EMU Still Slowing as Hot Air Keeps Blowing

Foreign and domestic orders among EMU members continue to trend upward by at an ever slower pace. That is the view from the yr/yr growth rates. Sic month growth rates (memorialized in the two-columns table shows a sharp slowing in six-month growth from 10.4% at an annual rate to 3.9% at an annual rate. Three-month growth rates paint the same picture with darker pigments with three-month growth in June at 8.7% but diving to 1.3%, in July, below the rate of inflation over the three-months ended in July. And last but not least the monthly data show that orders are lower in each of the last two months. Orders have started to decline outright. But that decline is not yet enough to knock the three month pace into negative territory but, as noted above, it has dropped three-month growth below the rate of inflation.

Foreign and domestic growth trends each are working their way lower but the three- and six-month growth rates are not very stable. If we look at the sequential growth rates (12-Mo, to 6-Mo to 3-Mo) in June the domestic order series shows a sequential decline but in July it no longer has that pattern. For foreign orders there is no tapering off in growth for the sequential growth rates in June, but by July the picture of decline is clear. For overall orders it is the recent period for which the declining orders profile is the most clear cut. Part of the problem is the intrinsic lumpiness of orders and the difficulty in getting seasonal adjustment done correctly. But the big picture plot of Yr/yr growth rates seems to nail down the trends of each series pretty clearly. Despite this near term volatility orders growth is headed south.

Meanwhile, the Southern European countries are in a bind. As the G-20 meet three has been little solace for Europe The rampant market selling over the last few days speaks of a scramble for liquidity that remains unexplained. We many only know in retrospect what the market scramble was about. With the fate of Greece hanging in the balance the thing that makes the most sense is that there is some deal to let Greece default and that word has been closely kept but not closely enough. Enough of the ‘right’ people know about it that various markets have moved sharply as investors have cut positions ahead of the growth-deflating event. If this proves to be the case it will be no surprise that commodities backed off so sharply since a Greek default would cut growth prospects and would put banks on the hook for losses crimping their ability to operate normally in the months ahead. Even credit agencies got into the breach as Moody’s downgraded eight Greek banks just ahead of the weekend.

Why now?

We can be clear of one set of facts, however:

(1) Once Greece has its event its problems will not be over if it remains in the Zone. Greece suffers an extreme price disadvantage since prices in Greece have gone up by 20% more than prices in Germany since these two countries have been locked together in the same exchange rate regime. That disadvantage does not go away if Greece remains in the Zone.

(2) If Greek debt is defaulted on there will be severe setbacks for banks in Europe especially in Greece as well as in France and in Germany.

(3) Bank problems can spread so we have risk of contagion in the aftermath of a Greek default.

(4) Default buys time for Greece but it does not restore its competiveness position. So just as Greece will at some point come back into the conversation, getting Greece off the hot seat only moves it down the line and queues up the next worse debtor for market inspection. This means that Spain or Portugal or Ireland could start grabbing headlines and eventually.

(5) This whole thing does not stop with Greece in fact Greece could be akin to the act of lighting the fuse on the bomb we all know is sitting there but has just been armed. There may be other hidden risks we have not yet identified since the Zone itself could wind up at risk.

Based on such reasoning while a Greek default would be a big deal it might only be the harbinger of bigger deals yet to come. If Greece is to default but remain in the zone all the issues of competiveness between the Mediterranean countries, the countries of central and northern Europe are back on the table as long run problems that are hard to solve will persist. The Zone has thus far not mooted a plan to solve the inter-zonal price discrepancies it has let emerge during the Zone’s early years. As much as EMU tried to get exchange rates right to start it was careless to that exact same degree in letting its finely chosen entry parity values for exchange rates become undermined by regional inflation differences.

As the G-20 meets and makes promises it can’t keep, for stability and cooperation, how we can take any of this at face value? In Europe the Germans have isolated themselves and many others have taken to isolating Greece. Who is next? In the US Republicans and Democrats could not organize a food fight in the Congressional lunch room. How are they part of any coordination that might be needed? To make it worse House Republicans have written a ‘threatening’ letter to Fed Chairman Bernanke, one of the conservative Republicans running for President has called the Chairman a ‘traitor’. There is no way to believe reassurances out of the G-?? pick your number Seven? Eight? Twenty? Three? It does not matter. When domestic politics are locked, international politics are undermined and that says it all.

Meanwhile growth is slipping. The slippage is steady. The cause of the slippage is not being fixed. The heightened risks have not moved anyone off their ideology to a new consensus. No matter how sure you are that your ideology is right, it is wrong if you can’t implement it. That brings you up to date. Absent compromise there is no progress and with ideology compromise is a dirty word and that about sums up where we stand.