feb192

The prospects for the world at the beginning of this year were once again over-hyped and overall aggregate demand trends have under delivered. For example, it was forecast that there would be a revival in US, Japanese and even European capital spending, however this hasn’t occurred with the result that inventory ratios have risen sharply. These high inventories ratios plus continuing weak global trade imply that many of the affected countries will need to experience actual falls in inventories. However, achieving a fall in the absolute level of inventories will tend to weaken overall GDP data, and impact the IP data possible quite significantly. Moreover, the need for so many countries to reduce inventories through production cuts and strong price discounting represents a considerable deflationary risk with global goods markets, leading to weak inflation trends in much of the world. Interestingly, Europe doesn’t seem to be affected by inventory overhang at present however we wonder if the disposal of some of the continent’s inventories were facilitated by the soft Euro policy.
Blog by Sophie

Abe’s reign has failed to produce either the real economic, nominal or fiscal results that had been envisaged. The weak Yen has collapsed world trade prices, hasn’t recovered domestic capital spending, is unlikely to generate more nominal GDP inflation and also tends to have little impact on real imports or exports. Nominal GDP growth is roughly 1/10 of the average rate that the MoF assumed it would be achieving by now. So the MoF’s fiscal targets can only be met if authorities start a deflationary tightening of fiscal policy over the medium term. It is likely that the MoF will tighten fiscal policy via more pension and medicare cuts, something that will likely depress consumer sentiment further. Consequently, we wonder if Abe-nomics will soon be consigned to the history books.
Blog by Sophie

After Friday 13th tragic events, France and Europe have a number of responses to prioritise, such as; tighter defence, stronger security and a greater need for an economic recovery. The importance and effects of these will differ between the various countries concerned, and in so doing this will impact the different economies in different proportions. This will change the equilibrium national rates of inflation and have implications for the various countries’ balance of payments positions – and hence their TARGET2 balances. To achieve these different effects, Europe must move closer to a single political and fiscal state, otherwise the existing fault lines in the system will widen and force TARGET2 into another unintended role. In the near term, we expect the size of the ECB’s asset purchases to increase as 9/11 showed us that policymakers have a freer hand when crisis’ strike and there’ll be less pressure for long overdue structural reforms. We fear that these effects will be positive for growth and markets in the near term but negative over the longer term. In reality, we would say that the awful events have increased the pressure on Europe either to seek political unification at an accelerated pace or return to the concept of a free trade area that is comprised of a union of individual nation states.
Blog by Sophie

China’s post 2002 growth, and particularly that which occurred from 2009 onwards, involved the creation of a massively outsized financial system. This caused a record breaking debt to GDP ratio which may turn into a compound-interest-driven Debt Trap similar to that which many LATAM countries experienced in the 1980s. Indeed, domestic debts may be over 300% of GDP and nominal GDP growth is decreasing towards zero, with the result that China may need to resort to zero interest rates. Moreover, the massive increase in credit has created an equally massive pool of domestic liquidity. If this pool of liquidity were to be utilized (via the equity market) into repaying their debt burden, this would represent the best possible outcome. However, if the excess money balances held by the private sector were to leave the RMB then an embarrassing decrease in the currency would occur.
Blog by Sophie, for full article contact Andrew

For the last five years it has been the auto sector that was responsible for almost all of the growth in German IP. Naturally, the Asia/EM slowdown had already started to impact German car exporters quite severely and there were also some signs of a slowdown in shipments to the rest of the Euro Area over the summer even before the VAG debacle. Therefore, it seems that the risks to IP are firmly to the downside. Furthermore, now that momentum in the terms of trade has been lost, it’s likely that household real income growth will ebb away. Indeed, retail spending trends have plateaued. Hence, with consumption flat and fiscal policy tightening, we suspect that we have already witnessed the peak in German growth this year and so the risks to the economy lie unevenly to the downside.
Blog by Sophie

It’s difficult even within the context of a ’closed economy’ to know just how much credit there is within the wider system and the situation is even harder to quantify when one comes to international credit flows. The official balance of payments data for a donor country (i.e. Japan, Europe or the USA) tends to simply show the equivalent of the banks’ capital / reserve deposits in a domestic system. This is why data differs so much between what is ‘received’ by countries which attract credit flows’ tends and what the donors appear to send.
Nevertheless, we can argue with some certainty that the post 1985 surge in global capital flows have given rise to what is in reality a long and winding chain of potentially highly leveraged flows that contains within it currency, maturity and most of all liquidity miss-matches. These are the building blocks for a financial crisis and it’s this illiquidity problem that lies behind the recent Asian economic slowdown and the growing signs of illiquidity within these economies. Unwinding this process has seen credit conditions continuing to tighten in many if not most of the EM. Therefore, despite the recent short-covering rally in financial markets, we believe that even now we have significantly more economic weakness in Asia ahead of us.
Somewhat surprisingly, it as the European banks were the primary donors of credit funds to the EM in 2013 and 2014. However, data suggests that this activity cooled quite dramatically in 2015H1 and that it has gone into dramatic reverse over recent months, primarily we believe because of the actions of Europe’s bank regulators
Blog by Sophie

The weak euro has increased the cost of non-oil imports to the economy – hence deflation has eased but the higher import prices represent a ‘tax’ on consumers. However, the decline in the oil price had more impact on household real incomes than did the rise in other import prices, so oil prices falling by more than the euro in late 2014 caused the pick-up in French consumption spending, an effect that may now be waning. Meanwhile, France’s highly indebted corporate sector will gained from the decline in borrowing costs created by the ECB but the marginal effect of this may also be waning. Finally, we note that the recovery in the credit data at the end of last year seems to have lost momentum. It may therefore be difficult for France to maintain its recent – already patchy – recovery, particularly as the marginal impact from lower oil prices dissipates.

The Dutch group CPB has reported that total world trade volumes are flat in year on year terms and down 1.6% YTD, as well as Asian import volumes being down 8% YTD and export volumes by a massive 9% YTD. In addition, the Asian airfreight volumes are down by 2% YoY therefore it is clear that Asia has become the epicentre of the current weakness in world trade. To us, this latest Asian trade and financial slump seems simply to be one of the less pleasant results of the game of credit boom ping-pong (rolling credit booms and busts) that began in 1985. Unfortunately, this latest bust may well have significant deflationary consequences for the global economy

Over the medium term, we can assume that our political masters will recognise the problems inherent in Asia’s latest slump and governments will turn back to more public expenditure and also seek to take more control of the private sector’s capital stock. While this will likely produce better growth in the near term, it will do little to improve the underlying state of the global economy over the longer term unless the money is spent wisely.

Of course, rather than embarking on credit boom ‘ping pong’ with the EM over recent years, the Western world should instead have invested in raising productivity through better education, encouragement of R&D and provision of physical infrastructure some years ago but this opportunity was missed.