Italy turns Japanese

More good data out of Germany overnight with German exports rising 2.5% in November after posting their biggest fall in half a year the previous month. The forecast was for 0.7% growth so the number of a large outperformance. In addition the trade surplus widened to €15.1bn, showing that imbalances within Europe remain.

There was some evidence early in the week that the figure would be solid as BMW has stated record sales in 2011, and Volkswagen stated over the weekend that its US sales targets were rising. It would appear that the weaker Euro is helping with trade figures rising even while much of Europe enters recession.

However it wasn’t all good news with a decline of 0.6% in industrial production in November suggesting future export numbers may not be so impressive. As I have said previously these number are a double edged sword because the outperformance of Germany over other European countries is one of the major problems in Europe.

The November data for France appears solid with industrial production rising 1.1% and manufacturing rising 1.3% in November. Those numbers were offset somewhat by Bank of France’s message that the country appears to be stumbling into recession.

The French economy was flat in the last three months of 2011, the Bank of France said Tuesday, confirming an earlier estimate amid concerns the eurozone debt crisis could spark a recession.

The French central bank said there was no growth between the third and fourth quarters of 2011, an outcome which should allow the government to come very close to meeting its full-year target for a 1.5 percent expansion.

Third quarter growth had come in at 0.3 percent, the national statistics institute INSEE said last month.

On the basis of the third quarter performance, the French economy should grow 1.7 percent growth for the year, it said.

INSEE said last month it expected France to fall into a brief recession, with the economy contracting 0.2 percent in the three months to December and another 0.1 percent in the first quarter of 2012.

The latest industrial output numbers may have a more positive effect than the Bank of France is predicting, however, given that France has a largely consumption based economy I expect economic underperformance to continue. The French government has forecast GDP growth of 1% this year, yet estimates on the effects of austerity tend to understate the psychological effects of the policies.

What we have seen from recent history is that consumers turn into savers in far greater numbers than expected causing a greater slow down in economic activity. A major component on France’s economy is consumption-driven so increases in taxes on consumption, such as the ‘social VAT‘ proposal, are likely to have a larger effect on the economy than forecast by the government.

While Germany outperforms and France tries to keep up, much of the rest of Euro-Zone looks to be about to get a little worse.

Fitch Ratings says a number of euro countries, including Italy, may see their credit ratings downgraded by one or two notches by the end of this month as they struggle to cope with the debt crisis.

Fitch’s head of sovereign ratings David Riley says Tuesday the agency will give its verdict on several countries by the end of January. Fitch currently has Italy, Spain, Belgium, Ireland, Slovenia and Cyprus on so-called “ratings watch negative.”

As I mentioned last week I expect Spain to return to centre stage in the coming months as the world realises, once again, that nothing has been fixed in that country. At this stage however,  the spotlight remains on Italy.

Yesterday I noted that:

The Italian government will not have to carry out an additional package of budget cutting measures to meet its goal of eliminating its deficit in 2013, Prime Minister Mario Monti said.

His government will now focus on producing a package of measures to spur economic growth and competitiveness in Italy to be presented before a meeting of European Union finance chiefs on Jan. 23, Monti said on the “Che Tempo Che Fa” talk show on state-owned RAI television.

Given what we have seen from other countries including Ireland, that is back getting prodded by the Troika , I suspect it is far too soon to make such claims about the need for additional cuts to meet deficit targets. From what I have witnessed over the last 2 years these estimates always fail to take into account the negative feedback loop that is created by imposing higher taxes on deflating economies. I do, however, have to applaud Mario Monti for his focus on competitiveness and economic growth even if I do think the entire plan is the wrong way around.

Italy does have the advantage that over 75% of its public debt is long term with an average maturity of approximately 7 years and only about 12% of that is variable interest rate. This means that even though Italian yields are high now ( 10yr @ 7.11) the flow-on effect to the overall deficit is relatively limited.

The real problem in Italy is that its economy has been stagnate for nearly the entire decade. According to the IMF between in 2000-2010 among all countries of the world Italy only grew faster than Haiti and Zimbabwe. In 2010, Italian GDP was only 2.5% higher than in 2000. This problem is actually made worse by the fact that this is such a long term trend. Italy’s per-capita GDP growth was 5.4% in the 1950s, 5.1% in the 1960s, 3.1% in the 1970s, 2.2% in the 1980s and 1.4% in the 1990s. Since the new millennium the country has hardly moved forward and if we extrapolate out that trend Italy will spend the next decade in contraction.

On top of stalling growth, Italy has a demographics issue. With a debt to GDP ratio at 120% along with a population with a median age of approximately 45 Italy really does look like the Japan of Europe. The only problem is Japan is competitive, runs a trade surplus and is sovereign in its own currency. Italy has none of these things.

Given all of these problems it will be interesting to see what Mario Monti can come up with to get the country back onto a path to growth while staying in the Euro and meeting the countries existing obligations. It would appear to be a monumental task.

The country’s issues have got worse recently  because the focus has moved to the banking system as it fails to find new capital.

UniCredit, Italy’s largest bank, is undergoing a trial by fire in the stock market, underscoring the challenges that European banks face in trying to right themselves.

Shares of UniCredit have been in free fall as investors have balked at a new stock offering meant to bolster the bank’s capital. Since last week, UniCredit’s market value has plunged by more than 40 percent.

In other news Portugal’s economy is likely to contract more than estimated in 2012, Quel surprise!, the ECB’s deposit facility is still hitting records even while the discount window still appears to be in operation, and finally, the IMF and the hedge funds appear to be playing chicken over the Greek PSI.


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      • You have to admit that there was a bit of hysteria going on regarding the EU last year on MB, especially coming from a number of commenters often fueled by more libertarian views and anti-EU sentiment…

        And, while I believe your economic analysis is spot on, I too noticed a slight change in tone in your recent posts. You still argue the same thing, just your choice of words has changed a bit which really makes a difference for us overly sensitive European types. 😉

      • why do you guys even bite. GB is permabull. he got you hook line and sinker with that comment..

  1. Hi Prince

    Just want to pull you up on your usage of ‘negative feedback’. I understand that you mean feedback that has negative consequences, however this is not a negative feedback loop.

    Negative feedback acts to oppose changes to a system, while positive feedback reinforces changes to a system. In this instance, the economy is shrinking. Austerity is introduced because the economy is shrinking, causing it to shrink further. This is a positive feedback loop.

    Positive feedback loops are characterised by uncontrolled responses to inputs, leading to overshoot and collapse. This can be represented by a sine wave that increases in amplitude with each oscillation.

    Negative feedback loops stabilise a system to a new level of output. This can be represented by a sine wave that decreases in amplitude with each oscillation.

    Why the quibble over semantics?
    Because in order to be sustainable in the long run, an economy must aim for ‘negative feedback’ not ‘positive feedback’ otherwise we will simply overshoot and collapse. Note that in engineering, positive feedback is avoided because it means you will create a system that is uncontrollable.

    • Does this not depend on the knowledge referenced?

      In that there are different theories and schools and often a ‘social feedback loop’ can be quite different to a ‘financial feedback loo’.

      Just asking the question it is like acronym confusion etc.


      • a lot of the time i agree with you prince. but on this no. the key problem with modern economics is that it tries to be a science/mathematically driven/engineering. it is not, it is a collection of individuals driven by fear and greed. the more behavioural economics becomes the better. also due to perverse incentives many of the brightest math minds/potential engineers, were sucked into finance in last decade, this further hollowed out western economies and diverted creative/innovative minds to cook up subprime/CDOs etc. the less mathematics and more behavioural economics becomes the better. sorry

        • Actually I totally agree with your disagreement! Behavourial finance for sure trumps the invalidity of the mathematically (but not dynamic engineering) based CAPM/MPT hypothesises. Indeed most of finance is categorised by math “try-hards”, particularly in property data analysis.

          But for economics, we need to merge the behavioural, complexity and probability fields – including dynamic analysis of credit and monetary systems instead of being stuck in a “equilibrium” fantasy world that ignores money and credit, has no conception of negative/positive feedback (h/t Dave) complexities, a made up world that any serious engineer would recognise as bogus.

          Further to that, and looking at my partner Q Continuum, we need more engineer capitalists – i.e people with a mind for the productive nature of capital (i.e to build things, not create financial instruments)

          And yes, I bemoan the waste of physics and math PhD’s writing algo’s for robots et al..

          Luckily most economists would make poor engineers…

          • now you are talking prince. so you support awerbuchs view of CAPM vs engineering valuations in renewables valuation.

            i like your hybridised approach too regarding schiller comboed with say soros and taleb for instance?

            as trading analyst i have become deeply interested in behavioural side of things and want to start looking at hormones and traders behaviours. work has been done on this too.

          • Theory is nice, what actually happens in practice is more important. First lesson once you leave uni. Unfortunately it doesn’t sound like that lesson is taught in economics. Probably because engineering feedback loops are stronger. Bad design – gear fails/explodes – boss gets made – money lost – no bonus or job. However in economics: GFC happens – people lose jobs, but typically not economists – economists employed to explain why it failed – paper written as to why the system was wrong and the theory was right – go home and have a G&T.

    • >Negative feedback acts to oppose changes to a system, while positive feedback reinforces changes to a system. In this instance, the economy is shrinking. Austerity is introduced because the economy is shrinking, causing it to shrink further. This is a positive feedback loop.

      Yes, point taken Dave however as Mainlander says below this is a point of reference thing.

      Maybe I should call it an “economically-negative positive feedback loop”.

  2. A weaker EURO (if it will last) it’s by far the best medicine for Europe. Germany will have to live with that. That was the nature of the crisis, the inability of peripheral countries to devalue their currency to become more competitive, as it usually happens. But now it looks like EURO repatriation has finished and a EURO decline has happened. Problem is: will it last and maybe go even lower? Will US and Japan be able to sustain a relatively stronger USD and YEN?

  3. I’ve been living in Europe now for 15 years and working in investment banking for my myriad sins. The view i’ve become convinced of is behavioural economics should be the dominant thinking (i was lucky to work with Albert Edwards for a while). The classical mode of economists ignoring a vast majority of human behaviour to produce theories of economic rationality, are now for the most part, easily understood to be bogus.

    However, the one nexus that gets less attention & for me has an enormous influence is the polital-banking one. The decisions driven by this complex have completely skewed the rationale & judgements of markets in the last 5-10 years. The small cabal that make these decisions makes trading and investing just a roulette wheel of outcomes (imho). The decisions get made & then the salaried economists supporting the complex theorise to support them.

    It’s a lose-lose situation until they exhaust all the possibilities they think they have.

    Then potentially we return to some semblance of economic cause & effect. Working in Greece these last 6 years i can attest to the fact that economic decisions made by the ordinary people get distilled to pure fear & greed when the wheels fall off and politicians try to “fix” the economy in ways that are intuitively alien to the ordinary punter. For e.g. the evolution of bank deposits here is a small testament to that.