Well, one good turn deserves another. So if, like Paul Krugman (and me, I think, though I hadn’t gotten as far as thinking through all the implications of what was happening when I posted the original piece) you take the view the Ukraine industrial output chart I put up yesterday is the smoking gun (or starter’s pistol, or line judge flag, or whichever metaphor works for you) that tells us that what we could come to call the second great depression may now have begun, then here are some more of those tell-tale charts to put in you pipe and smoke – or if , like Huck Finn that is your preference, to chew on.

(Update: someone in comments has made the perfectly legitimate point that Paul Krugman may only be saying that a Great Depression has broken out in Ukraine, and obviously only he can say what he really thinks, but as far as I am concerned, since one of the hallmarks of the original Great Depression was a sudden sharp drop in output, sustained over a number of years, and in a large group of countries, accompanied in several cases by outright price deflation, then I do think that what we now have on our hands is something that looks more like a depression than a recession (or slowdown) is what we now have on our hands, and what makes me more or less sure about that is looking not only at what is happening in Ukraine, but at neighbouring Russia, and China, and so on and so on. The point is that Ukraine is not an isolated case – if it were then we would simply be able to say that a large depression had broken out in Ukraine, and that would be that. But since part of the explanation for this sudden drop in output in Ukraine is a lack of working credit, and since this credit drought has now spread across most of Central and Eastern Europe (see Russia here, Poland here, and Romania here), and since the by-product of the Ukraine situation is likely to be a whole cycle of debt defaults, which will certainly spread well beyond Ukraine’s frontiers, and since in the wake of those defaults banks will become even less enthusiastic to lend, well then it does seem to me that what is happening in Ukraine has some more general significance. I also certainly think all of this was not far from Krugman’s mind when he made the post, since what he wasn’t doing was simply (in true bloggie fashion) saying ha ha, look what’s going on over there. What he was saying is “watch out, this can come back and give us all a kick” – which again is what he was doing with his Japan work in the late 1990s, and it did. My feeling, and it is only a feeling, is that what he wanted to do was move the debate on, and up a level. We can’t address the kind of problems we are facing if we fail to recognise we are facing them, and one of our problems in responding to this crisis (and especially here in Europe), has been a consistent failure to recognise the importance of what was happening, and to take measures which were up to the challenge. What was it they used to say: Ninja mortgages, ha, ha, ha. I don’t see these people laughing now.

Evidently, since history never exactly repeats itself, I am certainly not saying that the current crisis is going to last an entire decade, or end in a big war, or anything like that. What I am saying is that it has already made a place for itself in the history books, and already belongs to the class of large and unusual economic phenomena, and that we can learn a lot about how to handle our present problems by looking at the experience of 1930s. Of all of this I am absolutely convinced, and I have a pretty good idea that both Bernanke and Krugman are too, if you look at the constant references to those years in almost everything they say and do these days). Continue reading →

“In Ukraine, the evidence is still that policymakers do not quite understand the seriousness of the challenges they face,”. Timothy Ash, analyst at the Royal Bank of Scotland.

“There is a burgeoning economic crisis in the European periphery,” Krugman said on the ABC network Dec. 14. “The money has dried up. That’s the new center, the center of this crisis has moved from the U.S. housing market to the European periphery.”

Make no mistake about it. What is taking place right now in Ukraine is extraordinarily serious. The IMF have recently agreed a support loan to the country, but the politicians themselves still can’t agree on whether or not they are actually going to abide by the conditions attached to it. Meantime, as we can all see on our TV screens, tensions with Russia continue to escalate, fuelled by the conflict-ridden negotiations over Ukraine’s gas debt.

And just to add to the nighmare, Ukrain’s economy made a dramatic entry into recession in Q4 2008. In fact, so severe has been the slowdown that nobody at this point can even muster enthusiasm for opening up one of those interminable discussions about whether or not what the country is going through really counts as a “technical recession” (in terms of two successive quarters of GDP contraction) or not, since the drop in national output has been enormous, and it it fairly obvious that isn’t about to come bouncing back up again. At least not for the next several quarters it isn’t, and – to give us an early glimpse of the terrain onto which we are now entering – the World Bank have just forecast a 4% contraction in GDP for 2009. Continue reading →

Well, it seems I’m not the only one who thinks that the IMF have made a bad decision over Latvia, since this year’s economics Nobel Prize winner Paul Krugman seems to agree. From his New York Times blog:

I’ve been saying this for a couple of weeks, but Edward Hugh has the goods.

Hugh puts his finger, in particular, on one gaping hole in the logic of the opponents of devaluation. We can’t devalue, they say, because the Latvian private sector has a lot of debts in euros, and a devaluation would make it very hard for borrowers to service those debts. As Hugh points out, the proposed alternative — sharp wage cuts, and basically a major domestic deflation — will also make it hard to service those debts. In fact, I’d be a bit more specific than Hugh: other things equal, a nominal devaluation and a real depreciation achieved through deflation should have exactly the same effect on debt service (unless some of the debt is in lats rather than euros, in which case devaluation would do less damage.)

This looks like events repeating themselves, the first time as tragedy, the second time as another tragedy.

Continue reading →

Only one thing is really clear about the Germany economy at the present time, and that is that it is shrinking rapidly. In fact it contracted far more than most analysts and observers expected in the third quarter (although I, for one, was not especially surprised), entering what now appears to be its worst recession in at least 12 years as both exports and domestic spending continue to fall. German gross domestic product in Q3 dropped by a seasonally adjusted 0.5 percent from the second quarter, when it fell by a quarterly 0.4 percent, according to revised data from the Federal Statistics Office. The Germany economy last had a two quarter contraction of this magnitude back in 1996.

And all the signs are that the fourth quarter will be worse than the third one, so the situation may even surpass the 1996 recession.

And bad as 2008 has been the 2009 outlook promises to be even worse. The International Monetary Fund are now forecasting outright GDP contractions for the U.S., Japan and the eurozone next year, with Germany’s economy expected to shrink by at least 0.8 percent (this as we will see is one of the most optimistic forecasts currently on the table for German GDP next year). The European Commission declared the 15-nation eurozone to be in recession in November, and just over 40 percent of the exports from this highly export dependent economy go to other eurozone nations. Continue reading →

The IMF finally announced it’s Latvia “bailout” plan on Friday. The plan involves lending about €1.7 billion ($2.4 billion) to Latvia to stabilise the currency and financial support while the government implements its economic adjustment plan. The loan, which will be in the form of a 27-month stand-by arrangement, is still subject to final approval by the IMF’s Executive Board but is likely to be discussed before the end of this year under the Fund’s fast-track emergency financing procedures, and it is not anticipated that there will be any last minute hitches (although I do imagine some eyebrow raising over the decision to support the continuation of the Lat peg). The Latvian government admits that some of the IMF economists involved in the negotiations advocated a devaluation of the lat as a way of ammeliorating the intense economic pain involved in the now inevitable economic adjustment. But the government in Riga stuck to its guns (supported by the Nordic banks who evidently had a lot to lose in the event of devaluation), arguing that the peg was a major credibility issue, and the cornerstone of their plan to adopt the euro in 2012.

“It (the programme) is centered on the authorities’ objective of maintaining the current exchange rate peg, recognizing that this calls for extraordinarily strong domestic policies, with the support of a broad political and social consensus,” said IMF Managing Director Dominique Strauss-Kahn.

Continue reading →

In view of Greece’s EMU membership, the availability of external financing is not a concern, but the correction of cumulating indebtedness could weigh appreciably on growth going forward. While the risk of transmitting vulnerabilities to the euro area is very small reflecting Greece’s small relative size, large persistent current account deficits would increase the vulnerabilities to a reversal in market sentiment, leading to a corrective retrenchment of private sector balance-sheets in the face of rising indebtedness, and a possible appreciable rise in the cost of funding over time. These developments would have significant negative implications for growth.
Greece: 2007 Article IV Consultation – IMF Staff Report

The above quited paragraph from the IMF is a very good example of what used to be the orthodox wisdom about Greece’s economic imbalances – that given EMU membership the availability of external financing should not be a concern, and that the Greek economy is effectively too small for it to constitute a menace to the stability of the eurozone itself, even on a worst case scenario. Well, if we look at the growing yield spreads you can see in the chart above (please click for better viewing) the first premiss seems to be in real danger of falling, EMU membership no longer gives an automatic guarantee of oncost-free external financing, and if you look at the names of the other countries lining up in the queue behind Greece – Italy, Spain and Portugal in particular – you can begin to see the outline of a contagion mechanism whereby the coming to reality of the worst case Greek scenario might just extend itself into a problem of sufficient magnitude to transmit Greek vulnerabilities across and into the entire euro area. No one is too small to be a problem when it comes to financial crises, and if you think I am exaggerating just look at how the “pipsqueak” Baltic economies have paved the way and opened the door to much bigger problems right across Central and Eastern Europe even as I write.

But just what are the problems Greece faces, and just what are the risks of transmission of these elsewhere? Continue reading →

This, it seems, is the question of the day. According to the IMF Spain’s economy faces a contraction of at least one percent next year. And the IMF stress that the risks to this forecast “remain on the downside” since the country’s real-estate market is “in full correction,”. Also, horror of horrors (and we will return to this). The government’s budget deficit will exceed five percent of gross domestic product next year, the Fund forecast.

While the IMF seem to be more aware of the scale of the problem than the Spanish government currently are, they do seem to be putting all of the emphasis for recovery on some much needed labour market reforms, but personally I don’t think even these are playing in the right ball park, we need a big picture “breakout” escape plan, to cut loose from the pincers of cash drought, corporate bankruptcy, construction dependency, large scale contraction and price deflation. It’s a big mess, and will need an equally bold and ambitious plan to get to grips with it.

One point which is obvious at this stage is the Spanish government forecasting – where they have built a 1% expansion into the 2009 budget – is getting ever more out of line with the economic dynamic. Really this is the first thing which has to change. Spain urgently needs someone leading the country who is able to turn the page, put some realistic numbers on the table, and try to work to meet objectives, instead of simply failing to achieve them time after time. What do I mean by this, well, if you seriously think that the contraction next year will be of 2% of GDP then it is better to say 3%, and beat your target, that say 1% growth and come in with a 2% contraction. Not only will your citizens be getting more and more fed up with all of this (and the impact on morale should not be treated lightly) but much more to the point, since Spain is heavily dependent on foreign finance to buy the debt that the government is going to need to issue (see more below) to finance the fiscal deficit, then each and every failure to achieve target is likely to be punished with a higher cost of financing debt (as the yield spread on the risk rises). So as well as the credibility cost, this kind of playing fast and loose with the forecast is now likely to carry a real financial cost. Continue reading →

Now this is a very interesting question, isn’t it? The only honest answer I can give is that I don’t know, and indeed I haven’t the faintest idea. The government of Latvia (the Baltic state which is currently most rife with “rumours” about imminent devaluations) works in its own wondrous ways, and neither we (nor Latvia’s citizens) have any idea at all how they plan to lift their country out of the deepest depression they have experienced in many a long year.

What I do know is that, economically speaking,the present situation is simply unsustainable, and something is going to have to be done. Indeed the country’s government is in talks with both the IMF and the EU Commission about this very topic as I write. My own opinion is that domestic consumption is now dead (as a growth driver) for as far ahead as the eye can see (and maybe even further), that the country’s citizens now need to start to save rather than borrow more, and that the only way Latvia can turn itself around is by exporting more than it imports. But for a country which ran a 23% current account deficit in 2007 this is going to be very difficult objective to achieve, since after two years of very strong inflation Latvia’s relative prices with the rest of the world are completely uncompetitive.

Historical experience has taught us that it is not an easy thing to tell people “we are going to cut your wages by between 5 and 10% this year, next year, and then possibly the year after”. Apart from the fact that voters don’t like to hear this kind of talk, you can also enter into a deflation dynamic which then comes to be very hard to break out of. Hence, according to conventional economic wisdom, devaluation tends to be the preferred option. And it is my opinion that, despite all the attendant difficulties, devaluation is the best option among the unappetising list of unpleasant options presently available to Latvia (and the other Baltic states, and Bulgaria). Unfortunately, having reached this point there are simply no “pleasant” options available.

The curious thing is that for voicing this opinion I could go to prison in Latvia. Continue reading →

“Happy families are all alike; every unhappy family is unhappy in its own way”
Tolstoy

Well this is an interesting little fable of modern family life, even if all the families involved may not be ones which many of my readers would normally wish to belong to.

As is now reasonably well know Russian private oil company Lukoil is currently making a bid for the shares in Spanish energy company Repsol which are owned by the deeply indebted Spanish property company Sacyr Vallhermosa.

Shares in what is Spain’s fifth biggest builder, and which currently occupies the somewhat ignominious position of being Spain’s worst-performing stock this year, jumped the most in two years last Thursday (20 November) on reports they were about to sell their 20 percent stake in Repsol YPF to the Russian oil company OAO Lukoil. Sacyr, which said last week it was in talks over the possible sale of the stake, rose as much as 14 percent after EFE newswire identified Lukoil as a possible bidder. Lukoil is also reportedly willing to buy a further 9% of Respol stock owned by Criteria Caixacorp, the investment company established by Catalan savings bank La Caixa.

In fact Sacyr spent 6.5 billion euros building up their the Repsol holding, between October and December 2006, paying an average of 26.71 euros a share for the stake. It is estimated that the proposed sale of the shares may fetch 20 percent to 30 percent more than their current market value of 4.9 billion euros. To give an idea of what this means, we might bear in mind that Repsol shares closed in Madrid on Thursday at 13.61 euros, and rose 2.3% on Friday, while the Spanish newspaper El Economista reported that Lukoil was offering Criteria and the other shareholders 28 euros a share for the combined stake which constitues just under 30 percent of Repsol. An offer at this price would value the combined stake at about 10.2 billion euros, and would mean that Sacyr would walk away covering their initial investment almost completely, which in these hard times must seem almost incredible. I mean, you might like to ask yourself just why it is that Lukoil is able and willing to pay so much. Continue reading →

While we are likely to see a “substantial” drop in euro-region inflation, Bank of Spain forecasts for the 15-nation euro area do not show price drops. That is they “show an enormous moderation in price gains, but they do show price gains,” according to the latest statements by Miquel Angel Fernandez Ordoñez, ECB Council member and Governor of the Bank of Spain. Bank of Spain eurozone forecasts “don’t show deflation” he told reporters in Madrid yesterday (Wednesday).

The reason for this swift and adroit response to the question of the day in Spain was that EU Economy and Finance Commissioner Joaquin Almunia (not exactly your garden-variety world authority on macroeconomic topics) had earier said that the Europe’s economies were “facing the prospect of deflation” amidst the worst financial crisis since the 1930s. In fact Fernandez Ordoñez is right, as is his want – right on a technicality. The Eurozone as a whole is almost certainly not heading straight into deflation (yet), but this begs the question which he could have been answering: what about poor little Spain? Continue reading →