On the faltering auto sector GDP assist and also on Spain’s coming sovereign bailout
The US: autos
Last month I wrote one daily on the auto sector’s effect on non-recession reading. The gist of that post was that the auto sector was positively influencing both production and employment, helping the US avoid outright recession. Retail sales have been negative for three straight months but auto makers in the US have been keeping production levels high in anticipation of sustained demand. This is problematic for a couple of reasons.
First, as Investor’s Business Daily has profiled, GM at a minimum has ramped up riskier subprime lending to goose its numbers. At this point in the cycle, with retail sales flagging, it suggests GM is taking a riskier credit strategy that could backfire dramatically as the cycle turns down. In all business cycles, credit conditions loosen as the upturn advances and some get caught out as things turn down. I believe GM will be one of those firms.
Second, all indications are that US auto makers have overestimated demand. US auto sales were soft in July. (The same as true in Europe as evidenced by Mercedes Benz’s numbers.) And GM is getting hurt by not just its faltering European operations but declining numbers in the US. Note the following spin by GM in this Guardian article:
"Our results in North America were solid, but we clearly have more work to do to offset the headwinds we face, especially in regions like Europe and South America," said GM chairman and CEO Dan Akerson. "Despite the challenging environment, GM has now achieved 10 consecutive quarters of profitability, which is a milestone the company has not achieved in more than a decade."
GM’s European division reported an operating loss of $361m, compared with an operating profit of $102m a year ago. GM is attempting to restructure the unit and recently replaced several of its top executives in Europe. The company is planning to close at least one plant in Europe by 2016, but Dan Ammann, GM’s chief financial officer, said there were no immediate plans to announce more job cuts or factory closings in Europe.
In North America, GM reported an operating profit of $1.97bn, which compares to a profit of $2.25bn for the same period a year earlier. The company posted a loss of $19m in South America during the second quarter, and made a profit of $557m in its international division, primarily in China.
While GM’s North America sales remain strong there are signs that the slowdown in the US economy is taking its toll. On Wednesday, GM and Ford announced that sales had slipped in July; GM deliveries fell 6.4% and Ford 3.8%, according to statements. Chrysler increased deliveries by 13%.
Results in North America actually were not solid and i believe they will weaken. GM and other US car manufacturers will be forced to cut production and run off inventory – and this will take a toll on GDP in Q3 and Q4. I expect the shares of car makers will soon reflect these diminished earnings.
Europe: Spanish bailout
The Spanish Memorandum of Understanding was a disaster for Spain and Europe. Originally the bailout carried was supposed to be carry less draconian terms but that did not pan out as Spain has been forced to undergo more austerity. More importantly, the bailout did not break the sovereign-bank tie. Spain is now in the midst of a Greek style debt deflation rather than an Irish recovery. Why? Spain waited too long to crystallise bank losses while Ireland had first mover advantage.
Remember, even for Ireland, the macro view has to be that Ireland will be negatively affected by the deflationary spiral elsewhere in Euroland. Just because they are doing well on a relative basis doesn’t mean things are good. Let’s remember that Ireland’s government debt to GDP is something like 110%. Ireland can still default on sovereign debt too. I’d rather be Iceland than Ireland.
In Spain it’s worse and Reuters has a story saying that Spain will ask for a sovereign bailout in due course as a result. My question from last month is still valid though: What exactly will be the mechanism to effect a Spanish sovereign bailout? It seems from Draghi’s comments that the ECB is hinting at being prepared to monetise Italian and Spanish debt in concert with the European bailout funds with fiscal conditionality. That puts the ECB in a fiscal role – a clear no-no.
Mr Draghi has, possibly unwittingly, undermined one of the ECB’s cherished principles, without replacing it with some fresh (possibly more appropriate) principle. Which principle? The principle that the ECB does not meddle in fiscal policy and stays well within its remit of maintaining price stability and a healthy monetary policy transmission mechanism. Consider this statement by Mr Draghi: The “…guidance that we’ve given to the committees of the ECB differs from the previous program because … we have explicit conditionality here. And as a necessary condition, an adherence by governments and by euro area governance to its commitments.” Let’s unpack this. The previous program he refers to is the flurry of purchases of Greek, Portuguese and Irish bonds during 2010/11, the purpose of which was to stabilise these countries’ spreads and avert their insolvency. That program failed miserably, in the end, even though it did manage to slow down for a while the rate of increase of these interest rates. What Draghi is now saying is that, unlike those purchases which the ECB made without imposing conditionality on the three countries involved, any new purchases will come with strings attached; i.e. with a Memorandum of Understanding between the ECB, the EE and the member-state whose bonds the ECB will be purchasing in the secondary markets. This is, in my view, the end of any pretense to keeping monetary policy separate from fiscal policy. In effect, the ECB gives itself the task of enforcing into member-states particular (and highly austerian) fiscal policies.
What’s more is that this is a poor man’s bailout. It won’t work because the European bailout fund has limited resources and will exhaust its funds taking on Spain and Italy.
Europe is making all the wrong moves and this makes me less optimistic. Ireland is doing relatively better than the rest. But with the macro outlook so bleak, it too can be dragged down by its economic ties to the rest of Europe. I wish there were a silver lining. I don’t see it.