Victor Zarnowitz, well known US economist and expert on business cycles died last Saturday in Manhattan. He was 89. Although I didn’t know him in any way personally, I learnt a lot from reading Victor’s papers and his monumental book on the US business cycle – “Business Cycles: Theory, History, Indicators and Forecasting” (University of Chicago Press, 1992). Among other ideas of note, Zarnowitz divided the history of modern industrial society into deflationary and inflationary epochs, with the system switching around from one mode to the other for reasons we still barely understand. In his view, 1875 to 1918 would be, basically, an inflationary epoch, 1918 – 1945 a deflationary one, 1945 – 1995 an inflationary one, and 1995 to……… a disinflationary/deflationary one.

Thank you Victor, your presence among us will be missed now more than ever. Dennis Hevesi has an obituary in the New York Times.

Dr. Zarnowitz, who was emeritus professor of economics at the University of Chicago, was also a research associate for the National Bureau of Economic Research, and in that capacity was one of the seven economists who officially determine when the United States is in a recession. Speaking of the growing dependence of forecasters on computerized econometric models, he said the following in a New York Time Op-Ed in 1980:

“Their expectations ran high that in such models lay the answer to the challenges of economic forecasting and policy making…..They were to be disappointed……..Forecasts of econometric model builders have been no more accurate than the forecasts of those who analyze business conditions using less formal methods,”

Times, it seems have not changed that much. You can find a list of his NBER papers and other publications here, and his Conference Board biography here.

It isn’t only the bank bailout programme which is suffering in Italy due to lack of sovereign borrowing capacity. I couldn’t help noticing this piece in Bloomberg earlier in the week.

Italian Labor Minister Maurizio Sacconi said the government can’t provide unlimited unemployment benefits, La Stampa reported. The government is concerned about unemployment and has freed up about 8 billion euros ($10.3 billion) in regional aid that local entities can tap into, Sacconi told La Stampa in an interview. Still, “we cannot leave the taps running,” Sacconi was also cited as saying.

So as the recession deepens, and layoffs spread, the Italian government is obviously going to have problems keeping people afloat. Which lead me to think, maybe there are two ways to do this, the regular, and the irregular one. And maybe Italy is the ideal place for the application of rather more “unconventional tools” in fighting the crisis, especially since money for the conventional ones is beginning to run scarce. Continue reading →

Well, I had been warning this would happen. Credit default swaps measuring risk on five-year sovereign German debt touched 90bp yesterday and look set to rise above French debt for the first time in the near future. The current spike follows a warning by Deutsche Bank that Germany’s economy will contract by 5% this year as industrial exports collapse at the fastest pace since the Great Depression. I have been warning about this looming problem in my EU Bonds posts for some time now. Germany’s export driven economy is heaviliy dependent on fluctuations in world trade, and German industry is very dependent on Eastern Europe (which is more or less the focal point of the current global crisis at this stage). In addition, German savings went to fund investments in many of the riskiest assets, hence the need for a very large bank bailout. So moving forward things do not look that marvellous for German public debt, and another wave of health and pension reforms will now need to be put in the works as the population ages rather more rapidly than is desireable for stability.

Strangely, and again as I have been pointing out, despite an evident lack of substantial reform in recent years, France’s economy is preforming noticeably better than Germany’s, and the reasons for this will surely form part of the post crisis post-mortem.

Some indication of the headaches which are now looming, and of the fact that the market for German debt may not be as liquid as many had imagined, can be found in the statement from the Head of the German Federal Finance Agency this morning that Germany may increase sales of short-dated securities at the expense of longer-term or index-linked bonds if government borrowing rises more than forecast this year. Carl Heinz indicated that Germany was fortunate in this sense since the appetite for debt maturing in 12 months or less is “huge” as money managers are currently rather reluctant to deposit cash with banks. Germany will need to sell more debt this year than at any time since the end of World War II as Chancellor Angela Merkel increases spending to cushion the economy against recession, and the government plans to sell a record 323 billion euros ($414 billion) this year, almost 50 percent more than the 220 billion euros sold last year. The issuance will comprise 149 billion euros in bonds with maturity over one year and 174 billion euros of shorter-dated money-market securities.

So I think we should forget about stereotypes here, since this whole situation is now extremely fluid, and, of course, in need of rapid attention from EU leaders . Maybe instead of asking ourselves whether Germany can bail-out Ireland the question we should be asking ourselves is whether Portugalcan bail-out Germany?

And in case some of you simply think this is a joke, be careful what you ask for, since David Beers, head of sovereign ratings at Standard & Poor’s told Reuters this morning that the weakness of the global economy could be expected to have an impact on some countries’ credit ratings, and that he expected more sovereign ratings downgrades than upgrades this year, especially in the light of financial market concerns about the health of public finances.

Russia’s economy contracted at an annual rate of 8.8 per cent in January, according to the latest statement by the Russian economy minister. This data point, which provides us with the latest confirmation that a very sharp contraction is now taking place in Russia, follows last week’s announcement by economic development minister Elvira Nabiullina, economic development minister, that the economy shrank by 2.4 per cent between December and January. Industrial production also fell 16 per cent year-on-year in January, while there was a 17 per cent decline in construction.

It also gives us some indication of the viability of VTB’s Russian GDP Indicator (as posted here) which indicated a year on year rate of contraction of 4 percent in January, down from December’s 1.1 percent decline, and November’s 2.1 percent expansion. This is somewhat under the actual reading, but it is an estimate in real time (we got this at the start of February) and it was by far the nearest estimate I have seen. The Russian government is currently forecasting a contraction of only 2.2% for this year, which has to be way, way too optimistic as things presently stand.

Continue reading →

Well in some countries it never rains but it pours, as they say. Following the news that Ukraine GDP contracted at an annual rate of 20% in January, today we learn that S&P have cut Ukraine’s long-term foreign currency rating to CCC+, seven levels below investment grade. Ukraine’s rating is now the lowest in Europe and at the same level as Pakistan. S&P left the outlook negative, suggesting there may be more to come.

To give us all some idea of what this means contracts to protect Ukraine’s government bonds against default now cost 59.5 percent upfront and 5 percent a year, according to CMA Datavision prices for credit-default swaps today. That means it costs $5.95 million in advance and $500,000 a year to protect $10 million of bonds for five years. The cost is higher than for any other government debt worldwide. Continue reading →

Japan’s exports plunged by 45.7 percent year on year in January, producing a record trade deficit, as recessions in the U.S. and Europe, and a sharp downturn in China crushed demand for the country’s machinery, cars and electronics. A drop of this size is truly staggering.

“People are coming to realize that Japan is in deep trouble,” said Hiroshi Shiraishi, an economist at BNP Paribas Securities Japan Ltd. in Tokyo. “Considering what’s happening on the export side, and the implications that has for the domestic economy, the yen is clearly not a buy.”

Continue reading →

Close enough that prominent people are raising the spectre of capital account flight already underway.  Today saw a bleak op-ed in the Irish Times by former European Commissioner and GATT/WTO head Peter Sutherland.  Now Sutherland arguably got his hair singed on the other side of the crisis as a RBS Director (a position relinquished a few weeks ago).  His key point is that a crisis could originate not from directly within the public finances (at least the finances as they were) or from bad loans of banks but from a loss of bank deposits and in that sense very much an emerging market style of crisis —

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Let’s flash back quickly to yesterday (Monday). The big news of the day (at least as far as Central and Eastern Europe went) was that a number of East European central banks had reached an agreement to try to bolster their currencies via their first coordinated action since the start of the global financial crisis.

Czech, Polish, Hungarian and Romanian central bankers all agreed to speak publicly about the damaging effects of exchange-rate swings, according to the statement read by Romania’s central bank Governor Mugur Isarescu at a news conference in Bucharest. His counterparts in Prague, Budapest and Warsaw issued similar statements during the afternoon. The four currencies all gained significantly on the day. The Hungarian central bank even kept interest rates on hold to boost the currency, even though this will lead to an even sharper economic contraction and even higher unemployment. But how long did it all last?

Well, now fast forward to today, and a press conference in Brussels, attended by EU Commission President José Manuel Barroso and Hungarian Prime Minister Ferenc Gyurcsany. The message was meant to be that the Hungarian government was on the right path, and was going to receive full backing from the European Union. And how did our good prime minister “talk up” the currency?

“We’re in serious trouble indeed,” the Hungarian prime minister said.

And how did the forint react?

The sell-off on the forint market was almost immediate, and the Hungarian currency abruptly and sharply fell to over 303 to the euro from its earlier and hard won level of 297.

True all the talk about Latvian downgrades (see previous post) and East European weakness didn’t help, and the kind of verbal strategy decided on yesterday was always a sign of weakness rather than a sign of strength. As Danske Bank said in a report yesterday:

The markets might try to test whether this is just verbal intervention or whether the CEE central banks would be willing, for example, to hike rates to defend their currencies. The markets will be watching over the next days for more direct intervention in the CEE FX in the form of coordinated intervention and/or rate hikes. However, if they see that the talk is not being backed up by action, the depreciation of the region’s currencies could resume.

Still, you might have thought the policy would have lasted a little longer than 24 hours, and that the Hungarian people would have been a bit better served by their leaders.

And the Swedish Krona clearly didn’t like the news.

Standard & Poor’s Ratings Services today said it had lowered its sovereign credit ratings on the Republic of Latvia to ‘BB+/B’ from ‘BBB-/A-3’ and removed the ratings from CreditWatch negative, where they were placed on Nov. 10, 2008. The outlook is negative…….

We believe the necessary process of private sector deleveraging is likely to continue over several years, during which time real incomes will decline, testing Latvia’s commitment to both its exchange rate regime and its obligations under the EUR7.5 billion assistance program from the IMF, EU, and other official lenders. The adjustment is made more difficult as external demand for Latvia’s key exports continues to decline.”

The negative outlook reflects the likelihood of a further downgrade later this year or in 2010 if we believe the government is wavering from its economic agenda in a manner that intensifies currency pressures and risks delays in disbursements from official creditors. If the Latvian financial sector retains access to international markets at reasonable cost, economic prospects brighten on the basis of improved competitiveness, fiscal targets are met, and the near-term prospect for Eurozone entry improves, the ratings could stabilize at the current level.

Standard & Poor’s also said it had placed its ‘A/A-1’ sovereign credit ratings on the Republic of Estonia, and its ‘BBB+/A-2’ ratings on the Republic of Lithuania, on CreditWatch with negative implications. Which means that both of these may be up for downgrades in the not too distant future. Continue reading →