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Economy in Brief

Seemingly Unrelated Regressions... German Zew Index takes Plunge that Exceeds US Philly Survey Drop
by Robert Brusca  August 23, 2011

Extreme fluctuations set the stage In the US the out-sized and near record monthly drop in the Philadelphia Federal Reserve Bank's MFG index gave economists, investors and other interested parties reason for slack-jawed pause. Coming as it did one week after another super plunge that one in the U of M consumer sentiment index, it added to the sense of disarray in the US economy. Now from the other side of the pond, in a land far, far away in a seemingly unrelated place, with a different currency, and different central bank, a different language, and a very different view of the correct fiscal policy, we have yet another plunge, or if you will, more evidence of economic regression.

Do not compare these plunges with the NesteaTM plunge. This is no pause that refreshes.

The drops - The German Zew index has fallen to 53.5 from 90.6 in the space of one month in its current reading. Its expectation reading has dropped to -37.6 from -15.1. For both of these surveys these are very severe drops.

The context - Oh, you ask, how severe are they? Well here's the scoop. Out of 236 month-to-month changes in the current index calculated from January of 1992 to date, this month's drop is the worst on record. For the expectations index with the same number of observations this monthly drop ranks 218th or in the bottom three percent of all month-to-month changes.

Current status - In terms of levels things are not so weak or at least the picture is mixed. The current index, despite this record drop, is still stronger than its current value only 11% of the time that is it is weaker than this 89% of the time, leaving the index in still pretty strong territory. However, it is a 180-degree turn for the evaluation of expectations which are higher than this month's value more than 93% of the time (weaker less than 7% of the time). Expectations are set low indeed.

The unmaking of the optimists Zew's financial experts have seen their optimism bashed by the actions of S&P in the US and by the ongoing crisis of confidence in Europe and – undoubtedly- by the markets' adverse reactions to all of the above.

Can we be surprised about all these measures of activity dropping, sliding and plunging all at once? After all these measures all are evidence of economic regression in different parts of the world in different sectors…and all coming on all so suddenly... and together.

Hard choices in choice places Markets are reacting to politicians that have refused to make hard choices. In EMU they will not make hard choices. In the US Republicans and Democrats will not make hard choices. When politicians do not make hard choices economic activity takes it hard, investors take it harder and their choice of what to do is easy: sell!

Seemingly unrelated regressions These seemingly unrelated regressions in economic activity, and in confidence, and in markets are in fact bound as tightly together as could be. They are bound by the realization that we are all in this together and that our ship is sinking. This is not some planet or 'spaceship' earth ecology argument, it is one based on real even if not tangible economic linkages.

The economics of flaws As surely as the Titanic's fatal flaw took it to the bottom of the cold dark Atlantic when it met an unforeseeable adversary, so too are unexpected events taking Europe and America by storm.

In retrospect we cannot be surprised. Many things are designed with flaws that later are fixed (as Microsoft's history could tell you, for example...). Having a flaw in an initial product is not necessarily the end of it, if the basic product is good and especially complex and if the design team can quickly offer up a patch a product can survive and even flourish.

But the flawed EMU system has a gaping hole and water is pouring in and all that Europeans do is urge the ECB to bail faster and faster. Germans are angry because the ECB has diverted some of that flow to tis balance sheet. It would, instead have the ECB throw the Greeks themselves into the gap to stopper it up. Germany's Chancellor, Angela Merkel is under extreme political pressure at home for even trying to compromise. In this affair the Germans are like the Republicans in the US who would not give one inch on their demand to shrink the US budget using nothing but spending cuts. And the Greeks are like the Democrats who do not want to reduce any benefits or entitlements by one unit more (be that one unit a dollar or a euro).

The weight...you put the load right on me Ah these are 'unrelated events' but in a very interrelated world. A Greek is not a US Democrat and a German is not a US Republican, but they are in similar roles all and their common inflexibility is keeping the pressure on; on the ECB in Europe and on the Fed in the US. But why is the weight on the Central bank at all? Aren't these really fiscal failings?

Central banker: Stress test thyself It is more weight than a central bank has been stress-tested for. And with central banks denuding their balance sheets, is it only a matter of time before markets will ask be asking for central banks to run stress tests ON THEMSELVES. Won't that be a delicious irony?

At the Fed Ben Bernanke is trying hard to carry what is an unbearable load for a central banker and in Europe Jean-Claude Trichet, instead of basking in the glow of a job well done at the end of this term, is fighting for the preservation of the Zone.

Hunting with a fishing license? But neither of these are the jobs of the central bankers. Are we to applaud them for their 'good Samaritanism or should we decry their extension of central banking into a realm where it should not trade? Are central bankers in effect hunting with a fishing license?

A cat is not a dog or barking at the wrong cat-nip Fiscal policy is fiscal policy and monetary policy is monetary policy and never the twain shall meet- well, except or, of course, until they do. And that happens in periods of extreme economic stress. But isn't this a burden best turned back over to the fiscal authorities whoever they may be? Wouldn't the central bankers perform their duties better by making it clear that THIS IS NOT THEIR JOB? If you make it clear that the politicians must solve the problems they are more likely to do it than if they sit back and let the central banker wallow in deep do-do then blame him later for overstepping his mandate and making another mess. Isn't there powerful transparency in saying 'NO,' this is not my job?

The Greenspan effect just keeps on giving But that dear friends, colleagues, fellow economists, journalists, is where we are. In the end Alan Greenspan did the world a much worse disservice than we ever imagined at the time and his finger prints keep showing up in unexpected places. George Washington may have 'slept' in lot of places but Alan Greenspan sure touched a lot of stuff.

Once king of the world At one time getting for himself the title of the most powerful man in the world, Alan Greenspan contributed to the idea that the central bank could solve all ills. It could cut rates, it could raise rates; Greenspan relentlessly pursued an agenda of preaching the doctrine of anti-regulation. Yet, the 'Greenspan Put' was there to soften market drops.

Central banker as penicillin for the world-complete with repercussions Under Greenspan the central bank became the penicillin of all problems. It was exactly that. But as we saw with penicillin when it is overused it creates a more powerful set of opponents who come back and are ever more difficult to defeat. In stepping outside the traditional central banker role Greenspan essentially encouraged Bernanke and Trichet to do more and put them in the position to have to do more as he also left politicians with the notion that central bankers had a secret phone booth where they change into a costume complete with cape. Unfortunately, everyone uses cell phones now and those phone-booths are hard to find. The caped crusader became the 'capped crusader' as in the US Congress has gradually tried to reign in some of the Fed's policy options. Yet, the Fed is still left to clean up the mess. In Europe there are fewer repercussions than there is discord. Some derisively say Trichet oversees the EBB- the European Bad Bank. And these are places we never wanted monetary policy to go.

A bridge-loan too far? The ECB may be in a position to be in need of its own capital infusions yet, to its ignominy. The Fed has acquired a 'whole bunch' of low interest-bearing assets on its balance sheet. If ever a central bank has a mandate to keep inflation under control it is now the Bernanke Fed. It cannot inflate away the US debt problem as some have suggested it might or should try... Harvard Economist Ken Rogoff has suggested that the US needs a higher inflation target – one of perhaps six percent? Let's take about a millisecond to wonder what that sort of thing would do the value of the Fed's assets (treasury securities and other fixed income products) and to its capital base. How could that ever be good for US policy?

The greatest irony of all is that in the Fed, by pursuing such aggressive anti-deflation policy, may have condemned itself to doing so for a very long time. The Fed's own existence may depend on running a monetary policy in which inflation remains so persistently low (so that interest rates remain low) that flirtation with deflation may become a new fact of the Fed's post-crisis life.

The lesson here is that in the world of economics many things that are seemingly unrelated have links. As in the spirit of expression 'six-degrees of separation' many economic events have subtle links. The consistency in the problems of Europeans and of the U.S. and the trials of central bank head's Bernanke and Trichet, I hope, become case studies for the future that we can remember. It remains to be seen however exactly what happens and therefore what lessons of history will be learned and which mistakes from the past will be repeated.

Who does not have a clue? The head of the old German Reichsbank who created the hyperinflation in Germany protested that the inflation he created was not his doing. But he was given no choice but to follow orders. He understood full well the consequences; he did not make 'a mistake' or so he says. After the fact he was quite unrepentant and sure that the problem was not his fault. So who will emerge as the villain in this crisis, who is not at fault? Will it be a central banker? A legislature? A legislator? An unrepentant nation sticking to its 'rights?' A supra-national body? A President? A prime minister? A Chancellor? This guessing game could be new board game or video game; a sort of macroeconomic international game of ClueTM. Only the title will be, "who does not have a clue?"

ZEW Economic Index For Germany
  Level of Zew Index Averages
  Aug-11 Jul-11 Jun-11 Yr Ago 3-Mo 6-MO 12-MO
Current 53.5 90.6 87.6 44.3 77.2 82.6 80.0
Expectations -37.6 -15.1 -9 14 -20.6 -6.2 -0.9
  Percentiles  
Current 80.0 99.5 97.9 75.2  
Expectations 17.1 31.8 35.8 50.7  
Percentiles are readings in this period as percentile of the full range of values back to 1/92
Count Percentiles: reading is stronger than this 'XXX' percent of the time...
Current 11.2% 0.9% 2.2% 8.1%  
Expectations 93.6% 85.3% 84.0% 65.2%  
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