Hope. Global growth accelerated at the turn of the year. The strong US GDP numbers underscore this. While much of the dynamic undoubtedly came from the inventory cycle, the solid gain for final domestic demand is, however, awakening hope of self-sustaining growth!
Skepticism. We, however, remain skeptical. Households must first deleverage, job insecurity remains high, and government transfers will likely decline in light of exploding public-sector deficits. Nor do we expect any major impulses from business investment.
Strain. The reason for this is extremely low capacity utilization rates around the globe. Businesses can therefore ramp up production rapidly without having to expand or modernize the capital stock. And it is still no easy matter to obtain credit, especially for smaller and medium-sized firms. Corporate cash flow, however, has at least improved after the rigorous cost-cutting initiatives.
US. The recent strong increase in investment in equipment & software was therefore primarily just a technical correction after the preceding free fall. For 2010, we expect a relatively moderate increase, which is furthermore profiting from a statistical overhang. It will take years before investment activity returns to its pre-crisis level (pages 3-5 & chart below).
EMU. And when the GDP numbers are released next Friday, it should become apparent that the investment recession in the euro zone has not yet run its course. Nor should there be any change here for the time being, since – unlike in the US – lending standards for investment credits are still being tightened, although by no means as strongly as before (p. 6-8).
– Weekly Comment: Buy now, pay later (page 2).
– Germany: Jack Frost and GDP growth (page 9).
– Data outlook: No growth acceleration in the euro zone;
US consumers continue to remain skeptical (page 11).
– Market outlook: Euro to remain under pressure (page 20).
Buy now, pay later
Predictably, all the action at yesterday's ECB press conference was on the debt situation of Greece and other countries at the eurozone’s “periphery”. Mr. Trichet again tried to persuade investors that they should be looking at the eurozone as whole, which he argued compares “flatteringly” to its peers on the fiscal front, rather than at individual countries, some of which do not look all that good. He argued that the eurozone offers ex-ante support in the form of the easy and cheap financing of balance of payments deficits, with ex-ante conditionality in the form of the Stability and Growth Pact (SGP). But the problem is exactly that the ex-ante support works all too well, allowing countries to run up unsustainable debt levels, while the conditionality does not work at all – it becomes a “buy now, pay later” scheme which has pushed countries like Greece and Portugal to the forefront of market’s concerns, and has led the IMF to project a steadily rising debt/GDP ratio for the eurozone as a whole, from 66% in 2007 to 86% in 2010 and 96% in 2014. While this may compare “flatteringly” with other industrialized countries, it can certainly not be taken as a demonstration of success of the SGP. Trichet, like other euro-zone policymakers, also struggled to reconcile his argument that individual countries’ deficits do not matter with his message that Greece, Portugal and others need to put their houses in order, implicitly reminding them of the no-bailout clause. But in the end, if Greek debt is Greek debt and not euro-zone debt, investors should be looking at Greece’s imbalances, not the eurozone’s – as they will indeed continue to do. The assessment of the macro outlook was broadly unchanged, and the next press conference could be a significant market-mover, as the ECB might start unwinding some of its extraordinary measures as early as April.
In the end, there was just one underlying question at the press conference: whether and to what extent one should look at individual countries rather than at the eurozone as a whole. Trichet pointed out that if you look at the eurozone as a whole, you will realize it is in fact in a stronger fiscal position than most other industrialized countries: the IMF forecasts an overall 2010 fiscal deficit of somewhere above 6% of GDP for the eurozone, compared to over 10% for the US and Japan, and over 13% for the UK. And in terms of gross public debt, the eurozone looks a bit better than the US, a lot better than Japan, and only slightly worse than the UK, which however used to be in a much better position before the crisis. Trichet therefore argued that, while the overall fiscal position is weaker than we would like, given the kind of crisis we have been through the eurozone has in fact outperformed most of its peers in terms of fiscal performance. The numbers do back him up.
Most of the Q&A, however, focused on the predicament of individual countries and the risks of contagion. Here, Trichet made an interesting point, and in my view scored an own-goal. Trichet argued that the eurozone has an ex-ante anti-crisis mechanism: whereas a regular country needs to face a crisis before the IMF steps in to offer Balance of Payments financing and impose the corresponding conditionality, a euro-zone member enjoys ex-ante BoP support, with ex-ante conditionality. Being a euro-zone member allows a country to easily finance large CA deficits, but at the same time the country is subject to the conditionality of the Stability and Growth Pact with the enforcement mechanisms of peer pressure and the Excessive Deficit Procedure. History, however, shows that while the ex-ante BoP support functions all too well, the ex-ante conditionality does not – and that indeed is the eurozone’s main problem. In 2008, Greece ran a CA deficit of nearly 14% of GDP, Portugal 12% and Spain nearly 10%. Euro-zone membership allowed countries to run up unsustainable combinations of public and private sector debt at unrealistically low financing costs; meanwhile, the SGP proved to be completely unenforceable, insufficient to correct these trends. There is another IMF statistic that Trichet failed to mention: over 2003-2008, with economic growth at robust rates (by European standards), the eurozone ran a structural fiscal deficit of about 2½ % of potential GDP. The whole purpose of the SGP is to push countries to run a stronger fiscal position in good times so as to create room for fiscal expansion in a downturn without threatening fiscal sustainability. This has clearly failed, and in its October 2009 World Economic Outlook the IMF also forecast that the eurozone’s gross debt to GDP ratio will continue to rise from 66% in 2007 to 86% in 2010 and 96% in 2014. While this may compare “flatteringly” with other industrialized countries, it cannot be taken as a demonstration of success of the SGP.
On the exit strategy, Trichet was tight-lipped, and gave us “rendez-vous” at the next press conference. He made one reference to 2Q, however, which seemed to hint that some of the extraordinary support measures could start being unwound as early as April. Much will now depend on market developments on the debt of Greece and other countries, but the March press conference could be an important market mover.
ECB’s assessment of the macro outlook was broadly unchanged, with moderate and uneven growth, inflation under control and inflation expectations well anchored. Trichet however insisted on the need to ensure that sufficient credit will flow to the private sector, especially to those small and medium enterprises that do not have access to alternative market funding.