Daily Comments: 2013-06-06 – European economy
The data flow out of Europe today is pretty bad. German factories orders missed and unemployment rose to record levels in France and Greece. Meanwhile the IMF admitted that Greece’s delayed debt restructuring “provided a window for private creditors to reduce exposures and shift debt into official hands.” Does any of this change my bullish bias on Europe’s economy? No, I believe Europe will exit recession at some point in the second half of 2013.
My focus here is on the delta i.e. second derivatives – and they are pointing to an economy that is bottoming, helped of course by a less contractionary fiscal policy stance. The likely outcome is a move in Europe from a small GDP contraction as we have seen for six quarters (and likely a seventh when this quarter’s data is released) to slight GDP growth, driven by countries like Germany, Austria, and Ireland. Any growth is going to be anemic, putting the economy at stall speed, vulnerable to any exogenous shock. And the contraction in the periphery will linger, particularly in Portugal and Greece.
In Germany, factory orders came in well short of expectations, falling 2.3% versus an anticipated 1.0% fall. This demonstrates that the recession in Europe is now boomeranging onto the German economy in a negative way just as general elections are coming. This was always going to be the case given earlier German intransigence on austerity in countries as large as Spain and Italy as I predicted over three years ago. As I have been saying recently, the reason austerity targets are finally being relaxed is because the pain has moved out of the periphery to countries like France and the Netherlands and this brings the economic and jobs crisis into the core. Even in Germany, unemployment is now rising.
I see the economic picture as a net negative for Merkel in the general election. Peer Steinbrück, her opponent is trying to make hay out of this but his own party has supported Merkel’s policies. So I am not sure if this will resonate with voters. But it is clear that Merkel must go for growth in order to placate increasingly restless German voters who had been counting on Germany’s expansion continuing unabated.
In France, unemployment shot up to a new record high of 10.4% (10.8 just including the mainland). This is the highest since at least 1998 and puts Francois Hollande in the hot seat. As a socialist who backs growth over reform and consolidation, Hollande is in an untenable situation because the labor market has deteriorated and this has caused the deficit to balloon. The relaxation of targets was a must, if Hollande was to walk the tightrope between Europe’s fiscal rules and his own need to provide growth and jobs. Now that he has a two-year reprieve, he will use it.
It is interesting that former German Chancellor Gerhard Schröder has written an Op-Ed in the FT calling on France to copy the Germans approach – which basically meant flouting the deficit target and betting on export-led growth via structural reform and wage suppression. Schröder, a left of center politician, is voicing a view held widely across the political spectrum in Germany, that all of Europe should move to the ‘internal devaluation’ policy of Germany as a model for the future. This is essentially a beggar thy neighbour kind of policy because it means sacrificing domestic demand in order to run euro-area wide current account surpluses that must be financed by deficits somewhere else, most logically the United States and the other Anglo-Saxon economies.
I see this internal devaluation vision for Europe as completely unworkable at a basic social-political level because it requires a decade of stagnation throughout Europe, not just in Germany. And Europe is already in recession with record unemployment. More than that though, it is a beggar thy neighbour type of policy that can only work if other countries are willing to take the other side of this trade i.e. run trade and current account deficits to allow Europe to do this. It won’t work as protectionism would intercede given how massive the scale of a European-wide policy of this nature would be.
In Greece, the IMF is now admitting that it screwed up, that it front-loaded austerity to meet debt sustainability numbers that were unrealistic. More than that, the IMF also admits its delaying tactics were merely a cover for Europe to allow private creditors to reduce exposure to Greece and allow public creditors to step in. Had the EU allowed an immediate default, German and French banks’ undercapitalization would have been found out and that would have created massive problems in 2010. So they punted. The IMF’s admission here makes plain the tension that has been rising between a Christine Lagarde-led IMF and the EU. I have been hearing rumours that the plan now is to move forward with an EU-wide European Monetary Fund to replace the IMF in the future.
Meanwhile, in Greece unemployment climbed to another record. However, the prior month’s number was revised down. GDP contraction for Q1 was also revised down. And downward revisions are usually a sign of troughing or recovery. So, despite the bad headline, we should be watching the data flow in Greece in particular for signs of a trough. Greece is going to be the canary in the coalmine while Germany is the caboose on any European-wide recovery train.
“Click for the IMF’s “ex post evaluation” of its role in the Greek bailout. Its mea culpa.
And if you thought we were being harsh here, parts of the real thing are excoriating.”
So, the International Monetary Fund (effectively) wishes to apologise to all concerned for that little thing where it turned into Dominique Strauss-Kahn’s presidential election campaign a few years back.