”  The only other region in the world that puts in such a continuously poor performance is Japan.

The world’s second largest economy, China, has slowed fast. There is more than one reason. For one thing, China sits on a mounting debt pile, with local government especially badly exposed.  This is beginning to hurt. For another thing, the Chinese government is trying to re-engineer the shape of the Chinese economy, shifting it from investment and savings led, to consumption led. This is a good thing, but the transformation is hurting

Russia’s problem are well documented. It is clear that it has lost out big time to the falling oil price. Brazil has suffered from a wider fall in commodity prices, but like Russia, there were deep structural problems with the economy anyway.

So pick it apart, there is a reason for the slow growth. Even so, I can’t help but feel that the overall performance of the global economy, given how weak oil and other commodity prices are, is very disappointing. You could respond by saying that I have mixed up cause and effect. You could say that oil has fallen in price because global demand is low. But I would respond to that by saying at least part of the reason for the fall in the oil price has been the revolution in fracking and previous surges in oil investment. The rise of renewables are taking a toll, too.  I don’t accept that I have got things the wrong way round.

So what are the possible underlying drivers at work? There are to theories to explain what is happening, there is the Robert Gordon ‘innovation is slowing’ theory, and the Larry Summers Secular Stagnation theory. I will look at these theories in more depth in a few days.

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The ONS revised again. It always does, but it can be hard to keep up. You may recall, back at the end of 2011 the UK fell back into recession, suffering what we called a double dip — except it didn’t. Subsequent revisions of the ONS data on GDP revised the contraction away. You may also recall that the UK grew by 0.6 per cent in Q2 of this year, which was good, but working against this was that much of the growth came on the back of rising consumption, or falling savings. Given the high level of UK household debt, some might say that this development was a tad worrying — except that they didn’t. The data has been revised, and this time the story revealed is much more encouraging.

The first revision was to the headline figure. The ONS is now saying the UK economy expanded by 0.7 per cent in Q2. To put that in context, the US expanded by 0.4 per cent and the Eurozone by 0.3 per cent in the quarter. On an annual basis the economy expanded by 1.5 per cent.

Drill down, however, and the data looks more encouraging still.

It turns out – or at least this is what the latest data says – that investment jumped by 1.7 per cent quarter on quarter and net trade rose by 0.3 per cent. Okay, the poor old indebted consumer spent more too, largely by adding to his and her debt. Consumer spending was up 0.4 per cent – boosting retail sales in the process, but then again, it is all the more encouraging that at a time of growing consumer spending, net trade provided a positive contribution to growth.

As another story today shows that there has been a gradual rise in the UK’s export sector at a time when global trade is seeing only modest growth and this provides reason to hope that this time the UK recovery is for real. See: The UK’s export-led recovery

Drill down further still in the UK GDP data, and it emerges that both manufacturing and construction grew faster than services – or to remind you of the caveat, so says the latest data, which may get changed again.

Vicky Redwood, chief UK economist at Capital Economics, said: “Looking ahead, the economy still faces some serious constraints (including the fiscal squeeze and weak bank lending), so it may struggle to keep growing at quite such robust rates.”

It is not hard to be cynical about the data. Sure, manufacturing and construction are growing, but from very low levels. Considering where we are in the economic cycle, a growth rate of 0.7 per cent is pretty modest, and there are reasons to think growth will slow later in the year.

The point is, however, that the UK does appear to be recovering. The recovery is slower than we might like and there are reasons for caution, but compared to what we have seen over the last half a decade, the growth rate is pretty good. Relative to what we are used to, the UK is booming. In China, growth is around three times faster, but relative to what China is used to, it feels like a crisis. This time, unlike in 2010, the recovery does fell a little more real.

Let us finish on a qualified positive note. Other recent data from the ONS reveals that UK total net worth at the end of 2012 was estimated at £7.3 trillion; this was equivalent to approximately £114,000 per head of population or £275,000 per household. The estimated increase in UK net worth between 2011 and 2012 was £74 billion. Okay, the increase in wealth was largely down to rising house prices and equity values and they can fall as well as rise. The jump in asset values goes some way to justify rising consumer spending.

One question remains, however. How sustainable are rises in consumption at a time of high household debt on the back of rising house prices, at a time when they already seem too high?

© Investment & Business News 2013

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There is good and bad side to a currency falling in value. A cheaper currency is bad news for importers. It is bad news for consumers who want to pay as little as possible for the goods they buy, and for their holidays abroad. A falling currency can be bad news for inflation. But there is a flipside. It can at least hand exporters a massive terms of trade advantage. A country that needs to see exporters drive growth surely needs a cheaper currency. So why is it that the UK seems to have the bad side, but very little of the good side? A new report seems to provide an answer.

Between Q3 2007 and Q1 2009 the effective exchange rate of the pound fell 25 per cent. Inflation rose. Wage inflation didn’t, which left workers worse off. But the UK’s balance of trade in goods and services was largely unchanged. Why didn’t exports rise?

The Office of National Statistics has come up with four possible explanations.

Number one: Global supply chains. The argument runs like this: global trade has become so integrated, with supply chains being so closely in alignment, that it is very hard for a country that sits in a supply chain to suddenly start selling more goods just because prices have fallen. The ONS put it this way: “If multinational companies have an international supply chain structure, which involves moving goods and services between a number of countries before a final product is produced, it is difficult to change this structure in the short term in response to an exchange rate movement.”

Number two: Financial shock and composition of trade. This is a nice simple argument. The UK relies on financial services. In the aftermath of the 2008 crisis, financial services took the biggest hit, therefore UK imports were adversely affected.

Number three: Price effects. The ONS put it this way: “Domestic exporters – whose goods are relatively less expensive as a result of the depreciation – may choose to increase profit margins on sales to overseas customers, rather than passing on the full benefits of the exchange rate change.” There was another factor: oil. As the pound fell, the price of oil hit UK exporters.

Number four: Effect of downturn on main trading partners. This was surely the main problem for the UK. Sure, the pound was cheap, but our main trading partners – the US and the Eurozone – were in recession or even depression for many of the last few years.

So what can we take from all this, and say about what will happen to the UK next?

It does seem that the main reason why the falling pound did not lead to rising exports was short term in nature. The UK is slowly exporting more outside the Eurozone, but our exports to say the BRICS, were so tiny that it has taken time for the rise in exports to become noticeable. But the fact is that for the last couple of years export growth to China, for example, has exceeded import growth.

Ditto regarding integration within the supply chain. If it is the case that multinationals find it difficult to change their supply chain structure in the short term, this does not mean they cannot change it in the long term. The real hope, however, lies with re-shoring. If it really is the case that companies are beginning to return their manufacturing closer to where their customers are, that will lead to a slow, bit by bit improvement.

In other words, a cheap pound has not benefited UK exporters that much up to now. But that does not mean it won’t do so over the next few years

© Investment & Business News 2013

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It’s an odd thing, isn’t it? Not so long ago, people were talking about Belgium as being the country in northern Europe that was most in danger of going the way of Spain, Portugal and co. And for a long time, Holland – along with Germany and Finland – had been lecturing the rest of Europe about the need to live within one’s means. All of a sudden it looks a lot different. Holland is fast becoming the sick man of northern Europe, and the reason? Well, let’s hope George Osborne is paying attention, because it is a lesson he could do with learning.

According to data out recently, the Eurozone is out of recession. The German economy grew by 0.7 per cent, France by 0.5 per cent, and at face value it was encouraging stuff, but among all that good news there was one piece of worrisome news. The Dutch economy contracted by 0.2 per cent. It was not really a surprise. It contracted in the last quarter too, and the one before that and before that. In fact the country has been in recession for 18 months now. That makes this one nasty recession, but just remember, it was also in recession in 2008/09, so for Holland it has been a double dip of truly unpleasant proportions.

The reason is not rocket science.

During the boom years Dutch house prices rose too high – way too high. Seduced by the idea that owning a house in Holland was a sure-fire investment winner, sucked into the narrative that a shortage of land meant that house prices across the Netherlands were guaranteed to rise, urged on by a government that subsidised mortgages, the Dutch borrowed against their home, and borrowed against the belief their home would rise in value and they ran-up huge debts.

It really is a puzzle. Among those who lecture us the most about the need to live within our means – so that is Dutch and British finance ministers for example – there seems to be a kind of casual disregard for household debt. We must live within our means, unless that is to say you are a voter, in which case, borrow, put it on the plastic – it matters not, your home will rise in value.

According to OECD data, household gross debt to gross disposable income in the Netherlands is 285 per cent. This is the highest ratio across the OECD. To put those numbers in context, the equivalent ratio in the US for 2008 was just 108 per cent. In the UK the ratio is 146 per cent – which most would agree is worryingly high – and yet the UK household debt levels seem like prudence personified compared to those of the Dutch. Dutch house prices fell sharply in the first quarter of 2013, in 2012 and 2011. Yet despite the falls, Dutch house prices to incomes are still above the average for the country – although admittedly not by much.

Government debt is not so bad. Gross government debt is 71 per cent of GDP, net debt just 33 per cent, which is the lowest among the Eurozone’s bigger economies. Holland’s government appears to be in love with the idea of austerity; of prudence keeping government debt under control.

Yet consider what might happen if households find they just can’t afford their debt. Imagine what might happen if global interest rates rise, which they are likely to do over the next few years. If households find they cannot pay their way; if there is a surge in the number of properties repossessed by the banks, the chances that Holland will experience its own Northern Rock type moment seems real. The possibility of a Dutch banking crisis is very real. Yet the consensus among economists towards Holland seems to be one of relaxation. The country still boasts a top notch credit rating, for example.

The thing about austerity is that it matters not how prudent a government is, how clearly it balances its books (not that the Dutch government is balancing its books), when households run-up debts, and house prices crash, household debt can become government debt. This is what happened in Spain two years ago. It may happen in Holland, and may well happen in any country where the government tries to stimulate house prices, creating consumer confidence, in turn creating growth. Are you listening Mr Osborne?

© Investment & Business News 2013

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Now some surveys are suggesting that parts of the UK economy are enjoying their best growth since 2006. So is that it then? Is the crisis that began in 2008 well and truly over? And here is another question: does it just go to show the government was right all along? Austerity works, QE, or quantitative easing, is best?

There are reasons to think the recovery this time around is for real, unlike in 2009/2010 when the UK saw something of a false dawn. This time real things seem to be happening. UK exporters are enjoying more success selling their wares outside the Eurozone, and the success enjoyed by the car industry is a good example of this. Then there is evidence of reshoring, as companies look at return at least some of their manufacturing to their home markets.

But does this really prove that austerity works? Does this really prove QE was the right thing to do all along?

There is something quite ironic about something George Osborne has said. He has often laughed off ideas that the way to solve a crisis caused by having too much debt was to borrow more. That was how he has defended austerity. And yet, by encouraging a new housing boom, it could be argued that Mr Osborne is trying to solve an economic crisis caused by too much household debt, by getting households to borrow more.

It boils down to whether you think government debt is worse than private debt. Just remember that in many parts of the world, such as Spain for example, household debt became government debt.

Now let’s focus some more on UK household debt. In the year 2000 UK household debt to disposable income, according to the OECD, was 112 per cent. In 2007 it was 174 per cent, and in 2012 it was back down to 146 per cent. The Office of Budget Responsibility recently forecast that UK household debt is set to rise again – albeit not by a great deal. This differs, by the way, from the US which has seen the ratio fall to a much lower level, and which is expected to fall even further.

Household debt keeps getting forgotten. It was household debt across the UK, the US and Europe which explained why QE was never going to lead to hyperinflation. Households had become afraid to spend, to borrow. The money supply, the broad money supply, which economists believe is associated with inflation, is as much determined by debt and borrowing levels as anything.

Despite the Bank of England issuing £375 billion in QE over the last few years, the broad money supply has only seen very slight growth. See it terms of a bath with a big hole in it. You turn the tap on full, to make up for the water leaking out of the bottom, and many, who seem to be oblivious to the hole, fret that the bath will overflow.

QE was never going to lead to hyperinflation and the biggest failing of the European Central Bank was not to realise this.

But just because QE was not going to create hyperinflation that does not mean it is a good idea. If you have a bath with a hole in it, what is the best thing to do? Is it to turn the taps up full, or try to fix the leak? QE amounts to taking the former approach.

The trouble with austerity is that it can work when tried in isolation. But it has not been tried in isolation; rather it has been a Europe wide thing. This has had disastrous consequences for the UK and Eurozone.

The UK had a worse downturn than most of the Europe because the UK was more reliant on its banking sector. The UK is enjoying a faster recovery than the Eurozone partly because it is not in the euro and has a cheaper currency, and partly because of QE.

But while QE has not created hyperinflation, it has led to higher asset prices. To misquote George Osborne: “How can you solve a crisis caused by asset prices being too high, by getting asset prices to rise?”

What the UK, the US and Europe need is for central bank money printing to fund investment to enable the world’s developed economies to start fulfilling the potential of the fantastic innovations we have seen in recent years.

Instead, we have seen the UK return to old habits. Central bank policy via QE and government policy are combining to push up house prices and household debt when what we need is more investment. This is not a good development.

© Investment & Business News 2013

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The numbers say what the numbers say. It may not feel right; it may defy reason, but there are reasons to think the Eurozone may be set to exit recession.

The latest flash Purchasing Managers’ Index tracking Eurozone manufacturing and services hit an 18 month high.

That is good, but especially encouraging was that the July index was 50.00, which is good news because 50 is seen as the key level. Anything below 50 is supposed to correspond with contraction; anything above signifies growth. Okay, a reading of 50 is not that remarkable, and this is just the flash reading, meaning that it is an early estimate. But it is a good sign, nonetheless.

Markit, which compiles the data, said: “Manufacturers reported the largest monthly increase in output since June 2011, registering an expansion for the first time since February of last year. Service sector activity meanwhile fell only marginally, recording the smallest decline in the current 18-month sequence and showing signs of stabilising after the marked rates of decline seen earlier in the year.”

In Germany output rose at the fastest rate for five months. Service sector growth hit a five-month high while manufacturers reported the steepest monthly increase in output since February of last year. Overall job creation hit the highest since March.
As for France, the PMI hit its highest level since March 2012. It’s not the only good news out of France of late. An index showing that morale in the industrial sector recently rose for the fourth month running, led the French Finance Minister Pierre Moscovici to say: “Nous sommes en sortie de recession,” or “We are out of recession.”

On the other hand, the index measuring French industrial morale is still below the historic average. The PMI was up, but at 48.8 still pointed to contraction, and in any case, France has to enforce much more substantive reforms to its labour market before it can claim its struggle is over.

Ben May, European economist at Capital Economics, said: “There are some signs that the euro-zone economy is on the mend and might perhaps soon exit recession. Nonetheless, the PMI and other business surveys have signalled several false dawns in the recent past. What’s more, with banks still reluctant to lend and demand for credit remaining weak, it is still too soon to conclude that the region is in recovery mode.

© Investment & Business News 2013

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The US economy has not been good at exporting for some time. Recent data shows that its imports of goods and services still lag way behind exports. Yet there is one thing the US is good at exporting and that is economic news. And of late it has been exporting good economic news. So what is it; why; is it for real, and does that give us reason for hope?

Sometimes recoveries seem to be built on hot air. Sometimes they are down to confidence, and confidence creates growth, and growth creates confidence. During the boom years of the noughties, economic boom was built on debt. Households borrowed because house prices were up, and they rose partly because interest rates were so low, and partly because credit was so easy to come by, but there was something wrong.

The boom was built on foundations as shaky as a shaky house built of shaky match sticks, sitting on top of shaky hill made from quick sand. This time the recovery seem to sit on foundations that are a lot more robust. Yet still the doubters say it is all a lie.

So why the reason for cheer?

First and foremost, US households have cut debt. US household debt has fallen from $12.7 trillion in 2008, to $11.2 trillion at the end of last year. In fact, according to IMF data, US household debt to income has fallen from a ratio of 1.3 in the mid-noughties to around 1.05. In fact, the ratio is now higher in the Eurozone. At the same time, the value of US household assets have risen. According to Capital Economics: “Every $1.00 of debt is now backed by $6.30 of assets, whereas before the recession it was backed by $4.80 of assets.” Capital Economics, for so long a bear on the US economy, recently said that the US consumer is now well placed to drive “a faster period of economic growth.”

Secondly, US banks are in better shape. Q1 saw record profits for US banks, while their deposit-to-liabilities ratio recently hit a 20-year high of 84.6 per cent. See: US banks see biggest profits ever: is the US back? 

Thirdly, the US fiscal deficit this year is expected to be $642 billion, or so estimates the Congressional Budget Office. To put that in context, last year the deficit was $1.1 trillion. It will, in fact, be the first time since 2008 that the US deficit is less than $1 trillion. And, by the way, not so long ago the Congressional Budget Office was projecting a deficit of almost $200 billion more than that.

As for those who say the US sits on a financial and demographic time bomb, and that surging health care costs alone are sure to bankrupt the world’s largest economy there are some reasons to be cynical about such cynicism. See: The scaremongers are wrong: the US is not even vaguely close to going bust  and US medicare time bomb begins to look more like a pretty time piece 

US consumer confidence recently hit a five and half year high. US house prices are rising, and, unlike in the UK, they are rising from a point where the average price to income is below the historical average of 1.2 million, with June seeing a rise of 195,000.

Given all this evidence, why are many so cynical?

Some cynicism seems to be built on genuine concerns, while others seem to be cynical for its own sake.

One challenge is that this year US government spending will be falling while taxes are rising. This may be good for cutting government debt, but it may yet prove disastrous for the economy, and indeed the IMF has slated the US government for relaxing its fiscal stimulus too soon. But then that is what you get when you have a political system made up of two parties that seem to be hell bent on putting self-interest over national interests.

Partly as a result of the US fiscal stimulus’ going into reverse, recent  Purchasing Managers’ Indices (PMIs) have been disappointing, with the latest PMI tracking US non-manufacturing falling to a three year low. The latest PMIs suggest the US will grow at around 1 per cent in Q2 on an annualised basis. By recent standards, that is poor. But then these are problems with the short term.

Another challenge relates to the very difficult balancing act that the Fed has to manage. It is now talking about cutting back on its quantitative easing or QE programme quite soon – September being the date expected by the markets. The Fed has been buying $85 billion worth of bonds every month. To begin with the Fed will not stop QE, but merely slow down. The feeling is that it won’t stop altogether until next year, and rates won’t rise until 2015.

Not all see why. For one thing US inflation is modest, and appears to pose no threat at all. Fears that were commonplace a year or so ago, that QE would lead to runaway inflation currently look somewhat silly. So they ask: why cut rates so soon?

A more serious concern relates to ways in which the actual data may be misleading. So sure, US employment may be up, US unemployment may be falling, but US employment to the US population is not much less today than during the height of the recession. In part this is down to more people retiring, but it appears this is also partly down to some people pretty much giving up, and falling off the unemployment stats.

Then there are some who voice concern over student loans in the US. The big critic here is Nobel Laureate Joseph Stiglitz. See: Student Debt and the Crushing of the American Dream

This all leaves two big pluses.

The first plus is shale gas. This has led to falling energy costs, handing US households more disposable income after paying for energy. The second is signs of a kind of renaissance in manufacturing. This shows up in many ways. Both Apple and Google, for example, have recently announced that certain products will be made in the USA.

As US productivity rises, unit labour costs fall, and unit labour costs in China rise, the gap with China improves in favour of the US. More exciting is the potential of 3D printing, which may yet create a new kind of local craftsman, as is suddenly becomes viable for consumers to have bespoke products designed especially for them, or for just a small number of people.

A sustained US recovery is not guaranteed, but the odds are about as favourable as they have been for a very long time.

© Investment & Business News 2013