How soon will the US national debt be unaffordable?

It is time to look again at a subject which has been a regular topic in the comments section. This is what happens when national debt costs start to rise again? We have spent a period where rises in national debts have been anesthetized by the Quantitative Easing era where central bank purchases of sovereign debt have had a side effect of reducing debt costs in some cases by very substantial amounts. Of course  it is perfectly possible to argue that rather than being a side effect it was the real reason all along. Personally I do not think it started that way but once it began like in some many areas establishment pressure meant that it not only was expanded in volume but that it has come to look in stock terms really rather permanent or as the establishment would describe it temporary. Of the main players only the US has any plan at all to reduce the stock whereas the Euro area and Japan continue to pile it up.

So let us take a look at projections for the US where the QE flow effect is now a small negative meaning that the stock is reducing. Here is Businessweek on the possible implications.

Over the next decade, the U.S. government will spend almost $7 trillion — or almost $60,000 per household — servicing the nation’s massive debt burden. The interest payments will leave less room in the budget to spend on everything from national defense to education to infrastructure. The Congressional Budget Office’s latest projections show that interest outlays will exceed both defense discretionary spending and non-military discretionary spending by 2025.

The numbers above are both eye-catching and somewhat scary but as ever this is a case of them being driven by the assumptions made so let us break it down.

US National Debt

It is on the up and up.

Debt held by the public, which has doubled in the past
10 years as a percentage of gross domestic product
(GDP), approaches 100 percent of GDP by 2028 in
CBO’s projections.

Those of you who worry we may be on the road to World War III will be troubled by the next bit.

That amount is far greater than the
debt in any year since just after World War II

As you can see the water has got a bit muddled here as the CBO has thrown in its estimates of economic growth and debt held by the public so let us take a step back. It thinks that annual fiscal deficits will rise to above US $1 Trillion a year in this period meaning that from now until 2028 they will total some US $12.4 billion. That will put the National Debt on an upwards path and the amount held by the public will be US $28.7 Trillion. Sadly they skirt the issue of how much the US Federal Reserve will own so let us move on.

Deficits

These have become more of an issue simply because the CBO thinks the recent Trump tax changes will raise the US fiscal deficit. The over US $1 Trillion a year works out to around 5% of GDP per annum.

Bond Yields

These are projected to rise as the US Federal Reserve raises its interest-rates and we do here get a mention of it continuing to reduce its balance sheet and therefore an implied reduction in its holdings of US Treasury Bonds.

Meanwhile, the interest rate on 10-year Treasury notes increases from its average of 2.4 percent in the latter part of 2017 to 4.3 percent by the middle of 2021. From 2024 to 2028, the interest rate on 3-month Treasury bills averages
2.7 percent, and the rate on 10-year Treasury notes,
3.7 percent.

Currently the 10-year Treasury yield is 2.83% so the forecast is one to gladden the heart of any bond vigilante. If true this forecast will be a major factor in rising US debt costs over time as we know there will be plenty of new borrowing at the higher yields. But here comes the rub this assumes that these forecasts are correct in an area which has often been the worst example of forecasting of all. For example the official OBR forecast in the UK in a similar fashion to this from the CBO would have UK Gilt yields at 4.5% whereas in reality they are around 3% lower. That is the equivalent of throwing a dart at a dartboard and missing not only it but also the wall.

Inflation

This comes into the numbers in so many ways. Firstly the US does have inflation linked debt called TIPS so higher inflation prospects cost money. But as they are around 9% of the total debt market any impact on them is dwarfed by the beneficial impact of higher inflation on ordinary debt. Care if needed with this as we know that price inflation does not as conventionally assumed have to bring with it wage inflation. But higher nominal GDP due to inflation is good for debt issuers like the US government and leads to suspicions that in spite of all the official denials they prefer inflation. Or to put it another way why central banks target a positive rate of consumer inflation ( 2% per annum) which if achieved would gently reduce the value of the debt in what is called a soft default.

The CBO has a view on real yields but as this depends on assumptions about a long list of things they do not know I suggest you take it with the whole salt-cellar as for example they will be assuming the inflation target is hit ignoring the fact that it so rarely is.

In those years, the real interest rate on
10-year Treasury notes (that is, the rate after the effect of
expected inflation, as measured by the CPI-U, has been
removed) is 1.3 percent—well above the current real rate
but more than 1 percentage point below the average real
rate between 1990 and 2007.

Economic Growth

In many ways this is the most important factor of all. This is because it is something that can make the most back-breaking debt burden suddenly affordable or as Greece as illustrated the lack of it can make even a PSI default look really rather pointless. There is a secondary factor here which is the numbers depend a lot on the economic impact assumed from the Trump tax cuts. If we get something on the lines of Reaganomics then happy days but if growth falters along the lines suggested by the CBO then we get the result described by Businessweek at the opening of this article.

Between 2018 and 2028, actual and potential real output
alike are projected to expand at an average annual
rate of 1.9 percent.

The use of “potential real output” shows how rarefied the air is at the height of this particular Ivory Tower as quite a degree of oxygen debt is required to believe it means anything these days.

Comment

The issue of the affordability forecast is mostly summed up here.

CBO estimates that outlays for net interest will increase
from $263 billion in 2017 to $316 billion (or 1.6 percent
of GDP) in 2018 and then nearly triple by 2028,
climbing to $915 billion. As a result, under current law,
outlays for net interest are projected to reach 3.1 percent
of GDP in 2028—almost double what they are now.

This terns minds to what might have to be cut to pay for this. However let me now bring in what is the elephant in this particular room, This is that if bond yields rise substantially pushing up debt costs then I would expect to see QE4 announced. The US Federal Reserve would step in and start buying US Treasury Bonds again to reduce the costs and might do so on a grand scale.. Which if you think about it puts a cap also on its interest-rate rises and could see a reversal. Thus the national debt might remain affordable for the government but at the price of plenty of costs elsewhere.

 

 

 

 

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UK production and manufacturing have seen a lost decade

Today brings us what is called a theme day by the UK Office for National Statistics as we get data on production, manufacturing and trade. This comes at a time when the data will be especially prodded and poked at. This is mainly driven by the fact that there have been hints of an economic slow down both in the UK and in the Euro area. Added to that we have seen rising tensions around Syria and the Middle East which have pushed the price of a barrel of Brent Crude Oil above US $70 which if sustained will give us another nudge higher in terms of cost push or if you prefer commodity price inflation. If we return to yesterday’s topic of Bank of England policy we see the potential for it to find itself between a rock and a hard place as a slowing economy could be combined with some oil price driven inflation.

Production

This opened with a worrying note although of course the issue is familiar to us.

In the three months to February 2018, the Index of Production decreased by 0.1% compared with the three months to November 2017, due to a fall of 8.6% in mining and quarrying, caused mainly by the shutdown of the Forties oil pipeline within December 2017.

If we move to the February data we see that it rose but essentially only because of the cold weather that caused trouble for services and construction.

In February 2018, total production was estimated to have increased by 0.1% compared with January 2018; energy supply provided the largest upward contribution, increasing by 3.7%.

If we look into the detail we see that the colder weather raised production by 0.43% meaning that there were weaknesses elsewhere. Some of it came from the oil and gas sector where in addition to some planned maintenance there was a one-day shut down for the rather accident prone seeming Forties field. But there was also something which will attract attention.

Manufacturing output decreased by 0.2%, the first fall in this sector since March 2017, when it fell by 0.4%. Within this sector 7 of the 13 sub-sectors decreased on the month; led by machinery and equipment not elsewhere classified, which fell by 3.9%, the first fall since June 2017, when it decreased by 4.9%.

This has been a strength of the UK economy in recent times and concerns about a possible slow down were only added to by this.

 It should be noted that the growth in this sector of 0.1% during January 2018 and published last month, has been revised this month to 0.0%, further supporting evidence provided in the January 2018 bulletin of a slow-down in manufacturing output.

Although our statisticians found no supporting evidence for this there remains the possibility that the bad weather played a role in this. Otherwise we are left with an impression of a manufacturing slow down which does fit with the purchasing managers indices we have seen. The annual comparison however remains good just not as good as it was.

 in February 2018 compared with February 2017, manufacturing increased by 2.5%.

Also there were hopes that we might regain the previous peak for manufacturing output which was 106.8 in February 2008 where 2015 = 100 but we scaled to 105.4 in January and have now dipped back to 105.2. The situation in production is somewhat worse as we are still quite some distance from the previous peak which on the same basis was at 111.1 in February 2008 and this February was at 104.8. The issue is complicated by the decline of North Sea Oil and Gas but overall those are numbers which look like a depression to me especially after all this time which one might now call a lost decade.

Trade

We traditionally advance on these numbers with some trepidation after years and indeed decades of deficits on this particular front. So let us gather some cheer with some better news.

Comparing the 12 months to February 2018 with the same period in 2017, the total trade deficit narrowed by £12.9 billion to £27.5 billion; the services surplus widened by £11.1 billion to £108.3 billion and the goods deficit narrowed by £1.8 billion to £135.8 billion.

Tucked away in this was some good news and for once a triumph for economics 101.

Total exports rose by 10.4% (£59.4 billion) to £627.6 billion compared with total imports, which increased by 7.6% (£46.5 billion) to £655.1 billion.

In true Alice In Wonderland terms our exports have to do this to make any dent in our deficit because the volume of imports is larger.

“My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.”

Both goods and services imports have responded well to the lower value of the UK Pound £ as well as being influenced by the favourable world economic environment.

 Goods exports rose by 11.3% (£34.9 billion) to £345.0 billion ……..Services exports rose by 9.5% (£24.5 billion) to £282.6 billion

We rarely give ourselves the credit for being a strong exporting nation because it gets submerged in our apparent lust for imports.

As to the more recent pattern I will let you decide if the change below means something as it is well within the likely errors for such data.

The total UK trade deficit (goods and services) widened by £0.4 billion to £6.4 billion in the three months to February 2018

A little wry humour is provided by the fact that in terms of good exports our annual improvement was due to exports to the European Union. However the humour fades a little as I note our official statisticians have no real detail at all on our services exports which is a great shame as they are a strength of our economy.

Construction

After the cold spell in February this was always going to be a difficult month.

Construction output continued its recent decline in the three-month on three-month series, falling by 0.8% in February 2018………Construction output also decreased in the month-on-month series, contracting by 1.6% in February 2018, stemming from a 9.4% decrease in infrastructure new work.

In the circumstances I thought this was not too bad although this may have left me in a class of two.

You see the past is better than we thought it was which also confirms some of the doubts I have expressed about the reliability of this data.

The annual growth in 2017 of 5.7% is revised upwards from the 5.1% growth reported.

So it is not in a depression but has entered a recession.

Comment

There is a fair bit to consider as we note that any continuation of the recent falls will see manufacturing continue its own lost decade as we note that overall production seems trapped in one with little hope of  what might be called “escape velocity”. That means that the Bank of England faces a scenario where the picture for this particular 14% of the economy has seen the grey clouds darken. By contrast construction went from a really good phase into a recession which  the bad weather has made worse. I would expect the weather effect to unwind fairly quickly but that returns us to a situation which looked weak,

This leaves the expressed policy of the “unreliable boyfriend” in something of a mess as his forward guidance radar seems to have looked backwards again. Perhaps his new private secretary James Benford will help although I note his profile has been so low Bloomberg had to look him up on LinkedIn, I hope they got the right person. Also life can be complex as for example Russians in the UK might be thinking as they go from threats of financial punishment to seeing the UK Pound £ rally by 2% today and by over 10% in the past week to around 91 versus the R(o)uble .

Let me remain in the sphere of the serially uncorrelated error term by congratulating Roma on a stunning win last night.

 

 

How quickly is the economy of Germany slowing?

Until last week the consensus about the German economy was that is was the main engine of what had become called the Euro boom. Some were thinking that it might even pick up the pace on this.

 For the whole year of 2017, this was an increase of 2.2% (calendar-adjusted: +2.5%),

This was driven by the PMI or Purchasing Managers Index business surveys from Markit which as I pointed out on the 3rd of January were extremely upbeat.

2017 was a record-breaking year for the German
manufacturing sector: the PMI posted an all-time
high in December, and the current 37-month
sequence of improving business conditions
surpassed the previous record set in the run up to
the financial crisis.

This was followed by the overall or Composite PMI rising to 59 in January which suggested this.

“If this level is maintained over February and March,
the PMI is indicating that first quarter GDP would rise
by approximately 1.0% quarter-on-quarter”

Actually that was for the overall Euro area which had a reading of 58,8. The catch has been that even this series has been dipping since as we now see this being reported.

The pace of growth in Germany’s private sector cooled at the end of the first quarter, with the services PMI retreating further from January’s recent peak to signal a loss of momentum in line with that seen in manufacturing.

This led to this being suggested.

it still promises to be a strong 2018 for the German economy – with IHS Markit forecasting GDP growth to pick up to 2.8%

Still upbeat but considerably more sanguine than the heady days of January. Then there was this to add into the mix.

However, unusually cold weather in March combined with continuing payback from January’s jump in activity has led to the construction PMI falling into contraction territory for the first time in over three years

Official Data on Production and Trade

The official data posted something of a warning last week.

In February 2018, production in industry was down by 1.6% from the previous month on a price, seasonally and working day adjusted basis according to provisional data of the Federal Statistical Office (Destatis)…….In February 2018, production in industry excluding energy and construction was down by 2.0%. Within industry, the production of capital goods decreased by 3.1% and the production of consumer goods by 1.5%. The production of intermediate goods showed a decrease by 0.7%. Energy production was up by 4.0% in February 2018 and the production in construction decreased by 2.2%.

As you can see the monthly fall was pretty widespread and only offset by a colder winter. Whilst this did show an annual increase of 2.6% that was a long way below the 6.3% that had been reported for January and December. So on this occasion the PMI surveys decline seems to have been backed by the official numbers as we await for the March numbers which if the relationship holds will show a further slowing on an annual basis.

Thrown into this mix is concern that the decline is related to fear over the rise in protectionism and possible trade wars.

If we move to this morning’s trade data it starts well but then hits trouble.

Germany exported goods to the value of 104.7 billion euros and imported goods to the value of 86.3 billion euros in February 2018. Based on provisional data, the Federal Statistical Office (Destatis) also reports that German exports increased by 2.4% and imports by 4.7% in February 2018 year on year. After calendar and seasonal adjustment, exports fell by 3.2% and imports by 1.3% compared with January 2018.

This may well be an issue going forwards if it is repeated as last year net exports boosted the German economy and added 0.8% to GDP ( Gross Domestic Product) growth.

On a monthly basis we saw this.

Exports-3.2% on the previous month (calendar and seasonally adjusted). Imports –1.3% on the previous month (calendar and seasonally adjusted).

Of course monthly trade figures are unreliable but this time around they do fit with the production data. The export figures look like they peaked at the end of 2017 from an adjusted ( seasonally and calendar) 111.5 billion Euros to 107.5 billion on that basis in February.

What are the monetary trends?

If we look at the Euro area in general then there are signs of a reduced rate of growth.

The annual growth rate of the narrower aggregate M1, which includes currency in circulation
and overnight deposits, decreased to 8.4% in February, from 8.8% in January.

The accompanying chart shows that this series peaked at just under 10% per annum last autumn. So that surge may have brought the recorded peaks in economic activity around the turn of the year but is not heading south. If we move to the broader measure we see this.

The annual growth rate of the broad monetary aggregate M3 decreased to 4.2% in February 2018, from
4.5% in January, averaging 4.4% in the three months up to February.

This had been over 5% last autumn and like its narrower counterpart has drifted lower. If you apply a broad money rule then one would expect a combination of lower inflation and growth which is awkward for a central bank trying to push inflation higher.  If we move to credit then the impulse is fading for households and businesses.

The annual growth rate of adjusted loans to the private sector (i.e. adjusted for loan sales, securitisation
and notional cash pooling) decreased to 3.0% in February, compared with 3.3% in January.

This is more of a lagging than leading indicator of circumstances.

These are of course Euro area statistics rather than Germany but they do give us an idea of the overall state of play. A possible signal of issues closer to home are the ongoing travails of Deutsche Bank. There has been a bounce in the share price today in response to the new Chief Executive Officer or CEO as Sewing replaces Cryan but 11.8 Euros compares to over 17 Euros last May. Yet in the meantime the economy has been seeing a boom and added to that as I looked at late last month house price growth will have been boosting the asset book of the bank yet the underlying theme seems to come from Coldplay.

Oh no, what’s this?
A spider web and I’m caught in the middle
So I turned to run
And thought of all the stupid things I’d done

Comment

The heady days of the opening of 2018 have gone and in truth the business surveys did seem rather over excited as I pointed out on January 3rd.

This morning we saw official data on something that has proved fairly reliable as a leading indicator in the credit crunch era. From Destatis.

In November 2017, roughly 44.7 million persons resident in Germany were in employment according to provisional calculations of the Federal Statistical Office (Destatis). Compared with November 2016, the number of persons in employment increased by 617,000 or 1.4%.

The rise in employment has been pretty consistent over the past year signalling a “steady as she goes” rate of economic growth.

We can bring that more up to date.

 In February 2018, roughly 44.3 million persons resident in Germany were in employment according to provisional calculations of the Federal Statistical Office (Destatis). Compared with February 2017, the number of persons in employment increased by 1.4% (+621,000 people).

Thus we see that it continues to suggest steady if not spectacular growth and bypasses the excitement at the turn of the year. Looking forwards we see that the monetary impulse is slowing which is consistent with the reduction in monthly QE to 30 billion Euros a month from the ECB. We then face the issue of how Germany will follow a good first quarter? At the moment a growth slow down seems likely just in time for the ECB to end QE! So it may well be a case of watch this space…..

 

 

 

 

What does the 10 year yield of Greece tell us?

Today’s headline or title introduces a subject which I find both frustrating and annoying.This is not only because it regularly misunderstood but also because it represents something of a financialisation of the human experience. What I mean by that is that some have used it as a way of suggesting an improvement in Greek economic performance that does not exist. Personally I sometimes wonder if it is used because it is the one signal that does show a clear improving trend. Let me illustrate with this from the LSE European Politics blog this morning.

A fall like that looks good on the face of it. Few point out the irony which is that falls in bond yields like that used to mean that a country was heading into at best a recession and probably a depression. Actually a drop from around 10% to around 4% indicates that something may be wrong so let us investigate.

The Greek bond market

A troubling sign arrives when we look for the benchmark 10 year bond of Greece and see that the benchmark page at the Hellenic Republic debt agency or PDMA is “under construction”. If we look at the data at the end of 2017 we see that of total debt of 328.7 billion the total of bonds is around 50.4 billion and if we add in treasury bills and the like we get to 65.4 billion.

By comparison the European Stability Mechanism or ESM tells us this.

The loan packages from the ESM and EFSF are by far the largest the world has ever seen. The two institutions own half of Greece’s debt.

Actually the support for Greece totals some 233 billion Euros which means we need to add the IMF and the original Greece “rescue” package to the numbers above.

Oh and as to the bond total well there is still the SMP which sounds like something used in the Matrix series of films but is in fact the Securities Markets Program which has mostly been forgotten but still amounts to 85 billion Euros. These days that is I guess a balancing item in the ECB accounts but it does appear here and there.

The ECB’s interest income from its SMP holdings of Greek government bonds amounted to €154 million (2016: €185 million).

There was a time that the SMP was a big deal and regular readers will recall so was its “sterilisation” but the ECB got bored with that in 2014 and gave up. Oh well!

But if we move on we see that there are relatively few Greek bonds around and of those that do exist the ECB holds a fair bit.

Why has the bond yield fallen then?

You could argue that the bond yield should have fallen before. A possible reason for it not doing so is that it is now too small a market for big hedge funds to bother with, especially if we note that a busy month now for the market (December) had a volume of 120 million Euros. But if we look from now there have been changes in the bond metrics. For example the average maturity of Greek bonds has risen mostly by the fact that ESM loans have an average maturity of 32 years. Also bond investors may have noticed a certain “To Infinity! And Beyond” willingness from the ESM and added that to the overall bond maturity of 18.32 years.

Fiscal Matters

The LSE blog summarises matters like this.

Greece has outperformed Programme budget targets . According to the Hellenic Fiscal Council, Greece may have reached a 3.5% primary surplus in 2017 already, versus a target of 1.75%. There are reasons to be optimistic about Greece meeting the fiscal targets in 2018 as well. Maintaining a 3.5% primary surplus also in the years to come appears feasible. On balance, the overall improvement of the fiscal situation is impressive.

From a bond investor’s point of view this if combined with the extended average maturity looks more than impressive as it means on their metrics the thorny issue of repayment has been kicked into the future. They will also like this statement from the ESM on the 27th of March.

 Today the Board of Directors of the European Stability Mechanism (ESM) approved the fourth tranche of €6.7 billion of ESM financial assistance for Greece. …….The tranche will be used for debt service, domestic arrears clearance and for establishing a cash buffer.

Problems in the real economy

There is a very descriptive chart in the LSE blog.

This shows us that the initial credit crunch impact on Greece was what we might call Euro area standard. But those of a nervous disposition might want to take the advice of BBC children’s programming from back in the day and look away now from the real crisis. Here we saw “shock and awe” but not of the form promised by Christine Lagarde which back then was France’s Finance Minister. An attempt to achieve the fiscal probity so approved of by bond markets saw the economy plunge into quite a recession and made an already bad situation worse. But the rub is that the recovery such as it is was not the “V-shaped” bounce back you might expect but rather this.

However, not only is there no indication of any catching up following the crisis, but also the pace of growth remains below the Eurozone’s.

So whilst we now have some growth there has been no relative recovery and in fact on that metric things have got worse. This comes in spite of the “Grecovery” theme of around 2013 which was an example of what we now call Fake News and of course was loved by the Euro area establishment. The reality is not only did thy make the recession worse they seem to have managed to prevent a bounce back as well. We can bring this up to date with the latest business survey for Greek manufacturing.

At 55.0, the index reading signalled a
marked rate of growth, albeit one that was weaker
than the multi-year high seen in February (56.1).

I am pleased to see that but you see that is slightly worse than what the UK did in March. I will not tire you with the different themes and descriptions in the media but simply say I am sad for Greece and  its people and use the famous words of Muhammad Ali.

Is that all you’ve got George?

Comment

If we step back we can see the impact of what is called “internal competitiveness” or if you prefer squeezing real wages. Let us look at that a different way as the UK had some of this albeit not as much. But the measure here we gives us a scale of the disaster is unemployment which has got better in Greece but comparing an unemployment rate of 20.8% with one of 4.3% is eloquent enough I think.

It also gives us an easy cause of this issue raised by the LSE.

Direct tax revenues are not performing very well. The high rate of social contributions has probably increased the area of tax evasion.

Also I am reminded that the IMF has failed in an area it mostly used to be successful in.

The external position has improved sharply, although more because of weakness in domestic demand than strength in export activity. Export performance remains underwhelming.

You see on that performance any improvement will simply put Greece back into balance of payments problems which is sort of where we came in. Also there is this from the Bank of Greece.

On 8 March 2018 the Governing Council of the ECB did not object to an ELA-ceiling for Greek banks of €16.6 billion, up to and including Wednesday, 11 April 2018, following a request by the Bank of Greece.

The reduction of €3.2 billion in the ceiling reflects an improvement of the liquidity situation of Greek banks, taking into account flows stemming from private sector deposits and from the banks’ access to wholesale financial markets. 

So it has got better but it has yet to go away.

Thus in summary we see that we have seen something of a divorce between the Greek financial and real economies. Prospects for the bond market look good but the real economy has not done much more than stop falling with a lot of ground still to be reclaimed. Those who look at credit conditions will not be reassured by this from the LSE blog.

 According to the Bank of Greece, the annual growth rate of credit to the private sector stood at -1.0% in February, and that of credit to corporations at 0.2%.

There was a time when the supporters and acolytes of the Euro area “shock and awe” package accused me and others who were in the default and devaluation camp of being willing to collapse the economy so let me finish with some Michael Jackson.

Remember the time
Remember the time
Do you remember, girl
Remember the time

 

 

Germany also faces ever more unaffordable housing

The economy of Germany has been seeing good times as Chic would put it and this morning has seen an indicator of this. From Destatis.

 The debt owed by the overall public budget (Federation, Länder, municipalities/associations of municipalities and social security funds, including all extra budgets) to the non-public sector amounted to 1,965.5 billion euros at the end of the fourth quarter of 2017. ……..Based on provisional results, the Federal Statistical Office (Destatis) also reports that this was a decrease in debt of 2.1%, or 41.3 billion euros, compared with the end of the fourth quarter of 2016.

We talk of Germany being a surplus economy and here is another sign of it as it applies to itself the medicine it has prescribed for others.

 Net lending of general government amounted to 36.6 billion euros in 2017…….. When measured as a percentage of gross domestic product at current prices (3,263.4 billion euros), the surplus ratio of general government was +1.1%.

Of course all of this is much easier in a growing economy.

 For the whole year of 2017, this was an increase of 2.2% (calendar-adjusted: +2.5%),

Thus the national debt to GDP ratio will have declined and I am sure more than a few of you will have noted that the total debt is a fair bit smaller than Italy’s for a larger economy. This parsimony has of course been helped by European Central Bank purchases of German Bunds which means that even five-year bonds have a negative yield ( -0.07%). Of course there is a chicken and egg situation here but 469 billion Euros of bond purchases in a growing economy lead to yields which would lead past computer models to blow up like HAL-9000 in the Film 2001 A Space Odyssey.

Trade

Whilst we are looking at surpluses there is this ongoing saga which continued last year.

Arithmetically, the balance of exports and imports had an effect of +0.8 percentage points on GDP growth compared with the previous year.

Ironically Germany did actually boost its imports ( 4.8%) but its export performance ( 5.6%) was even better. This meant that the same old song was being played.

According to provisional results of the Deutsche Bundesbank, the current account of the balance of payments showed a surplus of 257.1 billion euros in 2017.

If we allow for the inaccuracies in the data and the latest “trade wars” debate mostly raised by President Trump has highlighted the issues here with some countries thinking they are both in surplus/deficit with each other the German surplus is a constant. This poses quite a few questions as of course on one line of thinking it was a cause of the credit crunch.

The International Monetary Fund (IMF) and the European Commission have for years urged Germany to lift domestic demand and imports in order to reduce global economic imbalances and fuel global growth, including within the euro zone.

As time has passed it is hard not to wonder about how much Germany could have helped its Euro area partners via this route. Of course a catch is that it would have to want what they produce which gets forgotten. Also I find a wry humour in organisations like the IMF and EC telling Germans to “spend,spend,spend” to coin a phrase and consume more and yet also warn regularly about climate change.

Labour Market

There is another sign of success if we note this.

The adjusted unemployment rate was 3.6% again in January 2018……….Compared with January 2017, the number of persons in employment increased by 1.4% (+631,000 people). Roughly 1.6 million people were unemployed in January 2018, 160,000 fewer than a year earlier.

So we see that the quantity numbers for the labour market are very good as the unemployment rate chases that of Japan. However if we move to the quality arena things look a little different. From Bloomberg.

The scramble for qualified workers has become an existential issue for companies across Germany, which are offering enticements ranging from overseas sojourns and ski outings to subsidized housing and sausage platters.

Let us park the issue of whether the sausages are delicious and consider the cause of this.

After years of robust growth, unemployment has dropped to a record low of 5.4 percent, and the country has 1.2 million unfilled jobs—nearly equivalent to the population of Munich. Manufacturing, construction, and health care are particularly stretched, and 1 in 4 businesses may have to hold back production as a result of the labor crunch, the European Union reports.

So our HAL-9000 would predict wage growth and of course if it was in a central bank it would be flashing “output gap negative” and predicting stellar wage growth. Meanwhile back in the real world.

The corporate largesse hasn’t dramatically boosted salaries, at least so far. Compensation in Germany rose 13 percent in the last five years as unions moderated wage demands to help their companies maintain an edge in the face of growing global competition.

There is another similarity here with Japan in that the financial media have been telling us that wages are about to soar or sometimes that agreements have been signed. So they must spend their lives being disappointed as whilst the German figures are better than Japan’s they are not what has been promised.

If we look into the detail of the report we see that in spite of strong circumstances companies these days seem to prefer one-off payments rather than wage rises. Have we changed that much in response to the credit crunch as in being less certain about the future or not believing what we are told in this case about economic strength? There is some logic behind that in an era of Fake News stretching to diesel engines and indeed hybrid performance if we consider areas especially relevant to Germany, Maybe wages measures should switch to earnings per hour.

the country’s biggest union this year accepted a lower increase in salaries in exchange for the right to work fewer hours.

But America already does that and it has not changed the picture but maybe still worth a go.

House Prices

I note that in February the Bundesbank picked out house prices and told us this.

According to current estimates, price
exaggerations in urban areas overall in 2017
amounted to between 15% and 30%. In
the big cities, where considerable overvaluations
had already been measured earlier,
the price deviations are likely to have increased
further to 35%.

Price “exaggerations” is a new one but presumably is being driven by this.

According to figures based on bulwiengesa AG
data residential property prices in urban
areas in Germany continued to increase
sharply by around 9%, and hence at a
somewhat faster pace than in the three
preceding years, when the increase averaged
7½%.

Indeed there may well be issues similar to the British buy to let problem.

As in 2016, the rate of inflation for rental
apartment buildings in the towns and cities
as well as in Germany as a whole was markedly
higher than for owner- occupied housing.

Comment

So we have good times in many respects as after all many would see rising house prices as that too. Of course I do not and let me now throw in the impact of easy monetary policy at a time of economic growth.

The average mortgage rate, which had already hit
an all- time low in the preceding year, settled
at 1.7%, which was slightly above its
2016 level.

Interestingly the cost of housing is soaring relative to wages however you try to play it.

The continuing sharp price rises for housing
in urban centres were accompanied by a
significant increase of 7¼% in rents in new
contracts, which are chiefl y the outcome of
rent adjustments in the case of repeat occupancies.

This poses a question for what would happen if later in 2018 we see an economic slowing as suggested by weaker monetary data and some lower commodity prices? We will have to see about that but much further ahead is the issue of Germany’s demographics which combine a low birth rate, rising life expectancy ( economics is clearly the dismal science here) and an aging population. This leaves the intriguing thought that travelling towards it just like in Japan leads to negative interest-rates, low wage growth and a trade surplus…….Yet the public finances are very different.

Cash is King

Something else that Germany shares with the UK. From the Bundesbank March report via Google Translate.

The value of accumulated net issuance of euro banknotes by the Bundesbank rose between the end of 2009 and the end of 2017 from € 348 billion to € 635 billion. Since 2010
On average, the Bundesbank gave an average of € 35.8 billion in euro banknotes a year.
This corresponds to an average annual growth rate of 7.8%.

Yet we keep being told that cash is so yesterday whereas we may still be in the adventures of Stevie V

Money talks, mmm, mmm, money talks
Dirty cash I want you, dirty cash I need you, oho
Money talks, money talks
Dirty cash I want you, dirty cash I need you, oho

 

Euro area monetary policy heads for a new frontier

The issue of monetary policy in the Euro area is of significance on several levels. Obviously it affects the Euro area itself but also it affects many countries around it as in a nod to the sad departure of Stephen Hawking overnight it is time to sing along with Muse.

Into the supermassive
Supermassive black hole
Supermassive black hole
Supermassive black hole
Supermassive black hole

This has been demonstrated by the way that zero and then negative interest-rates ( a deposit rate of -0.4%) in the Euro has forced others in the locale to follow suit. It was and is a factor in the -0.5% of Sweden the -0.65% certificate of deposit rate in Denmark and the -0.75% of Switzerland amongst others. It is also a factor in the UK still remaining with a Bank Rate of 0.5% after so many years have passed and not following the more traditional route of aping the moves of the US Federal Reserve.

What next?

This is the question on many lips both inside for obvious reasons but also outside the Euro area for the reasons above. Why? Well the President of the European Central Bank Mario Draghi explained this earlier today in Frankfurt.

The economy has been growing consistently above current estimates of potential growth, by more than a percentage point last year. All euro area confidence indicators are close to their highest levels since the start of monetary union, even if the latest readings came in slightly below expectations.

This as I regularly point out means that monetary policy is facing a new frontier. This is because it is procyclical where it is expansionary in an existing expansion. Mario has in fact gone further than me in one area as in his view it is even more procyclical leading to output being more than 1% above potential. If that sounds a little mad I will return to it in a moment.  But another factor in this new frontier is the way that both negative interest-rates and QE have been deployed.

We’ll open up the doors and climb into the dawn
Confess your passion your secret fear
Prepare to meet the challenge of the new frontier ( Donald Fagen)

Potential Output?

Looking at what output has been allows us to figure it out.

Over the whole year 2017, GDP rose by 2.3% in the euro area ( Eurostat)

That would mean that potential output is only 1% per annum but I suspect Mario really means the 2.7% if you compare the last quarter of 2017 with a year before so 1.5%. That is rather downbeat which is very common amongst central bankers these days as for example Governor Carney and the Bank of England used different language “speed limit” for the UK but also came to 1.5%. Due to demographic pressures the Bank of Japan is even more downbeat for Nihon at 1%.

We will see how the media treat that as they make a big deal of the UK situation but let is move onto what causes them to think this? We come to something which is genuinely troubling.

Second, the degree of slack itself is uncertain. Even if slack is now receding, estimates of the size of the output gap have to be made with caution. Strong growth may be leading to higher potential output, as crisis-induced hysteresis may be reversed in conditions of stronger demand. And the effects of past structural reforms, especially in the labour market, may now be showing up in potential output.

As you can see the certainty of earlier has gone as this clearly points out they do not know. We are back to imposing theory on reality again and even worse a failed theory as later we get this.

Phillips curve decompositions find that past low inflation dragged down wage growth from its long-term average by around 0.2 percentage points each year between 2014 and 2017.

If we step back we see that according to the Phillips Curve wages should be soaring as we are above potential output whereas in fact they are doing this.

 The unexplained residuals in the model – which in the past were sizeable – are diminishing, suggesting the link between unemployment and wages should improve.

As in there is no link visible yet but if you inhale enough hopium it will be along at some point! Also I hope you enjoyed the reference to labour market reforms from Mario as we mull the contrast between that and his policy press conferences which every time without fail have a section calling for economic reform.

More! More! More!

It is somewhat awkward when you are telling people the economy is running hot and implying it is overheating if you also say it may be about to run faster.

Non-essential purchases – which make up around 50% of household spending in the euro area – tend to be postponed during recessions and then to catch up as the business cycle advances. Such purchases are currently only 2% above their pre-crisis level, compared with 9% for essential ones. This implies that discretionary household spending still has scope to support the expansion.

So it is below potential Mario? Also an area central bankers love to see boom also seems to be below potential.

Moreover, housing investment is still 17% below its pre-crisis level and is only now starting to pick up, which will likely add an extra impulse to the recovery dynamic.

What about inflation?

This if you look at a Phillips Curve world should be on the march in both senses as wages and prices should be heading upwards and yet.

Wage growth has been trending upwards for the euro area as a whole, rising by 0.5 percentage points from the trough in mid-2016.

Not much is it? As to be fair Mario points out.

But consistent with the weakening of the relationship between slack and inflation, the adjustment of wages during the recovery has so far been atypically slow.

The trouble is the analysis seems to be based on pure hopium.

That said, our analysis suggests that, as the cycle advances, the standard wage Phillips curve should hold better for the euro area on average. The unexplained residuals in the model – which in the past were sizeable – are diminishing, suggesting the link between unemployment and wages should improve.

So when you really want it to work ( in a crisis) it fails and in calmer times it does not seem to work either. But they will continue with it anyway like someone who s stuck in the mud.

Comment

Actually I think that Mario Draghi is more intelligent than this as we see several themes come together. Back in the dim and distant days when I began Notayesmanseconomics I offered the opinion that central bankers would dither when it became time to reverse course on their stimuli. This became a bigger factor as the stimuli grew. Now we see a central banker telling us.

But we still need to see further evidence that inflation dynamics are moving in the right direction. So monetary policy will remain patient, persistent and prudent.

This works nicely for Mario as the inflation forecasts remain below the 1.97% inflation target defined by a predecessor of his ( Monsieur JC Trichet).

The latest ECB projections foresee a pickup in headline inflation from an average rate of 1.4% this year to 1.7% in 2020.

Thus as he has hinted at in past speeches which more than a few seem to have forgotten Mario Draghi may depart as ECB President without ever raising interest-rates. In fact it seems to be his plan and it is something he will leave as a “present” for whoever follows him. Another form of stimulus may have slowed but is still around as well.

The cumulative redemptions under the asset purchase programme between March 2018 and February 2019 are expected to be around EUR 167 billion. And reinvestment amounts will remain sizeable thereafter.

So now we see that policy has been decided and a theory ( Phillips Curve ) has been chosen which is convenient. Mario may not believe it either but it suits his purpose as does claiming their has been labour market reform. This is the same way that we have switched from the economic growth of the “Whatever it takes” speech to inflation now both suggest the same policy which allows Mario to give himself a round of applause.

 Considering all of the monetary measures taken between mid-2014 and October 2017, the overall impact on euro area growth and inflation is estimated, in both cases, to be around 1.9 percentage points cumulatively for the period between 2016 and 2019.

So another masterly performance from Mario Draghi but it should not cover up the many risks from advancing onto a new frontier of procyclical monetary policy.

 

 

 

 

Portugal hopes to end its lost decade later this year

It is time for us once again to head south and take a look at what is going on in the Portuguese economy? The opening salvo is that 2017 was the best year seen for some time. From Portugal Statistics.

In 2017, the Portuguese Gross Domestic Product (GDP) increased by 2.7% in real terms, 1.1 percentage points higher than the rate of change registered in 2016, reaching, in nominal terms, around 193 billion euros. In nominal terms, GDP increased 4.1% (3.2 in 2016),

So both economic growth and an acceleration in it from 2016. In essence the performance was an internal thing.

The contribution of domestic demand to GDP growth increased to 2.9 percentage points (1.6 percentage points in 2016), mainly due to the acceleration of Investment. Net external demand registered a negative contribution of 0.2 percentage points (null in 2016),  with Imports of Goods and Services accelerating slightly more intensely than Exports of Goods and Services.

It is hard not to feel a slight chill down the spine at the latter section as it has led Portugal to go cap in hand to the IMF ( International Monetary Fund) somewhat regularly over the past decades. But to be fair the last quarter was better on this front.

The contribution of net external demand to GDP quarter-on-quarter growth rate shifted from negative to positive, due to the significantly higher acceleration of Exports of Goods and Services than of Imports of Goods and Services.

Indeed the last quarter was good all round.

Comparing with the previous quarter, GDP increased by
0.7% in real terms.

Also whilst it fell from the heady peaks of earlier in the year investment had a good year.

Investment, when compared with the same quarter of
2016, increased by 5.9% in volume in the last quarter of
2017, a 4.4 percentage points deceleration from the
previous quarter.

This was particularly welcome as it needed it as I pointed out on the 6th of July last year the economic depression Portugal has been through saw investment collapse.

 A fair proportion of this is the fall in investment because whilst it has grown by 5.5% over the past year the level in the latest quarter of 7.7 billion Euros was still a long way below the 10.9 billion Euros of the second quarter of 2008.

Unemployment

The national accounts brought a hopeful sign on this front too.

In the fourth quarter of 2017, seasonally adjusted
employment registered a year-on-year rate of change of
3.2%, (3.1% in the previous quarter)

Of course this does not have to mean unemployment fell but in this instance as we learnt at the end of last month the news is good.

The December 2017 unemployment rate was 8.0%, down by 0.1 percentage points (p.p.) from the previous month’s
level, by 0.5 p.p. from three months before and by 2.2% from the same month of 2016…………The provisional unemployment rate estimate for January 2018 was 7.9%.

This means that the statistics office was able to point this out.

only going back to July 2004 it
is possible to find a rate lower than that.

The one area that continues to be an issue is this one.

The youth unemployment rate stood at 22.2% and
remained unchanged from the month before,

Is Portugal ending up with something of a core youth unemployment problem?

The latest Eurostat handbook raises another issue as it has a map of employment rate changes from 2006 to 2016. For Portugal this was a lost decade in this sense as in all areas apart from Lisbon (+1.1%) it fell from between 2.5% and 3,8%. Rather curiously if we divert across the border to a country now considered an economic success Spain it fell in all regions including by 7.2% in Andalucia. So whilst both countries will have improved in 2017 we get a hint of a size of the combined credit crunch and Euro area crises.

Is Portugal’s Lost Decade Over?

No it still has a little way to go and the emphasis below is mine. From the Bank of Portugal economic review.

economic activity will maintain
a growth profile over the projection horizon,
albeit at a gradually slower pace (2.3%, 1.9%
and 1.7% in 2018, 2019 and 2020 respectively)
. At the end of the projection horizon,
GDP will stand approximately 4% above the level
seen prior to the international financial crisis.

So it will be back to the pre credit crunch peak around the autumn. We will have to see as the Bank of Portugal got 2016 wrong as I was already pointing out last July that the first half of 2016 had the economic growth it thought would arrive in the whole year. Maybe its troubles like so many establishment around the world is the way it is wedded to something which keeps failing.

Projected growth rates are above the average
estimates of potential growth of the Portuguese
economy and will translate into a positive output
gap in coming years.

Actually that sentence begs some other questions so let me add for newer readers that the economic history of Portugal is that it struggles to grow at more than 1% per annum on any sustained basis. In fact compared to its peers in the Euro area 2017 was a rare year as this below shows.

interrupting a long period of negative annual
average differentials observed from 2000
to 2016 (only excluding 2009).

This is unlikely to be helped by this where like in so many countries we see good news with a not so good kicker.

The employment growth in the most recent
years, which was fast when compared with activity
growth, has resulted in a decline in labour
productivity since 2014, a trend that will continue
into 2017. ( I presume they mean 2018).

House Prices

It would appear that there is indeed something going on here. From Portugal Statistics.

In the third quarter of 2017, the House Price Index (HPI) increased 10.4% in relation to the same period of 2016 (8.0% in the previous quarter). This rate of change, the highest ever recorded for the series starting in 2009, was essentially determined by the price behaviour of existing dwellings, which increased 11.5% in relation to the same quarter of 2016………….The HPI increased 3.5% between the second and third quarters of 2017

The peak of this was highlighted by The Portugal News last November.

Portugal’s most expensive neighbourhood is, perhaps unsurprisingly, the heart of Lisbon, where buying a house along the Avenida da Liberdade or Marquês de Pombal costs around €3,294 per square metre; up 46.1 percent in 12 months.

Time for the Outhere Brothers again.

I say boom boom boom let me hear u say wayo
I say boom boom boom now everybody say wayo

The banks

Finally some good news for the troubled Portuguese banking sector as their assets ( mortgages) will start to look much better as house prices rise. If we look at Novo Banco this may help with what Moodys calls a “very large stock of problematic assets” which the Portuguese taxpayer is helping with a recapitalisation of  3.9 billion Euros. Yet there are still problems as this from the Financial Times highlights.

Portuguese authorities last year launched a criminal investigation into the sale of €64m of Novo Banco bonds by a Portuguese insurance firm to Pimco that occurred at the end of 2015. A week later, the value of the bonds sold to Pimco were in effect wiped out by the country’s central bank.

This is an issue that brings no credit to Portugal as Novo Banco as the name implies was supposed to be a clean bank that was supposed to be sold off quickly.

Comment

So we have welcome economic news but as ever in line with economics being described as the “dismal science” we move to asking can it last? On that subject we need to note that an official interest-rate which is -0.4% and ongoing QE is worry some. Also Portugal receives quite a direct boost in its public finances from the QE as the flow of 489 million Euros  of purchases of its government bonds in February meaning the total is now over 32 billion means it has a ten-year yield of under 2%. Not bad when you have a national debt to GDP ratio of 126.2%.

To the question what happens when the stimulus stops? We find ourselves mulling the way that Portugal has under performed its Euro area peers or its demographics which were already poor before some of its educated youth departed in response to the lost decade as this from the Bank of Portugal makes clear.

The population’s ageing trend partly results from
the sharp decrease in fertility in the 1970s and
1980s,

So whilst some may claim this as a triumph for the “internal competitiveness” or don’t leave the Euro model 2017 was in fact only a tactical victory albeit a welcome one in a long campaign. Should some of the recent relative monetary and consumer confidence weakness persist we could see a slowing of Euro area economic growth in the summer/autumn just as the ECB is supposed to be ending its QE program and considering ending negative interest-rates. How would that work?