Research Dept. News
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Monthly Report, num 352 - December 2011
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International review
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United States
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The United States: The vigour of autumn fails to clear the air
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The United States picks up in the second half of year, without improving expectations for 2012.
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The economy's recovery is consolidating. October's business indicators show the upswing continuing in the third quarter, where gross domestic product (GDP) grew by 0.5% quarter-on-quarter and by 1.5% year-on-year. This should take growth for 2011 as a whole to around 1.8%, a rate that is higher than what was expected in September. The reasons for this renewed vigour can be found in consumer behaviour, cheaper oil and industrial investment.
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The push from consumption is supported by lower savings.
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This improved tone of the US economy in the second half of the year averts the spectre of a double-dip recession and is particularly welcome in a situation where the global economy is feeble. Nevertheless, the United States is still having serious problems of insufficient growth, which means that a significant part of its production resources have been left idle, perpetuating the weakness in the labour and housing markets. This upswing, which seems temporary in nature, does not suppose any significant improvement for this problem. This is because the push from consumption is based on lower savings, because investment in industry will probably lose steam and, thirdly, because crude prices don't look like they will continue to fall with the same intensity. Similarly, the lack of political agreement regarding what the route map to fiscal consolidation should look like may result in fiscal policy being more of a burden than a stimulus in 2012. All this means that expectations have not improved for 2012, with growth that's unlikely to exceed 2.0%.
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Industry will moderate its upswing but still has a lot of room to improve.
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This consumer appetite could be felt in retail consumption which, excluding the volatile automobiles and petrol, continued to rise, growing by 6.0% year-on-year in October, meaning that, in real terms, it exceeded the pre-crisis levels of December 2007 by more than 2.0%. Automobile sales in the last three months up to October also intensified their growth while the University of Michigan consumer sentiment index for November left behind four months of lethargy.
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However, this push by consumption has been achieved thanks to a drop in the savings rate that, in terms of household disposable income, went from 5.3% in June to 3.6% in September, the lowest since December 2007, when the effects of the credit crisis had yet to be felt among consumers and indebtedness was not seen as a problem. Considering that household debt, after peaking at 130.2% of disposable income in September 2007, was still at a high 114.4% at the end of June, the savings rate is expected to rise over the coming months, with the consequent harmful effect on consumer spending. In addition, the good performance by automobile sales should tend to slacken in the next few months.
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Job creation is slow and the unemployment rate is 9.0%.
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The verdict is less clear regarding the continuity of investment in industry, another support for the upswing. In 2011, industrial investment has been benefiting from generous fiscal conditions, allowing investment to be repaid very quickly. The reduction of these advantages in 2012 will probably lead to a slowdown to some extent. Along these lines, the Institute of Supply Management (ISM) business sentiment indices for manufacturing and services point to a downward trend. In October, the ISM manufacturing index stood at 50.8 points, while the index for services was at 52.9, in both cases consistent with weak growth in the economy as a whole. Nevertheless, industrial investment might meet some resistance in 2012 as, in spite of the latest upswing, the recovery has a long way to go yet, as it is still 7.5% lower than the level at the start of the crisis, discounting price rises. The good figures for industrial production in October, up by 3.9% year-on-year, would reinforce this hypothesis.
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The labour market is the true sounding board for this crisis. The upswing in the third quarter could be felt in job creation, accumulating 469,000 new jobs in the July-October period. The problem here is the slowness of the recovery. Between March 2010 and October 2011, i.e. in 20 months of recovery, the US economy created 2.3 million jobs, a figure that is very far from the close to nine million lost between 2008 and 2009. The high proportion of long-term unemployed, reaching 42.5% of the total unemployed and double the peak in the previous crisis, is creating problems of adjustment, with job vacancies that are not being filled because the applicants do not have the necessary skills. The insufficient growth in aggregate demand might make the unemployment rate, which in October stood at 9.0%, pick up again slightly in 2012. A change in trend is unlikely as the contingent of discouraged workers or those working part-time involuntarily, who are not included in the official unemployment rate, will absorb a significant part of any new jobs created.
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The CPI, up 3.5%, with 2.1% for core inflation, should moderate in 2012.
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Unemployment and the slowdown in wages are reducing household income and playing an important part in increasing mortgage default, resulting in foreclosures on housing that, pending auction, are swelling the numbers of properties for sale. If employment doesn't improve, any aid that does not reduce the amount of mortgage debt will fall on stony ground as, after the grace period, people default again on their mortgage repayments. Both housing prices and construction activity are still at rock bottom and any recovery is unlikely before the second half of 2013. Because it's at rock bottom, residential investment no longer detracts from growth in the economy as a whole. But the well is deep and one gauge of this is the relative weight of residential investment in GDP, which in the third quarter was 2.4%, very far from the 5.2% for the period 1995-2000, prior to the bubble.
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With this panorama of low growth, the trend in inflation gives the Federal Reserve leeway to employ expansionary policies to boost employment and lessen the problems of bad mortgage debt, with a real possibility of a third round of quantitative easing in 2012. The moderation in oil prices, which seems to be taking its time in being passed on to consumer prices, meant that the consumer price index (CPI) slowed up its rise to 3.5% year-on-year in October. A moderation in inflation that is more evident in the core index, which excludes energy and food prices, up by 2.1% year-on-year supported by the price of rented housing, an item that, in October, contributed more than half the rise in total core inflation compared with September. The moderation in commodity prices and persistence of low production capacity utilization should keep inflation moderating throughout 2012.
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With regard to the foreign sector, the corrective trend in the trade imbalance has been confirmed thanks to a certain vigour in exports, coinciding with the moderation in oil prices and reducing the sum for imports. The trade balance deficit for goods and services in September was 43.1 billion dollars, the best figure for the last year, endorsed by the good performance of the deficit excluding oil and its derivates, which is a better reflection of the underlying trend. But this good development is unlikely to lead to significant contributions to GDP growth over the coming quarters, as the world's economic slowdown will reduce the demand for US exports, at the same time as oil's resistance to sharper price drops will prevent imports from falling.
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Japan
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Japan: a recovery with an expiry date
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Japan grows by a minimal 1.5% in the third quarter and confirms its recovery.
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After three consecutive quarters of decline, the Japanese economy confirmed its recovery from the effects of the tsunami and nuclear crisis in March. Third quarter GDP was higher than expected, up 1.5% quarter-on-quarter, leaving it just 0.2% below the level of the same period a year ago. This recovery was based on robust growth in private consumption, up by 1.0% quarter-on-quarter, and on the recovery in exports, growing by a resounding 6.2% but from a very low starting point. However, the latest figures raise doubts as to whether this expansion can go much further.
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But growth will not improve. Industrial production is falling and exports will suffer from the global weakness.
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Monthly indicators for September point to quarterly growth being concentrated in the months of July and August. Industrial production, which had regained more than two thirds of the 15.2% it had lost with the tsunami in March, fell by 3.4% in September compared with August and showed some signs of exhaustion, also confirmed by machinery orders, an early indicator of investment spend. In the case of exports, what had been lost in August was made up again in September but the recovery looks unlikely to continue. Exports have already reached pre-tsunami levels so that, together with the slowdown in world growth, especially in Asia, which is where half of Japanese exports end up, there is little leeway left. The appreciation of the yen doesn't help either, with most exporters seeing their profits eroded more than in industry as a whole.
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Demand weakens and prices fall again.
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Retail sales also joined the retreat being made by industry in September, as well as automobile sales in October and housing, which in September saw an end to the increases of July and August. Along the same lines, prices also turned somewhat deflationary in nature. In September, the CPI fell back to its level of a year ago, while the core CPI, the general index without energy or food, took another step backwards, down 0.4% year-on-year.
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China
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China: inflation and fine adjustments
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The CPI slows up to 5.5%; the food CPI to 11.9%.
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The prime minister, Wen Jiabao, almost certainly felt relieved on seeing the rate of inflation finally moderate in October; a long-awaited figure since, in January, the Chinese authorities established as their main macroeconomic priority for 2011 to put a stop to the excessive rise in prices. The general CPI rose by 5.5% year-on-year, clearly lower than the 6.1% of September, while the CPI for food, which in China accounts for half the general index, also slowed up, from 13.3% to 11.9%. Even so, the greatest achievement was in production prices, whose rise moderated from 6.5% to 5.0%.
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Now the priority is once again growth and preparing for a gentle slowdown.
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But good news doesn't last long in the present climate. To contain the inflation rate, China increased its interest rate six times in one year and established credit ceilings. These restrictions particularly hit small and medium-sized firms, which account for 80% of the jobs, as credit institutions preferred to lend to large conglomerates with a guarantee from the central government. The restrictive tone of the economic policies in the first half of 2011 has therefore helped to slow down economic activity and will probably result in GDP growing slightly less than 9.0% in the fourth quarter. The figure for industrial production in October, up 13.2% compared with the 13.8% in September, certainly points in this direction of a gentle slowdown, although other indicators such as motor vehicle production and electricity suggest a bigger slowdown.
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Exports continue to slow up but less than imports.
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The slowdown in the global economy and the evident symptoms of fatigue shown by the real estate sector might also make the landing for China's economy less gentle that it would hope. That's why Wen Jiabao stated that the time had come for preventative fine-tuning; in other words, relaxing monetary policy and boosting growth. The first signs of this change in direction in economic policy have not taken long to appear: in October, credit rose and the repo rate fell to seven days.
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The real estate market is showing signs of exhaustion.
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On the other hand, the foreign sector has become a weak factor, in contrast to the pre-crisis years. October's trade surplus grew to 17 billion dollars but this was due more to the drop in imports, especially commodities, than to exports performing well. Exports grew by 15.9% year-on-year, immersed in a slowdown that is likely to continue until year-end. By geographical area, of note is the drastic slowdown in exports to Europe, up by 9.2% year-on-year and, to a lesser extent, those aimed at North America, up by 13.0%. Exports to Asia, which account for 46.3% of the total, also slowed up but still advanced by 18.4%.
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With regard to housing, October's prices fell in most of the main cities, with sales also in clear decline. Of note is the 5.5% cumulative drop compared with June in the city of Wenzhou, in the province of Zhejiang, one of the most economically active and with a large number of small and medium-sized firms. In any case, the continual migration from rural areas to cities is providing a support for growth that other economies lack. Private consumption also has quite a long way to rise and should offset smaller growth in investment and exports. The relative speed of these processes will set the pace of the economy for 2012 and beyond, hence the renewed importance of fine-tuning mentioned by Prime Minister Wen.
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Brazil
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Brazil: the goal, a soft landing
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The tendency for Brazil's economy to slow up is consolidating.
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The slowdown in the Brazilian economy has intensified over the last few months and this has been particularly confirmed by business indicators, especially the marked fall in industrial production in September (-1.6% year-on-year). There are basically three reasons for this: the delayed impact of tougher economic policies implemented as from the beginning of 2011 to counteract the risk of overheating; the persistence of an overvalued real for a long period; and the recent deterioration in the world's growth prospects. Given this scenario, Brazil's economic authorities have turned around their economic policies in order to ensure a soft landing for an economy that managed to dodge the crisis at almost breakneck speed.
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Monetary policy is clearly countercyclical with interest rate cuts and more relaxed capital requirements for consumer credit.
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There is little room to manoeuvre on the fiscal flank, although a reduction in the tax on foreign investment in shares is being studied, as well as resorting again to quasi-fiscal stimuli via public banking. For the moment, however, the weight of this task has fallen to monetary policy. In September, after a prolonged series of rises that took the SELIC rate to 12.5% in July and although the rate of inflation was still at a peak, Brazil's central bank prioritized growth and started to lower the official interest rate without any warning. It lowered it again in October and the bulk of the evidence available suggests that it will cut the interest rate by another 50 basis points at the end of this month, leaving it at 11.0% till the end of the year. The capital requirements for consumer credit have also been relaxed and further stimuli of a similar nature have not been ruled out.
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The real has also joined in the fray. After a long period of appreciation, external uncertainty and increased risk aversion have weakened the currency to levels not seen since 2009. The expected monetary relaxation over the coming months should lead to even further depreciation in 2012, although the persistence of capital inflows and still favourable exchange periods will soften the blow.
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The real, on a clearly downward trend, has joined in the fray.
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In spite of the renewed countercyclical tone of economic policies, we do not expect any clear improvement in the rate of activity until mid-2012 (provided external conditions don't get much worse) and this improvement will probably be gradual. Moreover, the pace and intensity of stimuli will have to be carefully monitored while there is still pressure on prices. In this respect, the robustness of consumption and the inertia in wage formation (the main engine behind inflationary pressures) continue to cause doubts regarding the shift in monetary policy: inflation finally started to ease in October (to 6.97% and due particularly to favourable base effects) but refuses to move away from the level of 7% and is unlikely to return to the target range in 2011.
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With a view to 2013, and if the prognosis of a soft landing comes about, we do expect the progressive upswing in the global economy and the proximity of the World Cup to provide a new boost to growth in Brazil.
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Mexico
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Mexico: robust growth
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The Mexican economy surprises with strong growth of 4.5% in the third quarter.
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The slowdown in the rate of recovery in the second quarter, not only in Mexico but at a global level and particularly in the United States, suggested a phase of moderation in growth that, for the moment, has diminished. The third quarter's GDP growth figures, up 4.5% in year-on-year terms and 1.3% compared with the previous quarter, certify that the Mexican economy is still advancing firmly along a path of robust recovery. Buoyed by resistant exports and the increasingly important support of domestic spending, Latin America's second economy refuses to give in to the winds of moderation affecting part of the world's economy.
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The latest macroeconomic indicators also suggest that activity is looking good. The solid advance made by industrial production in September (3.6% year-on-year) and especially the good performance by manufacturing (the main beneficiaries of the upswing in growth in the United States) suggest that this economic improvement will continue. Nonetheless, we still expect a slower rate of growth for 2012 of around 3.5%, in line with the moderation in the pace of the world's recovery and with the gradual correction in the output gap.
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There is some leeway to implement new stimuli if the risk of an external slowdown materializes.
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Actually, the fact that this gap is still negative explains, in part, why the notable dynamism in demand has yet to put excessive pressure on prices: general inflation without food is at a cyclical minimum while core inflation for services is still falling. Relatively reasonable wage rises and the moderate impact of the peso's recent weakness have also helped prices' composure. The rest can be attributed to the firm commitment of the Mexican authorities to policies of macroeconomic stability.
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This commitment has not only allowed their economy to come out of the crisis in an even stronger state and tackle the external slowdown from a relatively comfortable position, but has also given them some leeway to implement new stimuli (especially in the monetary area), if required. In this respect, the good growth figures for the third quarter confirm our main scenario, which does not foresee any reduction in the official interest rate up to the first quarter of 2012.
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Nonetheless, the immediate future of the Mexican economy is still closely linked to what is happening on the other side of the Río Grande. If the situation in the United States becomes more complicated or even if the crisis in the euro area continues and the perception of global risk increases, this moderation in 2012 may be more extensive, leading the authorities to take their monetary ace out of their sleeves.
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Commodities
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Oil withstands the troubled waters
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Oil remains at 108.5 dollars and refuses to fall.
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The price of crude resisted falling between 20 October and 22 November, dropping a minimal 0.5%, taking it to 108.50 dollars per barrel (Brent quality, for one-month deliveries), 16.7% higher than the start of the year and 29.6% higher than last year's level.
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The downward trend consolidates in spite of sporadic upswings.
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Oil prices still refused to fall, unlike the rest of commodities. This was primarily due to supply-demand factors. The International Energy Agency predicts that, in 2012, oil prices will remain above 100 dollars per barrel with a global demand that has altered very little in spite of lower growth and low stock levels. A second factor behind expensive oil is the ongoing political tensions in North Africa and the Middle East. Particularly important in this case is the possibility of escalating conflict in the Iranian nuclear programme. With 4.3 million barrels a day, Iran is the world's second largest producer and an interruption in its production would particularly affect China and India, the destination for one third of all its exports.
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Falls predominate in the rest of commodities, affected by lower global growth and the slowdown in China's demand. The CRB index dropped by 3.0% between 20 October and 22 November. Precious metals picked up in the last week of October but have been correcting downwards since then. Copper was also up 21.5% at the end of October, in reaction to the sharp drop in September, afterwards returning to the fold and falling by 10.6%.
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2012: more deleveraging in sight
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Three years after Lehman Brothers went bust, advanced economies are generally undergoing a dubious recovery and some countries are at great risk of a double-dip recession. This weak tone can be put down essentially to two factors that are hindering economic growth: on the one hand, the need to carry out significant fiscal adjustments in order to stabilize and start to reduce the burden of public debt; and, on the other, the efforts that must be made by the private sector (households, firms and financial institutions) to reduce their high level of indebtedness. This Box focuses on the latter, namely private deleveraging, with the aim of clarifying, based on past experiences and the current circumstances, how this might be expected to develop, especially in the case of Spain.(1)
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Over the long term, private indebtedness (or leveraging) has tended to rise due to the effect, for example, of innovations in the financial sector, the fall in real interest rates and globalization, which has improved access to external financing and to deeper capital markets. However, like many other economic variables, such leveraging behaves cyclically around this trend: a typical indebtedness cycle lasts around six years on average, during which time the leveraging ratio rises by about 24 points of GDP. This is followed by a deleveraging cycle that lasts, on average, around five years and where the debt rate falls by about 19 points of GDP. Around these averages, the duration and intensity of deleveraging episodes have tended to vary, from less to more, depending on whether they have been associated simply with an economic recession, whether this has been combined with a real estate crisis or whether, in addition to all this, there has also been a banking crisis (see the graph below). In the presence of a banking crisis, deleveraging cycles have averaged an adjustment in the debt ratio of around 32 points of GDP and have lasted about seven years.
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(1) To a large extent, the content of this box is based on the "la Caixa" Documento de Economía in the upcoming publication entitled «Perspectivas de desapalancamiento» by Aspachs, Jódar and Gual.
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A typical deleveraging process also has different phases. Initially, both GDP and the volume of credit tend to contract, limiting the fall in the indebtedness ratio. After one year, and for approximately two years, nominal GDP growth recovers but credit continues to decrease, significantly reducing leveraging. For a further three years, in the last phase of the deleveraging cycle, growth in credit returns to positive figures, albeit lower than the growth in nominal GDP, thereby still allowing a reduction in the percentage ratio of debt to GDP.
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Like other advanced economies, Spain is fully immersed in a deleveraging cycle. The credit boom associated with the real estate bubble pushed the credit ratio up sharply to 172% of GDP in 2008, some 55 points of GDP higher than the long-term trend. Since then, this ratio has embarked on a downward slide, for the moment gentle, reaching 167% of GDP in September 2011. An extrapolation of the long-term trend observed would show that, by the middle of the decade, the ratio should be around 145% of GDP, which would mean that the current level of leveraging would have to fall by 22 points of GDP over a timescale of little more than four years.
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If this were the case, the size of the overall adjustment between 2008 and 2015 would be similar to the one observed in other economies which, in the past, were forced into deleveraging within a context of real estate and banking crises. This therefore seems to be a reasonable picture of what we might expect to happen. 17% cumulative growth in nominal GDP between the third quarter of 2011 and the end of 2015 (implying an average annual rate of 3.8%, for example resulting from real growth of 1.8% and 2.0% inflation), combined with very modest cumulative growth in credit over the same period, of less than 2%, would result in deleveraging of this intensity. In 2012, the outstanding balance of credit is likely to decrease by around 2.5% while nominal GDP will grow more than 2%, reducing the leveraging ratio to 155% of GDP by the end of year.
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Nevertheless, several factors could affect the deleveraging trend over the coming years. To begin with, if the liquidity tensions that are currently upsetting wholesale financing markets persist for long, the supply of credit would be limited, thereby intensifying the deleveraging process. A prompt resolution of Europe's sovereign debt crisis is therefore essential to avoid a vicious circle of accelerated deleveraging. Similarly, Spain's deleveraging process will also depend on other factors related to the financial system, such as how quickly losses from doubtful loans are recognized. In this respect, quickly writing off damaged bank assets could, in theory, help new credit to be provided. However, a strategy of this kind might be costly in fiscal terms, presenting a serious risk within the current context of doubts regarding public debt.
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Lastly, anything that helps towards greater GDP growth, fundamentally improved productivity, will make deleveraging more bearable as it will reduce the indebtedness ratio by increasing the denominator. When all is said and done, anything that reduces the role of the numerator in driving the evolution of the credit-to-GDP ratio, i.e. avoiding a sharp fall in demand or in the supply of credit, will alleviate the otherwise inevitable pain of deleveraging.
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This box was prepared by Enric Fernández
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International Unit, Research Department, "la Caixa"
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