April 4, 2008 | posted by Michael Baxter in Eurozone | comments (0) |

Spain and Ireland are in trouble.        Both have bloated housing markets, they have enjoyed years of rapid growth in GDP, leaving the two economies looking overheated, and they have both been over-reliant on a booming construction sector.    But both countries could be saved from disaster, thanks to one piece of perverse luck.

Neither Spain nor Ireland have especially sophisticated personal finance markets.    According to the IMF, both countries enjoy only limited equity withdrawals.

Take Ireland.  House prices have already fallen by 10 per cent, while Capital Economics has predicted an additional 10 per cent fall this year, but throughout the country’s boom it managed to retain a high savings ratio – around 10 per cent.   This means that the knock on consumer spending may not be as bad as you would have initially thought.

Mind you, despite the low equity withdrawal rates, both countries have high mortgage debt to income ratios.    Ireland is in fifth place and Spain in sixth place in the IMF list of 17 countries.  (Denmark, Netherlands, the UK, Australia and the US have higher debt ratios.)

But the two economies have this Achilles heel: construction.

Until recently, construction accounted for no less than 25 per cent of gains in employment in Ireland over the last decade.  But now there are signs it is going into reverse.    Capital Economics reckons Irish unemployment could rise by 100,000 or so over the next year or two as a result.

Actually, although the Spanish construction industry was vital to its economic growth, the sector is smaller as a percentage of GDP than in Ireland.

Even so, of the 17 major economies the IMF reported on, Spain has the second-most-active construction sector, as a proportion of GDP.

More worrying, the latest composite Purchasing Mangers index for Spain fell to a record low in March.     Even more worrying, it was the services sector that performed particular badly, so that means services are falling just at a time when economists expect the country’s recently buoyant construction sector to skid to a halt.

Mind you, although it expects growth to slow sharply, Capital Economics still reckons Spain will grow by 1.8 per cent this year, and Ireland by 1.5 per cent this year and 2 per cent next.

It does, however, say the risks to its forecasts are on the down side.

March 31, 2008 | posted by Michael Baxter in Eurozone | comments (0) |

What a dilemma.    It seems the Fed made two mistakes.     First, it let the rate of interest fall far too low earlier this decade – fuelling a consumer borrowing boom and a bubble in asset prices.  But, maybe more recently it was too slow to lower interest; as a result, the most recent cuts in rates seem to be having limited effect.  A stitch in time saves nine,  and it appears by lagging behind the curve, the Fed has left itself with lots of rapid stitching, in an apparently vain attempt to fix the threadbare fabric of the US economy.

But now, all eyes turn to the UK and Europe.     Many argue that the Bank of England and European Central Bank need to embark both on rate cuts, and on pumping money into the economy now, and in the process avoid the apparent panic that has become endemic at the Fed.

But inflation in Europe is on the up.

Many think the rate of inflation in the UK could once again move by more than a full percentage point above its inflation target within the next few months, thus promoting another of those embarrassing letters from the Bank’s governor to the chancellor.   In such an environment, how can the Bank of England start lowering rates?

Then this morning, news came in telling us that the CPI rate of inflation in the Eurozone is now 3.5 per cent, up from 3.3 per cent in February.

It now stands at the highest level since March 1992.

It’s a tough one.

If the global economy is set to slow dramatically, then that will presumably mean lower demand, and prices will then fall.  Think ahead, say those itching for rate cuts,  inflation is up simply because of one-off effects.  When they ease out of the system, inflation will fall rapidly – now is the time to allow for this.

But it appears a new school of thought is growing.  This school says first of all that in future, central banks must take into account inflation of asset prices when setting rates.   

Furthermore, goes the argument, the period of low inflation was not caused so much by low demand – which usually requires cuts in interest rates, but was simply down to external factors - one-offs, for example, advances in productivity and cheap imports.   It may be be a mistake to keep rates high now, because inflationary pressures are down to one-offs, but equally it was a mistake to let rates fall so low earlier this decade because low inflation was down to one-offs.

Maybe, then, monetary policy has got it completely wrong.  Rates were cut when demand was already too high.  Now rates are too high, when demand is falling off the edge of a cliff.

It’s all very well of course, but we are being wise after the event.

The conclusion: we now need to stitch this idea into economic thinking going forward, but it may not be that relevant to solving the crisis we are in right now.

March 10, 2008 | posted by Michael Baxter in Eurozone | comments (0) |

But while the UK totters, with debt seemingly coming out of every economic orifice, others turn their attention to Spain, where prime minister Jose Luis Rodriguez Zapatero was re-elected yesterday.

Here is an economy in especially dire straits – at least some say that. But there is another side to the argument.  Sure, Spain may well struggle to stay clear of recession, the economy does have deep problems, not dissimilar problems by the way from those besetting the UK, but it does have one massive advantage over the UK.

Like the UK, Spain is enjoying its longest-ever run of uninterrupted economic growth. It is now 14 years since the country has had a recession. Like the UK and US, and indeed Australia, the economic boom has been propelled by consumer spending. Just like the UK, but unlike the US, productivity has not performed so well – leading many to say the economic good times can not be sustained.

Also, just like both the UK and US, and indeed Australia it, suffers from a massive balance of payments deficit – in fact the Spanish deficit is even worse than that suffered in the UK and US, - its deficit on the current account is not far short of 10 per cent of GDP – putting the US and UK deficits in the shade.

Spain has also experienced a property boom, and now some say the Spanish property market is in for a big fall. Capital Economics recently estimated that Spanish house prices would fall by between 5 and 10 per cent.

The Spanish economy is much more reliant on the construction sectors than most other economies. In 2007, construction made up around 10 per cent of Spanish GDP, compared to just 5 per cent in the UK and 6 per cent in the US, so a fall in Spanish house prices will have a catastrophic effect upon the economy.

Spain also suffers from high levels of consumer debt. Its total consumer debt to income ratio is 1.01, not as high as in the UK, US and Japan, but much higher than France, Germany and Italy.

If you want an explanation as to why the Spanish economy has many similarities with the Anglo Saxon world, here is a possible explanation.

Just like the UK, US and Australia, Spain has a particularly-high level of property ownership. In fact, according to the Halifax, in 2006, no less than 82 per cent of properties were occupied by their owners. This compares to 70 per cent in the UK and Australia, 69 per cent in the US, 56 per cent in France, 55 per cent in Holland and just 45 per cent in Germany.

Looking at those figures, it certainly does seem that economies that have a high level of owner occupancy, have seen high house price inflation and ballooning consumer debt; they have become more and more reliant on the consumer to drive growth.

But Spain has one massive advantage over the UK. It has a truly impressive fiscal surplus of almost 2 per cent of GDP. Compare this with the UK with a deficit of around 3 per cent of GDP. As for total government debt – last year this stood at just 36.2 percent of GDP, much lower than in all the other major developed economies.

Keynes once said that in times of high debt, a reduction in the rate of interest was akin to pushing on string. Monetary policy can, to an extent, be useless in times like these. Sure, Spain has no control over its monetary policy, and it could be argued a part of its problems reside with the euro – with Eurozone interest rates far too low when the Spanish debt bubble was building, but at least she has room to spare.

Unlike the British government, Spain’s government did not spend as if money was going out of fashion during the boom. Instead, she did what every prudent consumer would do, saved when times were good, and now she has money to play with – and while the consumer pauses for breath, the government is more than capable of taking up the slack – and in the process, grapple with some of the deep underlying problems in Spain; she can do something about the road network, for example.
 

February 15, 2008 | posted by Michael Baxter in Eurozone | comments (0) |

Every now and again, out comes an economist or two, predicting a crash in the Spanish economy.

Yesterday, it was Capital Economics’ turn. “Most commentators are agreed that the Spanish economy is heading for a slowdown,” it said, “but we think the ‘consensus’ forecast of a relatively soft landing is too optimistic. We expect a major downturn in the property and construction sectors to cause a much sharper slowdown in GDP growth. It may not quite be a recession. But after the rapid growth of the last decade, it will certainly feel like one.”

It is predicting a 5 to 10 per cent fall in Spanish house prices, which will in turn lead to a fall in employment in the construction sector. It says lower Spanish house prices will pull down consumer spending, and could then hit the banking sector hard.

Spain is one of those economies that has been subject to rampant house price inflation – and it has an even bigger trade deficit as a percentage of GDP than both the US and UK.

Interestingly, Spain has long enjoyed a situation in which a very high proportion of its population own their own homes. In 2006, its owner-occupancy rate was 82 per cent, compared to 70 per cent in the UK. And if you rewind the clock back to 1970, its owner-occupancy rate then was 78 per cent, compared to 66 per cent in the UK.

It is interesting how Spain’s strengths and weaknesses are really quite similar to those in the US and UK. It has experienced a golden period of rapid growth – but is now suffering from too-high house prices, too much consumer debt, and a massive trade deficit.

The common denominator seems to be high owner-occupancy.

February 1, 2008 | posted by Michael Baxter in Eurozone | comments (0) |

No so long ago, the talk was that the Eurozone needed to take the baton, and propel the economy forward.  Well, all of a sudden, it is as if the region has grabbed the wrong baton – and is instead running with a stick made of lead.

Inflation in the Eurozone has soared to 3.2 per cent – the highest level in 14 years.  More to the point, it appears that core inflation is surging.   

Capital Economics said, “Given probably-neutral energy effects and the favourable base effects of last year’s rise in German VAT, the increase suggests that core inflation may have picked up after being static for the last year or so.”  

Remember, if CPI inflation hits 3.1 per cent in the UK, the Bank of England governor has to write a letter to the chancellor explaining what is going on.  So Eurozone inflation of 3.2 per cent (it was 3.1 per cent last month) is very serious.  

Even more worrying, consumer confidence in the region has fallen -9 to -12.  

But, at least there is good news on unemployment.  Last month, unemployment across the region hit a record low, and then yesterday revealed a sharp fall in German unemployment, which now stands at 8.1 per cent, the lowest level since 1992.  

What is worrying, though, with all this data, is that the Eurozone really could do with a kick-start from reduced interest rates.   This morning, the NIESR predicted growth of just 1.9 per cent this year, with Germany and France only managing 1.8 per cent and Italy 1.4 per cent.   Yet, with inflation so high, it appears that for the time being, the European Central bank can not afford the luxury of a cut in rates.

January 25, 2008 | posted by Michael Baxter in Eurozone | comments (0) |

You may have noticed. A split has emerged in the central banks. While the Fed slashes interest like it was the January sales in banking land, the ECB and Bank of England fret over inflation. At Davos, Jean-Claude Trichet – top man at the European Central bank, said, “There is one needle in our compass, which is price stability.” Earlier in the week, Bank of England governor Mervyn King warned inflation was on the rise.

At the same time, Europeans have been saying the key to solving the global economic problem lies in US consumers saving more and spending less.

Well, yes, that may be true up to a point, but if the US consumer was more frugal, the rest of the world would be a lot worse off. And that’s the problem. Can the world really afford for the US to behave in a more-financially responsible way?

As for Europe, with 3.1 per cent inflation in December, now at the highest level in six years, with German unions growing increasingly restless, with a Spanish consumer boom creating its own property bubble, not to mention an even-higher balance of payments deficit than the one we are afflicted with in the UK, the prospects for Europe are not so good.

Mind you, there is no talk of a European recession, yet. Capital Economics reckons Germany will grow at 1.7 per cent this year and, curiously enough, thinks the Eurozone will grow at exactly the same pace. The star of the Eurozone is expected to be Slovenia, which is expected to expand by 4.5 per cent, but France too is expected to grow at above the recent average, at 2 per cent.

Mind you, a growth of 1.7 per cent in a year when the US and UK are expected to slow sharply may mark the best economic prospects for the developed world this year, but it’s pretty anaemic. If this is Europe helping the global economy avoid recession, and running with the baton, then we had better hope China and India can take the baton on pretty quickly.