1:50:46 PM: Interesting talk about internet activism in the Middle East by an inspiring young woman – Esra’a Al Shafei of mideastyouth.com

1:54:44 PM: Esra’a Al Shafei the difference between digital activism in the East and in the West: here people are allowed to say what they want.

2:00:15 PM: Cory Doctorow paraphrased my diploma thesis of 2000 – so there was a way to turn it into a bestseller. Note to self: surfing is on the wave.

2:02:21 PM: Mary C. Joyce explained that online activism was a big thing for Obama, but it wasn’t what the election. The candidate was.

2:03:42 PM: That’s why it probably won’t matter that Angela Merkel has only about 6,000 supporters on her facebook profile…

2:05:16 PM: Later this afternoon, there will be an interesting discussion about an emerging European digital sphere.

2:05:30 PM: BTW, my twitter account is @almostadiary.

2:07:58 PM: But now: political blogs in Germany – and they put that in the agenda without any kind of question mark…

4:42:40 PM: The panel about the European blogosphere with Jon Worth and Jeremie Zimmermann was quite inspiring. Watch out for buses in Brussels.

Related posts:

1. Item
2. Parliament Live on Blogs
3. Second Life, Second EU?

1:39:45 PM: Really liked Ralf Bendrath’s talk about emerging democratic structures in social networks with particular reference to facebook. #rp09

1:42:47 PM: The follow-up chat at the Privacy OS subconference was even better – intereresting technology from Kaiserslautern: “Hello world”

1:44:06 PM: Now it’s on to “growing up in the web” – Danah Boyd’s topic without Danah Boyd… let’s see.

2:36:36 PM: The Role of the State in the Digital Society… philosophy or criminology?

4:56:31 PM: Germany’s interior ministery wanted input from netizens but faced opposition due to lost trust that will be very difficult to rebuild. #rp09

6:10:15 PM: The problem is that people aren’t listening to Lawrence Lessig…

Related posts:

1. Re:Publica Day 3
2. A pyrrhic victory for privacy?
3. VIPs have data too

3:21:56 PM: This seriously feels like 300bps. John Kelly of the Berkman center held an interesting talk about link structures in different blogospheres.

3:24:01 PM: He noted the prominence of neo-conservative bloggers in the Arab linksphere as well as the rise of a shiite theological blog cluster.

3:25:46 PM: Luckily he didn’t have much of an idea of the German blogs that he had mapped… that was taken care of in the following panel discussion.

3:27:32 PM: The usual suspects talked about the same things they have talked about since forever. In this case, shift ’09 didn’t happen.

3:29:17 PM: I asked penalist Stefan NIggemeier if he didn’t think it’s boring to keep having the same chat over and over, and he said, “in a way, yes”.

3:31:57 PM: The afternoon panel about “changing media” could have used at least one person with a bit of macro insight… like Thomas Knüver #rp09

3:34:49 PM: I learned about the A&R dropbox at EMI Australia’s theinsoundfromwayout.com at the presentation about hypem.com

3:36:07 PM: And in the end, I realised I may be too old for some things, 4chan for example.

Related posts:

1. Re:Publica Day 3
2. Understatement
3. Item

Related posts:

1. FYI
2. Bush in Europe
3. Ukraine: link roundup

So Which Are The Worst Affected Countries In The Present Crisis?

Obviously the simple answer to this question is “all of them”, and in particular all those countries who are members of the OECD. Perhaps that is the feature which best defines what is happening this time round (and which separates our present problems from, say, the Asian crisis in 1998) since this is a crisis whose focus has been, and still is, in what are often termed “the advanced industrial” economies, even though some of these are now more services than manufacturing-industry driven. But, come-on, within that ever so long list – which includes each and every member of the OECD (and a goodly number of those who aren’t) – who exactly are going to be the worst affected?

Well I don’t think I have made any secret on this blog that I think the principal focus of the present crisis is now situated in what Paul Krugman call’s Europe’s periphery – by which I would mean Central and Eastern Europe, Southern Europe, Ireland and the UK. To that list I would simply add those economies who are largely export driven, and who thus suffer most directly from the sharp contraction in global trade. In particular here Germany, Japan and China. My principal guess is that China is really going to be one of the worst case scenarious, and that consensus thinking still has some way to go in catching up with events here. Hong Kong based UOBKayHian have a Q4 estimate for year on year Chinese GDP growth of 6.3% for China (see here), and I think few people other than professional macro economists and bank analysts (and far from all of these if the truth be told) really realise what this means – it means the quarter on quarter rate of expansion was very low indeed, possibly verging on the negative. I’m guessing but it must have been somewhere in an annualised 0 to 2% range. This means we may well see quarter on quarter negative growth in 2009 in China, and that the possibility of a technical recession of two consecutive quarters of negative growth must be over 50% at this point. It wasn’t so long ago that the consensus was saying that annual GDP growth which was as high as 6% would be tantamount to a recession!

Societe Generale economist Albert Edwards is one of those who has been drawing our attention to the rapid decline in China’s GDP (although I myself had a go here) and he uses one very interesting “proxy” (an indicator which can serve as a rough and ready substitute for something else, in this case movement in GDP) – electricity output. If you look at the 3 month year-on-year moving average for electricity output in China (see chart below) you will see it is already falling, which means that (in all probability) China’s GDP is falling, which is just wow!

The history of using electrical output as a convenient proxy where we simply don’t have very adequate data has a long and reputable history – going back to the pioneering work of US growth theorist Edward Dennison in the 1960s – but in case you feel that the correlation may not be a good one, here (see below) is a chart from Edwards which shows China GDP and electricity output compared. The fit is obviously not a perfect one, but that isn’t the name of the game here, what should be evident is that a drop in electrical output as large as the one we are seeing in China at this point will be reflected in a very sharp reduction in GDP output.

A very similar situation can be seen in the OECD lead indicator for China, and below I produce a chart which compares this indicator for both Spain and China, and Spain we know is having a very strong contraction at this moment in time, but what we can see is that China post August is slowing much more rapidly, and even, looking at the steepness of the month on month drops, may well have started contracting in November. This is obviously all shell shock stuff.

Which takes me on to my next point, how reliable is Chinese data? Well, perhaps I am going to surprise some of you here, but I would day that for my purposes it doesn’t really matter, since what interests me is the rate of contraction (or expansion) in Chinese GDP, and not its absolute level. What matters to the rest of the world is not expecially how rich -or poor – China actually is (from a macro economic analysis point of view that is), but how rapidly it is expanding – or contracting – and what the rate of export and reserves growth is. The rest is interesting, but from a nuts and bolts point of view, it constitutes what Boris Vian used to call froth on the daydream. If the official data is rather inaccurate, then it is not unreasonable to assume that the inbuilt biases are the same from one time period to the next (the same point applies to the existence of the so called “informal economy”), and so my message here is – arrived at on the basis of looking at one economy after another in rapid succession – how much we can learn from how little, if only we know what we are looking for that is (I will come back to this point below).

Is Manufacturing Output A Good Proxy For GDP?

Basically, the economies I am arguing are likely to be the worst affected in what we can at least now call “the long recession” – Japan, China, Russia, Germany, East Europe and Spain – all have quite a significant level of dependence on their manufacturing industry (except Spain, but then Spanish services are now neck and necking it with Spanish manuafcturing industry), and it is manufacturing – and especially consumer durable and machinery and equipment manufacturing – which is worst affected by this stage of the credit crunch. In addition all these economies are now about to see “second round effects” across their manufacturing sectors, and this will then feed back into even stronger contractions as domestic purchasing power weakens even further. So I don’t think that in these cases manufacturing is such a bad proxy for what I want to look at, which really is the size of the hole that has just been blown in the side of the collective ship.

Basically, I am also relying on an old macro economists prejudice about the structural importance of industrial activity when all the froth is stripped away. It’s a hunch. I’m playing it, and the proof of the pudding will be in the eating, although up to now I think I ain’t doing too bad, if I may say so, since the German and Japanese economies did actually fold right on cue as far as my forecasts went, Spain has turned out to be a nightmare, and the focus of the current global financial crisis has moved to the East of Europe, just as I was anticipating in my posts here and on all those Eastern Europe blogs I maintain.

And for those of you who still remain sceptical that this argument has any validity, even for economies with a heavy industrial dependence, here (one more time) is the Manufacturing PMI/GDP comparison chart for Japan – GDP rates to the left, diffusion index PMI readings to the right (click over image if you can’t view too well). Not perfect, but not a bad guide I would say, if you like your football live, and want to see what is going on as it happens and not three to six months later.

And Now For the Russian GDP Indicator

The latest survey data from VTB Bank Europe point to an overall contraction in Russian GDP in December. For an economy that was only months ago growing at a 7% annual rate this sharp contraction is astonishing. The VTB GDP Indicator is derived from the bank’s Europe’s PMI surveys of business conditions in the manufacturing and service sectors of Russia. By weighting together the output measures from these surveys, an indicator of total output is produced. Regression analysis is then applied to derive an estimate of GDP growth. The bank itself describes the indicator as follows:

The Russian GDP Indicator has been developed for VTB Bank Europe by Markit Economics to provide a tool to help policymakers and investors monitor economic conditions in Russia. Key features of the Russian GDP Indicator are:

It is available several weeks ahead of official first estimates of GDP (for example, Goskomstat did not release their first estimate of 2005 third quarter growth until December 2005);

It is produced monthly, rather than quarterly, allowing quicker identification of changing business conditions and turning points in the economic cycle;

It is internationally comparable with other GDP Indicators that Markit Economics has launched, including the Eurozone GDP Indicator;

On average, Markit Economics’s GDP Indicators have been more accurate at estimating GDP growth rates than official first estimates (the latter tending to be revised significantly after initial publication)
VTB Bank

In December, the Russian GDP Indicator fell below zero for the first time since March 1999, to -1.1%, from 2.1% in November. Over Q4 as a whole, the GDP Indicator has signalled a year on year expansion of 2.0%.

But this is perfectly consistent with a quarter on quarter contraction, as we can see in the monthly diffusion index GDP chart. So there is no doubt about it as far as I am concerned, the Russia economy contracted in Q4 2008, and really, effectively, the Russian recession has now started.

Further evidence for the slowdown can be found in the fact that unemployment rose 400,000 in November and while retail sales grew at the slowest annual rate in five years. Also in November, real disposable income fell on an annual basis while capital investment growth continued to drop back. The rouble ended 2008 20% lower versus the US dollar and 15% weaker against the euro, while the budget for 2009 remains under threat from falling oil prices.

The most recent official GDP figures from the Federal Statistics Service indicated year on year GDP growth of 6.2% in the third quarter of 6.2%, a figure which was itself a three-year low. This result was rather weaker than the advance trend registered by the GDP Indicator, which averaged 6.8% over the same period. The stronger VTB GDP Indicator may well reflect the absence of construction coverage in the PMI surveys – annual growth of construction value added in Q3 almost halved compared to the previous quarter – and probably also did not fully capture the effect of plummeting oil prices and weakening investment growth, on the other hand it the number is not a bad first estimate at all, and I emphasise, we get it at the end of the month in question.

In fact over the past nine years the official statistics office series and the VTB GDP Indicator have had a pretty close relationship, and the correlation is currently 0.88 (see chart below). Moreover, the Indicator has successfully captured the major peaks and troughs in growth throughout the period, thus I think we need to take the latest PMI based data very seriously indeed.

So How Can You Do So Much With So Little?

Now for the methodological part. Basically I am arguing that really it is possible to make reasonably accurate short term forecasts (longer term ones are always – like the weather – much more problematic) on the basis of very little information, the composite PMI is one key reference point here, followed by consumer and business confidence data to give some idea of the immediate outlook, and then employment data to let you know what may happen six months or so down the line. This, and the inflation data (both producer and consumer prices) are all you really need in your home “Chief Economist” amateur toolbox really in order for you to have as good a chance of getting it right as any very highly paid professional.

But there is something else you also need: a framework in which to organise the information you gather. This is the tricky bit really. The good economist should always be testing, or pressing him- or herself in some way or another. Basically a forecast is based on conformity with empirical fact and with a theoretical framework. The late Sir Karl Popper had something to teach us here.

Famously, Popper used to enter the first class of any course and give his students one of those thrilling little “ice-breaker” exercises. “Observe”, he would tell them, and then sit down and start to read his newspaper (I doubt it was L’Equipe, or El Mundo Deportivo, but I’m sure you can more or less imagine the picture). Of course, normally not a lot of time would elapse before one of the bemused students would put their hand up and say, “but please, sir, what do we observe?”.

“Exactly”, would be Popper’s response, and so the course would formally begin, since the simple point he wanted to get across was that simple inductive empiricism doesn’t work, you always need a theory, or at least a hypothesis, to get the game started. Which is why some people could probably stare at the charts I have presented here today, and still not notice anything special.

And the other point Popper would draw to the attention of any good practicing economist is that you always need to be trying to prove yourself wrong. It turns out we are not, as Bacon thought, playing a game with nature, we are playing it with ourselves. What exactly am I getting at here?

Well, Popper wasn’t the first to do this, but he did notice that there was a simple problem with inductive empiricism, in that, no matter how many observations you make you can never actually “prove” a theory, since the next observation may well come along (you know, that black swan in Australia) and knock your whole edifice over. Popper was possibly the first, however, to notice that there is a logical asymmetry lying around in all this, since you can faslify a proposition (or hypothesis, or theory, or law), since the first bit of counter evidence you get should at least start you thinking that something may not be completely aright – although, of course, the first piece of counter evidence should never lead anyone to abandon their theory or hypothesis. But it should set you thinking.

The knack then is, and this is what every worthwhile and halfway serious economist should be trying to do, to try and decide what sort of evidence would make you change your mind, and would lead you to first modify, and then abandon, your theory. And I think if you can’t spell out what it is that would lead you to modify and change your framework, that is if you can’t spell out a body of facts and events which would lead you to seriously change your mind, then you are probably not doing serious economics at all, but playing round with some variant or other of what Popper would have called ideology.

And just in case anyone out there is asking themselves what the relevance of all this final homily is to what went before, well…

If China doesn’t get a level of GDP output well below the consensus in 2009, then I’ve got something pretty wrong somewhere. If Germany’s stimulus programme works by bringing domestic demand back to life before external events enable exports to expand again ditto. If Japan doesn’t go shooting straight off back into a serious bout of deflation the same (and if Germany and Spain don’t follow suit at least in the short term then there is something here I am not getting right). And of course, if Russia doesn’t have a very nasty bout of depression economics in 2009, and if Eastern Europe generally is not the most seriously affected region then I think I really do have something, somewhere upside down (due to the very unusual demographics). Oh, and yes, if Turkey ends up as badly off as the rest of the CEE economies I would not be methodologically happy at all, not at all.

And why do I say this, well here is what I said in a post entitled Turkey, Emerging Markets and the Coming Global Credit Crunch – published on Global Economy Matters on 5 September 2007, that is about three weeks after all that sub-prime “turmoil” broke out.

In a much quoted paper – published back in 2004 by two UCLA economists (Schneider and Tornell, full reference below) – it was argued that:

In the last two decades, many middle-income countries have experienced boom-bust episodes centered around balance-of-payments crises. There is now a well-known set of stylized facts. The typical episode began with a lending boom and an appreciation of the real exchange rate. In the crisis that eventually ended the boom, a real depreciation coincided with widespread defaults by the domestic private sector on unhedged foreign-currency-denominated debt. The typical crisis came as a surprise to financial markets, and with hindsight it is not possible to pinpoint a large “fundamental” shock as an obvious trigger. After the crisis, foreign lenders were often bailed out. However, domestic credit fell dramatically and recovered much more slowly than output.

In starting off with this quote I really want to draw attention to two things.

First off, the way in which the current sub-prime liquidity problem in the banking sector of many developed economies is now steadily extending itself into a credit crunch in several emerging market economies. We are now beginning to see a clear and all too familiar pattern. There has been a lot of talk about the Asian crisis, and evidently there are some similarities with the pre 1998 situation, especially, as I shall be arguing over the coming days, in the emerging economies of Eastern Europe.

Secondly there is the “typical crisis came as a surprise to financial markets” argument, since it puzzles me why exactly this should be, or better put, why it should be assumed as a “stylised fact” about currency crises that such major events are in principle not forseeable. I find this very hard to accept. Are we really so inept we are not able to see trouble coming when it finally does come? Is economic theory really so useless in the face of complex “on the ground” facts. Something inside me resists this view. We ought to be able to see things coming, even if we need to distinguish between the where and the when. What I mean is that it should be possible, if the theories you are working with are worth any sort of candle, to pinpoint the areas of likely vulnerability. On the other hand, given that often seemingly random events precipitate the ultimate unwind, it is pretty well impossible to say in advance which random event will turn out to be the detonator on any given occassion.

The sub prime debt issue in the US is a good case in point here, since only at the start of August the Federal Reserve were assuring everyone that problems associated with the US housing market were well under control, while obviously they weren’t and aren’t, and equally obviously, now, such problems will be seen from the vantage point of hindsight to have played a key role in the events which are now unfolding before our eyes.

So even with this caveat, and with due regard for the well known problem of human fallibility, lets see if this time any of us are able to do just that bit better than normal, and in attempting to see things coming lets see if we can learn something which may make us better able to handle and foresee macro economic problems in the future.

This post is about Turkey, and it may be surprising in the light of what I have just said if I now go on to suggest that it is precisely the fact that Turkey may not be so badly ensnared in the trouble which is brewing (I mean no one, but no one, will escape completely scott free) as some other emerging economies (and I am talking here about some key members of the EU10 accession countries, and for reasons explained in this post)which may well be of interest.

So summing up, I don’t accept that economics is not an empirically grounded science that is incapable of making testable forecasts, not for a moment I don’t. And if you do the sort of economics that turns out to be absolutely useless when it comes to making forecasts, then you should be asking yourself what it is about the theoretical framework you are using that leads to this situation, asking yourself what would need to be the case for a part of what you hold dear to be falsified, and get out there having a go at falsifying it.

Related posts:

1. JP Morgan’s Global PMI Shows Another Substantial Contraction In February
2. JPMorgan March Global PMI Report Shows (Slightly) Slowing Contraction
3. December’s JPMorgan Global PMI Shows Just How Far The Infection Has Spread

Germany’s economy started contracting in the second quarter of 2008, and went officially into recession in third quarter. Further the Federal Statistical Office estimated this week that the economy may have shrunk quarter on quarter by as much as 2 percent in the fourth quarter (ie at an annual contraction rate of 8%), and that annual growth for 2008 may have been as low as 1.3 percent (non calendar adjusted – 1% calendar adjusted) – about half the 2007 level.

Was any of this foreseeable? Well I was predicting annual GDP growth in the 1.3/1.4% range for 2008 back in July last year (see this post on RGE Monitor), and I have attempted to raise an alert about the possibility of Germany falling into deflation (this post here), a risk I now think to be real and immediate with a contraction in GDP of between 2% and 5% (which I think is where we are, and it wouldn’t surprise me to see the 2009 number coming in at the steeper end of this range. I mean I think there is more bad news coming in Southern and Eastern Europe that has not been factored-in yet).

Germany’s inflation rate fell to its lowest in more than two years in December, declining to a 1.1 percent annual rate from 1.4 percent in Novembe. That’s the lowest level since October 2006.

“With inflation in Europe’s largest economy dropping at that speed, the ECB has all the legitimacy it needs to cut rates rapidly,” said Jens Kramer, an economist at NordLB in Hannover. “German inflation will actually turn negative by the middle of the year.”

Month on month prices actually rose 0.4 percent, and in fact both the general and the core indices spiked upwards at the end of last year (see chart), but given the extent of the contraction which we can expect, I really don’t think that this is going to be very typical.

And The German Labour Market Has Finally Turned

Unemployment in Germany rose last month for the first time since February 2006, thus bringing inauspiciously to an end an unprecedented 34 month labour-market recovery. Figures released by the Federal Labour Agency last week show that the number of those seeking employment in Germany rose by a seasonally-adjusted 18,000 in December. The change is small, but the significance is great, since this is obviously but the first month of many when unemployment will rise in Germany, and this rising unemployment will now, in its turn, feed back into the industrial slowdown which is already underway. The seasonally adjusted unemployment rate remained unchanged (following data revisions for previous months) at 7.6 percent.

This is hardly a surprise, but it is certainly not good news.

In a separate release the Federal Statistical Office reported that the number of persons in employment living in Germany was 40.83 million in November 2008 – up by 500,000 persons on the same month a year earlier. However, the relative increase (+1.2%) was the lowest rate of growth since December 2006. In January 2008, the relative increase compared with a year earlier was 1.7%. So the economic downturn is finally beginning to show up in the labour market, too.

As compared with October 2008, there were 12,000 more people working which compares with an average increase of 53,000 in November 2005, 2006 and 2007.

Exports Drop Sharply In November

The reasons for the uptick in German unemployment are not hard to find, since German exports fell back at a record rate in November – in fact seasonally and working day adjusted current-price sales exports fell back 10.6 percent from October (when they declined 0.6 percent), according to the latest data from the Federal Statistics Office. This is the biggest monthly drop since records for a reunified Germany began. November exports dropped 12 percent year on year, while imports fell 5.6 percent on the month and 0.9 percent from a year earlier. The trade surplus (which is the key consideration when it comes to GDP growth) narrowed to 9.7 billion euros from 16.4 billion euros in October, and almost half the April rate of 18.8 billion euros. The current account surplus was down to 8.6 billion euros.

The immediate future looks even worse, with the latest data from the Technology Ministry showing new orders fell 27.2% (on aggregate) in November (as compared with November 2007) following a 17.5% annual reduction in October, while export orders fell back 30% year on year.

In fact it has been the sharp drop in orderswhich has sent Germany’s manufacturing sector into headlong contraction, and the sector shrank at the fastest rate in over 12 years in December, with the Markit Purchasing Managers’ Index (PMI) falling to 32.7 – down from 35.7 in November. The reading, which showed the sector contracting for the fifth month running, was the lowest since the series began in April 1996, while the sub-index for new orders also fell to a series record low.

Fiscal Deficit Worries

So what can the German government do? Well quite little at this stage of the game I think. Obviously the ECB can (and should) be taking steps to move into line with the Federal Reserve and the Bank of Japan and start readying up some sort of “European” version of quantitative easing, but as far as the national government goes, then I think we are near to the hang on tight and keep your fingers crossed stage. Chancellor Angela Merkel’s governing coalition did agree this week to a further 50 billion euro economic stimulus plan which includes items like investments in infrastructure, and tax relief and payments for families with children. This follows an earlier plan worth 23 billion euro, which was criticized at home and abroad as being too cautious.

But what I think most observers don’t appreciate sufficiently is that in an export-driven economy, where population ageing means that domestic consumption is simply not going to take up the slack and drive the economy, then there is simply a limit to what any government can do – without spending money which is going to be badly needed to pay future pension and health care costs, that is. German Finance Minister Peer Steinbrueck admitted in a newspaper interview with Financial Times Deutschland that he now expected Germany’s fiscal deficit to exceed 4 percent of gross domestic product in 2010 taking into account the latest stimulus plan. The issue here isn’t simply that EU rules require member states to rein in deficits to no more than 3 percent of gross domestic product (and cap national debt at not more than 60 percent of GDP), we are in an emergency and emergency measures are needed.

But EU member states also agreed in April 2007 to balance budgets by 2010, and Germany had been very critical of France for saying they would not be able to meet this target. Germany had already violated the deficit rule for four straight years between 2002 and 2005.

“Of course I would have liked to present you with proof at the end of the legislative period that we would manage to have a budget without new borrowing in 2011. Under normal circumstances, we would have managed that,” Steinbrueck said. “But we are dealing with a sharp recession, an enormous financial crisis and a crisis in the auto sector.”

The point is that falling back on this target will not come cheaply, in the sense that balancing the books was agreed to for a reason – the need to meet the costs of sustaining a society with a rapidly rising elderly dependency ratio. There is a lot of discussion of widening eurozone bond spreads in the eurozone at this moment, but I find myself asking one simple question: if investors start to get worried about the sustainability of German financing, whose bond will become the benchmark against which the other spreads will rise, France’s perhaps?

“A balanced budget remains our target because the demographic changes in Germany will increasingly have an effect from the middle of the coming decade. We must not overburden the younger ones,” Merkel said.

Black Hole In The Banking System?

And there aren’t only holes in the real economy to try and plug (with cement), the financial sector is also becoming an apparently bottomless pit, with the government being poised on Friday to step in and part-nationalise a second bank. Hypo Real Estate is once more in emergency talks with Germany’s bank rescue fund about a deal that looks likely to give the government a stake in the troubled investment bank. These negotiations draw a difficult week for the German banking sector to a close, following the announcement by Deutsche Bank of a 4.8 billion trading loss in the last three months of 2008 (which compares with a profit of about 1 billion euros a year earlier) while landesbank WestLB prepared to warehouse risky investments. WestLB wrote to its owners, local savings banks saying it needed to park troubled assets off its balance sheet in order to stage a recovery – the value of the doubtful assets involved is thought to be about 50 billion euros.

Munich-based Hypo Real Estate on 12 January received an extension until April 15 on a 30 billion-euro framework guarantee provided by Soffin, Germany’s bank-rescue fund. The lender said at the time that talks with Soffin regarding more extensive and longer-term liquidity and capital support measures are continuing. Commerzbank AG, Germany’s second-biggest bank, got a second state bailout on 8 January to strengthen its capital following the acquisition of rival Dresdner Bank from insurer Allianz SE. The German government in return agreed to take a stake of 25 percent plus one share in the combined Commerzbank-Dresdner.

And there is more to come, much more. Der Spiegel is reporting that the major German banks have so far written off only around a quarter of the nearly 300 billion euros in toxic U.S. assets they have on their books. The finance ministry in Berlin estimates that the entire German banking sector is carrying around 1000 billion euros of risky assets on its books, according to Der Spiegel. The government has aset up a 480 billion euro rescue fund to provide fresh capital or lending guarantees to the financial sector, and has already committed 100 billion of the 400 billion set aside for loan guarantees and 18 billion of the 80 billion earmarked for capital injections. However, some see even this as insufficient and there have been mounting calls for the creation of a “bad bank” that would buy up risky bank assets.

Finance Minister Peer Steinbrueck was quoted by the Frankfurt Allgemeine Sonntagszeitung weekly newspaper as saying he could “not imagine (such a step) economically or above all politically”. A bad bank would need to be financed with 150 billion to 200 billion euros of taxpayer funds, he said. “How am I supposed to present that to parliament? People would say we are crazy.”

China Pushes Germany Into Fourth Place

And to add insult to injury, China this week announced that it had become the world’s third-largest economy, surpassing Germany and closing in rapidly on Japan, according to Chinese government and World Bank figures. The Chinese government revised its growth figures for 2007 from 11.9 percent to 13 percent, bringing its estimated gross domestic product to $3.4 trillion, about 3 percent more than Germany’s $3.3 trillion, based on World Bank estimates. Even though China’s growth is now dropping rapidly – and some estimates suggest it may only be 6% in 2008, Japan’s is currently shrinking, and the growth differential is sure to remain, however bad China’s performance actually does turn out to be in 2009 and 2010. Hence I don’t think it will be that many years before China’s GDP manages to overtake Japan’s, which is currently estimated to be worth around $4.3 trillion.

Related posts:

1. Germany: Exports and Inflation Revised Down
2. Italy Slips Slowly But Steadily Into Its Worst Recession In Over 30 Years
3. Germany Leads

If this account is accurate, and his remarks are on message, it would be a significant change in the German position. It may be walked back — the German ambassador to NATO was quoted in yesterday’s Sueddeutsche Zeitung saying that no member expected Georgian membership soon — but the April summit in Strasbourg and Kehl could have some surprises.

Related posts:

1. The European Military project at a cross-roads
2. Still pushing the button
3. A change at the top of NATO

Now let’s stick it alongside the one Paul Krugman put up last week of the US Great Depression:

Now, arguably, what we can see here is that the current collapse in industrial activity is starting to get near the US historic one in terms of proportions, but we still aren’t quite there yet. What we could note that JP Morgan in their monthly report suggest that the present rates of output are equivalent to an annual fall of between 12% and 15%. Really to compare with the fall in the US we need to get up into the 20% region, but remember the global index is based on an average for 26 countries, and some of these are much worse than others (Japan, Spain, possibly Russia) and will already be around the 20% annual contraction rate in December. The point is also that the situation is still deteriorating, so hang on a bit, since it is not at all excluded that we will hit a 20% annualised contraction rate for the whole aggregate 26 sometime during the first quarter.

“The second half of 2008 has been dreadful for global manufacturing and the sector enters the new year mired in its deepest recession for decades. Manufacturing will therefore continue to weigh on world GDP figures, with December PMI data consistent with a drop in global IP of around 12%-15% saar as indexes for output, new orders and employment slumped to record lows.”

“The weakest performance was registered by Japan, whose output and new orders indexes fell to levels unprecedented in the histories of any of the national manufacturing surveys included in the global manufacturing PMI.”

“Employment fell for the fifth successive month in December, and to the greatest extent in survey history. All of the national manufacturing sectors recorded a drop in staffing levels, most at series-record rates including all of the Eurozone nations, China and the UK. The sharpest falls in employment were signalled for Denmark, Spain, the US, Russia and the UK.”

And watch out for the deflation backslap:

“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.”

And for those of you who are still sceptical that any of this has any validity, here’s a PMI/GDP comparison chart for Japan – GDP rates to the left, diffusion index PMI readings to the right (click over image if you can’t view too well). Not perfect, but not a bad guide I would say, if you like your football live, that is.

So never mind the depth, what about the duration? Well that is where I think that all of this will differ from what happened back then. As you can see in the US Great Depression Chart the 20% annual decrease went on for several years. At the present time I think there is no reason to assume that this will happen, ie that we will keep getting massive year on year contractions (in some cases maybe, Latvia perhaps?????), but activity does look set to fall to quite a low level, and there is no strong reason at present for believing it will simply bounce back up again. More than likely we will simply trawl the bottom, at least for some months, and who knows, maybe a couple of years.

Well that’s it for the big picture stuff, but I have actually been pretty hard at it all day down at the individual country level, so there is plenty more detail to come. In the next post.

Related posts:

1. JPMorgan March Global PMI Report Shows (Slightly) Slowing Contraction
2. JP Morgan’s Global PMI Shows Another Substantial Contraction In February
3. May Manufacturing Improves Again According To The JPMorgan Global PMI Report

Well China isn’t quite in Great Depression mode yet, but manufacturing activity – which forms the core of the Chinese economy and accounts for 43% of all activity – is already very close to a technical recession, and phew, it wasn’t very long ago that the Chinese economy was registering double digit growth. So the turn around is gigantic. The “close to technical recession in manufacturing industry” call comes from the people over at CLSA Asia-Pacific Markets, who compile the China purchasing managers index, and they base their judgement on the fact that their Chinese manufacturing index has now been registering contraction for five consecutive months.

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.

Related posts:

1. Great Leap Forward II
2. The Great Leap Forward
3. The Second Great Depression Spreads…..

Via.

A tree fungus could provide green fuel that can be pumped directly into tanks, scientists say. The organism, found in the Patagonian rainforest, naturally produces a mixture of chemicals that is remarkably similar to diesel.

“This is the only organism that has ever been shown to produce such an important combination of fuel substances,” said Gary Strobel, a plant scientist from Montana State University who led the work. “We were totally surprised to learn that it was making a plethora of hydrocarbons.”

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