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Producer Prices Fall Sharply

So the ruble is falling and the reserves are flowing out at a rather fast rate, but this is not producing inflation in Russia - in fact quite the contrary, disinflation is very strong in Russia right now, and indeed if things continue at this rate (especially given the sharp contraction in internal demand) deflation and not inflation is going to be the big headache. Some evidence to indicate this danger can be found in the fact that Russian producer prices - which are widely regarded as an early indicator of forthcoming inflation - fell sharply again in November, pushing the annual rate to its slowest pace since March 2007 as demand for material for industrial production weakened rapidly. The cost of goods leaving Russian factories and mines fell 8.4 percent between October and November, while the year on year rate of increase dropped to 4.2 percent as compared with the 17.4 percent y-o-y rate registered in October.

The November fall follows a 6.6 percent monthly drop in October, and it is clear that the rate of disinflation in producer prices is extraordinarily rapid, and it may be that we will soon enter outright price deflation. The biggest difficulty is the almost complete lack of control by anyone in authority and the with tecnical expertise to adequately handle macro economic management, whether on the upside or the downside. This is quite simply all terribly dramatic.

Consumer price inflation is also slowing, and was down to 13.8% in November, from 14.2% in October. Russia’s consumer price inflation rate was running at 0.1 percent in the week between December 9 and 15, according to the Federal State Statistics Service. Inflation was thus 0.3 percent for the month to date and 12.9 percent for the year to date, compared to 0.7 percent and 11.4 percent in the same periods in 2007. So disinflation is already well at work even in consumer prices. Still, these are very - unacceptably - high numbers, and those who so willingly acquiesced in them earlier will now feel the downside of their negligence, although unfortunately it is - as ever - the poor old Russian in the street who will really pick up the bill.

Rapid Economic Slowdown

More evidence for the rapid velocity of the economic slowdown is provided by the index of key economic activities, which has fallen back from a year on year high of 10.7% in April to a 2008 low of 2.6% year on year in October. This would seem to indicate that the economy may well have been contracting month on month between September and October, although as with much of the data which follows we do not have a lot of systematic access to direct month on month comparisons to be able to closely scrutinise what is happening.

Another short term measure of economic activity we have available - industrial production, which is responsible for about 40 percent of Russian GDP - contracted at a year on year rate of 8.7 percent in November, the fastest rate since the 1998 financial collapse. As a result Russia’s Economy Minstry now forecast that the eonomy may contract in the first two quarters of next year, and full year growth of 2.4 percent in 2009.

My feeling is that these estimates may well be too high, and that the economy may well already be contracting in Q4 2008 (in fact Deputy Economy Minister Kelpach more or less admitted that this was the case in a recent slip of the tongue), so we could easily see an outright GDP contraction in 2009 both in real terms and, much more seriously, in nominal terms (if we hit price deflation, everything depends on how fast the authorities let the ruble devalue). A contraction in nominal GDP would be very hard for the Russian authorities to handle - since we would be into using unconventional tools in an economy where policy managers have not yet learnt to satisfactorily use conventional ones. Month on month industrial output was down 10.8%.

Unemployment is also rising, as are overdue wages, which were up 93% over the previous month. The unemployment rate rate rose to 6.6 percent in November, which is the highest since April, but still comparatively low by historic standards, although experts suggest we could easily see this number rise towards 10% to 11% in 2009.

The total number of unemployed reached 5 million people, compared with 4.624 million in October, or 6.1 percent, according data from Rostat. Wages, however, are still rising at this point, and the average monthly wage rose an annual 7.2 percent in November to 17,995 rubles, while real disposable income fell 6.2 percent.

Russian retail sales also slowed in November and sales increased at an annual 8 percent, still quite strong, but down considerably from a revised 12.4 percent in October. Still this is the slowest pace of expansion since November 2003 and more significantly sales fell 3.4 percent from October. Retail sales have increased at an average annual rate of about 13 percent since 1998. However these have to a large extent been fuelled by unsustainable wage rises, and large scale consumer borrowing. Loans to individuals rose 58 percent in 2007, reaching 2.97 trillion rubles ($110 billion) as of 1 January 2008.

Capital investment has also been slowing, and growth was down to an annual 3.9 percent in November, the lowest rate since January 2005, according to the statistics office. Investments grew 6.9 percent in the previous month.

So an incredible trifecta - a unilateral decision to recognise Georgia’s two separatist regions, a 66 percent fall in oil prices and the worst global financial crisis since the Great Depression - has been whisked up, and has lead to a sharp spike in investor unease such that around $211 billion has been withdrawn from Russia (estimate by analysts at PNB Paribas) since that fateful day in August when the tanks went though roaring through the Roki tunnel. We now await to see just how sharp “sharp” means when we are talking about the slowdown in Russian GDP in 2009, although the real questions which must be in everyone’s minds must relate to the future beyond 2009. If the ruble devaluation produces - as seems likely - a rise in corporate and household defaults on forex loans, just how long will it take Russian consumption and Russia’s banking system to recover from the blow that this will represent? And when oil prices do eventually recover (in 2010?) just what will the Russian central bank and those responsible for economic management have learnt from this most unfortunate “boom-bust” episode.

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Spain’s Composite PMI Registers Another Record Contraction In December

Now, as I noted in my last post, according to the JPMorgan Global Manufacturing PMI report for December the weakest manufacturing performance was registered by Japan, whose output and new orders indexes fell to levels which were unprecedented in the history of any of the national manufacturing surveys included in the global manufacturing PMI. But at the end of the day this must have been a pretty close call, since while the composite reading for Japan was only 30.8, for Spain it was 28.5. Thus, on aggregate, Spain’s manufacturing sector was still leading the global charge down. Of course, if we are only talking about industry the situation in Japan is more critical, since the economy there in general is more dependent on manufacturing industry than the Spanish one is. The thing is - we will know on Monday - the services reading for Spain in December may not be much better.

Thus Spain’s manufacturing sector shrank at a record pace for the fourth month running in December, according to the Markit Purchasing Managers Index. The indicator fell to 28.5 from a previous low of 29.4 in November and marked the lowest level for any country in the near 11-year history of the survey. Around 43 percent of Spanish manufacturers in the PMI survey said they cut jobs in December to compensate for falling production, marking the highest level of layoffs in the series history and taking the employment indicator to a world series low of 29.4. Jobs have now been cut in the Spanish manufacturing sector for 16 consecutive months.

“The truly horrendous PMI data for December mean that Spanish manufacturing heads into the new year with little reason for optimism - 2009 is all set to be a very difficult year,” said Markit economist Andrew Harker.

December PMI data also showed the second steepest contraction on record for both new domestic and foreign orders, with cancellations from the United Kingdom, France and Germany

Retail Sales Continue To Fall In November

Spanish retail sales (at constant prices) were down by 9.6% year on year in November, according to data from the national statistics office.

This was the twelfth consecutive month of year on year declines, and retail sales hit a seasonally adjusted monthly high in November 2007 (see chart below), since which time they have continued to fall, and will continue to fall for some considerable time to come. Quite frankly I have no idea at all about when they will get back to those “heady” levels of late 2007, certainly not in 2009, and most probably not in 2010. And after that we will see.

Producer Prices Fall Back Dramatically

Spain’s factory gate prices fell sharply between October and November - by 2.6% month on month, bringing the annual rate of producer price inflation down from 5.9% in October to 2.9% in November.

Now falls like this are certainly not “normal”, and are an indication of massive underlying structural forces. Let us remember what JP Morgan said in their December report:

“The Global Manufacturing Input Prices Index posted 31.3, its lowest ever reading. The rate of deflation was especially marked in the US, were purchase prices fell to the greatest extent since June 1949. Rates of decrease in costs hit series records in the Eurozone, Russia, Switzerland, the Czech Republic and Denmark.”

So basically, if the PMI readout is anything to go by we could well hit negative year on year prices in December, and if not then certainly in January. As can be seen in the index chart below, prices have already been falling since July. All of this is quite important since producer prices give us an early indicator of the likely path of consumer prices in the coming months, which means, I think, that the deflation threat in Spain is a very serious one indeed.

Another Wave Of Credit Downgrades In The Works

Hardly surprisingly in this environment, Spanish financial organisations are now seeing quite frequent downgrades in their credit ratings. The latest here - as Jaime Pozuelo-Monfort reminds us on RGE Europe Monitor - Caja Mediterraneo (CAM) and Bancaja who have been downgraded by Standard and Poor’s from A- to BBB+ with negative outlook. At this point CAM and Bancaja still maintain their investment grade status, which is held for ratings of BBB- and above. Prior to the Standard & Poor’s downgrade, CAM and Bancaja were also downgraded by Moody’s (who use a different classification system) in August 2008 from A2 to A1.

Standard & Poor’s rebajó hoy la calificación crediticia a largo plazo de Caja de Ahorros del Mediterráneo (CAM) y Caja de Ahorros de Valencia, Castellón y Alicante (Bancaja) a ‘BBB+’ desde ‘A-’, y seguidamente procedió a retirar todos sus ratings a petición de ambas entidades, informó hoy S&P. La agencia de calificación, que afirmó el rating a corto plazo ‘A-2′ para las dos cajas valencianas, indicó que la perspectiva de la calificación era ‘negativa’ en ambos casos. En el caso de la CAM, Standard & Poor’s justificó su decisión en las expectativas de “un significativo debilitamiento” en el perfil financiero de la caja en los próximos trimestres debido a una mayor vulnerabilidad que sus rivales a la desaceleración económica. Respecto a Bancaja, indicó que su calificación refleja su previsión de un significativo debilitamiento del perfil financiero de la entidad en los próximos trimestres, “en el contexto de un cada vez más difícil entorno económico”. Además, S&P señaló que la perspectiva negativa refleja la posibilidad de un nuevo descenso del rating si percibe que el perfil financiero de Bancaja del perfil financiero “se va a deteriorar más allá de sus actuales expectativas”.

Bancaja is Spain’s third largest savings bank, with total assets of EUR 102.1 billion as of end-March 2008 and a market share of 8.26% in Spain’s financial system. CAM had total assets of EUR 69.8 billion as of end-March 2008 and a market share of 5.65%. Bancaja also have the misfortune to be bankers to crisis ridden Valencia football club, who are rumoured to be prepared to sell their international “crack” striker David Vila if the offer is good enough, after Bancaja denied them further credit (watch out for the football casualties to this crisis I think).

This little extract from Europa Press, which explains how Banco Pastor have decided to “dispense with the services of” Standard and Poor’s is also interesting for those of you who can read Spanish, as is their explanation for why they have done it (which, naturally, has nothing whatsoever to do with their October downgrade from A to A-) , which is basically that since the wholesale money markets are closed to Spanish banks then they can live without getting rated anyway. What’s more, they say, the guarantee they are sure to receive from the Spanish Treasury for their forthcoming issues (watch out Spanish taxpayers) makes the ratings agencies unecessary. Amazing! I couldn’t have believed it if it hadn’t actually happened.

Banco Pastor decidió hoy rescindir el contrato que tenía con la agencia de calificación crediticia Standard & Poor’s, informaron a Europa Press en fuentes de la entidad. El banco presidido por José María Arias adoptó está decisión debido a las actuales circunstancias del mercado, ya que los mercados financieros siguen cerrados, con lo que no hay apenas posibilidad de colocar deuda. Además, el aval del Tesoro es quien refrenda las próximas emisiones, por lo que la entidad considera que no es necesario la calificación de las agencias de rating. Banco Pastor, que no tiene vencimientos hasta 2010, mantiene una holgada posición de liquidez con un ratio de cobertura del crédito de los depósitos del 68%. La entidad gallega, que mantendrá su contrato con la agencia Moody’s, tenía actualmente un rating de ‘A-’ de Standard & Poor’s, tras ser rebajado el pasado mes de octubre por la agencia desde ‘A’. A finales del pasado mes de noviembre, las cajas valencianas Caja de Ahorros del Mediterráneo (CAM) y Caja de Ahorros de Valencia, Castellón y Alicante (Bancaja) también solicitaron su baja del servicio de Standard & Poor’s.

The article also informs us that the Caja de Ahorros del Mediterráneo (CAM) and Caja de Ahorros de Valencia, Castellón y Alicante (Bancaja) also asked to end their contracts with S&P’s following their respective downgrades. Petlulence will get you nowhere my child!

Property Prices Down Too

Spanish Property Buff Mark Stucklin reports that even on the rather questionable official House Price Index, published by the National Institute of Statistics (INE) average Spanish property prices fell by 3% over 12 months to the end of the third quarter. Mark comments that:

The index, which has only been published for 2 quarters, needs to be treated with scepticism, as its figures are simply not credible in the current market. In reality, prices are sharply down, though nobody knows by exactly how much. And as I have pointed out here before, new build prices in the official statistics do not reflect the prices developers are offering today to make sales. With a glut of around 1 million new properties, and developers falling like flies, industry sources report that new build prices are falling fast.

He also informs us here that Catalonia is suffering more than other parts of Spain. Taking data from reports published by webportal Idealista.com, he explains that sales have fallen by around half, new housing starts are down by 80%, and prices are falling significantly. In Barcelona city, prices are down 8.6% over 12 months, pushing resale prices back to where they were in 2005. Prices are falling more in Barcelona than in Madrid, Valencia or Seville.

According to the latest data from idealista.com, a leading Spanish property portal, nominal prices in Barcelona capital have fallen 10.6% in the last 2 years, which translates into a fall of 16% in real terms (after adjusting for inflation). A typical flat of 70m2 is now 30,000 Euros cheaper than it was 12 months ago.

Over 12 months the asking prices tracked by idealista.com have fallen by 14.7% in Sants-Montjuïc, 12.9% in Sant Andreu, 12.7% in Horta-Guinardó, and 11.7% in the Ciutat Vella, Barcelona’s famous old town Gothic Quarter. Coastal resorts around Barcelona popular with second home buyers are also in trouble. Asking prices have fallen by 15% in Malgrat, Pineda y Premià de Mar, 13.3% in Roses (Costa Brava), and 13.5% in Segur de Calafell (Costa Dorada).

And finally, for this batch, Mark also draws attention to the way in which Spanish banks are increasingly turning themselves into property companies.

Spanish banks are turning into some of the biggest real estate companies in Spain, just as they did during the last property crash of the late 80s and early 90s. To a greater or lesser extent, banks are running some of Spain’s biggest listed developers, companies like Colonial and Metrovacesa, who were forced to throw themselves at their bankers’ feet when they couldn’t cope with their billions of Euros of debt.

It’s not just the big developers with billions of Euros of debt that the banks are having to take over to prevent their loan default rates from going through the roof. All around Spain many small regional banks and savings banks have been quietly taking over small local developers for the same reason. Having taken over developers or their assets in return for cancelling debts, many banks and savings banks, known as cajas, now find they own a wide variety of real estate assets from land and flats under construction to finished developments and business parks.

As Mark also points out the banks seem to be taking some consolation from the fact that on both previous occasions this move turned out to be extremely profitable to the banks as boom followed slump, and prices rebounded. But what if this time it is different. What if this time - following the trail blazed by Japan in 1992, and Germany in 1995 - prices come down and stay down; for decades.

Oh yes, but don’t worry, not everything in Spain is going down. Unemployment, for example, is surely going up, and strongly so, as we will more than likely find out on Monday. So, in true Goethean spirit, ready yourselves, since onwards and upwards they will undoubtedly lead us.

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Now for those of you who are new to the world of Purchasing Manager’s Indexes (PMIs), welcome. Basically these indexes are very useful, since they give you a “just in time” point of reference to tell you what is actually happening. These are composite indexes - measuring things like current output, new orders (both domestic and export), employment and input prices. They are not perfect, but they are reasonably accurate - the fit which you can get between composite PMIs (manufacturing and services combined) and GDP is often attractively good - and in a country like China where the main data we get is year-on-year (which in a critical moment of rapid change like this one is virtually useless) it is very hard to see what is happening. The Shanghai-based Industrial Bank estimate, for example, that GDP growth in China will be 5.6% in Q4 2008. But what does that data point - if accurate - tell us? That the economy is slowing fast, well we already knew that. But just how fast? Well GDP was 9% in Q3 - down from 10.1% in Q2. So the deceleration is very rapid, but did the Chinese economy actually manage to contract in Q4? I doubt it, but it may do in Q1 2009, although the only way we would really know would be if the National Statistics Office published quarter-on-quarter seasonally adjusted numbers, which as far as I can see they don’t. Indeed only a small group of highly developed economies actually take the trouble to do this, and you don’t even find all EU member countries doing it yet, although Eurostat (thank god for Eurostat) do require such data from members (but those of you who ever get round to checking will see there are still blanks for some countries in the Eurostat quarterly releases).

Hence you can see why, in the case of somewhere like China, the PMIs are very, very useful, for those of us who would like to try and follow what is happening as it actually happens.

As for the PMI itself, China’s composite manufacturing index contracted for the fifth consecutive month in December as recessions in the U.S., Europe and Japan bit deep into demand for exports - indeed China’s exports fell year on year for the first time in seven years in November. The CLSA China Purchasing Managers’ Index registered a seasonally adjusted 41.2, compared with a record low of 40.9 in November. On such indexes any reading below 50 reflects a contraction.

Despite the apparent small improvement in December the current output index actually fell sharply, and was down to a record low of 38.6 from 39.2 in November, so production was falling, and the index was basically nudged up slightly by other factors, such as the measure of new orders which rebounded to 37 from 36.1, driven by a rise in export orders to 33.6 from a horrific 28.2 in November. However, according to the report, Chinese manufacturers reduced the size of their workforces at a series record in December, and the employment index has now contracted for five consecutive months, to hit 45.2 in December.

So where exactly are we? Well we aren’t (quite) in the Second Great Depression yet, but the situation is deteriorating, and rapidly. Manufacturing output is now contracting at quite a sharp pace, while it was rising in the first half of the year at something like a 15% year on year rate. In a useful summary of the Chinese situation back in November, Nouriel Roubini defined a hard landing in China - which he felt was coming - as follows:

There is thus now a growing risk of a hard landing in China. Let us be clear what we mean by hard landing. In a country with the potential growth of China, a hard landing would occur if the growth rate of the economy were to slow down to 5-6% as China needs a growth rate of 9-10% to absorb about 24 million folks joining the labor force every year; it needs a growth rate of 9-10% to move every year about 12-14 million poor rural farmers to the modern industrial/manufacturing urban sector.

This is more or less the consensus view of what we used to think a hard landing would mean in China, but I think the latest data already take us beyond that. I think there is now a real risk of a technical recession in the more or less classic sense of two consecutive quarters of negative growth (let’s say that the risk is 50-50 at this point), and of serious economic and financial dislocation following in the train of this (btw, just how quickly can you burn your way through $1.7 trillion in reserves, it will be an interesting experiment I think).

Brad Setser (further down the same link) has long been more cautious on China, being sceptical about the impact of a dramatic slowdown in exports (and even more importantly in export oriented investment) on an export driven economy, but those of us who have been closely watching other export dependent economies like Germany and Japan over the last decade and a half were surely not quite so sceptical. However even Brad himself is clear that the possibility of an export downturn feeding its way back into the domestic economy - via some sort of negative feedback process - is real enough:

But the real key to forecasting China’s future growth consequently is determining whether domestic consumption and above all investment will continue to grow strongly in the absence of strong export demand. Remember, over the past few years both domestic investment and exports increased rapidly. If they fall together as well, Chinese growth will slow quite significantly. And unfortunately the latest indicators seem to suggest that they are correlated; consequently domestic demand may fall along with exports.

The $1.7 trillion question is, then, just why China is so export dependent? Doubtless there are many factors at work, but one of these is, I am almost sure, China’s very special demographics (30 years of one child per familiy policy), and the special problems that these present in the context of building a sustainable national pensions system at the same time as the population pyramid inverts. Obviously the absence of a credible pension system has to be one of the factors influencing the strong desire to save which we are seeing in China. Economics Nobel Franco Modigliani also thought this, and specifically addressed the Chinese saving puzzle in his last published paper:

China’s per capita income ranks below 100th in the world. Its saving rate, however, has been one of the highest worldwide in recent decades. In this paper, we attempt to explain the seeming paradox within the framework of the Life-Cycle Hypothesis developed by Franco Modigliani. The key LCH variables are income and population growth. Our results based on data we put together from official sources show that income growth has been the dominant factor behind the dramatic increase in China’s saving rate, as predicted by the LCH. Demographic structure and inflation also had significant impact on the fluctuations of the saving rate.
The Chinese Saving Puzzle and the Life-Cycle Hypothesis - Franco Modigliani and Shi Larry Cao

By Way Of Brief Conclusion

Well basically, the conclusion here is that there is no conclusion, at this point at least. But I would draw attention to two potential points of interest for all you “economy watchers”.

Firstly, a couple of months back my fellow blogger Doug Muir drew our attention to a very interesting point being made by US economic historian Scott Reynolds Nelson:

As a historian who works on the 19th century, I have been reading my newspaper with a considerable sense of dread. While many commentators on the recent mortgage and banking crisis have drawn parallels to the Great Depression of 1929, that comparison is not particularly apt. Two years ago, I began research on the Panic of 1873, an event of some interest to my colleagues in American business and labor history but probably unknown to everyone else. But as I turn the crank on the microfilm reader, I have been hearing weird echoes of recent events.

At the time of reading this I thought to myself hmmmm! This isn’t that simple, but he is on to something. Basically I think no two (or does that make it now three) Great Depressions are ever really exactly alike. I certainly think the resemblence between what is going on now and what happened between 1929 and 1933 is more than passing (especially for the sequencing, of which more in another post), but evidently there are elements of the 1873 one too, and Scott Reynolds puts his finger on some of them, especially in the context of surplus to requirement investment and large capacity overhangs. So my best guess is that what we have is a hybrid, and that what is now happening in China is the best example of the underlying dynamics behind that other great depression that hit our grand- (or great grand) parents and that may well be now about to come back to hit us, boomerang style.

Which brings me to my second point, the Smoot-Hawley Tariff Act, which, as wikipedia explain, was signed into law on June 17, 1930, and raised U.S. tariffs on over 20,000 imported goods to record levels. After the act was passed, many other countries retaliated with their own increased tariffs on U.S. goods, and American exports and imports plunged by more than half. Many economists now regard the Smoot-Hawley Act as having been the principal feedback catalyst for the severe reduction in U.S.-European trade, and which took it from the 1929 high down to the depressed levels of 1932 and which thus accompanied the start of the Great Depression. And here, in the spectre of a repeat performance comes just the danger we face in the wake of the dramatic contraction which is now underway in China.

It is my personal guess that the first major issue to face Barack Obama as President of the United States may well be what to do about China, and especially what to do about a China which lets - as I now suspect they may well do - the yuan float, in order to see it float DOWN as the economy unwinds. If this does indeed happen then Obama will really have to struggle to hold back the protectionist pressure I think.

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