Three Speeds In Europe, All Slower

The latest publication of the GDP data for the EU shows three distinct trends but one unifying theme - slower growth.

In an important but dwindling group are those economies which are still expanding, led by Germany where GDP grew by 0.5% in the first quarter of 2012. In a larger group are those countries where the economy is stagnant. This now includes France which recorded zero growth in the quarter. The largest numerical group are those countries in recession, which includes Britain, Italy, Spain, Ireland, Portugal and Greece. The net result was that both the Euro Area group of 17 countries and the EU group of 26 recorded zero growth in the quarter.

If the focus shifts to the 12-month growth rates, comparing the first quarter of 2012 to the same quarter in 2011, the picture is even more stark. Outside of the Baltic States, which are still recovering from a 1930s-style Depression with the aid of substantial EU investment , only two countries recorded growth above 1.0%. These were Finland at 2.9% and Germany at 1.2%. The fact that the German motor of the EU economy is sputtering close to 1% growth is cause for alarm. It suggests that the entire EU economy is decelerating, and that the risk of renewed recession is increasing.

In fact this is the EU Commission’s forecast for 2012; a contraction of 0.3% for the Euro Area and zero growth in the EU as a whole. For the Euro Area 12-month growth is also now zero, and for the EU as a whole it is just 0.1%.

Even for the group of countries where growth has been strongest, growth is clearly slowing. The deceleration of the German economy is important for the entire European economy. These trends are shown in Figure 1.

Figure 1

But there are a growing number of countries that have headed back into recession, including Britain, Spain and the Netherlands – Figure 2. France has grown by just 0.1% in the last 6 months and maybe headed in the same direction. There is little to suggest that growth can accelerate with current policies.

Figure 2

The Euro Area has contracted by 0.3% in the last 6 months as has the EU as a whole. The crisis countries continue to contract sharply, led by Greece – Figure 3. However, the much greater weight of the Italian economy, seven times larger than the Greek economy, means that its clear slump is even more significant for the European crisis.

Figure 3

Formerly stronger economies are experiencing a slowdown in growth. Crucially this includes Germany. Other countries, such as Britain where growth had been stagnant have gone back into recession. This is also true for Spain and the Netherlands. France may be headed in the same direction. Significant falls in output are still occurring in the crisis-hit countries. These may now appear to be joined by Italy, where the crisis is deepening.

What do bond markets think of ‘austerity’?

The victory of Francois Hollande in the French Presidential contest provides a further insight into the operation of the bond markets. It is frequently argued that there can be no retreat from ‘austerity’, which in reality is simply the transfer of incomes from labour and the poor to capital and the rich, because the bond markets will recoil and long-term interest rates will soar. This is important as significantly higher long-term interest rates could, unchecked, choke off recovery.

As the new French President has made some gestures in the direction away from ‘austerity’, then it should be expected that at least French long-term interest rates would rise as a result. But French government bond yields have fallen since the Socialist victory, by 18bps (basis points, equivalent to one hundredth of a percentage point, or 0.18 per cent). Ten-year French government bond yields declined to 2.79 per cent¹, lower than before the election.

It could be argued that financial markets do not believe Hollande will carry through a genuine alternative to cuts in wages and public spending programmes. He was certainly cautious enough in his pronouncements to support that idea. Even so, he is not Sarkozy who directly promised further cuts and some uncertainly remains among financial market commentators about whether, or how quickly, the new President will change course. At the very least his commitment to verbal support for austerity is less than his predecessor. Clearly, the assertion that the bond markets will punish any slight step away from ‘austerity’ is incorrect.

In fact, the German powerhouse has increased economic divergence within the EU because it has not adopted itself the prescription it has insisted on for others. The latest departure from orthodoxy is the call for higher German wages from Finance Minister Schauble.² Yet German yields also fell to 1.55 per cent and remain the lowest in the Euro Area.

Role of bond markets

It is important to distinguish between the views expressed nightly on our TV screens by ‘experts’ from the financial markets and the actions of the main bond investors, pension, insurance, sovereign wealth funds and others. The most famous ‘expert’ in the world is Bill Gross, Chief Investment Officer for one of the world’s largest bond funds PIMCO. Previously, he very publicly announced he was selling all US government debt holdings because of quantitative easing in the US and Obama’s fiscal stimulus. He was later forced to apologise to investors and buy back US government bonds he had sold, having missed a huge rally in bond prices (which leads to lower yields).

It is necessary to explain briefly the role of bond investors. The creation of a national debt is one of the primary ways in which financial capital establishes its dominance over the rest of the economy. Debt interest is supplied by diverting income from the productive sectors of the economy. Since all value is created by labour, labour is also the ultimate source of all debt interest. This entails a transfer of income from labour to capital. In fact, given the regressive tax changes that have taken place in many industrialised countries including Britain, labour and the poor are also the direct source of that transfer of incomes, as they supply the bulk of all tax revenues (income tax, VAT, etc.).

For any sector of capital the main motivation, its raison d’être is the maximisation of capital. Ordinarily this means the expansion of capital at the maximum sustainable rate. But in a crisis where losses are anticipated, maximisation can mean simply preservation. Industrial capital is currently being hoarded via the investment strike. It is being preserved. For finance capital, specifically the portion that is allocated to government bonds, the main important indicators are usually, growth, inflation, government deficit levels and so on. All of these are gauged in order to optimise the sustainable expansion of capital through interest payments.

But in a crisis the focus will switch to the preservation of capital. This is why Germany, with its large external surpluses and falling budget deficits remains the strongest borrower in the EU even while increasing investment and wages. Investors believe they are certain to get their money back. In an extreme crisis, these investors may even been willing to accept the prospect of small losses in order to preserve the bulk of their capital, and interest rates have occasionally been negative in countries like Switzerland and Japan .

The very modest changes in French government bond yields are evidence of this dominant factor. The possibility of even a very modest adjustment in the drive towards ‘austerity’ has increased the likelihood that French bond investors will be repaid, that there will be no default on French government debt. The productive sectors of the economy, which finance the debt interest, may be in a slightly stronger position to do so if they are faced with slightly fewer cuts.

Varied Responses

Not all EU government bond markets rose in the wake of the French Presidential poll. Those countries where bond prices fell, so pushing up interest rates, include Greece (with its own inconclusive election), but also Ireland, Italy, Portugal and Spain. They have all adopted a programme of public spending and other cuts, with different degrees of severity.

Their policies are the opposite of the verbal gestures Hollande has made in the direction of stimulating growth. The most extreme case is Greece where ten-year yields are over 23 per cent. But in a country like Ireland, which is routinely held up as the example of successful ‘austerity’, yields on some debt have risen by 50bps in the last week alone.

In the current crisis, bond market investors are obliged to consider whether they will preserve their capital, not just how they may be able to increase it. They have already experienced final losses of a partial default in Greece. In many of the crisis-hit countries current bond prices are considerably below where they were issued.

They have been faced with a new choice of at least a verbal commitment to growth from France, and persistent ‘austerity’ in many other countries. The response has been to buy French government bonds and sell those where the governments, via the ‘Troika’ in some cases, are committed to further cuts. This is because the judgement is that the investors’ capital is more likely to be preserved via growth than through austerity.

The repeated assertion that pro-growth policies cannot be adopted because of the negative reaction of the bond markets is a false one.

Notes

¹ All yields taken from Financial Times, benchmark government bond yields, 9 May 2012

² ‘Schauble backs wage rises for Germans’, Financial Times, 6 May 2012

The campaign to prevent Londoners knowing they will be £1,000 better off with Ken Livingstone as Mayor

During the last month an extraordinary media campaign has been waged to attempt to persuade Londoners that the main issue which confronts them at the election for Mayor is not how much they, that is Londoners, will be better off with either of the two candidates for Mayor – that is which candidates policies will best protect Londoners living standards from the effects of the economic downturn. Instead, in circumstances when most Londoners are facing the most difficult economic times they have ever experienced, the main issue confronting London is supposed to be the personal tax arrangements of candidates.

What is the purpose of this frenetic campaign? It is to attempt to divert Londoners attention from knowing that most of them will be £1,000 or more better off with Ken Livingstone, due to his fares reduction and other policies, and that they will be £1,000 or more worse off with Boris Johnson. To check these figures, and to calculate how much you would save personally yourself, simply go to http://www.betteroffcalculator.com/.

Why is such a strange campaign waged? Evidently because if Londoners realize that they will be £1,000 or more better off with Ken as Mayor then Ken will win the election easily. The only way to try to prevent them knowing this to attempt to make a great noise about something else to try to distract attention from this fact.

As it happens the reality on the tax, as the published figures show, is Ken Livingstone has paid 35% in tax and Boris Johnson 40% - as Boris Johnson earned eight times as much as Ken Livingstone if he didn’t pay a higher rate there would be something wrong with the tax system! But the whole issue, whatever happens, leaves Londoners not one penny better off. 

This really is the critical issue of the next four weeks until the Mayoral election. There are few things Londoners can do that will make them and their families £1,000 better off – and quite a lot will be more than £1,000 better off. That they can be £1,000 better off in half an hour by going to vote, and thereby making their families significantly better off, is one of the easiest things they can do.

Ken Livingstone has four weeks to make sure Londoners know they can be £1,000 or more better off if he is Mayor. The media supporting Boris Johnson, by campaigning on tax or any other issue they can think of, has four weeks to attempt to prevent Londoners knowing they can be more than £1,000 better off with Ken as Mayor and £1,000 worse off with Boris Johnson.

Which of these two campaigns is successful will decide the outcome of the Mayoral election.

Calculate how much money you will be better off by if Ken wins on 3 May - for readers in London

Ken Livingstone's campaign for Mayor of London has published a calculator which allows you to find out how much better off in money terms you will be if you live in London and Ken is elected Mayor on 3 May. You can calculate the result for yourself here. Why not find it out for yourself and encourage those you know to also find out? If you want to pass on the link it is http://www.betteroffcalculator.com/

The incredible shrinking UK economy

By John Ross

The magnitude of the blow suffered by the UK economy since the beginning of the financial crisis is very considerably minimized by not presenting it in terms of a common international yardstick. Gauged by decline in GDP, using a common international purchasing measure, dollars, no other economy in the world has shrunk even remotely as much as the UK (Figure 1 and Table 1).

As most countries produce only annualized GDP data it will be necessary to wait before a comprehensive global comparison can be made for 2011. However it is clear no substantial growth in dollar terms took place in the UK economy during that year – GDP at national current prices rose only 1.4 per cent between the 1^st and 3^rd quarters and the change in the pound’s exchange rate against the dollar during the year was a marginal 0.3 per cent. Therefore there will have been no significant recovery from the UK data set out in Table 1 below, and the gap between the UK and other European economies, which form the next worst performing major group, is too great to have been qualitatively affected by changes in the Euro’s exchange rate – the Euro declined against the pound by only 3.3 per cent in 2011.

Table 1 shows that the fall in UK GDP in 2007-2010 was $562 billion compared to the next worst performing national economy, Italy, with a decline of $65 billion – i.e. the decline in UK GDP in the common measuring yardstick of dollars was more than eight times that of the next worst performing national economy. Table 1 shows the 10 national economies suffering the greatest declines in dollar GDP.

It is also extremely striking that the UK’s decline was more than two and a half times that of the entire Eurozone. The UK accounted for a somewhat astonishing 77 per cent of the EU's decline.

Table 1

Figure 1

Expressed in percentage terms the situation is no better. of all economies for which World Bank data is available only Iceland, with a decline in dollar GDP of 38.4 per cent, suffered a worst percentage fall than the UK - even bail out economy Ireland, with a fall of 18.4 per cent, outperformed the UK economy.

Two trends intersected for the UK's performance to be so much worse than that of any other economy. First, contrary to the government's anti-European rhetoric, UK economic performance in constant price national currency terms has been significantly worse than the Eurozone during the financial crisis (Figure 2). Up to the latest available data, for the 3rd quarter of 2011, UK GDP was still 3.6 per cent below its pre-financial crisis peak compared to the Eurozone's 1.7 per cent below. Second, between the beginning of 2008 and the beginning of 2012, the pound's exchange rate has fallen by 21.0 per cent against the dollar compared to the Euro's 11.4 per cent drop in the same period. The multiplicative effect of the severity of the relative drop in constant price GDP and the fall in the pound's exchange rate accounts for the unequalled decline in UK GDP in dollars.

Figure 2

As at present the UK economy shows no substantial sign of recovery, the present UK government, which maintains a steadfastly ostrich like attitude towards Europe in particular, and most other countries in general, may argue that a measure in terms of dollars at current exchange rates is irrelevant – the UK currency is the pound and what counts is constant price shifts. Such an argument is false and an attempt to disguise the true scale of the decline of the UK economy.

The internationally unmatched decline in UK dollar GDP is a huge fall in real international purchasing ability. The far higher than targeted inflation in the UK during the last two years, which has substantially eroded the population's living standards, is itself in part a reflecton of the decline in the UK's exchange rate and consequent raising of import prices. In short, the decline in the international purchasing power of the UK's economy translates into a direct fall in real incomes. The decline in the UKs ranking among world economies in terms of GDP, being recently overtaken by Brazil, statistically reflects the same process .

It may also be seen that the government's claim that the UK is outperforming Europe and the Eurozone is entirely without foundation even in constant price national currency terms. But when measured in terms of real international comparisons, i.e. in dollars, the UK's performance is incomparably worse than Europe's.

It appears extremely unlikely that the UK's economy will escape from this circle of decline in the next period. The austerity policies pursued by the present UK government have substantially slowed the economic recovery that was taking place in 2009 and the first part of 2010 - between the 3rd quarter of 2010 and the 3rd quarter of 2011 the UK economy grew by only 0.5 per cent. The opposition Labour Party has recently also endorsed essentially the same austerity policies which have failed not only in the UK but in other European economies, such as Greece and Ireland, where they have been pursued.

Even if any partial recovery takes place, for example by some increase in the exchange rate of the pound against the Euro, the sheer magnitude of the decline in the UK economy makes it implausible that this could be on a scale sufficient to reverse the fall in its relative international position.

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This article originally appeared on Key Trends in Globalisation.