For the EU summit agenda

One of the original motivations for tomorrow’s EU summit was the perception that Nicolas Sarkozy’s aid plan for French carmakers was in effect encouraging them to preserve production in France at the expense of Slovakia and other central European countries.  In that light, how should one interpret the following apparently likely sequence of events: Government of Germany takes equity stake in Opel; Opel sells one of its German factories to Daimler, and Daimler aborts a project to build a new factory in Hungary since it will now have the extra German capacity?

Japan’s Industrial Slump Deepens In January

Japanese manufacturing output fell in January by a record 10 per cent month-on-month while new job offers declined 18 per cent, reflecting the deepening recession in the world’s second biggest economy. Industrial production was down a whopping 30.8 per cent year-on-year, as manufacturers of vehicles, electronics parts and devices and general machinery cut output to adjust to the rapid fall in global demand.

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Will it be a different world on the Ides of March?

The next 2 weeks look like they will be critical in determining the global policy response to the financial crisis.  Events are moving faster than any long-scheduled summit (such as G20 in April, let alone G8 in Sardinia in July) can hope to maintain their relevance.  One interesting element of the response is that the multilateral financial institutions appear to be acting to the maximum of their existing mandates even as the politicians talk about revisiting their mandates and functions.  

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A Dog’s Life In Latvia

From Vyacheslav Dombrovsky:

Just when you thought there is nothing that can surprise you anymore in this country, comes this. LNT’s “Degpunktā” reports that Valmiera state prison had four special guards dogs shot as part of the “economy regime”. Apparently, the guards couldn’t bring themselves to do that so they called in an outsider and gave him a gun. I wonder if that’s the kind of measures that Mr Slakteris, the minister of finance, meant when he famously told the Bloomberg TV that “we will be …taupÄ«gi [economical].”

But more seriously, this is another point to the case that “wage devaluation” just does not seem to be working very well in the public sector. In theory, what was supposed to happen is mostly nominal adjustment in wages of public sector employees, without affecting the supply of (useful) services of the public sector. It’s hard to call the above case a “nominal adjustment”. Having fewer guards dogs will make it easier for inmates to escape, which is a pretty real effect as well. Generally, there seems to be growing evidence that the economy regime is largely about cutting the supply of public services, and not just a nominal decrease in wages. This is not how it’s supposed to be.

Meanwhile, it seems that in Latvia, the expression “being treated like a dog” assumes a whole new meaning…

Not Really Good News for Anybody

Hot off the wires, the US contraction is larger than expected.

Gross domestic product contracted at a 6.2 percent annual pace from October through December, more than economists anticipated and the most since 1982, according to revised figures from the Commerce Department today in Washington. Consumer spending, which comprises about 70 percent of the economy, declined at the fastest pace in almost three decades.

The annual decline in the previous quarter was much smaller (0.5 percent), so here’s hoping that this is data on the worst quarter. It may not be, though.

Sunday Is “D Day” For The European Union

Well, the Economist have finally scrambled out of their dugout and have now joined the fray. Welcome!

Today they have a leader entitled “The bill that could break up Europe“, with the sub heading “If eastern Europe goes down, it may take the European Union with it”, so I think we can all get the message easily enough.

Many west Europeans, faced with severe recession at home, will see this [an Eastern European “bail out” – Edward] as outrageously unfair. The east Europeans have been on a binge fuelled by foreign investment, the desire for western living standards and the hope that most would soon be able to adopt Europe’s single currency, the euro. Critics argue, with some justice, that some east European countries were ill-prepared for EU membership; that they have botched or sidestepped reforms; and that they have wasted their borrowed billions on construction and consumption booms. Surely they should pay the price for their own folly?

Yet if a country such as Hungary or one of the Baltic three went under, west Europeans would be among the first to suffer (see article). Banks from Austria, Italy and Sweden, which have invested and lent heavily in eastern Europe, would see catastrophic losses if the value of their assets shrivelled. The strain of default, combined with atavistic protectionist instincts coming to the fore all over Europe, could easily unravel the EU’s proudest achievement, its single market.

Indeed, collapse in the east would quickly raise questions about the future of the EU itself. It would destabilise the euro—for some euro members, such as Ireland and Greece, are not in much better shape than eastern Europe. And it would spell doom for any chance of further enlarging the EU, raising new doubts about the future prospects of the western Balkans, Turkey and several countries from the former Soviet Union.

The thing is, all of this is much more complicated than it seems at first glance. Surely local policies by individual governments and decisions by householders have been partly to blame for the mess. But so have lending decisions by Western banks, and the national central banks who supervise them. And then we have the policy decisions (or the lack of them) taken in Brussels or at the ECB in Frankfurt. We are singularly lacking in any form of self cricisism here, and yet, paraphrasing Oscar Wilde just one more time, losing one child may be put down to an accident, but losing all your children, all at the same time, surely that must be negligence. When you are up before the judge it just doesn’t wash to say that they were all very badly behaved, and you couldn’t control them. Whatever happened to our sense of parental responsibility?

Put another way, if you are a teacher and 10% of your students fail then that is their problem, but if 90% fail, then it is your problem, or it should be.

So Sunday is D Day, the day when we finally have nowhere to hide, and we need to take real decisions. Obviously this situation needs more than simply “tweaking”, it needs confronting head on. There is a gap in EU and Eurozone architecture and this lack now needs to be addressed. Short of this the markets, which already have woken up to the problem, will not settle and will not be convinced.

There is no longer a middle road, as I have argued here we need EU Bonds, and we need to clear the pathway for euro membership for those Eastern states who want it (see this post). Talk of beefing up the balance sheet of the European Investment Bank simply won’t wash at this point – we can see what is already happening to the spreads as the rumor mill goes to work. (Borrowing costs for the EIB’s 10-year bonds has already risen to 90 basis points above the benchmark German Bunds, a yield which is drawing ever closer to the borrowing costs of countries like Spain and Austria).

What we need are full blown EU bonds (ie backed by the Union and not by individual member states or subordinate entities), and we also need a fiscal component (ie simply making loans cheaper to obtain won’t work). Of course, in the short term our leaders may need some sort of dual discourse, one for the markets and one for the voters (who have hardly been prepared for all of this), but this is for the politicians to sort out, since they dug themselves into the mess in the first place, so over to you Angela and Nicolas. You go live in 48 hours.

Bailing out the same mythical Polish plumbers who just stole everybody’s jobs will be hard for Europe’s leaders to sell on the doorsteps of Berlin, Bradford and Bordeaux, especially with the xenophobic right in full cry. German taxpayers are already worried that others are after their hard-earned cash (see article). The bill will indeed be huge, but in truth western Europe cannot afford not to pay it. The meltdown of any EU country in the region, let alone the break-up of the euro or the single market, would be catastrophic for all of Europe; and on this issue there is little prospect of much help from America, China or elsewhere. It is certainly not too late to rescue the east; but politicians need to start making the case for it now.

Happy Birthday Italy

You are two today, since you just completed 24 consecutive months of retail sales decline.

Business confidence isn’t looking any too rosy either:

And I hope you are “readying up” that rescue plan for Sunday Angela, since the difference between German and Italian benchmark bond yields widened to the most in nearly 12 years today as Italy sold 10 billion euros ($12.8 billion) of government securities.

The spread between the 10-year note yields increased as much as four basis points to 161 basis points today, the widest since May 1997, based on generic Bloomberg prices. It was at 155 basis points as of 12:05 p.m. in London. The average in the past 10 years is 31 basis points.

Germany or the International Monetary Fund may be forced to rescue members of the euro bloc that struggle to refinance debt, former Bundesbank President Karl Otto Poehl said today.

“The first will certainly be a small country, so that can be managed by the bigger countries or the IMF,” he said in an interview with Sky News. “There are countries in Europe which are considering the possibility to leave the eurozone. But this is practically not possible. It would be very expensive.”

Angela Merkel Says “Maybe” To Common EU Initiative In Support Of Member States

Sunday is obviously going to be “D Day” or something like it for the European Union. Leaders of all 27-member EU states will meet in Brussels to discuss concerns about growing protectionism and to examine ways to finance an all Europea economic recovery plan. On the table are two big issues:

a) What to do about eurozone member states who find themselves in difficulty.
b) What to do about the problems posed for the whole EU by the mounting problems in Eastern Europe.

On the first topic “our Angela” is clearly shifting from the time when the German Finance Ministry was simply denying “Der Spiegel Reports”, and is now saying that euro zone nations need to show solidarity towards each other in the current crisis, offering her strongest signal yet that Germany is prepared to help weaker members of the bloc. According to Reuters:

“We have shown solidarity and things will stay like that, but this must be on the basis of the commitments that form the foundation of our common currency,” Merkel said, when asked about possible German aid to fellow euro zone members.

Speaking at a news conference with the foreign press in Berlin, she referred directly to Ireland, which faces ballooning deficits, saying: “A country like Ireland .. is in a very different situation from a country that has fewer banks, such as Slovakia.” Germany has made clear it opposes the idea of a joint euro zone bond issue to alleviate financial pressure on fragile states in the bloc. But a consensus seems to be forming around some other form of aid, with strict conditions attached that would compel recipient countries to consolidate their budgets in line with the goals set out in the EU’s Stability and Growth pact.

On the second issue Merkel put out a call, which I wholeheartedly endorse, for East European states to be absolutely honest, and get all their economic bad news up and on the table, once and for all.

German Chancellor Angela Merkel said she expects an “honest report” on the economic status of eastern European Union members at a summit on March 1. “We need to remain attentive over the problems of the member states in eastern Europe,” Merkel told reporters in Berlin today. “Yet for that we need them to speak openly about their problems.” “We expect them to speak clearly at the summit this weekend,” Merkel said. “Although there are marked differences in the situation of those members we know that foreign banks are withdrawing capital.”

Decisions need to be taken on Sunday, important decisions. The time for procrastination is over.


I have put forward extensive arguments on both these issues in my recent posts:

Let The East Into The Eurozone Now!

The EU Bonds Story Rumbles On

US Fiscal Deficit Projected At 12.3% of GDP In 2009

According to the 2009 budget Barack Obama is sending to congress today, the United States will have a $1.75 trillion deficit this year. The figure represents 12.3 percent of estimated gross domestic product, double the previous post-war record of 6 percent in 1983, and the highest level since the deficit totaled 21.5 percent of GDP in 1945, at the end of World War II. It seems the numbers are about to start getting let out of the bag, and it will be interesting to see how the markets react. You can find many more details here.

Now if you look at the chart below (prepared by Lazard for a presentation on consumer deleveraging) you will see that this is not the first time something like this has happened. The earlier peak in US indeptedness occured (of course) between 1930 and 1933, when total debt peaked at 299% of GDP. In fact total debt expanded quite rapidly between 1930 (211% GDP) and 1933, largely as a result of GDP contraction and price deflation (which is why it would be preferable not to see extensive price deflation this time round). As a result, while private sector debt contracted between 1930 and 1933, public sector debt held steady, and rose from 34% of GDP to 72% of GDP (for better viewing click on image, and try zooming in a bit. Sorry, that’s the best I can do/suggest).

This is the phenomenon we are seeing now. If the stimulus programme is successful then we might see US debt to GDP stabilising around 2013, since the deficit is expected to remain around $1 trillion for the next two years before starting to decline to $533 billion in 2013, according to budget projections.

So what is likely to happen to prices? Well, if we look at the chart below, we can see that US consumer price inflation was pretty lacklustre right the way through from 1920 to 1940 (that’s why I called the whole interwar epoch a deflationary one in my last post), so I guess, if we’re lucky, we might get to see some serious inflation around 2020. If history is any guide that is, which ain’t necessarily the case, but still.