The Weight of the Global Economy

November 3rd, 2012
in contributors


According to Eurostat, unemployment in the eurozone remained at 11.4% in September, the highest since the introduction of the euro in 1999. More than 18 million workers remain unemployed, with a heavy concentration of displaced young workers. In Greece, the unemployment rate for those under 25 is 55%.  In Spain, 52.9% of young workers are unemployed. The societal impact on Greece and Spain could be huge, as hordes of young, angry people with time on their hands search for an explanation and a reason for hope.


According to Markit, manufacturing in the eurozone contracted for the fourteenth consecutive month in September. Although Germany’s PMI improved from 44.7 to 47.4 in September, it still contracted for the sixth month in a row.  VDMA, the German Engineering Federation, reported that new orders for Germany’s plant and machinery industry fell 11% in August from a year ago, which suggests weakness is likely to persist.  This weakness was evident in October as the German Ifo assessment of current conditions fell from 110.3 in September to 107.3.  As we discussed in the August Macro Strategy Review, since 1995, whenever Germany’s Ifo index has fallen to this extent, a recession has followed. Should a recession develop in Germany, causing an increase in its unemployment rate, German support for providing additional funding for the EU’s weak sisters will sag.

The ECB’s Outright Monetary Transaction program has yet to be implemented, but it has succeeded in lowering bond yields in Spain and Italy. On October 18, Italy sold $24 billion of 10-year bonds at an average yield of 4.76%, down from a high of 6.5% in late July. It was Italy’s largest bond offering ever, and it will satisfy its borrowing needs for the rest of 2012. Spain sold $6 billion in bonds, as yields on its 10-year bond fell to 5.32%, the lowest since early April.


The Spanish auction was helped by Moody’s decision not to lower its rating to junk on Spain’s bonds, and the perception that Spain will eventually ask the ECB for financial assistance. The decline in yields in Italy and Spain relieves one pressure point of Europe’s dilemma.

However, lower yields, while helpful, will not provide the spark needed to pull Europe out of its recession, nor heal Europe’s broken banking system. The ECB has  dramatically increased its balance sheet, but more than $1.1 trillion of funds provided to European banks remains parked at the ECB.  Just as with the Federal Reserve, the expansion of the ECB’s balance sheet is not resulting in money flowing into the European economy.  In fact, European bank lending standards are still being increased, which suggests that credit availability will continue to contract.

We expect the economic paralysis gripping Europe will extend well into 2013, which will pop the current bubble of tranquility that has becalmed Europe’s financial market. Progress is being made, but the structural changes needed to make the EU a true union may take more time than those on the receiving end of austerity have the tolerance to endure.


In the wake of the 2008 financial crisis, the People’s Bank of China responded just as their counterparts in the U.S. and Europe did by cutting interest rates. But since China’s central bank is controlled by China’s government, it literally force fed lending into China’s stateowned enterprises.  This ramped up lending, goosed infrastructure spending and industrial export capacity, and encouraged real estate speculation. The resulting surge in Chinese demand for raw materials helped lift Brazil, Indonesia, Australia and other Asian
countries, which thrived on exports to China.

China’s post-2008 GDP surge peaked at 12% in the first quarter of 2010, and has been slipping ever since. China’s third quarter GDP clocked in at 7.4%, which would be a dream come true for most countries. However, for those who export to China, the 38% fall from the early 2010 peak feels like hitting a brick wall. We’ve warned for some time that the investment boost after 2008 was likely to lead to overcapacity problems, which have appeared in the steel industry and other industrial goods sectors, and hurt profits. China’s economy is not likely to rebound until the level of excess capacity is reduced. This suggests China’s demand for raw materials will remain muted in coming months, as will their imports of raw materials.


When the National Party Congress convenes on November 8, China will implement their once-in-a-decade transition of installing new political leaders.  It is expected that the new general secretary will be Vice President Xi Jinping, with Vice Premier Li Keqiang assuming
the post of premier, which bears chief responsibility for the economy. The next 10 years are going to be particularly challenging, as China attempts to rebalance its economy from investment and exports to more consumption.

Exports and investment now comprise almost 50% of China’s GDP, while consumption is just 34%, compared to 70% in the U.S. The slowdown of exports to Europe and the U.S. and the overcapacity issue will complicate the transition. The average Chinese worker earns less than $4,000 per year, which suggests the loss of GDP from exports and investment might be tough to overcome with increased consumption in the short run.  Wages have been rising faster than GDP, which will bolster consumption over time, but also pose problems managing inflation in coming years.  In coming months, we expect the new leadership to cut interest rates and the bank reserve ratio to spur growth, which should stabilize growth in the 6 to 8% range.


Disclaimer: Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can full as well as rise. Past performance does not guarantee future results.

This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.

©2012 Forward Management, LLC. All rights reserved.
All other registered trademarks or copyrights are the property of their respective organizations.


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