Do The Latest European Bank Lending Numbers Reveal A Major Headache Looming For The ECB?

by Edward Hugh: Barcelona

According to Ralph Atkins, writing in the Financial Times:

"Eurozone mortgage borrowing grew last month at the fastest pace in almost two years in a sign that bank lending across the 16-country region may be flickering back to life. Lending for house purchases rose at an annual rate of 3.4 per cent in June – the fastest since September 2008, according to European Central Bank data published on Tuesday. The acceleration pointed to a revival in consumer confidence and an increased willingness by banks to fuel the economic recovery with loans to the private sector."

So is this really the good news it seems to be? Well the answer is (as usual) yes and no. The problem is that behind the positive aggregate data lie the individual national details (you know, the place where the devil is usually to be found), and when we dig down to this level, then we find the position is much more complicated than it seems. Nor should this surprise us, since if a one-size-fits-all interest rate policy didn't work in the pre-2008 world (just look what happened to Spain and Ireland for heavens sake), is there any good reason to assume that it will in a post-2010 one?

To take the two extreme cases, France and Spain, in France mortgage lending was up by an annual 5.3% in June (considerably above the aggregate average of 3.4%), and not only this, lending has in fact been accelerating since it hit a trough in October last year (see chart below).


In Spain, on the other hand, mortgage lending continued to languish, rising by only an annual 0.9%.



Indeed, lending to households generally was up in France, by an interannual 4.4%.



while in Spain total lending to households was only up by 0.5% over June 2009.



This is not simply a question of there being a vicious credit crunch operative in Spain (which there most certainly is), but one of different relative levels of indebtedness, since total household debt in Spain is 902 billion euros (or around 90% of GDP), while in France it is just a fraction under 1,000 billion euros (or just a tad over 50% of GDP). So French households have the capacity to leverage themselves more, while Spanish households are dangerously overleveraged, and herein lies the danger for the ECB, with its single interest rate policy limitation. Not raising rates risks fuelling a sizeable consumer credit and construction boom in France, while in Spain raising them (given that in Spain around 90% of mortgages are with variable rates) it means flooding the Spanish banking system with non-performing loans.

In fact the situation in the construction industry is quite different between the two countries, In Spain construction seems (for the time being) to be in near terminal decline.



while in France construction activity may not have revived, but then it never fell as dramatically as it did in Spain.



Nor did industrial output fall as far or as fast, as it did in Spain.






Retail sales reveal a rather similar picture.





As do the respective sevices PMIs.

Jack Kennedy, economist at Markit and author of the France Services PMI, said:

“Growth momentum in France remained marked during June, rounding off a strong Q2. A solid gain in service sector employment – the sharpest since April 2008 – is encouraging for the labour market and, by extension, consumer spending. Overall, the upturn appears to still have considerable traction despite signs of a recent cooling of growth in the manufacturing sector.”

Commenting on the Spanish Services PMI survey data, Andrew Harker, economist at Markit and author of the report said:

“Latest Spanish service sector PMI data provide some worrying signs regarding the path of the sector. Foremost among these is the first drop in new business since February. Also of note is the marked weakening of sentiment seen in the previous two months amid worries surrounding austerity measures in Spain and the effects these will have on the fragile economy.”

So the divergence between these two economies couldn't be clearer at this point. While house prices continue to fall in Spain.



In France there is already evidence of an uptick.




Of course, this is still early days yet. But lets just remember how Spain got into the mess it is currently in.




During the key years of the construction bubble negative interest rates were applied to a booming Spanish economy (the yellow parts of the chart above, looks like a dental X-ray showing where you need the filling, doesn't it?). So what is happening now in France?



As can be seen (blue patch at the end), since December last year the French inflation rate has been above the Eurozone 16 one, something that has almost never been the case since the Euro came into existence. And since almost the same date French interannual inflation has been above the ECB policy rate of 1%. That is to say, negative interest rates are being applied to the French economy. Possibly there was no harm in that while that economy was in the midst of the deepest recession in a decade, but now the French economy is showing clear signs of recovery and the remedy (along with the massive "emergency" liquidity provision from the ECB) simply isn't called for.

But if we come to look at the French goods trade balance (a sure early warning indicator of problems to come) we can see that the trade deficit is widening again, which basically means that French industry is once more losing competitiveness, and the economy becoming structurally distorted (note the point in the French PMI quote about the weakening manufacturing performance just as the services sector is accelerating). This is just what happened to the Spanish industrial sector in its day.




So as Ralph Atkins says, "The pick-up in mortgage lending could offer some cheer after months of gloomy eurozone bank lending data and fears about the stability of the region’s banking system" - but it could also add to the worries too. As far as I can see there are only two ways around this problem, either start increasing rates at the ECB, or press for a substantial internal devaluation to restore economic growth in Spain, but both of these routes pose serious issues for the stability of the Spanish banking system, since in the former case the burden of mortgage interest payments becomes excessive (and quickly - simply raising the refi rate from 1% to 2.5% would represent an almost 100% increase in mortgage service costs given the close attachment between Spanish mortgages and 1 year Euribor), while in the latter the reduced nominal incomes make the burden of the mortgage repayments even more weighty, with almost inevitably the same result - more mortgages going "bad". One thing is for sure though, some sort of solution or other needs to be found, and soon, if not the one Eurozone economy where domestic consumption isn't a dead man walking at this point may be sent on a roller coaster ride which is in no-one's interest.

Under Stress

After a long and rather tense wait, the initial response to the publication of the European bank stress tests was always going to be something of an anti-climax. Indeed the results should hardly have comes as a surprise to anyone It is hardly breaking news to learn that a number of Spanish cajas will find themselves badly undercapitalised if the economic recovery – as surely might be expected – fails to materialise as planned. For the rest, the outcome is really a victory for politically correct: thinking. The situation, we learn, is slightly more serious than previously acknowleged, but we are a long way from seeing the imminent collapse of the European financial system. How could we be, when we have the friendly face of the ECB, always there ready to offer a helping hand.

Chile's Economy - Steady as she Goes

By Claus Vistesen: Copenhagen

BBC's travel program Fast Track had a story about how Santiago has been working hard since the earthquake to (re)build its position as a cool global city. I have never been to Santiago (let alone Chile) so I cannot say whether there is any position to rebuild or whether Santiago isn't simply moving up and ahead regardless of the recent blow to tourism in the wake of the earthquake. However, what I can say for certain is that when it comes to Chile's economy at large it is in no need to rebuild anything; it is both global, cool and very strong.

Enviable Economic Performance

Let us begin taking stock on the performance of Chile's economy in the past two years compared to the US and the EU16 in order to see that while the crisis indeed has been global (and still is) notable divergences are present.

Chile's economy contracted through three quarters from Q4-08 to Q2-09 but has since returned to growth and, crucially, seems to have returned to trend growth unscathed from the fangs of the economic crisis which will have wide repercussions in the rest of the OECD for many years. In this sense, Chile entered the crisis unlevered and with sound demographic fundamentals which precisely gives the economy the ability to reach escape velocity and quickly resume positive output growth. As a backdrop it is exactly this pulling power which many economies in the OECD don't have which again means that for us to find a solution to this we have to find a way to export our way out of trouble but since this is not possible for everyone at the same time it does represent us with a unique challenge.

This is not the case however in Chile where the economy expanded at a heaty pace of 11.3% and 13.7% in Q4-09 and Q1-10 respectively (yoy), numbers which are bound to be considerably lower going forward especially since the effect of the earthquake in February will cast a shadow over Q1 GDP figures which may still be revised down considerably once the full effect has been factored in. The alternative is that the effect will be moved forward into Q2 numbers, but this is ultimately an accounting question.

Moving closer to real time developments the main activity index (the IMACEC) indicates a steady and ongoing expansion of Chile's economy even after the blip which occurred as a result of the earthquake (showing up in the March reading as it happened in end February).

In May, the IMACEC stood at 130.9 (2003 = 100) which is the strongest reading in the index' history and further encouragement has also come from the fact that May was the first month in which industrial production showed a proper increase on an annual basis after having moved sideways in Q1-2010; industrial production expanded 3.3% on the year. This points to an economy on a strong footing although some might note that at this pace and with the headwinds currently facing the global edifice the only way from here is down. I would agree in the main here as Chile may well give back some of the fine H01-10 performance as we move into H02-10 but Chile should be able to stand its ground and will expand at a healthy clip in 2010.

This view is supported by recent upward adjustment of economic expectations across the board even if the current expectations of continuing interest rate tightening may be overdone.

Regards, the evolution of GDP in 2010 the expectations remains fixed at around 4.5% to 4.8% which is around trend output according to the central bank's estimations. The 4.25% target for the monetary policy rate in 12 months implies a steep tightening schedule from the current level of 1.5% and many analysts have voiced caution that interest rate will climb this much in a 12 month horizon. This view reflects both the fact that the central bank may be too linear in the way it has set its 12 month target interest rate as well as it reflects the market's perception that appreciation of the Peso may become an issue as the yield advantage of Chile increases relative to the USD and Euro.

Strong Fundamentals

So, I am arguing that Chile is doing fine and that she is likely to continue the recent impressive expansion which is likely to put Chile even more at odds with what is expected to be a slowdown in the developed world. However, do the fundamentals back this?

Indeed they do and the focus should be on two aspects; demographics and a sound management of copper windfall.

If we begin with the former there are naturally many ways to spin a story on the graph below.

One could for example point to the fact that the population share of 20-49 is peaking right at this moment and is set to decline hereafter which means that Chile might just be running on the last fumes of full capacity. But this would be missing the big picture I think. In this sense, I think the main point to take away here is the remarkable stability of the population share aged 35-54 throughout the next 40 years (estimated of course, but we are fairly sure that this fits unless we get some kind of exogenous shock). I am emphasizing this because this particular age group has been found [1] to correlate well with GDP per capita levels and growth. The key to Chile's relatively stabile demographic trajectory is to be found in a very favorable demographic transition (at least when it comes to economic growth). Consider then that from 1983 to 2009 fertility in Chile decline from 2.5 children per women to around 2 in 2009. This trajectory is actually what one would expect if applying basic transition theory, but in the real world only a few economies have made the transition to achieve a somewhat stabile level at replacement fertility. The general rule is that fertility undershoots replacement level and has mighty difficulties recovering if at all.

This, more than anything, makes Chile stand out and as an emerging economy turning developed this aspect of the Chile's economy and thus the absense of a very quick and steep fertility transition is, to me, a key reason for Chile's success.

Another reason for Chile's strong economic performance is its copper reserves but more than anything the proper management of this to avoid dutch disease and to build up a strong fiscal position and indeed a sovereign wealth fund in which large chunks of the copper windfall has been stashed away. Naturally, this does not make Chile less dependent on copper as such, but it means that the economy has been able to avoid adverse effects from the volatility in growth that often comes from relying on commodities for revenue (and growth). In numbers, Chile has historically aimed at an annual fiscal surplus of 0.5%/GDP to act as a counterweight to the incoming copper revenues. Between 1996 and 2006, Chile’s public balance averaged 1.5% of GDP a position much better than that held by its peers in East Asia and Latin America. From 2005 to 2007 the structural surplus as a percentage of GDP was 1% and around 0.5% in 2008. However, the pure fiscal surplus, in 2008, as a percentage share of GDP stood at 8.1% which is quite extraordinary on any measure. Although the crisis and the earthquake are sure to have made a dent in these impressive figures the fact remains that on a gross basis Chile's government debt remains very low (6% of GDP in 2009 and 2010) whereas the net debt level is firmly negative (i.e. book value of financial assets exceed that of financial liabilities).

Upwards and Onwards

Does this mean then that there is nothing stopping Chile? Actually, yes.

A renewed severe global slowdown or even a relapse into the financial crisis as well as continuing uncertainty surrounding Chinese momentum and thus copper prices are all factors that could derail Chile's economy in some way or the other. However, it is fair to assume that in the event of an external shock Chile should fall less and rebound more strongly than many other economies and this means that Chile is likely to perform well in relative fashion.

Certainly, I don't want to come of off as complacent but looking at the evidence before and with the qualifier that Chile is not hit by a surge of severe earthquakes (which of course will accumulate in the loss of output) I really cannot see where the stumbling block lies for Chile. In this sense it seems, for now, to be steady as she goes in Chile.

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[1] - See this for example.

Biting The Fiscal Bullet In Poland

There is a good deal of speculation in the press at the moment over the tricky issue of whether or not Poland will be able to comply with its agreed deficit-reduction deadline on the basis of the latest budget proposals announced by the government there. Personally, I tend to agree with those analysts who feel the spending and revenue assumptions being made by the Polish government are rather unrealistic, and that they will this be unable to comply with the terms of the Excess Deficit Procedure as laid down for them by the European Commission: difficult territory this in the "post Greek crisis" world, but it would not be the end of the world were the slippage to be justified. Unfortunately, as I will argue below, I don't think it is justified, indeed I think it is just the opposite of what sound economic management principles would prescribe in the Polish case, and seems to respond more to the impact of impending political pressures than to the precepts of good policymaking. So I do agree with the consensus here in feeling that Poland needs to do a lot more to reign in the deficit (which means unfortunately spending cuts, since I think raising taxes which will crimp growth and raise inflation is most undesirable at this point), although my reasons for arguing this are actually rather rather different from those that are normally advanced.

One Fiscal Size Fits All?

The facts of the matter are, more or less, as follows: the European Commission has given Poland until 2012 to meet its deficit limit of 3 percent of gross domestic product, after Poland’s shortfall swelled to 7.1 percent of GDP last year as the impact of the global economic crisis depleted government revenue and increased expenditure costs. Next year’s budget assumes something like 3.5% GDP growth and 2.3% inflation, with nominal wage growth rising by 3.7% employment increase by 1.9%.


The EU Commission expect the deficit to only narrow to 7 percent of GDP next year following a 7.3 percent budget gap in 2010. But given that Poland's debt to GDP level is only around 50% of GDP, and that Poland is one of the few large EU countries to still have dynamic internal consumption, you might want to argue that stimulus should be maintained, if only to help Poland's export dependent neighbours.



I want to argue that this view is basically wrong, and that far from needing more in the way of stimulus, what Poland needs to do is contain an overdramatic expansion of credit based domestic demand, an expansion which, if unchecked, could very easily lead to the sort of structural distortions and competitiveness loss we have just observed in the South of Europe and Ireland.

Poland Largely Escaped The Great Recession

But first, lets step back a bit and see what the problem is.

Poland, as most observers note, escaped the worst of the 2009 great recession.



Poland was basically able to endure without too much bloodletting for three principal reasons.

In the first place the level of household indebtedness is still not excessively high. In the second place Poland had maintained a floating exchange rate which meant that it could let the zloty rise during the heady days of 2008, and then allow the currency to devalue when the crisis hit. An thirdly, the level of Forex lending never rose as high in Poland as it did in some of its East European neighbours, which meant that when the time came to devalue there was not such a threat of increasing the Non Performing Loan rate. As can be seen in the chart, it was starting to take off when the credit crunch came along and (fortuitously) stopped it dead in its tracks.


Interestingly enough then, it has been the very fact of not having gone for early Euro adoption that left the Polish monetary authorities with the flexibility needed to respond to the crisis in an appropriate manner. As the IMF put it in their latest Article IV staff report:

"Staff does not support early euro adoption. While this should remain an important goal, entering ERM2 any time soon would not be advisable in view of the uncertain global outlook and the rigidities in the macroeconomic policy mix discussed above. More importantly, the crisis has underscored the importance of being able to use the exchange rate to facilitate adjustment to external shocks. In staff’s view, the swift change in the real exchange rate was one of the key reasons for Poland’s not falling into recession in 2009".

Indeed, the very rapid way that using currency flexibility to resore competitivenes helped should be evident from the Real Effective Exchange Rate chart below:



As can be seen in the run in to the crisis Poland had been losing competitiveness with Germany, following a well known and well trodden path. But in 2009 the country was able to recover much of the lost ground, simply at the push of a (trader's) button - and the currency is now trading at something like 18% below its pre-crisis peak in real effective terms. This remedy is, unfortunately, no longer available to the likes of Spain, Greece, Portugal and Ireland. Even more interestingly, Poland has been able to carry through the devaluation process without provoking a very strong inflation spike.



Of course, there was another factor in Poland's ability to not fall from grace, the fiscal stimulus package. As the IMF put it:

Fiscal policy is providing significant counter-cyclical stimulus. There was a discretionary fiscal relaxation estimated at 1¾ percent of GDP in 2008 and 2½ percent of GDP in 2009, mainly due to tax cuts enacted in 2007 but coming into effect with a delay. While the government initially intended to offset revenue shortfalls to the extent needed to maintain the state budget deficit below the limit of Zloty 18 billion in 2009—through what would have been highly pro-cyclical expenditure cuts—it appropriately changed such plans at mid-year, when it raised the limit to Zloty 27 billion. As a result, the general government deficit increased from under 2 percent of GDP in 2007 to over 7 percent of GDP in 2009. The strong counter-cyclical stimulus provided by fiscal policy—through a combination of discretionary relaxation and the work of automatic stabilizers—was a major reason for Poland’s not falling into recession during the global crisis.

And it is, of course, the issue of just how to withdraw this fiscal stimulus that is the main topic of debate. Unlike many of its regional neighbours, the Polish economy is now in the process of returning to reasonable levels of growth. The levels will surely not be those (possibly unsustainable) ones seen before the crisis, but rates in the order of 3% for 2010 & 2011 do not seem unreasonable.


Monetary Policy In Times Of The Great Immoderation

The problem is, as the output gap gradually closes, the central bank will increasingly have to think how to formulate a response to the inflationary presures which will inevitably follow in the wake. Evidently, in a era of globalised capital flows, conducting monetary policy is not as simple as it used to be, since simply raising interest rates may prove to be counterproductive, and investors look to get the benefit of the increased yield margin on offer.

In fact, the IMF draw exactly the opposite conclusion, namely that if upward pressures on the zloty persist (see chart below), and inflation remains contained, then they argue that the policy rate should be cut. That is they prioritize (correctly in my view) competitiveness issues over the conduct of orthodox monetary policy.

The recovery in global risk appetite, not least in the demand for assets of countries that have weathered the crisis well, suggest that foreign demand for Polish assets could continue to build, resulting in further zloty appreciation. In that case, staff believes that the MPC should revert to an easing bias and cut the policy rate.

In fact with the central banks policy rate at 3.5% there is room for some easing, and room for increased carry too, if the rate stays were it is as risk appetite grows.


The Fiscal Arm Is The Only Effective One

And this is where the real argument for turning the fiscal screw comes in, not in order to simply comply with the EU's 60% gross debt rule (Poland's government debt to GDP is currently around 50%), but rather because in the absence of applying monetary tightening to contain excesses and avoid (further distortions) the government really do need to drain excess demand from the economy by resorting to fiscal policy.

As I have said, the Polish economy is now showing signs of a renewed burst of growth. Industrial output is up sharply (it is now more competitive with imports, among other things):



While retail sales are also strong



And credit growth has once more taken off again:



If this were to remain modest, then it would be a good sign, but continued growth, and monetary loosening, would surely run the risk of seeing the acceleration go too far. And as if to warn us, construction activity has just seen a strong lurch upwards:



Faced with the danger of all of this getting out of hand the authorities can basically do two things. They can tighten loan conditions for the banking sector, by making the deposits required greater (or the Loan to Value ratios lower), and the income criteria stricter, and starting to move people over from variable to fixed interest mortgage rates on the one hand, and by implementing stricter fiscal measures on the other. Some say this will be difficult for Poland in a pre-election period, but are Polish voters really that unaware of what has been happening in other EU countries in recent years that they would willingly go for a bit of extra consumption now at the price of being another Spain five years on down the road?

Once More Those Structural Economic Distortions

Despite, all that improvement in competitiveness Poland is still running a trade deficit:

And it has been running a current account one for more years than anyone cares to remember.



Maybe the deficit has not been large by prior regional standards, but who really wants to go where others have gone before. And with each new deficit the level of external indebtedness simply grows, and is now reaching the 60% of GDP mark. By no means critical yet, but surely it would be more interesting to turn south before it does go critical. And in any event, the presence of the external debt makes the Polish economy unduly dependent on external financial flows, a point highlighted recently when the IMF announced an agreement to renew the country's US$20.43 billion flexible credit line.

Poland is one of the few large EU countries (alongside France) where domestic demand is (for the time being at least) all but dead and buried. Some of the reasons for this are historic ones, some are just quirks of fate (the crunch came before Forex lending got out of hand) and some are demographic. Curiously Poland, like France, is rather younger than many of its regional neighbours.



So for all these, and as they say many other reasons, I think the Polish authorities would do well to think again, and produce a revised set of budgetary projections for the years to come. If not, someone somewhere will one day ask them: "why didn't you see it coming".

Is There Global Economic Slowdown In The Works?

by Edward Hugh: Barcelona

According to Ralph Atkins writing in the Financial Times last week, "the pace of Germany’s recovery is helping dispel fears of a “double dip” recession across the continent as a result of the crisis over public finances in southern European countries". Coincidentally, however, on the very same day, Alan Beattie writing from Washington informed us that the IMF feel "the risk of a slowdown in the global economic recovery has risen sharply". This left me asking myself which is it: is the global recovery a question of up up and away, or are we at the start of a renewed slowdown (whether or not you wish to term this a "double-dip")? So I thought I would take a look through some of the most recent data (both hard and soft) to see if I could make any sense of the situation.

Well one place we could look for some sort of indication would be in the latest batch of PMI survey results. David Hensley, Director of Global Economics Coordination at JPMorgan, put it like this: "Signs are that growth of global GDP may have reached an near term peak in Q2 2010. June PMI data indicate that growth of business activity and new orders are starting to wane. Some cooling in the manufacturing boom was expected as the inventory cycle matures. What is more concerning is that the service sector also may be losing momentum."

Most importantly it is, as we shall see, new order growth that is waning, and that does look rather ominous, with even Ralph Atkins admitting that Germany is no exception here, since German industrial orders fell by a seasonally-adjusted 0.5 per cent in May compared with April according to the latest data from the economy ministry. Nor should this surprise us, since given that the German economy is export dependent, economic growth in Germany is a dependent variable (and not a leading indicator), since the German economy expands in the wake of expansion elsewhere, and falls back as the wave loses power.

And if you don't get this, just take a look at the evolution in German retail sales (below): a country with this lack of dynamism in domestic sales is never going to lead the global growth charge.



Manufacturing In The Van

In fact it is obvious that something somewhere is slowing, since the rate of growth of the entire global manufacturing sector fell back again in June, for the second month running, with the reading recording the weakest performance so far this year, although since it is still showing 55 it is clear that growth in the sector remains solid and indeed it is still above the longer run series average. So the worry here is not about what is actually happening now, but about what gets to happen next, about the future, and we might expect to happen in the second half of the year.

In fact manufacturing production rose for the thirteenth consecutive month in June and the Global Manufacturing Output Index averaged 59.1 across the whole second quarter, making for the strongest performance since Q2 2004. But current output is just one of the components of the PMI, and if we look at some of the other components the future however seems decidedly less optimistic, and especially in the new orders indicator where growth (and especially in new export orders) fall back sharply to hit the lowest level in six-months, with the rates of increase slowing in the majority of the national manufacturing sectors covered by the survey.




Thus the phenomenon seems far more general than local, and national PMI New Orders indices fell in the US (eight-month low), the Eurozone (weakest expansion in the year-to-date), Asia (one-year low) and the UK (seven-month low), although in each case the indicator continued to register expansion.

When we come to national performance, it is perhaps the Chinese reading which has generated most comment. At 50.4, down from 52.7 in the previous month, the headline China Manufacturing PMI showed only a marginal improvement in Chinese manufacturing sector operating conditions over May. What's more, it was the third month that the reading has fallen (see chart below).

In fact seasonally adjusted manufacturing output actually fell in China during June (as I said, the PMI is a composite, and output is but one of the components), bringing to an end a fourteen-month stretch of continuous expansion. Although it was only marginal, the contraction contrasts strikingly with the near-record growth levels registered at the start of the year. And for the first time in fifteen months, the level of new business taken by Chinese manufacturing firms fell in June. The rate of decline in new work was only fractional, but marked a distinct turnaround from strong growth seen throughout Q1 2010. Those respondents that reported a drop in new orders widely commented that this reflected softer market demand. New orders placed by foreign clients also fell in June, with the pace of decline the fastest since March 2009. Survey respondents widely mentioned that reduced new export business reflected lacklustre global demand, and really you would think that this was something Chinese manufacturers would know about.




And it isn't only manufacturing which is showing the strain, growth in the services sector (which remained fairly strong at 55.6) also weakened to what was a 15 month low. And although new business received by service providers continued to rise in June, the rate of growth lost further ground on the strong expansion seen at the start of second quarter. Hongbin Qu, Chief Economist, China & Co-Head of Asian Economic Research at HSBC had little doubt what the culprit was: “The slowdown in services activities reflects the effect of property market tightening measures. This, combined with the moderating manufacturing production, implies the economy is cooling off sequentially", he said.

Of course, none of this means China is spinning off towards recession, or anything like it. But it does mean the Chinese economy is unlikely now to become the source of global demand many expected, a fact which is reflected in the large goods trade surplus recorded in June (see below). Really the argument about the property boom doesn't need to be so much about whether China has had a bubble or not. The key point is that the earlier dynamic in the property sector wasn't sustainable, and the domestic market in China will note the consequences. As will those who have been benefiting from the imports surge into China (see Brazil below).

Brazil's Economy Slowing Sharply

Less commented on is the perhaps more surprising fact that growth also seems to be slowing in Brazil, as should be evident from looking at the Composite PMI reading. (The Composite is a synthesis of the separate services and manufacturing ones). This fell back to 51.6 in June, from 52.5 in May, and reflected a weakening of activity in both sectors. While expansion in the services sector was only marginal (50.9) manufacturing continued to show modest expansion with the reading (52.7) up slightly from May’s eight-month low of 52.4. Again we aren't necessarily talking about recession threat here, but we are also hardly seeing the kind of momentum we would need to see in terms of Brazil making a notable contribution to sustaining global demand.

India's Economy Heating Up?

In India, by way of contrast, growth continues to be impressive, and the International Monetary Fund just revised their 2010 economic growth forecast for the country to 9.4 percent from April's 8.8 percent estimate. And India's manufacturing industry continues to roar ahead, following the twenty-seven month peak of 59.0 seen in May, the seasonally adjusted PMI maintained the strong expansionary tone in June, despite slipping back slightly to 57.3. This was the fifteenth successive month of continuous expansion. Services put in an even stronger performance, and the headline Business Activity Index for the service sector hit a two-year high of 64.0. As a result the India Composite Output Index - at 62.8 - suggested the sharpest rise in activity for almost two years.Indeed, if you look at the chart below, it tells its own story.



India's problem is not then growth. India's problem has a different name: inflation. Just to show us that nothing in this world is ever completely perfect wholesale prices in India are now climbing at double digit rates. Indeed Central bank Governor Duvvuri Subbarao recently increased benchmark interest rates for the third time this year after they rose by an annual 10.16 percent in May.



Food price inflation is an even more serious problem, and the cost of feeding yourself went up by 12.63 percent in the week ended June 26, following a 12.92 percent increase the previous week (year on year figures in both cases). So India is likely to slow somewhat too, or at least a brake will be applied, and this is somewhat unfortunate, since India runs a trade deficit, which means that at this critical time it is a net provider of demand to the global economy.



There are, of course, other net providers of demand to the global economy, like the US.



Or Spain.



Or the UK.



But the problem is that these economies are all heavily indebted, and consumers need to deleverage, not take on more debt. So they need trade surpluses, not deficits. Running these unsustainable deficits was how we got here in the first place.

Exporting Their Way Into Trouble?

Then there are the current account and trade surplus economies, like Japan and Germany. Japan's Sevices Activity Index fell from 47.5 to a four-month low of 47.1 in June, suggesting a continuing contraction in the Japanese service sector. Nonetheless the Manufacturing PMI continued to show robust growth, even if it did fall back slightly /for the first time in five months), from 54.7 to 53.9. The New Export Orders index also fell slightly (by 0.6 points), but again remained at a high level at 56.9.



As a result of the stronger decline in services the headline Composite Output Index fell to 49.8, below the neutral level of 50.0 for the first time in four months.

While the fall-off in new export orders in the June PMI is hardly alarming, the drop in May core machinery orders (i.e., private-sector orders excluding shipbuilding and electric power company orders) that was reported by the Industry Ministry is slightly more preoccupying, since they slid by 9.1% from April, well under consensus expectations for a 3.2% drop. (All percentage comparisons are MoM unless otherwise specified.) These results are also consistent with the previously announced 10.2% drop in capital goods exports for the month. While it would be premature to make any rapid judgment (May was in fact the first month in which machinery orders and capital goods shipments both fell back) they do suggest we may be seeing a faster than anticipated peaking in machinery and equipment investment worldwide.




Turning to Germany, the recent export performance is certainly impressive. As is the fact that 30 billion euros out of the total of 77 billion exported in May went outside the EU.




The rebound in German industrial activity is also impressive, so it is perhaps not hard to understand why Ralph Atkins felt able to be so positive.




And even though the manufacturing PMI has fallen back slightly from the earlier very high levels, at 58.4 it is still showing very strong growth. But even in Germany the storm clouds may be gathering. As I have noted, German growth is ALL about exports, since domestic demand is more of a drag than a stimulus, but even in this case the June PMI data showed that new order growth slowed for the third month running and was at its weakest level since December 2009. New export order growth also eased markedly and was the slowest for five months. Now, you might say, that should not surprise us since they were growing very rapidly, but you can't take these movements in isolation: we are talking about exports here, so it is important to think about what is happening in the other economies.



Water, Water Everywhere

Lastly I would just mention the state of play with the Baltic Dry Index, since this has now registered 31 days of continuous decline, making for what Bloomberg describes as its longest losing streak since the 34 session run to Aug. 15, 2001. Of course, not everyone likes this index, since it measures shipping freight charges, and as Capital Economic's Julian Jessop points out, there are many factors (like shipping supply) that can affect it, and not just end demand. But as Bloomberg would doubtless be quick to point out, the drop does correlate with the movement of commodity prices in China. The price of hot-rolled steel, for example, has fallen 17 percent since it hit its 2010 high of 4,698 yuan on April 15. So while movements in the index should not be taken as strong evidence for anything, they should hardly be ignored as additional background information.




Something similar could be said about the work being done by the Economic Cycle Research Institute (ECRI) and their U.S. Long Leading Index. This has been pointing to growing economic weakness for months now, and it fell again this week with the growth component slipping to -8.3% from -7.6% at the end of June. Of course, there are plenty of other people out there who would disagree with them, but ECRIs record does seem to have been pretty good during the current crisis.

At the end of the day, it would seem to me, it all depends whether you are one of what Wolfgang Munchau terms the "optimists" or one of the "pessimists".

The pessimists believe that a strong global recovery is unlikely given the persistence of financial stress, and the deleveraging of the private and public sectors across the industrialised world.

The optimists divide into two groups. There are those who have difficulties counting to zero, who cannot add up the global private, public, and foreign balances, which must equal zero by definition.

And then there are the rational optimists, whose expectations of resurgence in private sector demand must surely rest on the assumption of a return to even greater global imbalances than before the crisis, to which the eurozone will this time contribute actively. But this is surely not a sustainable position.

The pessimists would argue that global demand growth will not be sufficiently strong to support a self-sustained recovery in the eurozone. Even the rational optimists, who believe that this is possible, would probably conclude that these imbalances are not sustainable, and may trigger another financial crisis down the road. And if that is what you expect, you are not really an optimist.

What we know is that some of our societies are deeply over-leveraged, and that de-leveraging them means running trade surpluses, not deficits (see the indebtedness chart for the US economy below).



What we also know is that it is deeply unrealistic to imagine that a burst of new consumer credit will restore growth to economies with such deep structural distortions, and the data seem to be confirming that this rebirth in new credit growth just isn't going to happen (at least not in the short term). According to the most recent ECB data, while the annual rate of Eurozone credit growth for general government stood at 9.8% in May, growth of credit extended to the private sector was at a meager 0.1%. The annual rate of change of loans to companies was -2.1% in May (yes minus, it fell) while the annual rate of change of consumer credit stood at -0.4%. So if it wasn't for the respective governments, I don't think it is too hard to see that domestic demand would be in contraction mode.

And the situation is broadly similar in the US, where the Federal Reserve announced last week that consumer borrowing in the dropped by $9.1 billion in May, following a revised $14.9 billion slump in April. In fact there have only been two months since the end of 2008 when borrowing has increased. So, when Jean-Claude Trichet says that all the global gloom over the Eurozone's prospects is being overdone, since the data they are looking at over on Kaiserstrasse is “not confirming this pessimism”, and adds that a double dip into recession “is not at all what we are observing” someone might just like to ask him which data it is he is looking at. Maybe we won't see a complete double dip, but a serious slowdown in growth does seem to be in the works, and contractions will be once more registered in more of Europe's economies than M Trichet seems to be currently contemplating.