One Significant Economic Development among the Sturm und Drang

September 15th, 2012
in Op Ed

What you’re not being told about the world economy, but should know!

by Fabius Maximus

Summary: The secret key to the FM website’s great forecasting record is that we do only the blindingly obvious, and give no dates - such as the long forecast of stability for the world economy, to be followed by ugliness. We revisit this again, showing that almost nothing is happening yet in the global economy. All the Sturm und Drang in the news media is exaggerated. There is only one new development, and that has not received sufficient attention.

OECD’s Composite Leading Indicator

Follow up:


  1. A look at the world using the OECD’s CLI
  2. US unemployment
  3. Europe: slow decline, cohesively
  4. New ECB policy: not a game-changer
  5. New FED policy: not a game-changer
  6. The new element disturbing the global economy
  7. For more information

(1) A look at the world using the OECD’s CLI

The OECD’s Composite Leading Indicators are one of the best economic leading indicators. Perhaps the most reliable, but also reported with the longest lag (yesterday they released the July numbers). It’s been flat since early. During the past 24 months the peak was 101.1 in February 2011. The trough was 100.0 in October 2011; it’s now 100.2.

The July report continues in its boring fashion of late. The tension builds across the globe, but so far remains contained:

  • Composite leading indicators (CLIs), designed to anticipate turning points in economic activity relative to trend, show that the loss of momentum is likely to persist in the coming quarters in most major OECD and non-OECD economies.
  • In Italy, China, India and Russia the CLIs continue to point to a slowdown. For the Euro Area, France, and Germany the CLIs point to continued weak growth.
  • The CLIs for Japan and the United States show signs of moderating growth above trend, while in Canada the CLI continues to point to growth moderating below trend.
  • The CLIs for the United Kingdom and Brazil tentatively point to a pick-up in growth, but remain below trend.
  • The OECD Development Centre’s Asian Business Cycle Indicators (ABCIs) suggest that ASEAN economies show overall resilience, though some signs of weakening are observed.

(2) US unemployment

Employment in the US has slowly gained since the Spring 2009 trough, although slower than expected given the rate of GDP growth. Weekly new claims for unemployment (seasonally adjusted) have varied from 360,000 to 400,000 since 24 September 2011.

All those confident descriptions of our “depression” and imminent recession have consistently proven false.

(3) Europe: slow decline, cohesively

The biggest surprise to me from the world economy has been in Europe. Not the slow decline of the periphery economies; that was an obvious and inevitable result of their austerity policies (recovery remains almost impossible without some combination of currency devaluation, fiscal stimulus, or radically lower rates — on a large scale).

The surprise is that those nations have retained their cohesion under immense stress lasting years. For example, Greek unemployment was 16.3% in Q2 of 2011, 22.6% in Q1 of this year, and 23.6% in Q2. Despite hysteria in the US about their small-scale protests (eg, at Zero Hedge), these people have withstood adversity well. Perhaps too well (forcing new policies might have been wiser). Even more amazing, they remain devoted to the European unification project.

What comes first: recovery or something breaking in the social fabric of a periphery economy? My guess: breakage. Something snaps. Note that support for unification remains strong in the northern European nations , despite the confident predictions of public revolt against unification.

(4) New ECB policy: not a game-changer

This was nicely explained by Albert Edward of Société Générale, 14 September 2012:

… Clearly the actions by the ECB buy time. But time for what? If the doctor has misdiagnosed the disease and is applying the wrong medicine, then all the time in the world will not see the patient recover. There is still precious little acceptance that it is not a fiscal crisis that has brought growth in the periphery to its knees. This is a classic balance of payments funding crisis of which the fiscal crisis is merely a symptom.

Going into this crisis, we highlighted the burgeoning trade imbalances that were building within the eurozone. The GIPS (excluding Italy) experienced rampant credit growth as a direct consequence of an inappropriately low, one-size-fits-all, eurozone interest rate. The booming domestic demand growth in the GIPS resulted in massive trade and current account deficits that were mirror images of surpluses elsewhere in the eurozone – most notably Germany (the eurozone’s overall current account being in rough balance with the rest of the world).

… Indeed the size of the current account deficits in the GIPS and the accumulated measure of those trade imbalances, i.e. the International Net Debt Position, were the biggest single warning signs of subsequent GIPS economic collapse. The problem here is that nothing much seems to have changed.

Despite the GIPS being in deep recession, if not depression, it is surprising that the cumulated external imbalances have not corrected at all. Also surprising was Germany’’s July orders data, for it seems that although overall new orders are flat-lining, export orders still seem to be holding up surprisingly well despite the weak eurozone and global backdrop. The July data suggests that any weakness that there is in the overall orders series is coming from the domestic rather than export sector.

Société Générale, 14 November 2012

As so many have said so often, going back to the creation of the euro, the structure of the EMU is flawed. The measures taken to date, such as depressing short-term sovereign debt rates and providing loans that cannot be repaid, only buy time for structural reforms. The crisis started in March 2010, and the 2.5 years of time has been squandered. The primary treatment has been to administer austerity, hoping for the Confidence Fairy to bless their work. It’s failed so far, and probably will continue to fail.

(5) New FED policy: not a game-changer

Yesterday the Fed announced that it will continue the open-market purchases of mortgage-backed securities it, which began in November 2008, beyond the scheduled end in December — at roughly the same rate as in QE2. While some research shows QE2 to have had some effect on the economy, the inflationistas forecast have yet again proven wrong.

  1. inflation: minimal
  2. adjusted monetary base: -0.4% YoY
  3. adjusted reserves: -5.5% YoY

What will QE3 do? We turn to Paul Krugman at today’s New York Times:

It certainly sounds as if Bernanke is reacting to the Woodford critique, which argues that quantitative easing is mainly effective through its effect on expectations. While the policy does take the form of purchases of unconventional assets — mortgage-backed securities — Bernanke is not relying on portfolio balance effects alone; instead, he’s trying to move expectations by declaring that the Fed will continue to ease for some time afterthe economy has begun to recover:

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

In effect, the Fed seems to be trying to “credibly promise to be irresponsible” …

This is daft. Consumers and business leaders do not act on the basis of Fed open-mouth operations. Nor should they, as Bernanke’s claims are bogus. Today’s Fed leadership cannot bind future Fed actions. No matter what they say today, the Fed probably will turn off the tap immediately at the first signs of recovery and inflation.

More importantly, there is a large body of research showing that the Presidential “bully pulpit” usually has little effect on either public opinion or any element of US leadership. That probably applies even more strongly to the Fed Chairman. He cannot shape our expectations with a wave of his hand; attempting to do so shows either mad hubris or desperation.

But there is an amusing aspect to this: watching the hysteria at another round of monetary easing. Inflationistas are like millennialists, always expecting the Second Coming of Inflation. But we’ve followed Japan into deflation-land.

(6) The new element disturbing the global economy

Several insightful experts have warned of a little-appreciated support of the global economy — China’s massive current account surplus, fed by buying Treasuries, gold, etc — might be vanishing now. It’s one aspect of a China bust (a scenario which has been well-covered in the news, and deserves close attention). If this continues as some forecast, it will change the world.

For an explanation we turn to Russell Napier of CLSA, 14 September 2012:

The PBOC defeated deflation, not Bernanke.

It’s generally held that inflation is the likely outcome of unfettered money creation in our fiat money world. However, in reality key global players do not live in this world. Most EM authorities allow the quantity of money in their economies to adjust as necessary, while managing their exchange rates relative to the US dollar. Two thirds of the growth in the global money supply since 2007 was from these countries, with China alone contributing 40-45%, whereas US money-supply growth accounted for just 15%.

Forced money-creation in EMs is ending.

A sudden deterioration in EM external accounts automatically produces a major deceleration in money growth. The key driver of this is inflation, which undermines EM nations’ ability to attract and retain capital, thereby reducing their need to create money. China’s capital-account surplus accounted for around half of its total surplus, but this year it has moved to a capital-account deficit and its foreign-exchange reserves are starting to decline. As investors in EMs have learned many times before, capital can move very quickly. A balance of payments anchored on a material current-account surplus can quickly become one driven by a capital-account deficit. We are close to such a tipping point, and if EM authorities respond by defending their exchange rates, a dramatic slowdown in money creation will ensue.

Money-supply growth in the developed world is sluggish.

This slowdown would come while developed-world central banks are still struggling to create robust, sustainable growth in broad money. US money growth has slowed from 8% YoY to 5%, while Japan has zero growth. Europe’s broad money is growing at around 3.5% pa, but this looks set to fall, as lending to the private sector is contracting. If Europe’s next step towards fiscal federalism falters, the region will face a monetary disaster. Whatever happens, the least likely outcome is accelerating money growth.

For more detail we return to Albert Edward of Société Générale, 14 September 2012:

Economist, 4 August 2012

The Chinese economy too has surprised decisively on the downside this year with the recently released August data catalysing another round of GDP downgrades. Stimulative measures have been tardy and largely ineffective so far.

For me, the most significant data item over the holiday period was China’s Q2 balance of payments deficit (see chart from The Economist). This is a game changer for the global economy. For as tensions mount within China and money flees for safer shores, we explain inside how this deficit exacerbates the risk of economic and political turmoil.

… capital outflows in Q2 (red bar) outweighed the current account surplus. One of the themes we have been talking about over the past 18 months is how the current account surplus in China has been declining in recent years, not just because of recent weakness in key export markets such as the eurozone, but because the renminbi is tied to the US dollar. The trade-weighted exchange rate has therefore ended up becoming excessively strong.

… We have been among a handful of commentators to have consistently identified the rise in China’s FX reserves as a key liquidity pump for both itself, and indeed the global economy. For much as the Chinese authorities have complained recently about profligate US monetary policy and QE, the Chinese have been doing the same – i.e. printing vast quantities of renminbi to peg their undervalued exchange rate to the US dollar.

This is a common theme in emerging markets in general and often helps explain rapid growth rates and asset booms in those countries. And to the extent that excess optimism about China’s growth has been built on unstable, Kilimanjaran mountains of debt, we have long warned that this pack of cards could come crashing down – in stark contrast to the consensus. Although the absolute decline in reserves is small, the change marks a massive shift down through the gears for the monetary printing press. And if the capital outflows accelerate, the next gear may yet be reverse.

GMO’s Edward Chancellor wrote an excellent analysis on this very topic. Discussing the clear acceleration of capital flight in Q2 he quotes Victor Shih, of Northwestern University, noting that wealth is highly concentrated in China and given recent economic and political developments, rich Chinese have many incentives to take their money abroad.

China’s cash pile provides no shield“, Edward Chancellor, Financial Times, 5 August 2012:

When capital flees the country, China’s forex reserves will shrink. Professor Shih reckons that the collective fortunes of the top 1% of Chinese households are larger than those reserves. This vulnerability can be viewed from another perspective. Chinese money supply (M2) is not only twice the size of the country’s economic output, it is more than four times greater than the forex reserves. Reserves are currently equal to 22% of China’s money supply. By contrast, the forex reserves of the Asian Tigers averaged around 35% of money supply when their currencies collapsed in 1997.

China is a little far north of the normal range of the elephant, but it is the economic elephant in the global room today.

(7) For more information

  1. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
  2. Inflation or Deflation? Nobody knows what path will we take., 21 July 2009
  3. Fetters of the mind blind us so that we cannot see a solution to this crisis, 1 April 2009
  4. A lesson from the Weimar Republic about balancing the budget, 10 February 2010
  5. All about deflation, the quiet killer of modern economies, 19 July 2010
  6. Important things to know about QE2 (forewarned is forearmed), 21 October 2010
  7. Bernanke leads us down the hole to wonderland! (more about QE2), 5 November 2010
  8. Two regions diverging, tearing the world apart. Birth pangs for a new geopolitical order., 18 November 2010
  9. Explaining the gold standard, the Euro, Default, Deflation, and Hyperinflation, 12 December 2011

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