Italian Industrial Output Falls

This news today seems to confirm a lot of the points I was arguing in this post on Afoe. It is going to be very hard for Prodi and co to maintain course on deficit reduction if growth in the economy stagnates in 2007 as it looks like it may well do:

Italian industrial production unexpectedly fell in July for the first time in three months as near-record oil prices raised manufacturing costs and weighed on consumer demand.

Output declined 0.3 percent from the previous month when it gained 0.1 percent, the national statistics office Istat said in Rome.....Output dropped 0.2 percent from a year earlier.

The economy of the dozen euro nations is showing signs of losing momentum after expanding at the fastest pace in five years in the second quarter. Crude oil prices reached a record of $78.40 a barrel on July 14. Manufacturers may trim output in coming months as energy cost sap consumer spending and exporters rely on a slowing global economy.

``It looks like there will be a moderation of growth'' in the second half, said Marco Valli, an economist at UniCredit Banca Mobiliare SpA in Milan. ``It remains to be seen by how much but it should be a gradual slowdown.''

French industrial production unexpectedly declined for a second month in July, Paris-based national statistics office Insee said Sept. 11. In Germany, Europe's largest economy, business confidence declined for a second month in August.

The production decline indicates that growth in Europe's fourth-biggest economy continues to lag behind that of its biggest trading partners. The European Commission said Sept. 9 that Italy will expand 1.7 percent in 2006, compared with growth of 2.5 percent in the economy of the dozen euro nations, the fifth year that Italy trails the euro region.

China Modifies It's Rebates Policy

This piece in Bloomberg today about China's move to restructure its export rebates policy is definitely worth a look. Note: they are not removing export incentives, but simply trying to redirect them as part of a policy to move up the value chain. As such this move may well be 'neutral' on China's trade surplus situation. As I have a go at explaining here, China's problem is not so much that it has too much cash coming in, as that this cash is leading to distortions in the investment process. Basically I have less sympathy with those who simply criticise China for having the surplus per se, since it is hard to see China importing consumer products from the developed world on any substantial scale at present. As a consequence most of the purchases they make are bound to be as a contribution to the investment budget, so the new policy could be seen as simply a way of redirecting surplus investment into higher value activities. As such is a good move on China's part. Now we will see whether those who were worried about China producing too many T-shirts and sandals are any happier with being on the receiving end of their IT products.

China cut export incentives for steel and textiles and increased them for high-technology and biomedical goods, seeking to curb a record trade surplus and encourage production of higher-value goods.

Export rebates on steel and textiles were cut by as much as 3 percentage points while incentives for technology and processed agricultural products were raised by up to 8 percentage points, the government said. The rebates reduce the amount of sales tax paid on exports.

The changes may help China fend off criticism that the world's fastest-growing major economy uses an undervalued currency to boost exports of cheap goods. Group of Seven finance officials gathering in Singapore this weekend are expected to renew pressure on China to let the yuan gain more rapidly.

The Cascajal Slab

Archaeologists working in the Veracruz lowlands in Mexico have come across a stone slab inscribed with what seems to be the oldest writing yet discovered in the New World. The writingon the slab dates back nearly 3000 years to the height of the Olmec culture that was the first Mesoamerican civilisation, Mexican archaeologists report.Now to be known as the Cascajal slab, it was found along with a number of other artefacts from a quarry at Lomas de Tacamichapa, in 1999, where it had been destined for use in road fill.

The slab weighs about 12 kilograms and is about the length and width of a laptop computer, but much deeper (36 centimetres by 21 cm by 12 cm). It is blank except for one side, which has been ground smooth and inscribed with 62 symbols of a hieroglyphic script. The symbols are arranged in rows and some are repeated, similar to other written languages.

Three of the 28 distinct symbols appear four times, six appear three times, and 12 appear twice. Some symbols resemble objects including an insect, an ear of corn and a throne.

Of course it is one thing finding and dating the slab, but it will be quite another working out what it means.

Jonathan Wheatley, Brazil and the BRICs

I have always thought that the idea of the BRICs group of economies was an ill-born child. On the one hand China, India and Brazil, partly because they are large countries, and partly because they are in the process of getting their demographic dividend , are bound to grow in importance, and, each in their own way, become growth engines of the future (I made part of this argument yesterday in this post on Indian Economy Blog). On the other hand Russia is big, but getting smaller, and is experiencing a demographic penalty, not a demographic dividend.

That Goldman Sachs didn't quite get this thing a little wrong is one thing (they were at least early in recognising the importance of India and China) , and reading this kind of silliness from Jonathan Wheatley in the FT this morning really quite another:

When Goldman Sachs coined the term BRICs for Brazil, Russia, India and China in 2001, it did so to call attention to the four countries’ potential for fast and sustained growth. By 2041, it predicted, their economies would be worth more than those of the US, Japan, Germany, the UK, France and Italy put together.

The BRICs are on target to fulfil that prediction. But they would do so more quickly if their average rate of growth were not being held back by Brazil.

Firstly it is obvious that Brazil isn't holding anyone else back, anyone else apart from Itself. Secondly it is clear that the chap doesn't know that this isn't only about size, but also about demography.

China’s economy grew by 11.3 per cent year on year in the second quarter. Brazil’s grew by 1.2 per cent. It is set to grow by a miserly 3 per cent this year, probably making it the laggard not just among the BRICs but among all the world’s emerging markets.

Something struck me as odd about this growth rate, Brazil isn't China, but still, it isn't doing that badly. So I couldn't help noticing on Bloomberg that the IMF in its World Economic Outlook predicts that

"Economic growth in Latin America will slow to 4.2 percent next year......This year, Argentina's economy will expand 8 percent, Venezuela's will grow 7.5 percent, Brazil's 3.6 percent, and Mexico's 4 percent"."

So Brazil's growth this year could well be 3.6% and not the (evidently highly selective 2nd quarter y-o-y figure of 1.2%). If we wish to understand what may be going on here, the next paragraph should help clear up some doubts:

"Brazilians themselves seem not to care about growth. President Luiz Inácio Lula da Silva of the left-leaning PT party appears comfortably assured of winning another four years in office at elections next month."

And get this:

"The reasons for the president’s popularity are many but chief among them is global demand for Brazilian exports – led by China, India and other faster-growing markets. Brazil is recording trade surpluses of more than $40bn a year and, consequently, its currency has appreciated by 65 per cent against the US dollar since the end of 2002.

Inflation is at its lowest level in decades. As the spending power of the poor has increased, the prices of many foods have actually fallen.

The rich are doing nicely, too. Brazil’s central bank uses high interest rates to fight inflation and although its benchmark rate has fallen by 5.5 percentage points in the past year, it remains among the world’s highest, at 14.25 per cent a year. This creates a bonanza for anyone with capital to invest."

The impression I get from all of this is that things in Brazil are now much better than they used to be, and long may they continue that way. Obviously there is always much more to do in terms of reform, but Lula has a delicate line to walk. And in the meantime Jonathan Wheatley's article is not only a diservice to the paper whch published it, it is also a diservice to the cause of economic literacy.

And in the meantime, on we go: Brazil Economy Watch.

Eurozone Inflation

Oil, as is well known has been generally dropping in recent days, and are now somewhere around the lowest prices seen since last March. It is hard to know how much of the correction is due to the fact that it was previously over-valued, how much is due to the anticipation of a developing slowdown, and how much simply reflects relief that there were no serious hurricanes this year.

In any event the drift is down, although the thing which could upset the whole apple cart is an 'up the anti' in the argument about Iran's nuclear programme.

So it is hardly surprising to find that inflation in Eurozone countries is also taming somewhat. According to German the Federal Statistics Office in August German consumer prices rose 1.8 percent from a year earlier after increasing 2.1 percent in July. In France, the annual inflation rate in August fell to 2.1 percent after increasing 2.2 percent in July, according to the national statistics office Insee.

What I would say is that if oil prices hold either steady or drift down then we are unlikely to see any significant upsurge in inflation here in europe, especially with a high euro, and record imports fromChina. Which puts the ECB in a rather embarassing situation.

Certainly I think the idea of a surge in passing on costs is very unlikely, internal demand (even in France) just isn't sufficiently robust, so I think this argument is a mistake:

Euro-region inflation may accelerate in coming months as faster economic growth gives companies room to pass on rising costs and workers leeway to seek more pay. At least four European Central Bank council members signaled in the past week that interest rates may keep rising into 2007 to counter higher prices.

``Temporarily, we'll see an easing of inflation because of oil prices,'' said Rainer Guntermann, an economist at Dresdner Kleinwort in Frankfurt. ``The ECB realizes only too well that higher inflation rates need to be expected again next year. It's under pressure to continue normalizing interest rates.''

And on the central banking front, will they be embarassed at the end of the day if all this turns out to be completely off the mark:

ECB council member Nicholas Garganas said in an interview in Basel, Switzerland, on Sept. 11 that there's ``no evidence'' of easing inflation pressures with more signs of a ``greater pass- through of past oil price increases.'' His German counterpart Axel Weber said Sept. 5 that ``no decision has been taken to end the process of normalization at the end of the year.''

``Obviously we are very worried'' that inflation is no longer expected to slow in 2007 on average,'' Garganas said. ``That is why we are strongly vigilant.''

More Puzzles

Reading through a Bloomberg piece on China's trade surplus I was struck by this paragraph:

"China's trade surplus swelled to $18.8 billion in March, a monthly record, as exports soared, the customs bureau said yesterday. The gap, which is set to top last year's record $102 billion this year, is leaving the economy flush with cash that's been channeled into investment projects. "

This made me sort of stop in my tracks and read it again, since my first response was 'well that's good isn't it", that's what development is all about. Well apparently no, since:

"The IMF yesterday said China should loosen its grip on the currency to support government efforts to slow investment. Too rigid currency controls reduces the efficiency of the central bank's monetary policy, the fund said."

So the issue isn't exactly that China is making too much money, and thus being able to move its population into productive activity (this is called development I think) it is that they may be doing this too quickly. But how do we know this? I would argue that we have only a very vague idea of how quickly an economy like the Chinese or the Indian ones can grow, indeed I have just put a post on this very matter on the Indian Economy Blog.

My feeling is that basically people can't believe what is happening, so they are rationalising their disbelief into 'concern'. Basically the issue is not growth per-se in China, but distorted growth, which is partly due to an undervalued currency, and partly due to inefficient banks and capital markets. But the presence of many of these distortions is hardly surprising in the context of a newly developing economy.

The main areas of concern are obviously property, although rising properties prices in China are just as (if not more so) sustainable as they are in the US, and insofar as there is 'froth' it is in the most globally influenced sectors of the Chinese economy. The other distortion is of course in exports, and this is, at the end of the day, what the fuss is all about.

China's growth is in some significant part being driven by exports, and the distortion is producing a positive feedback process: exports are producing extra cash which are feeding more exports, since there are not deemed to be other projects which are attractively profitable as an alternative. This rate of export growth is, naturally, unsustainable, but I would say that the great worry in the event of a slowdown globally isn't a hard landing inside China itself, I think they have the means to avoid this, it is not, after all, a fully market economy, no, the worry is what happens to all those exports that are being produced, and what will they do to global prices in the event of a slowdown? And todays warning from Rodrigo Rato that housing may be significantly slowing may encourage the Chinese to maintain their current currency value rather than lettting it rise.

One last point, China's economy doesn't of necessity have to become flush with cash as a result of a protracted surplus (with the implication that this process is inflationary), a brief history of the recent history of Japan reveals that, where the problem has been deflation, not inflation.

The issue is what happens to the money. Normaly central banks have some kind of sterilisation policy or another:


"Sterilization (or neutralization) policy is a specific combination of monetary and exchange policy. When the central bank buys or sells foreign exchange the money supply increases or decreases. The purpose of sterilization policy is to offset this effect. The mechanism is for the central bank to sell securities at the same rate that it is buying foreign exchange, and to buy securities at the same rate that it is selling foreign exchange. In reality, therefore, neutralization policy involves an exchange of foreign reserves and bonds."

The main concern then is really the effectiveness of this sterilisation process in the context of an economy where there is still a lot of unofficial money floating about, and where the value of the currency is guaranteed. This is what, at the end of the day, the IMF is getting at when it says "currency controls reduces the efficiency of the central bank's monetary policy".

The Eurozone and the US Downturn

Over at Afoe Mark Thoma had an interesting guest post last week on whether the eurozone will be affected by any possible downturn in the US. This same post was picked up by New Economist,as it is by Claus Vistesen at Alpha Sources.

Personally I think I think that Nouriel Roubini's view (which comes up in the post) that the rest of the world may not be able to decouple from the US is a mistake. In a sense the world already has decoupled. If you look at the fact that global growth this year is likely to be in the 5% region, while the US might grow say 3.5%, and Japan say 2.5% and the eurozone say 2.0%, then it is clear that someone somewhere else is now doing the heavy lifting. Most likely candidates are places like China, India, Brazil, Turkey and a string of other developing countries like Argentina and Chile who are to some extent riding the commodities boom generated by the aforementioned.

This is a sea-change from the 1995-2000 period, when US growth did account for a huge proportion of global GDP growth. I think this de-coupling will become even clearer after the next recession (which could be 2007 or 2008, we have no crystal balls, but I would pencil something in for 2007, especially if the collsion with Iran continues its course). The next upswing will surely be pulled by the new Growth Pandas (or if you like growth giant pandas).

The big issue is going to be how you square the circle on trade and capital flows.

Of course recognising that there are new growth engines at work isn't quite the same thing as saying that it doesn't matter to the rest of the world what happens in the US. Obviously if consumption in the US is sufficiently affected then this will be noticed in Germany, Japan and China.

One important point that isn't being noticed (or isn't being given sufficient importance) is that three of the G7 economies are going to have severe fiscal tightening in 2007 to accompany high oil prices and raised interest rates (Japan, Germany and Italy).

So the machine isn't going to be pulled in this direction. This tightening isn't, as Rogoff suggested frustrating, it is, unfortunately, entirely in the logic of things since these three economies have lived through the good times of this upswing with sustained fiscal deficits, and their budget liabilities with their aged populations mean that some time or another they have to change course. At least for the time being the plan is to change course in 2007 (this may, of course, be revised in the face of inclement weather).

But the big underlying issue is that these elderly economies cannot sustain strong internal demand, and can only live by trade exports and by the export of capital which is a spin off of the high savings rates. (In the case of Italy this is less clear, since the trade surplus has collapsed, but the gap is currently being made up by cheap finance from the eurosystem which goes to pay for Italian government spending).

Anyway, the real probem as I see it is this one. Most of the developing countries need to be export driven, and when they are not buying raw materials and equipment they will have an in-built tendency towards deficit during the development process. At the same time the elderly part of the G7 needs to run surpluses for quite other reasons. So this leaves us with very few countries to balance the books. The UK is undoubtedly one that can run a deficit, France could too, but the big big customer is undoubtedly the United States.

And this is the importance of the argument about housing, since if people stop recycling equity then demand for goods from abroad is likely to drop. This can then have a whole domino impact across the global economy, which far from encouraging investment in the US to take up the slack can have exactly the opposite effect as companies across the globe slash prices to offload unwanted excess output, thus discouraging further investment in the US. The recent surge in capital investment in Japan should fill one with a little foreboding in this regard. As should the recent marked fall in machine orders in Japan serve as a warning.

French Industrial Output Also Falls

Well, the picture is getting clearer:

French Industrial Output Unexpectedly Falls in July

French industrial production unexpectedly fell in July for a second month as manufacturing of cars and electronics gear slumped.

Production at factories, utilities and mines fell 1.3 percent from June, Insee, the national statistics office, said today in Paris. Economists expected an increase of 0.3 percent, the median of 28 forecasts in a Bloomberg survey shows. The June figure was revised to a decline of 0.1 percent from unchanged.

Economic growth in France and the dozen countries sharing the euro may be cooling, as oil prices near record highs and the euro's appreciation dent purchasing power and exports. Europe's third-largest economy expanded at the fastest pace in more than five years in the second quarter, driven by corporate investment amid higher European demand.

China's Trade Gap Widens

Meantime China's trade gap continues to widen:

China's trade surplus rose to a record for the fourth straight month in August, adding pressure on Premier Wen Jiabao to let the yuan gain faster.

The gap widened to $18.8 billion last month from $14.6 billion in July, the government-run Xinhua news agency reported, citing the Beijing-based customs bureau. The figure brings the trade surplus so far this year to $95.7 billion, compared with a gap of $102 billion for the whole of last year.

China's ballooning trade surplus is flooding the economy with cash, hampering government efforts to rein in lending and investment. With the gap set to top last year's record $102 billion this year, Wen may be pressed to let the yuan rise faster to slow money inflows and avoid U.S. trade sanctions.

``China appears to be running out of effective tools'' to slow growth, said Charlene Barshefsky, a former U.S. Trade Representative and now a senior international partner at law firm WilmerHale in Washington. A more flexible exchange rate would be ``an effective and efficient means of cooling the economy and placing China's growth on a robust and sustainable course.''

Well, China may be running out of effective tools to cool off, but if the demand for its export products worldwide takes a serious knock, then that should cool things off a bit, unfortunately. Inflation, what inflation??

Japan Machinery Orders Slump

Wow, get this from Bloomberg today:

Japan's Machinery Orders Drop Most in Almost 20 Years

Japan's machine orders fell the most in almost 20 years, dashing expectations that the central bank will raise interest rates before the end of the year.

Non-government orders excluding shipping and utilities dropped a seasonally adjusted 16.7 percent in July from a month earlier, the largest slide since October 1986, the Cabinet Office said today. Orders from semiconductor, steel and mobile-phone businesses paced the drop.

``With risks over the U.S. economy looming large, we don't think the Bank of Japan can raise rates'' before March 31, said Yoshimasa Maruyama, an economist at BNP Paribas Securities in Tokyo. ``While part of the drop is a correction from several months of strong data, this was still a considerable decline.''

Today's drop ``is payback for strong orders in recent months,'' said Itsushi Tachi, director of business statistics at the Cabinet Office. ``The trend is for growth.''

The government forecasts machinery orders will increase 4.9 percent in the quarter ending Sept. 31.

``To reach this target, we need growth of 16 percent in August and September,'' Tachi said.

I will write and post more on this as and when I have some time. For now I would just point out that on both this and the German front I have long forseen what was going to happen and in a certain sense the data is now 'coming home to Daddy', although I can't say that this makes me especially happy: I would prefer to have been wrong.

More fuel on the fire will definitely comes from this news last Friday in the US:

"The Federal Reserve reported Friday that consumer borrowing rose at an annual rate of 2.8 percent in July, down from an increase of 7.3 percent in June."

"The slowdown was led by a sharp deceleration in credit card debt, which rose by just 3.4 percent in July after gains of 13.2 percent in June and 13 percent in May."
Associated Press

This is what we could call a second stage event, and now has all the hallmarks of a classic domino chain, although it still isn't clear how far it will reach (all the way to Shanghai??). I am not at all convinced that investment in the US will take up the slack given what we know about fixed capital investment in China, and given the way capacity in things like machinery and equipment has just been ramped up so much in Germany and Japan. As we can see, in Japan it is fixed capital investment that is being hit first.

So watch out everyone, 2007 could be a very complicated year.

Basically the whole Greenspan/Bernanke hand-over was bungled, they should have had one token pause back in November, then Bernanke wouldn't have had to prove his inflation fighting prowess so, and advance over what seems to have been a bridge too far. (I was in fact arguing this back then on this blog).

Also the central bankers collectively should carry some of the can, if what looks like it might happen actually does, since all this 'inflation fighting' jargon has really been quite stupid. As Rogoff has been arguing, what we really have is a change in the terms of trade.