The Global Economy

Monthly letter from Swedbanks Economic Research Department by Cecilia Hermansson No. 8 November 19, 2012

Global weakness political compromises can improve the situation

The international economy is sharply bifurcated. On the one hand, we see glimmers of light in a more robust US recovery and signs of a turnaround in China. On the other hand, the euro zone and Japan are now both in recession. Fighting in Middle East also raises risks for growth and commodity markets. Considering the major political challenges, there is an uncertainty that could be reduced once decisions are made. Strong corporate and household confidence would improve investment, hiring and consumption mainly in the US, but also in other countries where concerns of a worsening global crisis are impeding activity. Monetary policy is becoming more expansive in emerging markets as inflation and demand slow. More developed countries are using quantitative easing and pledges to keep interest rates low for an extended period. Until then fiscal policy is being tightened at the same time the banking sector in several developed countries is undergoing an acid test that is keeping lending in check. The challenges are great and economic policy isn't likely to significantly help demand. On the contrary, it is a question of creating confidence by managing the crisis well.

USA positive trend at risk of being broken

Now that the US presidential election is over, the focus is instead shifting to finding solutions to the countrys fiscal problems. A great deal is at stake. The relatively slow recovery continues in the US, but the positive trend could be broken if politicians do not reach a compromise so that the country can avoid the fiscal cliff on January 1. Many experts expect that the political discord will never reach a point where the economy is in jeopardy. Uncertainty still exists, however, at the same time that a new debt ceiling and long-term fiscal dilemma have to be resolved next year which won't be easy considering how little some members of Congress are willing to compromise. Economic data point in different directions, but the upside prevails. Third-quarter GDP grew preliminarily by 2 percent based on quarterly growth on an annualized basis (and 2.3 percent at an annual rate). If you look at the underlying data released since then, large contributions from inventory in August and September suggest an upward rather than downward revision when the next data are published. Growth has largely been

driven by public sector investment and consumption, however, while the underlying economy is still sluggish and has been affected by weaker global conditions.
USA: Annual growth in retail sales and real disposable income as well as consumer confidence (index), threemonth moving averages

Percent

The pace of industrial production indicates weakening growth, not least in consumer goods, while production of equipment is pointing higher.

Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740 E-mail: ek.sekr@swedbank.se Internet: www.swedbank.com Responsible publisher: Cecilia Hermansson, +46-85859 7720, Magnus Alvesson, +46-8-5859 3341, Jrgen Kennemar, +46-8-5859 7730, ISSN 1103-4897

Index

The Global Economy Monthly newsletter from Swedbanks Economic Research Department, continued No. 8 November 19, 2012

Some glimmers of light can also be found in supply and demand in the real estate market and construction sector, though from low levels. With regard to retail sales, conditions are decent. Octobers decline was probably affected by Superstorm Sandy and concerns about the fiscal cliff which is holding back consumption. The first monthly decline in retail sales in four months was also driven by lower auto sales. (In the US auto sales are included in the retail numbers, which isnt the case, for example, in Sweden.) Given the relatively weak growth in disposable income, the higher third-quarter consumption was based on a decline in the savings ratio from 5.8 percent in the second quarter to 3.7 percent. Leading up to the presidential election, the focus was on job numbers. There was a lively discussion among journalists and analysts whether the US Bureau of Labor Statistics (BLS) had cooked the books when unemployment fell to 7.8 percent in September. Despite that the October figure, which was released despite Sandy, showed an increase to 7.9 percent, many still felt that there were irregularities in the numbers. That probably isn't the case, and it is important to study job, labor supply and unemployment data.
USA: Labor market

month to keep unemployment constant. On the other hand they are now slightly stronger than consensus estimates, which had been around 100 000 new jobs for the month. Although the employment ratio rose slightly as a share of the population in October, it was from a low level, and at just under 59 percent is well below the pre-crisis level of 63 percent. The slightly lower unemployment is a reflection of the cautious recovery. Sandy has adversely affected the labor market and more people than in some time (1 years) have applied for unemployment (439 000 vs. an expected 375 000). Even if the storm slices a half percentage point off GDP growth in the fourth quarter, we should see the opposite effect next year as reconstruction picks up. If Congress fails to extend the current fiscal pact until next year, the US will again fall into recession with rising unemployment as a result. Following the election the Republicans seem to be in a slightly weakened position. The most likely scenario is some form of compromise where budget cuts are combined with higher taxes for the wealthiest Americans (possibly where the dividing line for rich is higher than the USD 250 000 per household currently suggested). By pushing off the issue of the fiscal cliff and including it with the debt ceiling and an extended timeframe, uncertainty will persist at the same time that some austerity will kick in. This will have a negative effect on investment and consumption in 2013 and reduce GDP growth by about a percentage point even in one of the better scenarios.

China new leaderships challenges

On Thursday, November 15, after China's 18th Party Congress had concluded in Beijing on the previous day, the party announced which members have been selected to the new Politburo Standing Committee, i.e., the true political power in China. The number of members has been reduced from nine to seven, and it was known in advance that Xi Jingping (59) would take over as the partys General Secretary and then in March become the countrys president. It was also correctly speculated that Li Keqiang (57) would become the new Prime Minister and that economic spokesman Wang Qishan (64) would get a seat on the committee. He has the most experience with economic policy and international relations, and now will have responsibility for fighting corruption and graft. The other four are Zhang Dejiang (an ally of Jiang Zemin who got his chance when Bo Xilai was

The BLS household survey showed that employment rose by 410 000 in October, but that the workforce increased slightly more, due to which unemployment climbed marginally. Previously employment had risen slightly, but the number of workers did as well, which meant both lower unemployment and employment share of the population. At the same time the establishment survey from BLS show that 171 000 jobs were created in October, up from a revised 148 000 in September. These data are not especially strong, given that around 150 000 new jobs are needed a

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The Global Economy Monthly newsletter from Swedbanks Economic Research Department, continued No. 8 November 19, 2012

outmaneuvered), Zhang Gaoli (a cautious reformer of the financial sector with strong ties to Jiang Zemin), Liu Yunshan (from the youth movement, who is taking over the propaganda and ideology portfolio) and Yu Zhengsheng (from Shanghai with contacts with Deng Xiaopings family). Among these other four the average age is over 65, which means they will retire at the next party congress in five years. Those who were elected are relatively conservative. Only three of the members, Xi, Li and Wang, are recognized as cautious reformers, while the four others are seen as more conservative. The question is how this governing clique will attack the growing challenges in Chinese society. Social unrest has increased in the wake of income gaps, corruption, environmental problems and a less effective growth model that relies too heavily on export- and investment-led growth. Growth has mainly been among state-owned enterprises, which has adversely affected other businesses. Local authorities have become more indebted and dependent on rising land prices at the same time that household income as a share of GDP is declining despite that consumption has to take over more of the responsibility for growth from exports and investments. Another challenge facing the party is that the middle class is growing in size and becoming better educated. There are already 500 million Internet users (some may have multiple accounts, so the actual number may be lower), and social media are growing in importance. The most likely outcome is that we will see increased democratization within the party without reducing its control and position. China is likely to choose its own model rather than copy a Western democratization model, but the question is what it will look like. GDP growth has fallen at an annual rate from 9.1 percent a year ago to 7.4 percent during the third quarter this year, in line with the partys 12th fiveyear plan (2011-2015). This raises concerns that growth below 7 percent could be destabilizing, causing rising unemployment and an increased risk of social unrest. On the other hand, exports have increased more than expected at the same time that retail sales are rising fairly strongly. A stimulus is now being deployed and could contribute to a turnaround, but won't be the same size as in 20082009. Find out more in the Swedbank Asia Analysis soon to be published.

China: Annual change in GDP and industrial production, and PMI

Japan new election and new recession

Japans GDP fell by 0.9 percent on a quarterly basis and 3.5 percent at an annualized rate during the third quarter. Contributing factors included lower consumption among Japanese households, the conflict with China, which has primarily affected manufacturers, the weaker global economy, including in Europe and China, and the relatively strong yen. It is likely that also the fourth quarter will show a fall, leading Japan into a new recession.
Japan: Annual change in industrial production and exports, and PMI

Prime Minister Yoshihiko Noda is said to be willing to call new elections for the lower house of the Diet on December 16 and is at risk of becoming the sixth leader in as many years to stay in power for only about a year. The political situation is complicated by the fact that Japan is headed for a new recession that will require stimulus measures at the same time that debt relief is being discussed,

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Diffusion index

Percent

Percent

Index

The Global Economy Monthly newsletter from Swedbanks Economic Research Department, continued No. 8 November 19, 2012

including a VAT hike. The new election could also be linked to discussions between the government and opposition on parliamentary reforms and the independence of the central bank.

EU: Weaker institutions

economy

but

stronger

The recession in the euro zone is already a fact. GDP shrunk for the second consecutive quarter, and for the second time since 2009 the region is in recession. More important than looking at individual quarters, however, is figuring out the underlying reasons and trying to understand how long and how much the economy will weaken. Private and public deleveraging, credit austerity and weakening domestic demand in the wake of the budget consolidation are contributing to the decline, at the same time that outside demand has also slowed. Since the region has huge imbalances, a recovery is likely to take time and be slower than normal.
GDP growth in the EU and euro zone (%)

debt write-off, extended repayment terms and lower interest rates. The crisis certainly isnt over, but conditions have mainly worsened in the real economy, while institutional development has improved in the last half year. In Decembers EU Summit more details will have to be presented on the banking union. Crisis management could then again come into question if reforms arent instituted and/or we see a lack of ambition/consensus between the countries. Another important question is whether Spain and Italy will have to turn to reform programs to reduce financial fragmentation in the region. They probably have to since fall in interest rates may not be sufficient and sustainable.
Euro zone: Sentiment indicators
120 115 110 105 100 Index 95 90 85 80 75 70 65 05 06 07 08 09 10 11 12
Source: Reuters EcoWin

Germany France Italy Spain Netherlands Austria Belgium Portugal Greece EU-27 EA-17
Source: Eurostat

Q/Q 0,2 0,2 -0,2 -0,3 -1,1 -0,1 0,0 -0,8 .. 0,1 -0,1

Y/Y 0,9 0,1 -2,4 -1,6 -1,4 0,4 -0,3 -3,4 -7,2 -0,4 -0,6

Germany Euro area Spain Greece France

At the same time there are signals that the institutional framework is being strengthened and that crisis management is becoming more predictable. Confidence that the euro will be able to avoid a collapse has increased. A growing chorus of experts expects Greece to meet the challenges assuming that it receives some form of additional
Swedbanks Economic sekretariat
105 34 Stockholm tfn 08-5859 7740 ek.sekr@swedbank.se www.swedbank.se Ansvarig utgivare Cecilia Hermansson, 08-5859 7720. Magnus Alvesson, 08-5859 3341 Jrgen Kennemar, 08-5859 7730

Unemployment is still rising in the euro zone and could potentially threaten political stability. Business and household confidence have continued to fall and there is no turnaround in sight yet. Psychology is important, and politicians in particular have to restore confidence in these dark times. Finding an endpoint to the budget consolidation and focusing reforms to improve growth and competitiveness in a broader sense should be the next step for the euro zones members. Cecilia Hermansson

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