“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.

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In an article in the New York Times, Andrew Stettner called for an increased focus on the job market in the US:

“People have been focused on the housing crisis, and rightly so,” said Andrew Stettner, a policy analyst at the National Employment Law Project, “but now the deterioration in the job market should be demanding much more attention from policy makers.”

The job cuts so far in the US seem to be fairly consistent with the early stages of a period with a reversal of the wealth effect. According to Washington Post the distribution of job cuts was:

The numbers are far worse than economists were forecasting, and they solidify the case that a serious economic downturn is underway.
….

The report shows clearly how the problems in the housing and financial markets are rippling through different sectors, showing the deep interconnections between seemingly separate parts of the economy.

The number of construction jobs, which has been falling steadily for 18 months, continued its rout. That sector shed 51,000 positions, as fewer residences are being built.

Fewer houses mean less construction and building materials; the number of manufacturing jobs fell by 48,000, with some of the steepest losses among makers of lumber, drywall and other materials. Automakers also shed jobs. With their homes less valuable, Americans seem to be holding off on big-ticket purchases.

Consumers pulling back means stores need fewer workers; the number of retail jobs fell by 12,400. The steepest losses were in sellers of building materials and appliances, both of which are highly tied to the housing business.

The branches of the economy, of course, are not seemingly separate. They are visibly interconnected. Job cuts are most severe in construction and associated industries. Then there are wealth effect consequences in the auto industry and consumer retailing. Its logical and as expected.

As to the depth and duration of this crisis, this is what Ian Shepherdson had to say in NYT today:

Many forecasters argue that the economy will rebound by the fourth quarter, a view rejected by Ian Shepherdson, chief domestic economist for High Frequency Economics.

“We are in for a much longer recession than Wall Street thinks,” he said. “This particular downturn is driven by a rare contraction in consumer spending, and that is starting to hurt a broader range of people than those hurt by the mortgage crisis.”

©2010 from the hip. All Rights Reserved.

Every time the rate has been cut in the last six months, the stock market has reacted positively. And the Fed has been looked upon as an institution that actually does something to reverse the current crisis in the American economy. The rate cuts have been said to stimulate the economy, and so on.

And, yeah, guess what, lower interest rates are great for the stock market. Always have been, always will be. Simply because lower rates means that on the average, and everything being equal (ceteris paribus, it’s often called), and all of that, stocks become more attractive as investment instruments compared to other instruments.

So, if the crisis facing the US had been a financial crisis, that would have shored up things neatly. But the current crisis is not financial – it only has some financial aspects. The crisis in 2008 is structural (I’ve discussed this a bit in previous post, and will get back to it as well in later posts).

Structurally, for the real economy, negative interest rates may be bad news, even if they are good for the stock market and for financial institutions in trouble.

If you think about if, you will quickly realize that negative interest rates simply mean that almost any investment that have a yield equal to the rate of inflation becomes a profitable investment. So, the lower the interest rate, the stupider the investments, so to speak.

And low interest rates were one of the main causes of the current housing crisis (quote from Bonfire of the Builders, Business Week):

A diverse cast of characters combined to launch the once-in-a-lifetime housing boom of the past five years. Traditional mortgage companies and banks unleashed a barrage of loans, many to borrowers with iffy credit histories who didn’t bother to read the fine print about upwardly mobile interest rates. Wall Street egged on the often-reckless underwriting by buying vast quantities of home loans for repackaging as securities. Now that the boom has fizzled and foreclosure rates are rising, the important role of large homebuilders as lenders is also coming into sharper focus.

In addition to spitting out subdivisions, many of which now stand half-empty, builders jumped into the mortgage business to a degree they never had. Wall Street provided the same encouragement it offered other lenders. Even as the housing supply began to exceed demand last year, builders kept sales brisk by pushing adjustable-rate, interest-only, and other risky loans. In some cases they attracted clientele who couldn’t afford conventional mortgages.

So now, with low interest rates, there is the risk of fueling the same speculative building spree again. And also, to make investors spend precious capital on low-yield projects that look good today, but will surely be bad once interest rates come up again.

In my opinion, and I’ll say more about this later, the American economy currently need high interest rates (something like a real interest rate of +3-4%) to ascertain that capital is spent on smart projects and to reduce non-productive speculative investments.

©2010 from the hip. All Rights Reserved.

©2010 from the hip. All Rights Reserved.

No wonder. They make most of their income when the housing market is bullish. But is it going to be up this year? Is it over? Is it really only a crisis in the sub-prime loan market and some associated financial instruments, so that all it takes is a few write downs, a reduction in the interest rates, and a little time, and then it will all be over?

Well. It depends a little on what you mean by a few write downs then.

An article in the Financial Times, entitled America’s economy risks mother of all meltdowns, refers to Prof Roubini, who states:

Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000bn and $6,000bn in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.

So, yeah, if 4.000 to 6.000 bn, or something even near that, is a little. Or, compare that to the following from Wall Street Journal:

Merrill Lynch economist David Rosenberg, one of the most bearish Wall Street economists, says to look past the 1990-91 recession as a guide to the current downturn. The key difference: the depth of home-price declines.Mr. Rosenberg says in a note to clients that the current downturn is hitting more broadly than the credit crunch and real estate meltdown in the 1990-91 recession, which lasted eight months (as did the mild 2001 contraction). Home prices today are falling in 85% of the country vs. 40% during that period, he notes. When prices hit bottom in 1992, the inventory of new and existing homes for sale was at 7 months of supply. Now it’s at 10 months’ supply “with no improvement in sight,” says Mr. Rosenberg, who was among the first economists to forecast a 2008 recession. He sees average prices nationwide dropping 20% to 30% more, on top of the 11% decline since the 2006 peak.

And this, of course, is really the start of it all. Both talk about 20-30% drop in housing prices. That’s pretty substantial. And, this is when the negative wealth effect kicks in, because people that have lost 3.000, 4.000 or 6.000 bn dollar are not going to be spending quite as much as they did before they lost their money.

I think 2008 will not see any improvements at all. Rather I think we have only just begun to see the bad news of 2008.

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The fall in the housing market, which is likely to last for quite a while – I think well into 2009 – has another disturbing effect. It reduces the value of property in America. Thus, the wealth effect – everybody getting “richer” because the value of their houses and apartments have increased, and spending some of that newfound wealth on consumption – is reversed. Now there is a negative wealth effect.

A negative wealth effect means that this time increased spending will not be fuelling the economy and lifting it out of recession.

The effects of the reversal of the wealth effect are now slowly becoming visible in the US. Automakers are adjusting their sales expectations down:

Dismal Year Is Forecast for Car Sales

writes New York Times. And it doesn’t stop there:

Slump Moves From Wall St. to Main St.

In Seattle, sales at a long-established hardware store, Pacific Supply, are suddenly dipping. In Oklahoma City, couples planning their weddings are demonstrating uncustomary thrift, forgoing Dungeness crab and special linens. And in many cities, the registers at department stores like Nordstrom on the higher end and J. C. Penney in the middle are ringing less often.

… Many economists forecast that overall consumer spending will slip 1 percent for the first three months of the year.

“That’s a wow,” said Robert Barbera, chief economist for the trading and research firm ITG. “Outright declines for real consumer purchases are unusual.”

What is shaping up as the second recession of the 2000s is the product of declines in home values, which play a far bigger role in most Americans’ personal finances than the stock market. Households have borrowed against the increased value of their property to buy cars, send their children to college and add home theater systems.

What all the stories of declining demand point back to, is of course the wealth effect. And in months to come, it will increasingly be reinforced by imported inflation, making the crunch on the dollar increasingly felt by the consumers as well.

Indeed – all the charts for the US look bad for the moment: Jobless claims up, consumer sentiment down, housing starts down, retail sales down, industrial production down, dollar down. Meanwhile, the stock market will continue to be turbulent.

To me, it seems a rough ride is ahead!

More to come.

©2010 from the hip. All Rights Reserved.