Tuesday, February 05, 2008
The ISM Services report is shocking everyone who doesn't look at NACM, but the real news is in Europe:
Royal Bank of Scotland Group Plc said its purchasing managers' index for services dropped to 50.6, the lowest since July 2003, from 53.1 in December. A reading above 50 indicates growth. Retail sales in the euro region declined 2 percent from a year earlier, a record, the European Union's statistics office in Luxembourg said today.Retail sales fell 2% YoY, which ought to tell ECB that constraints on inflation exist in any way that monetary constraints on inflation can function.
If a society doesn't produce goods and must import them, inflation of those goods is NOT SUSCEPTIBLE to that society's monetary policy. ECB is fighting the last economic war, and is likely to produce a European semi-depression if it doesn't loosen.
And the Fed? The Fed has discharged most its ammunition for the time being. There's a constraint to how much you can lower rates - they can't go negative without depressing lending, and you can't fight a credit contraction by depressing lending.
As for our ISM Services report, the drop was magnified by a new way of calculating it. (See Bloomberg article.) Nonetheless, the decline is real. It is also not surprising. The only things not contracting are speed of deliveries (not a positive), export orders (a positive), and prices. Imports are contracting, which is positive.
This month's survey included a special question:
Question 1 — Is the turmoil in financial markets having any effect on your firm's ability to obtain regular or additional financing?
Nonetheless, this recession has been going on for a while now, and the offsetting effects are already moving into place. You are looking at the second cycle of a normal recession now. But will this be a normal recession? That's what we don't know, and that's why the credit contraction assumes such a huge importance. Employment falls significantly only after a recession has already begun. A significant credit contraction on top of the normal recessionary pullbacks will act as an amplifier.
If the EU could wise up and begin to deal with reality, the US might see a late 2008 growth in manufacturing which would cushion the worst of this. To date, the ECB is acting like it has a hood over its head. If you look at EU fundamentals, they have worse problems than we do! If they persist in their course much longer, we could see a mild worldwide depression develop. You'll have plenty of warning of that possibility if you watch the Brazil Bovespa, and right now we are far from it. By mid summer that could change.
Inflation is truly hurting some of the developing countries. China removed food export subsidies, and Indonesia is taxing food exports. You cannot expect these countries to pick up all the slackening demand seen in the developed countries.
If a society doesn't produce goods and must import them, inflation of those goods is NOT SUSCEPTIBLE to that society's monetary policy.
I think its a lot more complicated. Under an international gold standard I could see foreign creditors ignoring an individual country's monetary and fiscal policies. Gold is gold. Under a fiat system, foreign creditors need to worry about the purchasing power (supply) of a currency.
There are more players today (billions actually). Its no longer just a simple coordinated effort by Europe and America. I think Trichet is correct to worry about inflation. We already have negative interest rates on both sides of the pond.
As for interest rates, they are also relative.
I have an uneasy feeling about what's coming, but things can change quickly. We'll see what the next month brings in the EU. The worldwide initiative is now in its court.
Inflation is dangerous as so much of the government's budget is linked to CPI. Social security, government wages, etc. are all tied to CPI. I can easily envision a scenario where inflation stagnates business growth and yet escalates government costs. Talk about a budget buster!
Inflation aside, going stupid low with global interest rates is not the answer. We need to encourage some old fashioned savings in short term instruments. Stocks and houses aren't substitutes for short term savings. Think duration mismatch. I suspect this is why Europe is not in the panic the U.S. is in. They can afford to worry about the longer term.
A personal safety net would add a lot of confidence to our lower 4 quintiles.
Investment bankers want Trichet to drop rates in step with the Fed - this weekend I was told, "who cares about inflation when your banking system is on the brink!" This from the same person who thinks weakness in the dollar is good.
MAB - yes, I don't disagree. The problem is that CPI understates inflation, though. It allows us to pretend that it isn't happening and dig ourselves deeper. The only cure for what ails us is less spending and more saving, which is what is going to cause a long recession.
A lot of this debt is not repayable; how quickly it gets written off will determine how quickly the economy rebounds.
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