When Push Comes to Shove
As my readers may have noticed I am pretty much letting my colleague Edward running the show at the moment in terms of detailing the fall from grace of European economies. It is funny to think about how it is under a year ago that the notion of decoupling was fiercely debated. What a difference a couple of bust economies and banks make eh? In any case, what follows will be some semi-random observations on last week's and the coming ditto's events. As a common theme I think it is safe to say that in the context of the European economy as well as in a more wonkish theoretical perspective on the global economy push, as it were, looks very close to becoming shove.
Towards a Common European Answer?
As I mentioned last week, Q4 was an absolute horror story in terms of European data with an aggregate Eurozone contraction of qoq GDP standing at -1.5% as well as cartoonish numbers from Eastern Europe. Unfortunately, the abyss does not seem to be any less daunting one week later and if anything, it seems that the chasm may have widened. Consider for example that Ukraine's economy contracted a full 20% yoy as measured by, an adimittedly dodgy, monthly GDP estimate. It should come as little surprise that the country is now being put into spotlight for a potential sovereign default. At least, the latest brief on Eastern Europe by Danske Bank goes a long way to convince me that the end may soon come for Ukraine. Not only do we have considerable insecurity about the proposed IMF package negotiated earlier this year, the rating agencies are also naturally on high alert. Here is Danske;
The ratings agency Standard & Poor's this week warned Ukraine it could face another ratings cut, saying it distrusted Ukraines ability to implement a crucial IMF deal. The agency said it could cut Ukraine's B foreign currency rating and B-plus local currency rating by one or more notches.
Hence Ukraine's commitment to adjust is wavering against a backdrop of contracting growth, es-pecially in the manufacturing sector (industrial production dropped an exorbitant 34.1% y/y in January), and the upcoming presidential elections in January 2010. Recently an IMF mission failed to sign off on a first review of Ukraine's performances under the USD 16.4bn IMF pro-gramme during a recent visit, sparking fears of non-implementation. Ukraine says it may approach other countries including Russia for additional financial help.
Yep, it does not sound good and the prospect of Ukraine betting on the whims of Mother Russia certainly cannot be accommodative for foreign investors' willingness to finance the ballooning current account deficit (well, they aren't of course which is also why the Hryvnia is collapsing).
Further afield in the context of Eastern Europe it seems as people are finally waking up to the fact that the unfolding mess will need a common European response. There are of course obvious political reasons for this, but also in economic ones since if something is not done to stop the whirlwind it is likely that the European banking sector will get dragged down too due to their exposure to Eastern European economies. Edward simply notes that we should let the east into the Eurozone now as well as he has forcefully argued why we need a common EU bond scheme to get to heart of the problem with the widening of financing conditions for Eurozone economies. And don't for a minute think that EU bonds to help Italy et al. issue bonds to pay to clean up the mess has nothing to do with the CEE. Basically, contagion works in mysterious ways sometimes and with the amount of direct exposure of European banks to Eastern Europe sovereign debt ratings and spreads could easily be hit by this. Today, FT's correspondent Munchau chimes in with a similar point. Once again, I think it is important to point out that if we let things go their own way, the whole European economic system is at risk. This view is further given life by Morgan Stanley in their recent installment on the Polish economy which, as the biggest CE economy, is also riddled with the same weaknesses as its peers. I would especially note the following bit which is a general and important point ...
The notion that the euro area (mostly made up of Western European countries) can just ignore the issues ongoing in Eastern Europe is fundamentally flawed, in our view, for at least two reasons. First, Austrian (mainly), but also German, Italian and French banks have lent aggressively in the region, and have an interest in ensuring that CEE can see through the current downturn. Second, the trade linkages between the euro area and Central and Eastern Europe have expanded significantly over the recent years: the euro area now runs a €50 billion annual trade surplus with the CEE (CE + Baltics + Bulgaria), by our calculations.
Alas, how many times have I not hoped that Trichet and his fellow chums in Frankfurt would pay just a little bit attention to the unfolding tragedy to the East. So far, they have stayed firmly in the Ivory Tower, but I reckon that this will change.
And don't think for a minute that the clock is not ticking. Last week also brought the news that the Latvian government has chosen to resign. Now, apart from likely confirming Manuel Alvarez-Rivera's prediction that Latvia is headed for an early election it also brings up the question of where exactly that political stability and will the IMF called for in connection to their policy of maintaining the peg is. My feeling is that the IMF has its credibility firmly on the line here, and one has to wonder how this idea about the policies demanding a strong political consensus fits together with what we are observing.
And the going is getting increasingly tough in key areas;
Latvia, Estonia and Lithuania, facing a prolonged recession, say they will protect their currency pegs whatever the cost. That strategy may be as crippling as the alternative, economists say. The three-nation Baltic region is in its deepest crisis since breaking from the Soviet Union in 1991. Latvia, which spent $1.26 billion in 11 weeks defending the lats last year, was forced to turn to an International Monetary Fund-led group for a $9.6 billion bailout. Its economy may contract 12 percent this year, while Estonian gross domestic product may shrink by as much as 9 percent and Lithuania’s GDP by 4.9 percent.
Latvian Premier Ivars Godmanis resigned on Feb. 20 and Lithuania’s two-month-old cabinet is struggling to win over a skeptical electorate after the two nations suffered the largest street riots since independence last month. Keeping the peg “will likely mean a number of years of very low economic growth,” said Lars Christensen, chief economist at Danske Bank AS in Copenhagen. “Wages and prices will have to fall to reestablish competitiveness.”
One has to wonder why there is such asymmetry with respect to the economies in Eastern Europe? I mean, Ukraine and Russia has been devaluing like there is no tomorrow and also the Forint has taken a solid beating. Even though the two former might be outside the IMF's definition of political will and stability I think we should remember two things; one is that the economies who are now devaluing in nominal terms will be Baltics' main competitors for exports and secondly, the adverse effect of balloning debt and bankruptcies will also ensue in the context of deflation to restore competitiveness. No easy solutions here, but if the Baltics are not accepted de-facto into the Eurozone I still hold that they will need to devalue.
The coming week will be interesting not least in relation to how European leaders respond to the realization that this now actually, and without doubt, demands a solution in which nations just as banks may need to be bailed out.
Getting to the Heart of the Matter on the Global Economy
Leaving the travails of the Eurozone and her Eastern brethren for a minute I was also positively surprised by a couple of well put points by two of the big boys in relation to economic punditry. Let us begin with Martin Wolf writing about the lessons to be derived from Japan in a world of balance sheet deflation . Now, the first thing to dispense is obviously what a balance sheet recession is . Well, the term originates from from economist Richard Koo and basically advocates that in situations like this, a strong fiscal stimulus is the most effective remedy. I tend to agree here, but I will leave that discussion for. Rather, I would like to turn the attention to one of Wolf's last remarks with respect to summing up the global situation (emphasis added);
It is, for this reason [see the article], fanciful to imagine a swift and strong return to global growth. Where is the demand to come from? From over-indebted western consumers? Hardly. From emerging country consumers? Unlikely. From fiscal expansion? Up to a point. But this still looks too weak and too unbalanced, with much coming from the US. China is helping, but the eurozone and Japan seem paralysed, while most emerging economies cannot now risk aggressive action.
Where indeed Mr. Wolf where indeed. Regular and perceptive readers will know that this is one of my main hobby horses in the context of the global economy. In fact, as recent as two months I, sort of, took the same Wolf to task on his piece on global imbalances in which he argued that credit worthy surplus nations should put into place measures to expand domestic demand. As I pointed out at the time this may be easier said than done especially because there are underlying structural reasons as to why surplus nations cannot easily ramp up demand to suck up excess global capacity. I am happy to see Wolf framing the situation as he does here because it means, in my humble opinion, that it brings us one step closer to the understanding of what the heck is going on here.
Adding to the choir Paul Krugman also joins in on Koo and Wolf and apart from the standard fiddle about the importance of fiscal policy (which I agree with, remember) Krugman also makes another point. Quite simply, Krugman points towards the well known fact that whatever recovery Japan has had since 2000 it has been all about exports (and foreign asset income); and at the end we get this:
And needless to say, we can’t all export ourselves out of a global slump.
So, how does this end?
Needless to say I cannot answer the last bit, but I do think that we are making progress here since apart from a poor little graduate student (in applied economics of all atrocities) some of the big ones are making some crucial points about what exactly the underlying structural dynamics are here (hint: demographics!) Here is to hoping that the thinking is being stimulated across the board.