On recession prospects


EU Commission some days ago came out with their downwardly revised economic forecasts now showing -0.3 per cent for this year instead earlier projected growth.

Now I can largely agree with EU Commission on the broad direction of the economy. It took annoyingly long time to get some sanity out of these econ PhDs but once they come out with something that makes sense, I will happily support them.

The premise of deep and long recession in Europe would require war, forced contraction of money supply, abrupt and strong reversal in fiscal policies, massive supply shocks or breakdown of civil order. While the weakest members of the Euro-zone are precisely there, they still constitute a small percentage of European GDP and will not drag the entire continent down with them.  Will Finland, Netherlands, Sweden, Austria, Germany and others take a hit? Yes, but further deterioration will require additional shocks.

Given the actions by the ECB, already deflated real estate bubbles, somewhat steady albeit slow growth in US and the time private sector has already had to reorganize the utilization of resources in more productive areas, I don’t see how there could be a Europe wide deep and prolonged recession. A recession in Europe? Yes. A depression in Greece? Yes. But more interesting question is how much long-term damage have we taken as a result of misguided policies?

One particular interest of mine is Euro-zone’s development as an optimal currency union, because what has happened over the last 5 years or so has definitely pushed the Euro-zone away from this optimum. In 1999 a Nobel Prize in economics was granted to Mr. Mundell for essentially showing that Euro-zone does not work. While the adoption of ESM itself is currency union positive from strict economics perspective, and if you are for some odd reason in favor of removing local democracy through EU and Euro-zone, it is what you should advocate. However, the demise of PIIGS and the potential rise of protectionism certainly do not bode well for the functioning of the common currency area and it was not that fluid to begin with.


Spain’s figures are somewhat of particular interest as at least:

  1. I don’t really believe in them
  2. Some EU ministers have come out saying that no one believes in them
  3. They announced that unemployment would approach 25% this year
  4. They are expecting 1.7 per cent contraction this year
  5. They are in cross hairs with EU over their planned budget deficit

My problem with their figures is with the 4th quarter real GDP and employment. Their latest figures showed significant deterioration in not only unemployment rate but the absolute number of people that are employed and yet they claimed that their real GDP year-over-year was growing at 0.3 per cent. The employment dropped by over 600,000 people year-over-year on the fourth quarter, that’s about 3.3 per cent of total, a huge drop. In addition to that the PMIs have been deeply negative for some time.

Irrespective of that, they are currently in a recession and Spain’s economy is one that could keep Europe pretty depressed going forward.

Post PSI Greece

Finally Greece has defaulted.

And while this has been a markedly positive development in Europe, I do frown upon the use of the term PSI or private sector involvement, because that pretty strongly implies that private parties losing money on their investments is somehow extraordinary when nothing could be further from the normal state of things. Failure in the form of default and bankruptcy are integral parts of capitalism, and government debt should under no circumstances be treated as risk free, although this is one of the many fallacies that constitute modern finance and economics teaching.

Greece economy is currently a function of reduction in the G component, reduction in C+I due to businesses cutting back, great uncertainty and taxes going up, X-M not improving much because Greece is still fixing their exchange rate against Euro-zone and setting it too high against everyone, bank run and capital flight because of threat of re-denomination and lack of opportunities, corrupt and ultra-inefficient political-legal system, smartest ones leaving the country, rioting making things just a bit worse, severe social stress on top of the economic one, and on the plus side cheap money entering the country.

And while the crystal ball readings from the EU have become more reasoned as of late, some of the worst case estimates that 2013 will be flat to positive seem little out of touch with reality.

Our finance minister Urpilainen even came out some days ago saying Greece is making good progress. Really? In what? Here’s the Greek PMI; it’s at all-time lows, as in the rate of contraction from already depressed levels is at a record.

Japan and UK

Both of these countries are in recession, i.e. the ability to print does not prevent contraction in real GDP.

Japan and UK both have sovereign currencies, the ability to print to cover tax shortfalls. Both of these countries have most certainly done so and both of them have significant budget deficits. Yet, they are both in recession, something that US should probably take note of.

Furthermore, these two countries are the most leveraged economies in the world; UK first, Japan second. Japan is the most indebted government with interest payments about half of tax revenue. UK isn’t doing much better with their government announcing they are out of money and that private sector must push the country to grow if any growth is to materialize.

Japan is in a particularly interesting point with the country possibly entering a longer period of negative trade and current account balance. Japan needs those current account surpluses in order to keep the aging population and government debt and deficit in check. I tend to agree with the “superstar” hedge fund manager Kyle Bass who holds the view that Japan should be on everyone’s radar due to their fiscal, balance of payments and demographics situation.

And I must add that despite the religious fervor with which various mainstream economists, pundits and cheerleader channels proclaimed that in the aftermath of the natural disaster and nuclear meltdown, Japan would soon enter a period of raging V-shaped recovery, the country has continued in recession, much like I somewhat cynically stated back then in Japan GDP drops by 3.7 per cent, double the expected, Keynesian nonsense commences (May 19th):

It seems that those mainstream economists had to come in contact with reality as Japan reported GDP dropping by 3.7 per cent instead of 1.9 like expected in the aftermath of the earthquake. This follows a 3 per cent drop in last quarter and according to mainstream economists the Japanese economy will contract 3.3 per cent this quarter followed by a rapid Keynesian wet dream induced V-shaped recovery on the 3rd and 4th quarters…

…Moreover, the nuclear disaster has not ended, although the mainstream media refuses to report anything about it at this point. In fact, just in the last week or two we have learned that 3 reactors experienced full meltdown almost immediately and that Japanese officials decided to lie about everything. Now, I don’t have any first-hand knowledge nor do I have any idea what is going to happen next, but the worst nuclear disaster ever is not going to be GDP positive, not now, not ever, regardless of what the mainstream economists or anyone else says. In addition, the Japanese now have a quite problematic electricity production problem, which also will not help boost the economy.

I just don’t see the recovery happening.

Interesting how Japan is still in recession for the precise reason I claimed it would and they are in process of shutting down all of their nuclear power plants for some time, thus energy suffocating the country, which surely does not boost growth.

I mean, who knew that broken windows do not increase prosperity?

The US does not look great but recession unlikely

Since the Q3 scare ended up being nothing more than an outlier, the probability of a recession in US is very low notwithstanding some significant turn in policies applied. Employment, industrial production, consumer credit and many other indicators are growing steadily, there is no real estate bubble anymore and corporate sector is doing great. They do have longer-term problems. Employment-to-population isn’t growing, new jobs are part-time and low wage, tax revenues aren’t really growing, pensions are severely underfunded and no one is doing anything about it, fiscal situation is a huge mess, health care is a huge mess, government is practically hostile towards small enterprise in favor of Fortune 500, energy policy is clueless, civil rights have been removed etc. But as much as I would like to believe that stupid decisions and immoral policies make GDP go down, they don’t. A lot of pressure might build up under the surface and the economy might become prone to black swans, but that is of no concern to those seeking public office this year or the next. Returning to free market economics would collapse the GDP and even addressing the pension underfunding would push the country into a recession, so self-deception is probably the way forward. At least the US is better off than Europe or Japan.

Things to watch out

While it is starting to appear as if worst of the downside has happened and the likelihood of either US recession or some deep protracted recession in Europe is very small, there are plenty of things to watch out for before 2013:

  • While various statistics bureaus might be trotting out positive real GDP reports, what you really care about is how much real stuff your hour of labor buys. And if you look at for example the last 10-20 years of real household income development for different quintiles in the US, the picture isn’t that pretty.
  • How long will the financial repression, gradual degradation of our institutional framework and moral hazard suppress our ability to create some sort of real growth? That is, is around 1% growth the new normal? Even with peak liquid fuels being some ways off?
  • How much worse will the bank run from periphery and the imbalance in the Euro system get?
  • The opaqueness of Spain’s debt, deficit, local government, real estate losses and bank balance sheet situation
  • Situation with PIIGS, stubbornness of Troika, French election, Greece’s new parliament, growing xenophobia and protectionism etc. causing a political crisis in Europe
  • French election where they are about to replace bad Sarkozy with bad Hollande. 10 % unemployment and growing political disagreement in EU gives him plenty of room to advance his populist socialist agenda.
  • US-Israel-Iran and oil: definite potential for a big disaster. Since Panetta has now stated that Iran does not seek nuclear weapons and that US will attack if all else fails, an attack seems to be given. Iran might not win, but US will certainly lose just like it lost in Iraq and has been digging itself into an ever-deeper hole in Afghanistan.
  • Oil and gas prices with Brent in euros hitting all-time highs surely not helping Greece nor any other importer
  • Central bank exit strategies or lack thereof (i.e. if you ignore the mandate for stable prices then the equation becomes pretty simple) in addition to the infinite unintended consequences of their singular strategy to loosen monetary policy as a solution to everything
  • Youth unemployment in Greece, Portugal, Spain possibly seeing its worst figures this summer. Will the rioting get worse?
  • Will OWS turn into an Obama re-election campaign? So far it has seemed to be positive on balance. The election itself is a non-event.
  • China’s growth slowing down
  • Canada is one the brighter spots in global economy not least due to their vast non-conventional oil reserves, but they certainly do not need to blow any more hot air into their housing bubble
  • US stocks well on their way into the next bubble-blow-off-top-collapse cycle while Fed promising to keep ultra-low monetary policy for years to come. Nothing could go wrong with that one, right?

As a summary, it is not really difficult to list risks to the growth picture.

A Statesman moment

EU and their talking heads have pretty strongly invested their entire political and social capital into the current form of saving Greece, Portugal, Ireland and Spain. You don’t come out that trench easily; the amount of money, time and political capital invested into the Troika led effort is too great for anyone to back out of it.

Part of me wants to think that soon there is going to be a time for someone to start acting like a real statesman. The opportunity for this certainly exists. I certainly wouldn’t mind if that someone was our new President Niinistö, but it seems he is not interested in being part of the solution. There exist a historic chance to do so, perhaps even an imperative to do so, but the lack of ability to see the error of one’s ways is a burden we’ll probably bear.

I’d like nothing better than to see some actual progress instead of the endless fakery. Finland has an army of bureaucrats that contribute nothing; for example we have 19 cabinet ministers while I am hard pressed to invent a reason for 10 of them. I mean we are a nation of 5.6 million people. On EU level, what did we achieve with the obviously half-assed approach to the economic situation and why are we continuing the obviously misguided centralization of power policy? Why is US continuing their obviously failed foreign policy when they would have been and would still be much better off supporting opposition in Middle East and investing all the money they wasted in illegal wars to fix their broken energy policy at home?


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