Mish's Global Economic Trend Analysis

Greek 1-Year Bond Yield Hits 1,006%
Report Shows Netherlands Would Benefit by Leaving Eurozone; Country by Country Aggregate Costs; Dutch Freedom Party Wants Euro Exit Referendum; Critical Juncture for Eurozone
Eurozone Services and Composite PMI Back in Contraction; Italy, Spain, France at New Lows
Disingenuous Recession Explanations from ECRI Regarding Coincident Indicators; An Email Response From ECRI; Does the ECRI Even Believe Its Own Indicators?

Posted: 05 Mar 2012 05:28 PM PST

As a matter of curiosity more than anything else, I occasionally take a peek at Greek bond yields. Today, the Greek 1-year yield topped 1,000% for the first time.

The following chart courtesy of Bloomberg.

To be specific, the yield is a nice 1,066.661%

That yield reflects the idea that 1-year bonds will be nearly worthless before the month is over.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Report Shows Netherlands Would Benefit by Leaving Eurozone; Country by Country Aggregate Costs; Dutch Freedom Party Wants Euro Exit Referendum; Critical Juncture for Eurozone

Posted: 05 Mar 2012 02:50 PM PST

Report Shows Netherlands Would Benefit by Leaving Eurozone

Inquiring minds are reading a 73 page detailed report The Netherlands & The Euro that explains country by country why Italy, Greece, Portugal, and Spain are going to need lots more money, and the Netherlands and Germany will end up footing the bill.

The study highlights the fundamental flaws of the Economic and Monetary Union (EMU), the damage done by the euro to date to the Netherlands, and the potential costs down the road. The report conclusion is Netherlands should exit the EMU.

Here are some snips from the report regarding the finances of Italy, Spain, and Portugal.

Italian Projections

It cannot be assumed that roll-over of existing debt as it matures can be done with private lenders, as in the past. Italy has virtually zero real growth, and interest rates that, at 6% or so, are 4-5% ahead of likely future inflation. A government debt burden well over 100% of GDP in a country whose real interest rate exceeds its real growth rate by 4% or more is theoretically unsustainable. The debt ratio is almost certain to mount indefinitely. In this context, it is realistic to analyse a scenario in which financial markets conclude that Italy has slipped into the "Greek trap". In that case, official Eurozone financing will be needed not just for the budget deficit, but to refinance maturing debt as well. This would be a major added burden, as Italy's maturities are €305 billion in 2012, €175 billion in 2013, and €140 billion in 2014 and 2015, before falling below €100 billion a year. In this scenario, financing Italy within the Eurozone could quadruple in cost to a five-year average of €250 billion a year.

All of the above highlights the risk that Italy's debt will increase its net ratio to GDP from 100%. But the SGP, Maastricht criteria, and recent pact to "save" the euro, all require that Italy reduce its gross debt ratio to 60% of GDP or less. Clearly there is not the slightest chance of this within decades, unless Italy quits the euro and inflation rises. The setting of this target is fantasy – the 60% number is arbitrary, relating to no rational (or achievable) objective, though for Italy in the euro, with negligible potential nominal growth, the sustainable limit of government debt is clearly far below the current level.

Spanish Projections

Portugal is in desperate trouble – well beyond rescue, with business net debts at 16 times net cash flow – and Spain, and possibly France, in serious trouble: their ratios of around 12 times net cash flow being about that of Japan in 1996 that was followed by six years of zero growth. The analysis here will focus on Spain, its grim conclusions simply being grimmer for Portugal. French risks will be seen to be less.

The Spanish government has actively pursued a tighter fiscal stance, in line with the current Eurozone insistence on austerity. It is likely to prove counter-productive. Unemployment has already mounted from 8% in late 2007 to over 20%. The government's GDP estimates have ceased to be credible, registering a real decline of just under 5% in the recession, with negligible recovery since. It is highly improbable that such a recession, less than that of the US, Germany or Britain, would lead to a 12 percentage-point rise in unemployment, even with the lay-off of masses of low-productivity casual construction labour, much of it migrants from eastern Europe. But, as elsewhere, denial followed by bluff has been the standard Eurozone response to critics throughout the crisis. Almost certainly, the true fall in GDP has been much greater.

Spain's business finances, in the context of austerity, are caught in the same vice as Italy's government finances. As long as they stay in the Euro, austerity is worsening, not reducing, the debt problem. The only solution to these debt problems is growth, and that is precisely what the Berlin-Brussels-Paris political élite is ensuring will not happen.

The risk, obviously, is to the Spanish banking system. Even after Japan's six-year "drying-out" period, its banks had to undergo a substantial debt write-down in early 2003 (8% of GDP) before economic recovery became sound. In Spain, it is unlikely that exaggerated asset values – especially in real estate, but also in business generally – can withstand the coming economic downswing. Once they start to tumble, the call on the government to bail out the banks could cause its debt to soar. This is like Ireland a couple of years ago, when it dealt with the business debt problem, so that government debt, which has soared, now accommodates the business debt excesses of the boom. A recession in Spain now probably implies serious debt service problems in business, asset liquidation leading to falling asset prices, and major bank write-offs requiring government recapitalisation. There is a major danger that current austerity policies will lead straight to depression.

Portugal Projections

Portugal will probably be out of the EMU quickly if Greece goes, and this will bring the focus onto the two large Med-Europe countries, Italy and Spain, of which Italy will probably be "next up". The debt crises of Ireland, Portugal and Spain (in order of overall debt/GDP ratio, all of them with a higher ratio than Greece or Italy) lie in the private sector, and are therefore "slowburn".

In Portugal, where the chief export market is potentially recessionary Spain, where cost competitiveness is worse than Spain, and the business debt burden much higher at 16 times net cash flow, as is government debt relative to GDP, the private sector is actually still in deficit – the current-account deficit is larger than the budget deficit.

It is almost impossible to see how Portugal can avoid a crash. It is a poorer country than Greece, so the Franco-German decision to insist on no further government debt write-offs after Greece means the country is likely to be returned to penury – having in any case had very little growth since it joined the euro at its inception.

In this projection of Portuguese financial needs, the assumption is that coping with the extremity of business debt ratios creates a crisis that requires the write-off of existing debt over three years, as in Greece above. The projected government debt of zero in 2015 is therefore fictitious in the sense that the existing debt will have been replaced by a large volume of government debt to finance a banking recapitalisation. This could be substantially larger than Ireland's 2010 31% of GDP, as Portugal's business debt is larger than Ireland's was. Portugal's future debt capacity will be extremely low, as it has negligible potential growth and, assuming it stays in the euro, no inflation either – yet market interest rates are likely to be quite high.

Austerity + Subsidy – Not a Cure

In summary terms, curing a country's excessive debt problem requires one (or more) of the three 'de's: devaluation, default or deflation. The Eurozone has ruled out the first two – and adopting the third seems likely to achieve a fourth 'de': depression.

With unchanged Eurozone membership, the only method of adjusting costs and prices in Med-Europe to be competitive without extreme and constantly reinforced austerity, leading to depression, would be stimulation of rapid inflation in The Netherlands and Germany for a decade or two; and acceptance over that adjustment period of large fiscal subsidy payments to the deficit countries – not loans to be repaid later, but unrequited transfers. Such transfers are already happening through banking systems being subsidised by access to the ECB's repo "window" to finance themselves at interest rates well below those paid by their own governments

The danger for The Netherlands is that the potential for subsidy needed by Med-Europe is open-ended. All official scenarios are based on a rapid reversion to recovery, both in Eurozone economies and financial markets. Official scenarios never anticipate recession or financial crisis. This is part of the problem. The imbalances that are poisoning the Eurozone economies cannot be acknowledged because their cure, once they are acknowledged, clearly requires major exits from the euro, or its disbandment. Unacknowledged, they remain unaddressed, so continued financial deterioration is likely, unless the core Eurozone countries step in and provide the continuing subsidies outlined above.

Aggregate Potential Costs of Current EMU Membership

Dutch Freedom Party Wants Euro Exit Referendum

Bloomberg reports Dutch Freedom Party Wants Euro Exit Referendum

The Dutch Freedom party wants voters in the Netherlands to decide in a referendum whether the country should return to the guilder, De Telegraaf reported today, citing an interview with party leader Geert Wilders.

The Freedom Party hired Lombard Street Research to investigate the cost of maintaining the Euro zone and alternative scenarios if countries elect to leave, according to a statement by London-based FTI Consulting. The report will be presented in The Hague on March 5.

How Significant is the Dutch Freedom Party?

Inquiring minds may be wondering how big and influential the Dutch Partij voor de Vrijheid ('PVV', the Party for Freedom) might be. It's a good question, too. The short answer is the PVV is a critical part of the coalition holding the Netherlands government together.

Reuters explains in commentary from November, Analysis: Populists exploit euro zone crisis to gain influence

In the Netherlands, eurosceptic politician Geert Wilders is staging a campaign which could push the minority government to the brink of collapse after barely a year in power.

Last week, Wilders proposed that the Netherlands should hold a referendum on whether to ditch the euro and embrace the Dutch guilder again, pending a study of the long-term economic costs.

The government relies on the support of Wilders's Freedom Party (PVV), even though it is not in the ruling coalition.

PVV won the third-largest number of seats in parliament in elections last year, mainly because of its tough stance on immigration and Islam. It has a pact with the coalition of Liberals (VVD) and Christian Democrats (CDA), giving the pro-euro government the majority it needs to pass legislation.

Wilders denies he wants to bring down the government over the euro but he is playing up a split on a major issue between the coalition and the party on which it relies for survival.

"The euro and Europe is the key element of our foreign policy. How can we have a split between VVD-CDA who strongly support Europe, and PVV? This is the most dangerous issue for our cabinet," Eijffinger told Reuters.

"If you disagree on such enormously important issues then it becomes harder and harder to avoid accidents. At a certain moment it will accelerate."
The Freedom Party has become the second-most popular party in Dutch opinion polls, mainly because it opposes the costly bailouts of the euro zone's heavily indebted members.

By proposing a referendum, Wilders has heightened tensions between his party and the government. The euro zone debt crisis has already toppled several governments and now threatens to engulf Dutch Prime Minister Mark Rutte.

Rutte has shot down the idea of quitting the euro, saying it would be disastrous for the export-oriented Dutch economy.

But his government has been criticized for supporting bailouts of countries such as Ireland and Portugal, and a stability fund intended for future rescues as the euro zone debt crisis spreads like wildfire to bigger economies like Italy.

Opinion polls suggest many Dutch still hanker for the guilder, and resent having to pay for Europe's more profligate members, particularly while the Dutch government is cutting spending on healthcare, education, and social security benefits.

A poll at the weekend found 32 percent favored quitting the euro, 60 percent were against leaving, and 43 percent wanted a referendum on whether to return to the guilder. Another poll found that a majority wished the country had stuck with the guilder.

With elections due in 2013, Austria's Freedom Party is neck and neck with the governing Social Democrats and ahead of the conservative People's Party, the junior party in the coalition.

"Now even Paris and Berlin are thinking about splitting up the euro zone. We in the Freedom Party suggested this at the start of the euro crisis because in truth it is the only correct solution. This is the only way to save Europe," Strache said.

In an interview with the newspaper Oesterreich in May, he warned: "We have to get out of the euro before it plunges us into the abyss. We need a new currency along with other strong-currency countries."

Critical Juncture for Eurozone

This new report could very well topple the government of Dutch Prime Minister Mark Rutte. Put that bit of news together with the fact that French Presidential candidate wants to redo portions of the just signed "Merkozy" treaty. Polls show French president Nicolas Sarkozy will not survive the next set of elections.

German chancellor Angela Merkel is rapidly losing support as well. Ironically, the breakup of Merkel's coalition might be to a coalition wanting to lend still more support the nanny-zone.

Regardless, the net effect of the demise of the governments of Germany, France, and the Netherlands would be for far more feuding, adding to the overall pressure for a eurozone breakup.

The eurozone is at a critical juncture now. If governments in the Netherlands, Germany, and France collapse, and I think they will, the eurozone could be nearing the inevitable breakup stage already.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Eurozone Services and Composite PMI Back in Contraction; Italy, Spain, France at New Lows

Posted: 05 Mar 2012 10:58 AM PST

Markit Eurozone Services and Composite PMIs show renewed contraction due to drop in services activity, making it extremely difficult to deny that Europe is in a recession. Let's take a look at some numbers.

Markit Eurozone Composite PMI®

The Markit Eurozone PMI® Composite Output Index fell from 50.4 in January to 49.3 in February, dropping below the earlier flash estimate of 49.7. The final reading confirmed that business activity contracted in February, having briefly returned to growth in January following four months of decline at the end of last year.

Key points:

Final data confirm slide back into contraction, as drop in services activity offsets marginal rise in manufacturing output

Strong downturns still evident in Italy and Spain

Employment and prices charged fall as firms seek to cut costs and win new sales

Markit Eurozone Services PMI®

Service sector weakness poses new recession risk

Key points:

Service sector activity contracts for fifth time in six months

Ongoing fall in new business leads to job losses

Growth in Germany contrasts with steeper declines in Italy and Spain

Business confidence hits seven-month high

Of the four largest euro countries, only Germany showed expansion in February, and the rate of growth slowed from January's seven-month high. The French service sector stagnated, ending a two-month period of mild expansion. Both Spain and Italy registered steep contractions, with the rates of decline gathering momentum in both cases.

Nations ranked by business activity (February)

Ireland 53.3 12-month high

Germany 52.8 2-month low

France 50.0 3-month low

Italy 44.1 4-month low

Spain 41.9 3-month low

Spanish service providers reported a further particularly steep drop in payroll numbers, and employment also fell sharply in Italy's service sector. French headcounts rose only slightly, while services employment growth in Germany slowed to the weakest since June 2010.

Companies frequently sought to boost sales by cutting prices, and average prices charged for services fell for the fifth time in the past six months as a result. Price trends varied markedly by country, however, ranging from ongoing upward pressure in Germany to steep falls in Spain and, to a lesser extent, Italy. France registered a slight fall in prices charged for services, reflecting the stagnation of new business flows in February.

In contrast to the trend for charges levied by service providers, input prices in the sector rose for the twenty-seventh straight month, pushed up in many instances by higher fuel and energy prices.

Profit Squeeze

Note that prices received fell for the fifth month in six, but prices paid rose for the twenty-seventh straight month.

Let's take a look at the second biggest economy, France, to see what is coming up.

Markit France Services PMI®

French service sector output stagnates in February, despite rise in new business.

Key points:

Final Markit France Services Activity Index(1) at 50.0 (52.3 in January), 3-month low.

Final Markit France Composite Output Index(2) at 50.2 (51.2 in January), 2-month low.

Recent growth of French service sector output slowed to a halt in February, as activity levels stagnated. This was despite a marginal rise in new work intakes, with poor weather impeding output. Nonetheless, backlogs of work declined again, albeit only slightly. A mild increase in staffing levels was indicated. Future expectations strengthened markedly in February, albeit remaining below the long-run series trend. Meanwhile, strong competition led to a further reduction in output prices despite solid input cost inflation.

Spain is in an economic depression as are Greece and Portugal. Italy is not in a depression but it is a basket case as shown by the business activity above.

See that positive GDP in the France chart? Don't expect it to last because it won't.

Moreover, austerity measures across the board coupled with a slowdown in Asia strongly indicate the vaunted German export machine is about to break down as well.

The European recession will be both long and deep.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Disingenuous Recession Explanations from ECRI Regarding Coincident Indicators; An Email Response From ECRI; Does the ECRI Even Believe Its Own Indicators?

Posted: 05 Mar 2012 01:13 AM PST

Late last month in ECRI Sticks with Recession Call on CNBC; More than a Bit of an Exaggeration by Achuthan to Make His Call? I questioned the ECRI's use of coincident indicators to make a claim regarding recession

I count three instances between 1990 and 2000 where ECRI coincident indicators flagged a recession by the methodology Achuthan cited.

I have numerous other problems historically with ECRI claims, including their alleged "perfect" track record. Please see A Look at ECRI's Recession Predicting Track Record for details.

This time, I happen to think Achuthan has very valid points. However, once again, Achuthan has a hard time articulating them in a purely factual manner in spite of the fact he is clearly bright and articulate.

Email Response From ECRI

In response to that article, reader "Art" sent an email to the ECRI and received this email back from Melinda Hubman, ECRI Managing Director, Operations.

Hi Art,

Actually, it is incorrect to say that the U.S. Coincident Index (USCI) year-over-year growth rate dropped even more in ~91, 95 & 98 and no recession followed.

We have attached an Excel file showing the straightforward calculations, based on the USCI data available from ECRI's website (http://www.businesscycle.com/reports_indexes/allindexes).

The latest USCI growth rate is 1.94% (which can be rounded off to 1.9%). In January 1996, it had dropped only to 2.06% (which can be rounded off to 2.1%). This was certainly not below current readings. Of course, no recession followed.

In 1998, the USCI growth came nowhere near current readings, so the question doesn't arise. It wasn't until January 2001 that it fell below 2%, and the recession began two months later.

The attached worksheet marks all months when USCI growth, rounded off to one decimal place, fell to 2.1% (marked in blue) or to 2.0% or below (marked in red).

If you look at all the occasions in the last 50-plus years when USCI growth fell to 2.0% or below (marked in red), it is clear that recessions began around those dates (obviously, we don't include the occasions when USCI growth had risen through 2.0% following the recessions).

In sum, it is precisely accurate to claim that y-o-y USCI growth has never dropped to current readings in the past 50-plus years without a recession ensuing.

Kind regards,

Melinda Hubman
Managing Director, Operations
ECRI

Disingenuous Response

I am rather amazed at the disingenuous response from the ECRI.

The ECRI rounded down 1.94% to 1.9% then rounded up 2.06% to 2.1% to make their claim. Really! You cannot make this stuff up.

The ECRI sent an excel spreadsheet to reader Art, and I took that exact spreadsheet and created a chart from it. Here is my chart.

ECRI Year-Over-Year Percent Change in Coincident Indicators

click on chart for sharper image

Incredulous Defense

Somehow the ECRI wants us to believe that a year-over-year plunge in coincident indicators from 3.71% to 1.94% (a 1.77 percentage point drop in 15 months) is more important than the 1995-1996 plunge from 5.23% to 2.06% (a whopping 3.17 percentage point drop in 12 months).

I am not the only one in disbelief of this ridiculous position.

Georg Vrba, P.E. wrote a pair of articles on Advisor Perspectives on the subject.

Is There Something Magic About 2 Percent?

I want to continue the discussion with a point Vrba missed, specifically the "magic" 2 percent threshold.

Melinda Hubman, ECRI Managing Director, took great "rounding" pains to defend a dip below 2 percent as if a decline to 1.94 percent was significant but a far bigger percentage point decline to 2.06% was not.

Indeed.

Spotlight 2007

Please take a good look at that chart created using ECRI data, supplied by the ECRI. What I want you to focus on is the decline in March of 2006 from 3.76% to 1.80% in October of 2007, all the way to 1.05% in February of 2008.

Please consider this image clip from the November-December 2007 ECRI Outlook (now conveniently redirected by the ECRI to another spot).

Got that?

The ECRI in its November-December 2007 Outlook, in spite of that massive drop in coincident indicators, in spite of a recession that I believe should have been obvious, actually said "this weakness is not pronounced, pervasive and persistent enough to be recessionary"!

Coincident indicators did not appear to be a concern at all in 2007, now (out of the blue), they are paramount.

Saturday, January 05, 2008
ECRI Says Fed Has Room To Cut Rates Despite Fears of Inflation

"WLI growth is now at its worst reading since the 2001 recession. However, the WLI's recent decline is not based on pervasive weakness among its components, suggesting that a recession could still be averted," Achuthan said.

Somehow a recession that had already started could be avoided.

Friday, January 25, 2008
ECRI Says There Is A Window of Opportunity for the US Economy

The U.S. economy is now in a clear window of vulnerability, given the plunge in ECRI's Weekly Leading Index (WLI) since last spring. Yet there is a brief window of opportunity within that window of vulnerability to avert a recession. That is why ECRI has not yet forecast a recession.

If we have a recession this year, it would turn out to be the most widely anticipated recession in history. Clearly, the pessimism of consumers and business managers could cause them to cut spending, creating a self- fulfilling recession prophecy. But there is another side to the story.

At turning points, a few months' lag in policy action can be immensely costly. If it spells the difference between a recession and a soft landing, a couple of months' delay can end up costing a couple of million jobs and couple of hundred extra basis points in rate cuts – and still not have the same effect. What a stitch in time can accomplish early in a down cycle cannot be achieved, even with far more aggressive action, a few months down the road. At best, forceful but delayed action can mitigate the severity of a recession.

Amazingly, in a recession that was now two months old, with coincident indicators all the way down to 1.05%, the ECRI saw a "Window of Opportunity" to avoid a recession.

What's even more amazing is the ECRI's discussion of a "soft landing"!

Friday, March 28, 2008
ECRI Calls it "A Recession of Choice"

The U.S. economy is now on a recession track. Yet this is a recession that could have been averted. In January, given the plunge in the Weekly Leading Index, we declared that the economy had entered a clear window of vulnerability. Yet we emphasized the brief window of opportunity within that window of vulnerability for timely policy stimulus to head off a recession.

The bottom line is that the outcome was not pre-ordained. Policy-makers had a choice about the speed with which stimulus took effect. If they had understood this, their actions could indeed have averted this recessionary downturn.

ECRI Digs Deeper and Deeper Holes

At the end of March the ECRI was still in denial about the recession that was then four months old! Amazingly, the ECRI has the unmitigated gall to claim a perfect track record at predicting recessions.

By the way, according to the Excel spreadsheet sent to Art, the ECRI monthly coincident index was .62 on March 1, 2008 and .32 on April 1, 2008 (the ECRI having finally thrown in the towel just 4 days prior).

In attempting to defend the indefensible, and by attempting "mind over indicators" the ECRI has dug a hole that is impossible to get out of.

Does the ECRI Even Believe Its Own Indicators?

I have to ask a serious question. Does the ECRI even believe its own indicators?

If it does, then why did the ECRI refuse to see a recession in late 2007 that should have been blatantly obvious? If it does, then why all these contortions now?

The only explanation I can come up with is Achuthan and the ECRI form an opinion, then twist and turn past history to defend it.

In this case, the ECRI made extensive use of coincident indicators to make its point, having totally ignored coincident indicators in similar conditions as recently as 2007. When you do that, you miss things, serious things, as I pointed out above.

As a result, the ECRI looks ridiculous.

On Making Mistakes

Regardless of how it may look, I do not have anything against the ECRI per se. Everyone makes mistakes. I have made dozens and I will make dozens more. The only way to not make mistakes is to not predict anything. However, I do have problems with people twisting facts and making claims known to be inaccurate.

The problem the ECRI has is twofold.

Pretending they have a perfect track record when they don't
Twisting and contorting their own indicators to say what they want them to say

One can only get away with each of those for so long. Indeed, on point number two, I would have to say the ECRI's interpretation has been good enough, long, enough, to generally mask the problem.

However, repeated cover-ups eventually blowup in spectacular fashion, just as they have done now.

About That 2012 Recession Call

In spite of all the above, I happen to like the ECRI recession call. Yes, I am biased, but it is hard to find anyone who is not.

I was way early in 2006 when the yield curve inverted, and I was early again this time, but never emphatic as was economist David Rosenberg with his June 13, 2011 "99% chance of US recession by 2012"

To go out on a limb, I think GDP in 2012 is going to hugely surprise on the downside, and 1st Quarter GDP may be as low as zero to .5%. A negative number (or more likely a revised negative number) would not shock me in the least.

If so, there is still room for the ECRI to be correct. The ECRI needs (by its own admission) a recession by mid-year to be correct. It will be interesting to see how much they twist and turn a few months from now.

However, even if GDP tanks big time, the NBER (the official designator of recessions) may not acknowledge the recession for another six months to a year.

In general, delayed NBER calls explain why the ECRI can also get away with late calls. However, it fails to explain why the ECRI stuck its neck out so early this time. The most likely explanation is as described earlier: "mind over indicators".

I don't care that much, recognizing that perfection is simply impossible. However, it does pose a big problem to the ECRI because they pretend they are perfect even though facts prove otherwise.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Mish's Global Economic Trend Analysis

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