from the hip

While the economic downswing is still making itself felt in the US, it is now also hitting several European countries hard. And inflation is soaring, and hit a record high of 4.1 percent last month.

“There’s no obvious trigger for strong economic growth in Europe until the end of 2009,” says David Owen, chief European economist at Dresdner Kleinwort in London. “Massive [financial] imbalances need to be worked out, and the corporate sectors in many countries remain in a substantial deficit.”

Consumer confidence for the euro area has fallen to negative 29.7, the lowest it has been since 1993. And the news about the plunge in factory orders in Germany, led to the following comment, reported in the New York Times:

“It now looks likely that the euro zone will be the first major economy to fall into recession,” Jonathan Loynes, the chief European economist for Capital Economics, wrote after the report of sagging orders in Germany.

Great Britain

Royal Bank of Scotland, Britain’s second-largest bank, recently posted its first loss in 40 years after taking a £5.9bn hit from the credit crunch. And Barclays, the third-biggest bank, took a fresh £2.8bn write-down. Also, the price of houses are dropping rapidly, according to Guardian

the Halifax said house prices last month were 11% down on a year earlier - the first double-digit decline since its monthly healthcheck of the market was first published 25 years ago.

House prices back to 2006 and still falling, says Times. And new housing orders are down 33%. And, of course, home repossessions surge.

Business groups and City analysts warned that deep and rapid cuts in the cost of borrowing would be needed next year to pull Britain out of its first recession in more than 15 years. House prices are falling more rapidly than they were in the property crash of the late 1980s and early 1990s

It would seem a possible recovery in Britain will not be aided by increased consumer spending in the short term!

Recession in Germany?

Spiegel online writes that the German economy may have shrunk in the second quarter, according to early reports, and that the outlook for industrial production isn’t lively. Germany could slide into recession, and the German economy may have shrunk by around one percent. They also note that:

German factory orders were down by 2.9 percent in June from May, and orders from abroad for German goods plunged by 5.1 percent. Production at German factories rose by 0.2 percent in June — less than expected

Spain in deep trouble

Portugal, Italy, Greece, and Spain all face severe challenges. In Spain, the imploding domestic housing market has pushed the unemployment rate to 10.7 percent. The number of bankruptcies in the building sector is exploding, and one third of the job losses stems from the construction sector. As well, the housing market is stalling. The inflation is about 5 per cent.

The US

The credit cruch is still being felt, and so is the reversal of the wealth effect and high oil prices. In addition to bad news from the banking sector, Fannie Mae, Freddie Mac, Indy Mac, and so, in the latest sign of the deepening troubles, G.M. recently reported a second-quarter loss of $15.5 billionfollowing a loss of $8.7 billion reported earlier by Ford. Car sales are dropping, especially sales of American cars.

Guardian notes that:

The US mortgage finance empire Freddie Mac yesterday predicted the worst housing slump since the Great Depression as it set aside $2.5bn (£1.28bn) to cover credit liabilities caused by delinquent loans and foreclosures.

And in New York Times, Peter S. Goodman recently wrote (August 1) that “More Arrows Seen Pointing to a Recession”.

Overall

Pretty gloomy still. The most positive piece of news is the slight drop in oil prices. But still serious signals of a slowdown of growth and possibly recession both in Europe and the US.

A new study from Harvard University lends considerable support to what I have previously written here about the crisis in the US housing market. The study predicts that

housing woes will continue as the economy wavers from the sharp drop in home building, credit and stock market turmoil, and a slowdown in consumer spending.

The study also adresses the negative wealth effects of the current situation in the housing market:

“Further price declines will not only increase the probability that mortgage defaults end in foreclosure, but also put a tighter squeeze on consumer spending,” the report stated.

As well, the report states that if the economy plunges into a severe recession, housing demand could fall even further. Many factors seem to still point in this direction. There are a number of negative indicators:

American Express experiences late card payments increasing

House prices dropping

Consumer confidence still dropping

The oil price is still rising

And so on and so forth. At the same time, inflation is on the rise, and while the Fed now is expressing strong concerns about this, they have still not really adressed it. My sense is that they will soon have to.

American media continue to focus on the rising price of oil, and how they drive inflation and increase energy costs.

While this is true, it is only true in an indirect sense. It’s not the oil that is extremely expensive - it was much more expensive in 1980, if measured in other currencies - it is the dollar that is weak.

Here’s that chart for the USD versus the Euro for the last 12 months:

Here is the Brent spot price for the same period:

Adjust oil prices for the dollar slip, and there is still a price increase, but it is actually not all that huge.

The dollar is weak because the US interest rate is low - actually negative when adjusted for inflation - and because the US banking system and credit markets are shaky. And the stock marked is in for a rough ride, whether Americans want to believe it or not. So investors, both inside and outside the US, go into oil and commodities.

This, of course, means the causes for the high oil price to a large extent is found in policy failures within the US. There really isn’t all that much cause to blame the Arabs or the rest of the world, certainly not for the current recession in the US, and only to a limited extent for the current oil prices.

The price fall in the US continues and accelerates. According to The Independent:

The price of the average home was 11 per cent lower than a year ago, the S&P Case-Shiller index showed yesterday, as repossessed homes flood the market – and economists predict that the price adjustment may belittle more than half over.

…. “It does not look like early 2008 is marking any turnaround in the housing market,,” said David Blitzer, S&P index committee chairman. “Home prices continue to fall, decelerate and reach record lows across the nation. No markets seem to be immune from the housing crisis.”

Other indexes point in the same direction. But actually all these indexes most likely underestimate the problems in the housing market for the moment. The reason for this is that a large number of sellers are holding back. So at the same time the market has slowed down (New York Times):

Sales of new U.S. single-family homes fell to the slowest pace in 13 years

On the other hand, real interest rates are now negative. And the Fed is pumping liquidity into the market. So it’s easy to think that the housing market will pick up relatively soon.

However, I don’t think that’s the case. Given the huge structural imbalance in the housing market and the time it will take to achieve balance, on one hand, and the need the Fed has to also look at factors in the much bigger recession picture on the other hand, they can’t and shouldn’t maintain negative real interest rates for an extended period of time. And smart buyers, I think, know this.

Because the bigger picture is a federal budget out of control, a foreign trade deficit that is monumental, a continued weakening of the dollar as a result of low interest rates, low productivity (see NYT, Feb. 7) growth in the economy (see also OECD), cautious lending by the banks (reacting to the current uncertain situation), and the danger of a substantial imported inflation.

Then add to all this that a negative real interest rate most likely is exactly the opposite of what the American economy needs over the slightly longer term, as cheap capital will lead to decline in productivity.

Taken together, these factors should imply that a negative interest rate - which just is plain stupid but may momentarily be necessary - will and should only be maintained until the financial institutions are over the worst.

More to come!

Following the coverage of the current crisis in the US, I strongly feel the news media in the US attribute far too big a role to the current prices of oil as a factor causing or contributing to the recession.

For instance, New York Times a few days ago published a graph showing the inflation adjusted price of oil, and pointed out that oil now was more costly than in 1980, and at its highest ever price (after the most recent price adjustments) (illustration from New York Times):

While this is obviously true, it is also only true when viewed from an American point of view. If the declining value of the dollar in international currency markets it factored in, oil is actually still 30-40% less expensive now than it was in 1980.

So to my mind, Americans, and most certainly American media, are looking in the wrong direction when explaining the crisis to the American public. To the extent that their explanations are believed, this may slow down the appropriate and necessary adjustments to the current challenges facing the American economy. It is necessary to look elsewhere.

More to come!