IFO Pushes Higher...Germany Takes The Lead In Europe While The Rest Of The Zone Flounders...And The G-7 Is Confused

Germany's IFO survey is strong in October. Expectations were for weakness to gnaw away at the German economy but instead the economy is pushing ahead. The diffusion reading on the Climate index rose the better part of two points to 14.5. It stands in the 95^th percentile of range and at an even higher point in its queue of historic values. All the German sector indices in fact have ranking percentile standing that exceed their simple percentage of range standings. That happens only when the readings get to a relatively high position in their range and that is the case with Germany.

Germany's sector percentile standings all are strong with the exception of construction. The overall sector ranking, in its 95^th percentile is the strongest among the sectors which may seem odd, but it is testament to the uniformity of the strength across sectors which is what this index measures: it is a combination of the sector measures and having so many of them so strong at once is unusual. Wholesaling a sector that includes exporters is especially strong. Manufacturing is strong.

Compare these results to the third quarter survey released today by France's INSEE. France's quarterly survey of business has produced a result with surprising vigor today. French firms assess their position domestically as a positive pickup from Q2 and rate their domestic competitive position in Q3 Vis-a-Vis the EU as nine diffusion points higher in the survey this quarter, jumping from plus-one to plus-10. French firms' competitive position outside the EU improved in Q3 by a huge 14 points from plus-8 to plus-22. The work week rose (+5 from +2) in the quarter but the outlook is for some set back (-1) over the next three months. The work force is rated as having contracted over the past three months and is set to contract over the next three months. Despite a rousing improvement in the quarter, firms do NOT want to hire; they will lengthen the work week, however to meet demand. (does this dilemma sound familiar to US economists?) Demand is rated as having risen to a plus-21in this diffusion framework from plus-9 in Q2. But the outlook is for a give back of two points in the quarter ahead. On balance it's a ‘good report' but with the euro climbing in value the outlook is already muted and set-backs seem to be widely expected. Despite strong improvement noted by the diffusion responses for Q3 the outlook is decidedly downbeat.

There is a bit of difference here between France and Germany, isn't there? Germany seems to be gaining strength while France, whose case is more illustrative of the rest of the zone, is on the verge of slipping. Germany, oddly, is improving strongly despite is ongoing domestic austerity tilt. The UK is an example of another EU member nation that had adopted the path of austerity and seems to be in the process of coming undone by its own austerity plan. Germany has been able to benefit from strengthening exports. That has been its secret. But currently the G-20 is getting ready to meet and the US is pressing for surplus countries to stimulate more. Germany is doing the exact opposite shrinking domestic demand and prospering through its current account.

There are a number of serious issues here that are coming to a head within the Zone the ECB will have an unsolvable problem trying make one policy to suit an strengthening German economy amid weakness elsewhere. Fortunately markets are beginning to treat Greece better but it is not the only country with issues.

Then there is the broader issue of countries with systemic surpluses. By definition they force systemic deficits on the global trading system. The US looks out and sees too many systemic surplus countries with export strategies aimed at the US and weak domestic demand at home. Germany has been a target of US criticism. But the US is focusing more on the large developing nations with export strategies for development. The US is in a demographic phase of aging where it should be elevating its savings rate. That should mean global demand will shift to other centers; except that no one wants to shift. The US plea for quantitative limits on the current accounts relative to GDP for surplus countries is an attempt to get that adjustment. But as a practical matter there is not a way for a nation to control that statistic therefore there is no way for another nation to agree to it as a limitation. This restriction is particularly irrelevant to a free trade paradigm. So as an international bargaining point it is a nonstarter. Still, the US under the leadership of Tim Geithner is pushing it. He needs to stick with pushing to get reform on the elements that will achieve these results instead of artificially trying to attain them through coercion.

The US is better off pushing where it was before on the exchange rate issue. There, at least, it can be in the right. There is no excuse for countries that run persistent surpluses and also accumulate foreign exchange reserves to truly deny that they are currency manipulators or that they are in fact subverting the international adjustment process. They are violating the rules of the trade game. A country that has a persistent surplus should find its currency appreciating. If it does not buy the currency that is supposed to weaken (depreciate) that is what will happen. But if the process is subverted then surpluses become systemic and so do deficits. The US needs to argue its case from a position of right not a position of gimmickry that has no standing. Fix what's really broken.