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Monday, June 25, 2012

Die Euroliebe Ist Ein Wildes Tier

Well, well, well. What would Candide say about this worst-of-all-possible-worlds scenario?

Words fail us. The Eurozone is heading for the rocks at blinding speed, and all the proposed solutions will solve nothing. That's why they are in trouble - they keep coming up with proposals that cannot possibly work. By now the proposals (such as Eurobonds) are getting insane enough to come close to outright rejection, which will speed up the financial flux cycle for Euro sovereign debt.

Ignore all the verbiage. What happened last week made it clear that if Germany does agree to Eurobonds, the German sovereign bond yields are going to rapidly jack up, and if Germany doesn't agree, Italy and Spain will continue to march toward the abyss.

So either way Doom Is Certain, because no matter what happens this week, the Germans will never agree to cover enough Eurobonds to bail out Italy, and Italy is that mammoth in Euroraum. This week's Schauspiel is about the timing of the collapse, not whether collapse can be avoided.

Germany is now going into recession. Manufacturing is too low, and the bad construction PMI means that no internal forces can keep the services sector up.

But what about the US? Are we doomed to recession this year, or can we continue to skip? It really depends on cars. A relatively minor downshift in the auto production trajectory is showing up pretty strongly as an economic negative (see CFNAI). But this was minor. If car sales fall a bit more, things get rough quickly.

Over the last few months, we have followed a very similar trajectory to 2011, and the reason is somewhat similar. Autos. Auto production. See Philly Fed.

The cause, however, is quite different and should give everyone pause. Extremely easy credit has been sustaining car sales, in part because used-car prices were so high that they sustained bad loans because bad loan losses were very limited. This may have worn itself out based on auto advertising I am hearing. If so, then we are in for a sustained deceleration in sales and auto production will shift toward a minor negative in the next few months.Last month's downward sales surprise hinted at this.

If that does happen, then all the negatives, which include external and internal factors (Euro tragedy and global deceleration, the domestic erosion of real incomes due to inflation, political uncertainty causing caution in business spending) start to pull us steadily down. Even if car sales stay up for the next few months, we probably will see some tax increases next year and therefore will go into frank recession then.

The current pace of unemployment initial claims implies that we are close to a controlled flight into terrain. If the Obama administration were not so witless it could have proposed something politically plausible to Congress to keep the economy up this year. But state and local funding is politically unfeasible, and in any case it would not work. State and local finances are so challenged by retirements that throwing more money in just slows the pace of cuts rather than forestalling cuts, much less boosting hiring.

In terms of Fed intervention, not much is currently possible. The core rate of inflation remains high, because US margins were compressed. Gas prices aren't coming down nearly fast enough to give money back to the consumer, and grocery prices are too high for the six-month expected spending in households to be covered by incomes alone. So there is very little of a counter trend innate in this economy. The Fed already has historic lows on mortgages. If the Fed were to launch another asset-buying program, it would immediately boost consumer inflation and cause further economic weakness, so I think even the normal Fed suspects will hold on this until after prices come down far more and core inflation begins to fall off.

Treasuries remain your friend.There is mild support on manufacturing from insourcing, some support in fracking/energy, and a basic North American (Canada, US, Mexico) strength that really does help us. So far rail seems to confirm that we are staying above the surface. However, last year's summer slowdown was exogenous, and this year's summer slowdown was endogenous, and so the end of year will not see the same type of acceleration out of the abyss. Last year the result was basically to move about one percentage point of growth toward the end of the year. This year it looks like we will just lose three quarters of a percent of real GDP growth. Since we were looking at 2%, that's a very dangerous position indeed.

ROW: Here things get grim.
The Euro-rim is deeply impacted. There are trade financing issues now for some countries. Needless to say structural demand issues are emerging and will not be quickly resolved. European car registrations are now down about 8.7% YoY. Commercial registrations are down 11%. Auto factories are going to be closing. At least one should be closing in Germany. This has legs

China is in deep, and sliding further into the abyss. In Q1 the economy was supposed to resurge in Q2 per CW. Well, it's almost the end of Q2 and we are hearing that the economy will resurge in Q3, but no data whatsoever supports that theory, and instead it looks like inventory overhangs are developing on the domestic side.And worse, some of the efforts to stimulate will probably increase overcapacity. China has a much steeper potential decline than anyone is admitting right now. The smaller manufacturers are being hurt by margin compression. The financing problems that developed last year were largely due to poor profits rather than an evaporation of money, and therefore they are very difficult to redress. Government efforts are largely aimed at slowing the decline. The epic flood of money that sustained very strong Chinese growth over the last decade is just quietly contracting for very strong fundamental reasons, and this must continue. Asset inflation cannot carry business financing any longer. You can use accumulated power production as a proxy for real Chinese GDP; the last accumulated was a 4.7% over 2011. Go to the very bottom of this release.

India: Clearly in trouble, because inflation is running much higher than GDP increases, and the fiscal gap is far too high to offer easy alternatives to the government. The central bank is struggling with high inflation and is limited in its stimulative capacity, and currency trends make it very difficult to cope with the fiscal gap or to control inflation internally. These forces really aren't showing up in the PMI data yet, but India will be struggling for a couple of years. The weak currency will tend to support manufacturing, but the trade gap is a genuine problem.

Hopping around to various countries:
Australia. Household debt did its damndest, and now the internal forces in the Australian economy are quite negative. Thus Australia is more dependent than ever on the Asian economies. Oops!

Singapore.http://www.singstat.gov.sg/ It's hanging in there, but things are getting tougher. A strong Asian expansion is not in the cards; Singapore net growth over the last year has fallen to the point that inflation is close to outstepping growth, so a bad year is to be expected. It probably won't be excruciating, but it will be weakening.

Indonesia: So far this year it has been supported by rising costs in China, which tend to shift a little more over to Indonesia. Growth is not brilliant, but they began this year marginally better than in 2011. I think the trajectory will shift lower in the second half, but that they'll hold up until the end of the year. Lower oil prices have the potential to help them.

Overall, I think the global economy would do okay if it were not for the Euro trauma. It wouldn't be stellar, but it would be okay if it weren't absorbing so much nonsense money all the time.

However the apparently chaotic nature of what is due to evolve in Europe over the next two years poses many questions for global trade. European banks have traditionally had tremendous involvement in external financing, and I have to believe that the massive uncertainty developing around Italy's fate is going to have long term effects on capital flows internationally.

The questions about Europe no longer involve "can they keep the finances afloat". Now the questions are more fundamental, like which countries have the the social cohesion and military/diplomatic resources to avoid becoming a battleground for outside powers. At the moment, all the potential outside powers are too busy dealing with their own problems, but that won't last.

In the last century, both Spain and Italy have been such battlegrounds. Just sayin'.
Isn't eastern Europe on the firing line? The Ukraine? The northern port cities - Estonia and Latvia?

The amazing part about this is that they've stuck Germany in on the board as Amerika, and now they are playing out the normal shtick without realizing that they are gutting themselves. They need to hold the German-French axis, and they need to hold the social/economic union if not the currency union.

For the sake of a six month's alibi you take the chance of throwing the grand alliance away?
Good questions. As far as I know, eastern Europe is keeping their act more or less together, politico/financially. The problem with Spain, Italy, and Greece is that the deficit spending WAS the state. If the national government isn't doling out the goodies, then the regional governments have a tendency to want to go their separate ways. Once that happens, it's a real temptation for one or more outside powers to take advantage of the inter-region rivalries to enhance their own power. Yugoslavia is a horrific example. China has historically had the same problem. That's why there's such fear in their eyes lately while they tell us they're going to displace the U.S. as top dog.

The EU is going to have to shift gears from worrying about banks to worrying about breakaway provinces. If they are not up to the task, then they'll need to shift gears again to worrying about whose elephants might cross the Alps or the Pyrenees.
Neil - the Russians want the Ukraine.

It's not the states themselves, but the grunting bear, which is running out of oil somewhat.
But I utterly agree with your basic point. The premise of all this was that it would work in a material sense.

You can see the regional tensions mounting in Italy almost by the month.

Spain - well, the history there is clear. Also the generational problem will be intensifying for years.
Russia is certainly one of the outside powers of concern (although, to your point, Russia has already locked out any EU influence in the Ukraine so it's really too late to worry about that). Potentially Turkey is, too, or Israel and even Iran by way of the Levant (which makes the outcome in Syria very relevant). Chinese cash might start to look relatively safe due to their lack of proximity.

The fear here is that Germany and France (and the UK or US) become simply two outside powers competing with other outside powers in the failed Mediterranean states. If this is not managed well, that sets up all of the above powers for a zero-sum "Great Game" in the Med. Not outright fighting between the powers, though it could come to that if somebody really gets the upper hand. (Imagine, for example, what position France might be in if Germany becomes the dominant power in Lombardy and the Piedmont without French participation.) And of course, it could easily get bloody in the failed states.

This is all textbook stuff--the reasons why failed states are so dangerous.
Bruce Krasting had some speculation on EU competition with Russia over the Cyprus bail-out - interesting connection with Syria:


The UK has just got around to trying Asil Nadir, king of the Cyprus banksters, 30 years after the fact.
The world economy has been dependent upon the American middle Class to buy
foreign high end goods generally with borrowed money. The American one percent cannot make up for the lost the buying volume of the past and without large volumes modern manufacturing quickly loses it appeal. The fact that social networking and telephones are the hot consumer items says much about the global economy.
Frankly little has changed since the credit bust other then the endless chatter from the political class.
When the Chinese start selling Treasuries in earnest,
our recovery is over and so is Free Trade.
shtove - Syria alone is a brewing volcano. This is truly a difficult time in global history.

It reminds me of the slow death of the Ottoman empire.

China continues to push in and around the South China Sea. It needs petrochemicals.

I wonder what all this will look like five years from now?
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