Saturday August 11, 2012
Can the euro graduate into a full bee?
What Are We To Do
By TAN SRI LIN SEE-YAN
EUROPEAN Central Bank (ECB) president Dr Mario Draghi can be forgiven since he is neither English nor an entomologist when he compared euro's growing pains with the impossibility of flight by the bumble bee.
The ECB president was reported to have said: “The euro is like a bumble bee. This is a mystery of nature because it shouldn't fly but instead it does. So, the euro was a bumble bee that flew very well for several years. And now I think people ask how come?' probably there was something in the atmosphere, in the air, that made the bumble bee fly. Now something must have changed in the air, and we know what after the financial crisis. The bumble bee would have to graduate to a real bee. And that's what it's doing.”
But it was his pledge to help in this transformation that attracted market interest: “The ECB is willing to do whatever it takes to preserve the euro and believe me, it will be enough.” Unlike politicians, markets do give deference to the ECB since it can match bold words with actions because of its powers to print unlimited euros. As to be expected, the very next day, Italian and Spanish bonds strengthened (Spanish 10-year bond yield fell below 7%, and Italian bonds, down to 6.03%); and the benchmark index for Italian stocks closed 5.6% higher and Spanish, up 6.1%.
Euro does not fly
Draghi's credibility was tested after ECB's recent meeting when he failed to deliver and soured market sentiment, in the face of German opposition to ECB's further purchases of sovereign debt, pushing Spanish 10-year bond yield back to 7.13% and Italian, to 6.3%. The euro hit as low as 1.214 against the US dollar. Safe haven German bunds however rallied, with 10-year yield at 1.25%. So, it does appear Draghi's bumble bee couldn't fly after all even though scientifically, it is established bumble bees can fly; but does not include a metamorphosis into some “real” bee. Be that as it may, it is unclear if the ECB will ever be transformed into a true central bank whether it can be eventually joined up in a currency, fiscal and banking union to overcome structural weaknesses in the current arrangement.
Draghi is right in pointing out that the growing gap in interest rates within the eurozone (with Greece paying 25% for 2-year money despite rock bottom ECB reference rates) reflects a malfunction in the transmission mechanism of monetary policy. Draghi labelled this: “financial-market fragmentation” which is threatening to undermine the euro as banks in one nation try to avoid dealing with banks in another.
Until 2011, 60% of money-market loans were made across borders. Today, it's only 40% and falling. So long as this persists, the eurozone will remain crisis prone.
Europe is now looking worse as the United States moves sideways. Unemployment in the eurozone hit 11.2% in June, the highest ever, bringing the total jobless to 17.8 million. But it hides vast divergences: from a low of 4.5% in Austria to a high of 24.8% in Spain. Eurozone activity fell at its steepest rate in July in more than three years, while export orders plunged despite a weakening euro.
The French economy contracted in the second quarter (2Q12) and is likely to slip into recession in 3Q12. Italy, the eurozone's third largest economy, is wallowing in recession, contracting further in 2Q12, its fourth straight quarterly decline. Spain's recession also worsened in 2Q12. In one of the starkest signs yet, German manufacturers suffered the largest fall in new export orders, indicating that Europe's powerhouse is now flagging. Manufacturing activity in both Germany and France fell at the fastest rate in more than three years.
Overall, economic sentiment in the eurozone fell to a near 3-year low in July as the bloc's economy deepened its slump and businesses became more pessimistic. Confidence had continued to fall, suggesting the slump is extending into 3Q12 as policymakers struggled to tame the euro and growth crises. Clearly, all macroeconomic indicators are pointing south: the gauge of sentiment among European manufacturers fell to -15 in June; the services confidence indicator dropped to -8.5, while the gauge of consumer sentiment slipped to -21.5. So much so Moody's Investors Service put a negative outlook on triple-A rated Germany, and borrowing costs from Spain to Italy surged to record highs, threatening the euro's survival. The euro had since depreciated 7.4% against the US dollar. With continuing fiscal austerity and debt reduction, eurozone as a whole is struggling amid its second recession in four years. The IMF has since cut its eurozone growth forecast for 2013 to 0.7%, expecting GDP to fall 0.3% in 2012.
Rising unemployment and growing pessimism about the future are grim evidence of how far the eurozone crisis is affecting ordinary people and the wider economy. Government spending cuts and tax increases aimed at stemming rising debt levels have combined with poor consumer and business confidence to spark widespread slowdown across the bloc. Already more than half-a-dozen eurozone nations are in recession. Expectations are for more nations needing a bailout. What's worrisome is Germany's weakening retail sales fell for the 3rd straight month in June. Consumers all over are retrenching as prospects sour.
Europeans are trading down to cheaper groceries, buying fewer big-ticket items and searching more for bargains online. The mood has also deteriorated in France where it is caught between trying to revive growth with major infrastructure spending and meeting EU rules to bring down the budget deficit. Private investors in France and Germany are holding back. Consumers prefer to save for the next rainy day. Eurozone investor sentiment fell for the fifth straight month in August amid ongoing worries about the bloc still in crisis. So long as the risk of a eurozone collapse remains a real possibility, private spending will not be forthcoming. Delay has become Europe's worst enemy.
US economy cools
The US expanded in 2Q12 at its slowest pace at a time when weakened labour market conditions prompted consumers to cut back on their spending. GDP rose by 1.5%, against 1.9% in 1Q12 (and 4.1% in 4Q11) as businesses became more cautious about spending and hiring as the economy lost more steam. Uncertainty and joblessness persist. Unemployment edged up to 8.3% although the private economy created 172,000 jobs in June. The slowing economy raises the possibility that any sudden shock including a major escalation of the eurozone crisis, could push the economy back into recession.
Meanwhile, the US Midwestern drought could slow down growth further and raise food prices, which make consumers stingier. Since then, big retailers had reported healthier sales in July despite private efforts to save more. House prices appear to have begun to turn up and recent house construction expansion looks sustainable. Automakers are also selling more. Of late, with interest rates so low, bank lending is rising lustily. But it's not enough.
Manufacturing new orders have since slowed. More than one-half of the counties in the United States are deemed disaster areas as the draught spreads. Overall, 5.2 million are still out of work for six months or more, and still looking. At July's rate of job growth, it will take more than eight years to get back to full employment. So, it's not surprising the Fed recently signalled its readiness to spur the anaemic expansion “as needed to promote a strong recovery and sustained improvement in labour market conditions.” Frankly, the Fed has used up most of its bullets. What's really needed is fresh fiscal accommodation, which it is unlikely to get in an election year. That's politics. Overall, the outlook for the rest of the year is not encouraging 3Q12 could be weaker than 1H12 amid slackening demand; US dollar strengthening will make it harder for exporters; and considering businesses have been stockpiling inventory in the face of sluggish consumption. Fed initiatives can only help. But markets are eager for quick and forceful action, and easily get disappointed if either doesn't deliver what's expected.
Sticky spell for Asia
This time around, emerging markets can no longer be relied upon to pick up the slack. Every major economic region is slackening in sync. At the last recession, China and India in particular provided strong support to shore up world demand. This will no longer happen as these nations face familiar problems of their own. In Asia, there are growing signs of slowdown almost everywhere. In China, slackening in manufacturing growth in July added to the broader ramp-down in the region. Manufacturing growth in India slowed significantly in July reflecting largely political paralysis; while South Korea, Taiwan and Vietnam experienced similar industrial contraction.
In South Korea (Asia's fourth largest economy), exports in July fell to its lowest in nearly three years and manufacturing activity shrank at its sharpest pace. The story is similar in Taiwan and Vietnam where the slowdown is compounded by poor domestic demand. Indonesia, South-East Asia's largest economy, experienced a pickup in manufacturing activity, but weak external demand widened its trade deficit significantly. GDP rose 6.4% in 2Q12 with robust domestic demand driving growth, led by the increasingly affluent middle class. In July, China reported its slowest growth at 7.6% in 2Q12, struggling to grow 8% for the whole year. For 2012, growth in Asia (outside Japan) would be 7.1%. The outlook has gotten weaker. While slackening global demand was crimping exports, it also helped to bring down rising oil and food costs, easing inflationary pressures. In South-East Asia, domestic demand and reconstruction should keep growth robust, with a strong rebound in Thailand and healthy expansion in the Philippines, Malaysia and Indonesia. What's important, Asia has sufficient policy space to conduct easier monetary and fiscal policies to provide the needed stimulus.
Emerging nations should do reasonably well. The IMF reckons emerging Asia will grow 7% in 2012, against 7.8% in 2011. Europe's recession had significant impact it sapped demand for its manufacturing exports and restrained price for its commodities. Russia, Brazil and South Africa are notable casualties. Fortunately, big emerging nations have scope to respond; most have restructured their banks are well capitalised and central banks, well stocked with foreign reserves. A hard landing in these nations looks unlikely. Nevertheless, there is no returning to past decade's unsustainable high growth. China for one doesn't want it. It is rebalancing and moving to adopt a slower growth model led by consumers.
When the dust settles, China will emerge as the “new normal.” In its recent monetary policy report, the People's Bank of China (its central bank) talks of stabilising economic growth as top priority in balancing its three objectives of: maintaining steady and relatively fast growth, adjusting the economic structure, and managing inflation. It sees the global slowdown (will remain relatively weak for an extended period) as the biggest risk to the Chinese economy and it may need to take measures to boost growth. It concluded: “The tasks of restructuring the domestic economy and expanding domestic demand remain huge, and domestic growth drivers still need to be strengthened.” It is clear China is determined to stimulate, if necessary, by spending more on urban social infrastructure and low-income housing.
What, then, to do?
The outlook for the rest of the year is darkening. The headwinds from a stagnating Europe are real and worrisome. The United States runs the risk of being “forced” into contraction in 2013. As I see it, there is serious concern over a looming crisis. Emerging nations face not just the risk of a cyclical downturn, but also the risk of a “new normal” of slackened growth over the longer term.
How can they cope? Economically, these can be dealt with relative ease, given the vast policy space they now have. Nations with large domestic markets and a prosperous middle class will cope better. Socially and politically, these risks are much more difficult to manage. More serious are growing tensions within the eurozone arising from further fiscal consolidation and forced compliance with much stricter terms of severe budget cuts and tax increases in the face of rising unemployment with its attendant potential for social upheaval. Political uncertainty will surely feed back into the economy, which will further deteriorate; and so the vicious cycle continues. Painted into a corner, politicians can be shocked into action perhaps by a serious euro-wide bank-run or a chaotic Greek exit. Maybe this is not such a bad thing.
> Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who speaks, writes and consults on economic and financial issues. Feedback is most welcome; email: email@example.com.