Eurozone Economy: When Paradigms Collide

When scientific paradigms collide everyone should duck, at least that is the best advice I can offer at the present moment. The provisional German retail sales for January are now in, and they don’t make especially pleasant reading:

European retail sales dropped for the first time in 10 months in January as spending in Germany slumped, adding to signs economic growth is slowing, the Bloomberg purchasing managers index showed…..German retail sales had the biggest drop in two-and-a-half years, with its index declining to 43.9 from 55.2 in December

Now for those who have been following the German economy in recent months none of this should be particularly surprising, since as is reasonably well known Angela Merkel’s government has just upped VAT from 16% to 19% in an attempt to address the ongoing federal deficit problems. And of course, one months data never offer a complete picture. But this decline in retail consumption in Germany forms part of a much longer ongoing weakness in domestic consumption (and here), one which many were arguing had finally come to an end in 2006. Some of us, however, seriously doubted that this was the case, and hence the initial significance of today’s reading. In particular what we may be faced with are changing structural characteristics of economies as median population ages rise. In particular – and following the well-known life cycle pattern of saving and consumption – more elderly economies may have a higher rate of saving and a lower rate of consumption increase than their younger counterparts.

Some more evidence to back this point of view comes from Japan, where today we learn that household spending in December declined for a 12th straight month, dropping 1.9 percent from a year ago. Yet the Japanese economy is not in recession, and output is actually rising. As Bloomberg say:

Japan’s factory production rose to a record and household spending fell, underscoring the central bank’s concern that growth has bypassed consumers and left the economy dependent on exports.

So please note: growth appears to have by-passed consumers, and the economy is ever more dependent on exports. The same goes for Germany, and this is why I talk about paradigm collision, since the neo-classical theory of economic growth – with its core conception of ‘steady state’ growth – was never built to handle median age related changes in economic performance and structural characteristics. Something new is clearly needed.

Over the coming weeks I will undoubtedly have more to say about all this, as we get to see more of the 2007 Eurozone data, but for now let me point you in the direction of Claus Vistesen, who has been patiently toiling away trying to work through a hypothesis which, in terms of the data we are now seeing, certainly seems more in keeping with current economic realities than the view we currently see emanating from the ECB. His arguments on Japan can be found in depth here, and his latest piece on the eurozone is reproduced below the fold.
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The Most Bizarre Monetary Policy DecisionOf Recent Times?

This was Wolfgang Munchau writing in the Financial Times a week ago:

The pre-announced interest rate rise that the European Central Bank is due to agree this Thursday must rank as one of the most bizarre monetary policy decisions of recent times. The economic recovery in the eurozone remains fragile, as last week’s German confidence indicators have shown. Even the ECB’s own forecast for headline inflation is relatively optimistic, while core inflation remained unchanged at 1.5 per cent in October.”

and he issued a warning:

“It is still not too late to propose ECB reform as part of the next treaty revision. For as long as EU leaders maintain the status quo, they have the central bank they deserve.

Central bank independence seems to be once more ‘a l’ordre du jour’, and the ECB may well live to find to its cost that there is one thing worse than actually playing the game, it’s playing the game and losing. Now why?
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ECB: Plus ?a Change?

The ECB met earlier today to conduct the monthly review of interest rate policy. It came as a surprise to noone that the outcome was to leave everything just as it is. Surprisingly though the decision this month is surrounded by a little more controversy than has been the case of late since Italy’s Berlusconi and economic opinion in Germany have been suggesting that some reduction of rates might be no bad thing, whilst Spain’s economy minister (and former EU commisioner) Pedro Solbes is reported to have been pushing for an increase. Why the difference?
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This Is One To Keep An Eye On

2003 was a good year for the Spanish banks, with interest rates at historic lows, lending boomed. News has it today that net profits at Santander Central Hispano, Spain’s largest bank, rose 29.6 per cent in the fourth quarter to ?681m ($857m) mainly on strong mortgage lending in Spain and growth in its consumer finance business in Germany and Portugal. Net profits totalled ?2.61bn for the full year, a 16 per cent increase over 2002 and the best year on record, while credit inside Spain was up 16.2 per cent as the housing boom continued on its relentless path hence generating strong demand for mortgages.

So good luck to the bank, and that’s it. Well again, not exactly. Why is there a boom in consumer credit and mortgage lending right now in Spain? That really should be the question.
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