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Friday, September 29, 2006

German Retail Sales

Well August retail sales in Germany don't look any too happy (and here).

The German consumer showed no sign of springing into life last month, despite the strong growth in Europe’s largest economy, official figures showed on Friday.

Retail sales in German were unchanged in August after a revised 0.8 per cent fall in the previous month, according to the Federal Statistics Office.

Sluggish consumer spending has long been the Achilles’ heel of Germany’s economy, dragging down the eurozone’s overall performance. But the latest figures surprised analysts who had expected a rise on the back of one of the strongest German growth performances for years in the first six months of 2006, powered by the country’s industrial sector.

Bloomberg suggests that the last quarter may be stronger:

``Retail spending growth looks to have slowed noticeably in the third quarter, which will contribute to a slowdown in economic Growth,'' said Sandra Petcov, an economist at Lehman Brothers International in London. ``But we do expect spending to pick up in the fourth quarter ahead of the VAT increase.''

But isn't that just the point, if they pick-up before the rise, what will they do after it? Actually the 'disappointment' may come from the fact that people expected more bounce before the VAT rise, and not getting it makes next year look even more complicated.

Also, according to the FT, and tucked away at the bottom, unemployment in France seems to have risen ever so slightly:

"Separately, France reported an unexpected rise in unemployment in August. The jobless rate rose to 9.0 per cent in August from 8.9 per cent in July."

This is not deeply significant, but again it is hardly good news. The French economy is consistently outperforming the German one, and the whole prognosis there is different. France may slow, but I doubt they will have a recession in 2007.

Japan: Good News or Bad?

The presentation of the latest set of industrial production figures from Japan is interesting. The consensus is basically upbeat (and here). But read between the lines and things aren't so clear. And if you look at my post here, Japan certainly seems to have been slowing for the best part of a year now.

As Bloomberg have it:

Japan's industrial output rose to a record last month and inflation accelerated, giving the central bank room to raise interest rates by the end of the fiscal year in March.

An index of production climbed 1.9 percent from July, led by autos and electronics output, the trade ministry said in Tokyo today. Core consumer prices, which exclude fresh food, gained 0.3 percent from a year earlier, the statistics bureau said. Both results were in line with economists' expectations.


Still, prices excluding food and energy, which haven't risen in eight years, continued falling last month, signaling recent gains in core consumer prices have been largely the result of rising oil costs. Prices excluding food and energy fell 0.4 percent from a year earlier, the statistics bureau said.

``August was the month when energy pressure peaked. We have already seen gasoline prices weaken,'' said Hiromichi Shirakawa, chief economist at Credit Suisse in Tokyo, predicting that core prices may resume declining by the year's end. ``That's a very tough situation for the central bank -- it's only energy pushing up the consumer price index.''

Core prices in Tokyo, home to one in 10 Japanese and a harbinger of Japan's nationwide consumer prices, were unchanged in September from a year earlier. Tokyo prices excluding food and energy fell 0.3 percent this month.


Today's factory output report showed that production, shipments and inventories of electronic parts and devices all rose to a record in August. A slowdown in global growth may pose a risk for production in the coming months.

``A potential risk is inventory accumulation in electronics parts and devices in anticipation of Christmas sales,'' said Morgan Stanley's Sato. ``This may result in unplanned inventory accumulation due to lower foreign demand.''

Japanese manufacturers cut output in 2004 when global demand for electronics and chips slowed, causing the economy to contract in the fourth quarter and almost pushing it into recession.

Interesting isn't it, the way you can 'spin' data.

Citigroup: The Next Move in US Rates Will Be Down

Citigroup have just revised their forcecast: the next move in US interest rates will be down. This is a far cry from just a month ago when the debate was focused on whether there would be a pause or a rate rise. It also fits in with my own personal 'call' made earlier this week.

The Federal Reserve will probably lower its benchmark interest rate in the first quarter of 2007 as slowing economic growth diminishes inflation pressures, according to economists at Citigroup Inc.

The biggest U.S. bank by assets previously forecast the Fed would keep its target rate for overnight loans between banks at 5.25 percent through June. The bank now predicts a quarter- reduction by March, with the Fed holding the rate at 5 percent through September.

Mounting signs of a slowdown in the U.S. economy spurred Treasuries to rally this quarter and bolstered investor confidence that the Fed has finished raising rates. The Fed on Aug. 8 halted a two-year campaign of lifting rates, stating that slower growth was likely to damp inflation. Two-year note yields are heading for the biggest quarterly drop since 2002.

``The U.S. economy currently is in the most intense phase of its downdraft, due to plunging housing construction,'' Citigroup Global Markets analysts, including Todd Elmer in New York, wrote in a report to clients yesterday. ``The cooling in demand should reduce inflation risks sufficiently to open a window for a token easing early next year.''

Brazil's Rising Currency

Voices are frequently raised these days urging China to let its currency float upwards. In principle I don't disagree, although I think the timing of this is an important issue. 2007 may well be a hard year all round, and I can well understand the Chinese reticence. Here today is a salutory little tale about the Brazilan shoe industry. The Brazilian Real has risen by 60 per cent against the US dollar since January 2002. This is part of global 'rebalancing' but it is not without its attendant difficulties as the shoemakers point out. We need to remember that these are all developing economies, and that everything is not always either black or white here. In the longer run it is in everyone's interest that the developing economies 'develop', and a certain amount of patience is called for.

“We are suffering in an incredible manner,” says Jorge Luiz Faccioni, vice-president of the Novo Hamburgo association of trade and industry.

The immediate cause for complaint is the exchange rate. The Brazilian Real has advanced by 60 per cent against the US dollar since Mr Lula da Silva took office in January 2002. This has eroded the competitiveness of Brazil’s exports and made its products vulnerable to cheap imports at home – especially from emerging low-cost producers such as China.

The exchange rate, ironically, is a result of an export boom over the past four years. Brazil’s trade surplus will exceed $40bn (€32bn, £21bn) this year for the second year running. But, increasingly, exports are being driven by demand – from China and other faster-growing economies – for raw materials such as iron ore with little or no added value.

The impact on manufacturing industry is potentially devastating. “We are destroying our value-added export industries,” Mr Faccioni says. “If we don’t find a solution, we will see the deindustrialisation of Brazil.”

This is particularly frustrating for the footwear industry because Brazil’s shoe makers are among the most technologically advanced in the world. Companies have invested heavily in modernisation over the past decade and many have relocated part of their production to Brazil’s less developed north-east to save on labour costs.

But such efforts have been undermined by the exchange rate. Exports of shoes fell from 212m pairs in 2004 to 189m in 2005. From January to August this year exports were down 11 per cent from last year’s level.

Many in the industry are demanding direct action on the exchange rate, either in the form of capital controls on short-term money entering Brazil to take advantage of its very high interest rates, or through central bank intervention in the foreign exchange market.

Japan: Bulls or Elephants?

Lex has a column on Japan in the FT today. Basically it reflects the growing attention which is likely to be focused on Japan's fiscal situation. One interesting point which can be seen in the graphic he provides is the fact that Japan seems to have peaked in early 2005. This may be the longest running expansion Japan has had in many a long year, but we definitely seem to be in the downswing at this stage. Which makes you wonder about all those 'recovery' arguments we had earlier in the year.

Lex is also right to draw attention to all the uncertainty which there is about the level of the debt. He suggests that it may be as low as 90% if you take into account accumulated assets in the social security fund, although some argue that if you take that into account then you also need to consider the acquired liabilites (all the pensions yet to be paid) and then you end up with something in the region of the 'official' 175% figure.

The numbers don't seem to be the important issue. The important issue is the sustainability of this moving forward.

And don't miss the fact that he gets the main point, namely that "nominal growth could slow as Japan’s workforce shrinks more quickly."

The news that Japan will soon enjoy its second golf course flotation since 2004 should warm the hearts of bulls. Whether Shinzo Abe’s ascent to prime minister this week should do so is less clear. During the tenure of Junichiro Koizumi, his predecessor, the scourges of bad debt, deflation and abysmal confidence were largely overcome. Unfortunately, in spite of slaying post-bubble Japan’s dragons, Mr Koizumi left behind an elephant in the room: the level of public debt.

This can be exaggerated. Gross public debt is a catastrophic 175 per cent of gross domestic product. But deducting substantial financial assets held by the state, but excluding central bank assets, leaves net debt at 90 per cent of GDP – lower than Italy, a fellow fiscal reprobate. And any government which can borrow 10-year money at a rate of 1.66 per cent cannot be said to face an imminent fiscal crisis. Mr Abe’s new cabinet confirms that he prioritises growth over lower debt. Koji Omi, finance minister, a proponent of higher consumption taxes, has said that this revenue-raising measure is off the agenda until after the July 2007 upper house elections.

And in the longer term? As cabinet secretary, Mr Abe signed up to Mr Koizumi’s July plan to eliminate the primary deficit (that is, before interest payments), currently 4 per cent of GDP, by 2011/12. Aside from the leisurely pace and, arguably, the lack of detail, there is one big objection: a primary balance may not be enough to lower net public debt relative to GDP. By 2011/12 the level of gearing will have reached about 100 per cent. For it to fall, the state’s effective net cost of borrowing must be lower than nominal GDP growth – today, at 1.5 per cent, it is at least 50 basis points below. But low real interest rates may well rise, while nominal growth could slow as Japan’s workforce shrinks more quickly.

China Enters The Fusion Club

This is fascinating. The shape of things to come?

Scientists on Thursday carried out China's first successful test of an experimental fusion reactor, powered by the process that fuels the sun, a research institute spokeswoman said.

China, the United States and other governments are pursuing fusion research in hopes that it could become a clean, potentially limitless energy source. Fusion produces little radioactive waste, unlike fission, which powers conventional nuclear reactors.

Beijing is eager for advances, both for national prestige and to reduce its soaring consumption of imported oil and dirty coal.

The test by the government's Institute of Plasma Physics was carried out on a Tokamak fusion device in the eastern city of Hefei, said Cheng Yan, a spokeswoman at the institute.

China is a partner in the ITER reactor, along with the European Union, the United States, Japan, Russia, India and South Korea.

A Tokamak reactor uses a doughnut-shaped magnetic field to contain the hot gas.

Several countries have produced plasma using a Tokamak or similar device, said Gabriel Marbach, deputy head of fusion research at the ITER facility. He said producing plasma was only one step toward the fusion that ITER aims to perform, and that the project could be helped by the Chinese experiments.

"It was important for China to show that it is part of the club, and that adds value to its participation in ITER," Marbach said.

In an unrelated, but equally interesting, piece of news Vodaphone have announced they are about to launch a 3G 'own brand' handset, and guess who is doing the manufacturing, why China's Huawei, of course.

Vodafone has joined the own-brand phone club, launching the first device to bear its name today.

The 3G clamshell device, the Vodafone 710, is manufactured by Chinese hardware company Huawei and will be sold across Europe from early next month. A Vodafone spokesman declined to give pricing details, although the phone is likely to be aimed at the lower end of the market including pre-pay.

According to Vodafone, the device is designed to encourage consumers to try out new data services, including its mobile telly and radio services and portal. Data services have become the next great white hope for the operators to boost their ARPU (average revenue per user) although UK networks continue to struggle with encouraging users to take up services beyond SMS and MMS.

Vodaphone recently launched a flat-rate broadband internet connection here in Spain, and next month I am planning to test out the service. The experts say we spend far too much time indoors, so if this works I will be blogging this winter from my own little 'secret spot' in the Gaudi (Güell) Park here in Barcelona, since the park is just a brisk ten minute walk from where I live.

Thursday, September 28, 2006

2nd Quarter US GDP

OK, well now it's official really: the US economy is slowing. But that still doesn't tell us how far or how fast. We just have to watch and wait.

U.S. economic growth slowed to a weaker-than-expected annual rate of 2.6 percent in the second quarter, reflecting a slackening in business spending, consumer demand and homebuilding that may carry into 2007.

The gain in gross domestic product, the value of all goods and services produced in the country, compares with the government's 2.9 percent preliminary estimate last month and follows a 5.6 percent pace in the first three months of 2006, the Commerce Department said today in Washington. A measure of inflation eased from the government's prior estimate.

Italian Economy Watch Revamped

The Italian Economy Watch Blog has just been given a facelift. Almost literally, since we now have two new faces who are about to start posting. Below is the latest piece which I have just put up. Don't miss the part about Japanese debt which is worked into the middle section.

The Battle Is About To Commence

The FT this morning has a piece about the looming battle over next years budget:

Romano Prodi, Italy's prime minister, struggled on Wednesday to keep intact his planned deficit-cutting 2007 budget as moderates and leftwingers in his ruling coalition fought each other over his proposals to slash public spending.

Communists and other radicals insisted they would not endorse cuts in expenditure on schools and local government, while centrists voiced concern that the budget was drifting in the direction of higher taxes rather than spending cuts.

Bloomberg also covers the story.

As the FT also points out:

Italy's budget, due for cabinet approval on Friday, is the country's most important since it joined the eurozone in 1999, because the nation's public finances and international competitiveness have significantly deteriorated over the past eight years.

So 2007 is going to be a very hard road for Italy to travel. In some ways the moment of truth time is coming. Again the FT:

"Italy remains at risk of seeing its sovereign debt downgraded by credit rating agencies if its forthcoming budget is not rigorous enough."

Really it is very hard to just at this stage the importance of this threat. Much more than the credit rating agencies it is the response from the ECB which will be important if Italy fails to keep to the terms of the new version of the Stability and Growth Pact. Last year, we should remember, the ECB asserted that it would not accept government paper (bonds) in the future from any country which has not maintained at least an A- rating from one or more of the principal debt assesment agencies. So the threat may not be a hollow one, since if the ECB stop treating Italian paper at par, then this could easily, in and of itself, send Italy off on a default path.

These are not little issues.

Precisely for this reason I am rather sceptical that the ECB would be in any rush to actually carry out its threat. News from Japan though suggests that the climate may be changing. Japan, as is reasonably well known, also has a rapidly ageing population and a large government debt problem. In principle Japan was programmed to take some important steps (like Germany) to begin to correct the situation. The election of Shinzo Abe as prime minister has begun to put question marks over this process, and Standard and Poors have not been slow in reacting:

Japan may slow the pace of fiscal reforms under its new Prime Minister Shinzo Abe, ratings agency Standard & Poor's said on Wednesday, a day after he formed his new cabinet with a "no growth, no fiscal consolidation" policy.

The ratings agency questioned Abe's preference for growth policies over fiscal consolidation, saying his stance may lead to a deceleration of the pace of fiscal consolidation.

S&P currently has a positive outlook on Japan's rating.

But the direction of the sovereign rating depends largely on Abe's government's ability to pursue public sector reform pushed by his predecessor, the agency said.

"The two biggest constraints on the rating are Japan's fiscal position, which though improving remains weak, and its outstanding debt," said the report.

"Critical factors are therefore the pace of fiscal consolidation, the stability of the Japanese government bond market, and interest rates," it said.

Citing Japan's aim to achieve primary account balance in fiscal 2011 through spending cuts and revenue increases, the agency said how the new government meets the target is a major issue for the future direction of the sovereign rating.

So I would say that the issue of sovereign debt is now well up and over the radar, and that the agencies will be serious about downgrades.

The big problem is that EU institutions cried wolf for so long about the Stability and Growth pact that they have been left with a credibility problem. This has been doubly undesireable since it meant that during the relatively good years of 2002-2006 many countries were running deficits when they should have been aiming for balance or even - god forbid - surplus. Now the headwind may have changed, and may well be about to turn negative. The next two or three years ,may well be much harder than the last two or three.

I know that this view seems to go against the prevailing wisdom, but frankly many of the people making the 'euro growth engine call' simply haven't been thinking about the demographic dynamics of the situation. Claus Vistesen has been admirably covering all this, and a very useful point of entry is this post.

So the real question we are left with is what exactly is to be done? This is a very hard question, and I don't have any simple answers handy in my back pocket to pull out at the appropriate moment. Clearly Italy needs to move onto a sustainable fiscal path. It also needs to attach itself firmly to the EU Lisbon Reform agenda, and generate a consensus among the Italian population that the reforms are needed by getting across to the Italian people just why they are needed.

Naturally the political class in Italy isn't exactly an asset here.

Immigration undoubtedly forms another part of the picture, but this immigration (which is largely unskilled) needs to be coupled with an expanison of the high value services and new technology business sectors, so that a labour market environment can be created where the best of Italy's young talent can find work appropriate to their abilities, and thus help pull Italy out of this mess.

Over the summer I saw a film from the Italian director Paolo Virzì entitled Caterina va in città. The plot is summarised as follows:

When her father, Giancarlo (Sergio Castellitto) is transferred to Rome from the small country town of Montaldo Di Castro, Caterina (Alice Teghil), a 12 years old girl, discovers her new classmates, a totally new world, an ambient extremely divided politically. She starts developing her friendship with the "left side", represented by Margherita(Carolina Iaquaniello), and the right, Daniela (Federica Sbrenna) side of her class. She will lose herself, without knowing who she really is.

This is the problem I think, an ambient which is extremely divided politically where young Italians do not know 'who they really are'.

German Unemployment Falls (slightly)

This is obviously good news:

German unemployment fell in September after companies stepped up hiring as consumer confidence reached the highest level in almost five years.The number of people out of work, adjusted for seasonal swings, fell 17,000 from August to 4.43 million, the Nuremberg- based Federal Labor Agency said today.The adjusted jobless rate held steady at 10.6 percent.

OTOH the drop is small, unemployment is still very high, and the situation is a deceptive one:

An increase in construction fuelled German growth in the second quarter of 0.9 percent, the highest in five years. German builders, doubling their outlook on Sept. 20, expect sales to grow 2 percent this year after a decade-long slump.

And just why has there been this burst of construction activity:

Chancellor Angela Merkel's plan to raise sales tax and curb some consumer tax breaks as well as slowing world growth cloud the outlook for 2007. The government plans to raise value- added tax to 19 percent from 16 percent to cut the budget deficit and reduce unemployment insurance premiums.

The increase of VAT will add 3% to the cost of houses purchased in 2007, so in large part this is economic activity which is being brought forward from 2007 to 2006. This years gains will be next years losses. This is why the German outlook remains a difficult one, expecially since it looks like the ECB will now have little alternative other than to keep raising interest rates.

Corporate Borrowing in the Eurozone

This is going to be an additional headache for the ECB:

Eurozone corporate borrowing grew last month at its fastest rate since the euro’s launch in 1999, and money supply figures watched closely by the European Central Bank also accelerated, strengthening the case for another interest rate increase next week.

The unexpectedly buoyant money supply and lending data released by the ECB on Wednesday highlighted the strength of economic activity in the 12-country eurozone, especially in the corporate sector, which is undergoing a wave of merger and acquisition activity. “They’re consistent with a positive frame of mind – by consumers and corporates. People are happy to take on debt,” said Michael Dicks, economist at Lehman Brothers.

This is because, as the FT suggest, it puts them under pressure to continue raising interest rates since:

the data will add to fears that still-low interest rates are encouraging excessive borrowing and creating longer-term inflation risks. The dangers of rapid credit expansion are likely to be cited by Jean-Claude Trichet, ECB president, after the central bank’s meeting in Paris next Thursday, when it is expected to raise interest rates by another quarter percentage point to 3.25 per cent.

Now this might all be fine and well were the borrowing to finance a new round of productive investment, but this may not be what is happening, what we seem to have is some kind of mergers and acquisition frenzy (especially in the energy sector) and this, in fact, is making the rating agencies nervous:

The huge increase in Eon's offer raised questions about the German group's financial discipline. German utilities gained a reputation in the previous round of consolidation for overpaying but Eon changed investors' opinions when it walked away from a bid for the UK's Scottish Power last year.

Standard & Poor's, the rating agency, said Eon's AA ratings remained on watch negative. A rights issue of up to 10 per cent could be possible depending on how much over the 50 per cent acceptance level a bid reached.

And please don't miss this one:

European investors who lend in leveraged buyouts face greater risks as borrowers chip away at creditor rights, Standard & Poor's said in a report.

Buyout firms who borrow to fund acquisitions are offering investors less protection against default as they rewrite loan documents in their favor, S&P said in the report entitled ``Ratcheting Up The Risk.''

Weaker loan contracts let companies cut their debt at a slower pace and give lenders fewer voting rights in the event of a bankruptcy, S&P said. Borrowers also have to set aside less cash to prepay their loans. At the same time, interest margins to compensate investors for taking greater risk have declined, S&P said.

``Financial sponsors are now able to borrow more and repay less, with fewer restrictions and for lower cost,'' S&P's report said. With demand for loans rising, companies will be tempted to weaken contracts even more and ``further erode lenders' rights.''

The survey covers 12 financing agreements for five borrowers including German chemicals distributor Brenntag Holding GmbH, British petrochemicals company Ineos Group Holding Plc, and Cablecom Holdings AG, the Swiss cable-television provider owned by Liberty Global Inc.

S&P cut its debt ratings by an average of one step on companies in the survey that amended their financing agreements following a refinancing.

Rising demand from investors has prompted buyout firms and borrowers to ``push the boundaries of transaction size and financial leverage,'' S&P said.

So what we may face moving forward is a eurozone which is slowing and a central bank which keeps raising rates to stop excess corporate spending and increasing credit default risk. Not an easy picture, and certainly a connundrum.

Monday, September 25, 2006

The Eurozone Is Slowing

Despite all the apparent optimism you can find round and about, the Eurozone is in fact slowing, the latest industrial output data from France seem to make this abundantly clear. What I find hard to understand is how so many people can have been wrong-footed on this. Claus Vistesen has a useful review of the arguments on the blogs, and New Economist has also been suitably cautious, but the rest seem to have missed the big picture. (Just as they have done with Japan really).

The worst offenders are definitely over at Morgan Stanley. Steven Roach leads the way, but Eric Chaney isn't far behind. And Brad Setser - and in particular his guest poster Charles Gottlieb of the Center for European Policy Studies (CEPS also seems to be way off target here) - seems to have fallen hook line and sinker.

Are we all putting our credibility on the line here gentlemen?

French Business Confidence Falls After Output Drops

French business confidence fell in September from a five-year high it reached in July, after industrial output declined.

Insee's index of sentiment among 2,000 manufacturers in Europe's third-largest economy dropped to 107 from 109 in July, the national statistics office said today in Paris. Economists expected the index to fall to 108, according to the median of 22 estimates in a Bloomberg News survey.

``This summer hasn't been that good, and things aren't as exuberant as they were in the first quarter,'' said Laurence Boone, a Paris-based economist with Barclays Capital. ``As we go towards the autumn, confidence is weakening.''

France's economy, which expanded at the fastest pace since 2001 in the second quarter, may be cooling as the cost of oil and the euro's gain against the dollar threaten purchasing power and exports. There already are signs growth in Europe has peaked after the European Central Bank raised its key interest rate four times since early December. Slower U.S. growth may also damp demand.

``According to entrepreneurs, past business has slowed down in the manufacturing sector,'' the report said, with orders from abroad thinning. Executives from the car industry remain the most pessimistic, the survey showed, after automobile production fell 1.4 percent in July.

French industrial production unexpectedly fell for a second month in July as manufacturing of cars and electronic equipment slumped, adding to evidence that economic growth may slow.

Incidentally, this Bloomberg piece is another classic example of how to get it wrong:

Europe, Japan Wean Themselves From Dependence on U.S. Consumers

Europe, Japan and emerging economies around the world are weaning themselves from dependence on the American consumer, and economists say it's just in time.

Demand in the world's largest economy is slowing as the U.S. housing market falters, a development that the International Monetary Fund on Sept. 14 called a key risk to global expansion. If so, it's a risk that the biggest exporting nations are better prepared to weather now than five years ago.

``Domestic demand in so many other parts of the world is picking up,'' says Jim O'Neill, head of global economic research at Goldman Sachs Group Inc. in London. ``If there ever was a good time for the U.S. to slow, this is it.''

Wishful thinking is not a substitute for sound economic analysis.

Woffgang Munchau

"In an environment of rising global inflation I would expect the euro to become increasingly important as a global reserve currency.....

Thus writes Wolfgang Munchau in today's FT. Well, well, not a man to mince his words:

Rest assured, the eurozone will prove its durability

The long-term viability of the eurozone has become a hotly debated topic. The blogs are full of it. The latest contribution comes from the London-based Centre for European Reform in the form of a pamphlet entitled: Will the Eurozone Crack?

My own prediction: it is the critics who will crack first.

What follows is now updated based on the full version of Wolfgang's piece which is avaialable here.

The debate on the blogs which he mentions was adequately covered by Sebastien Dullien here (and here and by me here).

Essentially Wolfgang makes 2 points:

1) That the Zone itself will not disintegrate:

What are the circumstances under which the eurozone could disintegrate? In practice, that would happen only if either Germany or France decided to quit. A departure by Italy or Spain, or both, would not suffice. However, it is extremely difficult to construct even a purely theoretical scenario under which it would make sense for France or Germany to reintroduce national currencies. A decision to quit would never pay off for the quitter in the short run. The administrative costs would be crippling, financial markets would be in turmoil and the quitter would almost certainly have to pay higher risk premiums on its bonds.

Now at this point it is worth bearing in mind that the target in his article is the the London-based Centre for European Reform who published a pamphlet entitled: Will the Eurozone Crack? The centre is strongly 'eurosceptic' and is grinding axes, so in this sense it is a long way from the actual debate which took place on the blogs, which was much more focused on the specific situation in which Italy finds itself.

Basically I completely agree with Wolfgang on the big picture story. It is extraordinarily unlikely that the Zone itself will disappear. There is however a secondary problem which Wolfgang doesn't consider which is what would happen if Germany hits ongoing deflation (a la Japan). This is not an entirely unconceivable outcome since it was clearly the German economy which was most at risk last time we were on deflation alert. Now in this case the ECB ought to follow a Japan-style zero interest rate policy, but this does leave us with the issue of how this would affect France, Spain, Ireland etc. No easy answer here.

2) The possibility that Italy might leave. Wolfgang is certainly much more guarded here, and in fact he doesn't exclude this possibility:

whether it is conceivable that one or more member countries could leave the eurozone without destroying the monetary union. The answer is yes, it is conceivable, but I would not bet my life savings on it. The second question is whether monetary union itself could collapse and member states revert to national currencies. My answer to that question is unequivocal: no, forget it.

Most hypothetical exit scenarios involve Italy, which has suffered from a large and persistent loss of competitiveness, as measured by the real exchange rate. So what would happen if Italy left or was forced out? Do not believe anyone who claims to know the answer. There is no script for such an event. In particular, it is not clear whether a country that left the eurozone would also have to leave the European Union.

Again I agree with him. No-one knows where this would lead us, although we can make some intelligent guesses. Even though it is not clear, I doubt in the extreme that Italy would leave the EU. That I really do find inconceivable, and there would be no evident necessity since, remember, 13 of the current members of the EU are already outside the zone.

Migration One More Time

This article from Stefan Wagstyl in the Financial Times contains some interesting thoughts:

Global shifts are driving immigration. The weakening of border controls following the end of communism are, along with economic globalisation and the spread of low-cost air travel and telecommunications, all playing their part. But increased immigration has also sharpened debate about its effects. Supporters cite the benefits of low-cost workers who ease skills shortages. Critics warn of the impact on low-paid natives, public services and national identity.

The recent history of migration shows, however, that those global forces are very powerful - and hard for governments to control. The net inflow into the UK reached 235,000 in the year to mid-2005, up from 47,000 in the first year of the Blair era. The population exceeded 60m for the first time and is set to grow further, driven largely by more immigration.

Labour has sought to allay national anxieties while meeting economic needs. It has in effect kept the door open to migrants from Europe but restricted access to non-Europeans by cracking down on illegal migration and asylum. Nonetheless, the biggest inflow over the past decade has come from the Commonwealth - especially India, Pakistan, Bangladesh and Britain's former African colonies. These traditional flows have been boosted by new waves not only from eastern Europe but also from north Africa and war-ravaged countries such as Somalia.

The European Union's 2004 enlargement eastward prompted a particularly sharp surge. According to the Home Office, 427,000 registered to work in the UK between May 2004 and June 2006. The total number could be as high as 600,000 once the unregistered are counted. However, east Europeans, unlike those from further afield, will not necessarily settle. As Cezary Olszewski, a Polish-born businessman who is setting up a network of financial services centres for the newcomers, says: "If you ask people how long they will stay, they say they don't know."

Migration has increased the number of foreign-born residents by 30 per cent in a decade to more than 5m - or nearly 10 per cent of the population, not counting some 250,000-500,000 illegal migrants. In London, which has the world's biggest concentration of immigrants, the foreign-born number about 30 per cent. However, the east Europeans are more willing than previous migrants to go outside the capital: Polish workers have become a commonplace sight on Norfolk farms, in Scottish bars and at Cornish hotels.

While employment is the main driver, for non-European immigrants asylum remains a big access route. Of the 179,000 from beyond Europe who were last year granted permission to to live in the UK, 69,000 were asylum-seekers and their dependants. New asylum claims declined following a government crackdown but the total was boosted by officials clearing a backlog.

Debate is growing about migration's economic impact. The government trumpets the advantages and estimates migrants have added 0.5-1 percentage points annually to growth in gross domestic product. Those who are liberal on the issue say migrants, generally healthy young people, contribute more in tax than they consume in public services - and fill skills gaps. For example, 30 per cent of the country's doctors are foreign-born. Danny Sriskandarajah, a migration specialist at IPPR, a pro-migration research group, says: "Far from being a burden, immigrants are vital to the publicservices."

However, for the migration control lobby this ignores low-paid native-born workers. Robert Rowthorn, a Cambridge University economics professor, has written: "Large-scale immigration of unskilled people may be beneficial for urban elites who enjoy the benefits of cheap servants, restaurants and the like, but it is not to the economic advantage of those who have to compete with these immigrants."

Obviously all of this is the debate of the moment. What I think is important is that people are fully informed about the importance and significance of the decisions involved. People's identities are not infinitely flexible, and there are limits to the rate at which they can change. But at the end of the day everyone is faced with one of those 'classic trade-offs', between just how much you value conserving one part of your traditional identity, and just how much you want to conserve sustainable pensions and living standards for yourself and your children.

Is The Deflation Alert About To Sound Again?

Using a footballing analogy, all the economic defences seem to be 'ballwatching' at the moment, and looking at the inflation issue. But the recent fall in oilprices, and the developing slowdown seems to be resurrecting a danger that many felt was long dead: deflation.

Look at this from Singapore:

Singapore's inflation rate fell to an 11-month low in August as a stronger currency made fuel and other imports less expensive.

The consumer price index rose 0.7 percent from a year earlier after gaining 1.1 percent in July, the Department of Statistics said in a statement today. That was less than the median 0.9 percent forecast in a Bloomberg News survey of 13 economists. From July, consumer prices were unchanged.

The Singapore dollar's 5 percent gain against its U.S. counterpart this year, the fifth-best performing of 15 Asia- Pacific currencies tracked by Bloomberg, is helping cut the cost of oil and other imports. That may prompt the city-state's central bank next month to extend its 2 1/2-year policy of allowing a ``gradual and modest'' appreciation in the currency.

``We are seeing less upside in fuel and utility costs,'' said Song Seng Wun, an economist at CIMB-GK Research in Singapore. ``The currency policy effectively keeps imported inflation minimal.''

and while the most recent EU data is still not out, Inflation in Germany does seem to be falling fast:

German inflation is expected to fall sharply in September as a result of declining petrol prices and base effects related to last years increase in energy prices after Hurricane Katrina, said Ken Wattret of BNP Paribas.

"Be prepared for a striking drop in inflation in September" Credit Suisse economists said.

Consumer prices data from key German states are due in the early part of the week and economists said they are likely to show a month-on-month fall of 0.2 pct in both the CPI and HICP measures. This will cut the CPI year-on-year inflation rate to 1.2 pct from 1.7 pct and the HICP rate to 1.3 pct from 1.8 pct.

Of course this is why the emphasis on 'core inflation' is so important, but still, more 'sudden drops' in German inflation will certainly not be good news.

Thinking Out Loud

I think one of the great virtues of blogging is that it allows you the possibility to say what you would normally only think. Here's an example of something which went across my mind at the weekend.

Basically, using back-of-the-envelope type rough-and-ready, rule-of-thumb, estimation procedures, I had the period 2012 - 2015 pencilled in as the time when push would really come to shove in the most demographically challenged economies - Italy, Germany, Japan and the Eastern European 'Lynxes'. However, working backwards from the solution leads me to think we may be in for choppy water rather sooner.

Basically the odds of a recession in these economies in 2007 are now around the 50:50 mark. But if we have a recession in 2007/2008 then the next growth cycle (which could well be a strong one as China consolidates, and India, Turkey and Brazil come fully online) could run through to 2014/2015. But we should be expecting trouble in the challenged economies sometime before this, which makes me ask myself whether the water is going to back-up-the pipes all the way down to 2008.

Everything really depends on expectations. Once financial markets twig that these economies have a problem, this will 'feed-forward' and impact well before the problem, left to itself, would normally become fully apparent.

As I say, just a thought, but certainly one to keep well in mind.

Difficult Times Ahead?

I have a post on Afoe about the dangers of contamination across Eastern Europe following the recent turbulence in Hungary.

Now one of the worries that must arise in these circumstances is whether a sudden downturn in some of these 'Lynx' economies could produce a haemorrage of you educated people outwards in search of work. If this were to happen this short-term crisis could have important long term supply-side consequences. Again, something else to watch for.

On this topic, the FT have details of an interview they had with Romanian Prime Minister Calin Tariceanu. Tariceanu is really at pains to re-assure Western Europeans (especially in the UK) that there will not be a sudden influx of Romanians after EU accession. My feeling is that the West Europeans have little to fear here (as he says the educated Romanians will head North, and the less educated ones will head South, and this doesn't seem to me to present any kind of problem). What he maybe should be considering is the impact of this on Romania itself: needless to say, in the current climate I think his growth expectations for the Romanian economy are way too high.

Romania dismisses EU emigration fears

Romania will win approval on Tuesday to join the European Union on January 1, but the country’s prime minister has denied that it will spark a massive wave of emigration from the Black Sea state.

Calin Tariceanu claims his country is in the middle of an economic boom that could see its gross domestic product double within 12 years, drawing migrant workers to Romania.

Speaking to the Financial Times, Mr Tariceanu also appealed to the British media and public – racked by a debate about the recent arrival of hundreds of thousands of migrant workers from Poland and other new EU member states – to remain calm: “People with higher educational levels might go to the UK but I don’t see too many.”

He said most poor Romanians would head to Italy and Spain, where they would have less trouble with the language, and only those with better schooling would go to the UK.

China and SOEs

As I keep suggesting, now is a very important time to have our fingers on the pulses, as it is clear that the global economy is slowing, while it still isn't clear how much it is slowing.

But in many ways it is a good time to hdge your bets a bit more. This is why the emerging markets are seeing capital outflow. Not entirely unexpectedly China seems also to be giving some serious consideration to how to weather the future. Resistance against short term flexibilisation of the currency would seem to be one indication of this, another comes in this news that:

More than 2,000 of China’s worst-performing state companies have won a stay of execution by being excluded from the country’s new bankruptcy law until the end of 2008.

Since the brunt of the slowdawn may well come in 2007 this would seem to be a pretty wise and perspicacious move. Of course the problem of Non Performing Loans and inefficient enterprises needs to be addressed, but next year may not be exactly the best moment to do this, and the Chinese administration seem to be aware of the fact. This is just one of the reasons I think China (and probably India) will weather the storm much better than most. Quite simply China is still a developing economy, and not yet a full-market one, and this has advantages at times.

Struggling China state companies win stay of execution

The move, aimed at cushioning the social impact on employees of financially strained state companies, will slow the disposal of bad loans held by state banks and distressed debt companies and perhaps also reduce buyout opportunities for foreigners.

The bankrupcty law, passed in August after more than a decade of debate, is seen as crucial stage in China’s reforms as it enables creditors and investors to weed out underperforming companies by filing for bankruptcy to recover at least part of their funds.

However, the law, which is due to come into effect in June 2007, will not apply to 2,116 state-owned enterprises considered at financial risk by the Chinese authorities until at least the end of 2008.

In an interview with the Financial Times, Professor Li Shuguang, one of the authors of the new law, said that for those companies, employees’ health and wage claims would still take precedence over creditors’ claims, an arrangement that had so far slowed restructuring in some sectors.

Estimates of the claims by state employees range from hundreds to thousands of billions of renminbi, China’s currency.

Oil Prices Continue to Fall

Oil has now dropped below the 60$ mark. This seems to be related with continuing downward revisions in the growth outlook:

Oil prices dropped below $60 a barrel Monday as commodity investors responded to high inventories and a lack of geopolitical tensions to sell, analysts said.

Light sweet crude for November delivery fell 60 cents to $59.95 a barrel in midmorning Asian electronic trading on the New York Mercantile Exchange.

Oil prices have dropped 23 percent since the middle of July, attributed to ample global inventories, eased worries about supply threats from
Iran and Nigeria, receding fears about this year's Atlantic hurricane season and as signs of economic weakness in the U.S. point to a possible softening in demand for energy.