20 April 2009

Weekly Macro Comment

Han de Jong, Chief Economist

Here is deflation…well, negative inflation at least

• Inflation negative in US, China, Japan, Switzerland, Spain, Ireland…

• Green shoots here and there
• Japan and the eurozone remain in poor shape

Inflation has now turned negative in a number of countries: US In the US, for example, capacity utilisation in the manufacturing
-0.4%, China -1.2%, Japan -0.1%, Switzerland -0.4%, Spain sector was only 65.8% in March, the lowest since records
-0.1%, Ireland -0.7% and perhaps others I have missed. This began in the 1950s. So a third of manufacturing capacity is
development is largely due to base effects and the drop in idle! And unemployment is rising rapidly. This will surely have
energy prices since the middle of last year. So you cannot further persistent disinflationary effects on the economy at
really call this deflation. Core inflation indices are much large, even if we were to see a recovery. In economists’ jargon,
stickier. However, core inflation tends to follow headline it will take a couple of years for the output gap to close again.
inflation with a lag. In addition, the economy is functioning Indeed, according to the April small business survey by the US
significantly below potential, as there is an unprecedented National Federation of Independent Business, 11% of
degree of excess capacity. companies surveyed are reducing employee compensation, a
record high for this survey (although I don’t know how long the
China: inflatiion and core inflation history is). At the same time, 11% (again!) of companies say
% yoy they are raising wages, a record low for this survey. This
suggests that downward pressure on wages—and presumably
10
on inflation—is starting to build. We are far from generalised
8
deflation, but if we wanted to go there, this is the way to do it. I
6 reaffirm my view that the risk of deflation during the next
4 eighteen months or so is significantly larger than the risk of
2 inflation.

0
The famous green shoots everyone is talking about
-2
Early signs of an improvement in economic conditions continue
2005 2006 2007 2008 2009
to appear—particularly in emerging Asia and the US, with
Inflation Core inflation
Japan and the eurozone lagging behind. However, the
Source: Bloomberg improvement is not everywhere to be seen, not even in Asia. It
is early days yet. Chinese GDP was up by ‘only’ 6.1% yoy in
Industrial production Q1, down from 6.8% in Q4 and the weakest in ten years or so.
In Singapore, GDP fell by 11.5% yoy in Q1, the largest decline
% yoy
ever. Singapore is, of course, a very open economy and has
10
been especially vulnerable to the collapse in world trade. This
5 collapse was undoubtedly partly caused by a sudden freezing
0 up of trade finance and credit insurance following the demise
-5 of Lehman Brothers. It seems that the situation with regard to
trade finance and credit insurance is thawing somewhat. Take
-10
Singapore’s exports: its non-oil domestic exports were down by
-15
17.0% yoy in March. Not great, certainly, but significantly better
-20 than the 34.9% decline in January. The same with electronics
2005 2006 2007 2008 2009 exports: -25.7% yoy in March, an improvement from -38.4% in
US Eurozone January. I realise that many people may wonder about the
Source: Bloomberg relevance of Singapore electronics export, not a decisive force
in global economics. Yet, this is the sort of indicator one would

HAN DE JONG +31 (0)20 628 4201 ECONOMICS DEPARTMENT

 20 April 2009

expect to show improvement before many others, so recent
developments are encouraging.
In the US, both the Empire State and the Philly Fed indices of
business confidence improved. The particularly encouraging
element was the sharp rise of new orders in both surveys. This
is consistent with the anecdotal evidence on an upturn in the
inventory cycle. This upturn should continue to support the
improvement in the wider economic data for a couple of
months.
A surprising positive came from the US index of confidence in
the construction sector. The index of the National Association
of Home Builders rose to 14 in April, from 9 in March. 14 is still
a low level, but it was the highest since October. The US
housing market is certainly not even close to being out of the
woods, but perhaps its darkest hour now lies behind it.
US: NAHB index
index
disappointing to many, but bear in mind that US households
are excessively leveraged. We cannot have a sustainable
recovery based on US consumer spending.
Also negative was industrial production. Eurozone production
fell by 2.3% in February and 18.4% yoy. US industrial
production dropped by 1.5% mom in March and was -12.8%
yoy. Japan’s production level was confirmed at -38.4% yoy in
February.
More negatives on Japan: nationwide department store sales
were down by -13.1% yoy in March, against 11.5% yoy in
February.
On balance, the sharp drop in economic activity of recent
months seems to be coming to an end. The combination of
policy stimulus, the inventory cycle and the perhaps improved
availability of trade finance and credit insurance may well lead
to better economic numbers in the period ahead. However, the
situation remains fragile.

80
Quant easing, what quant easing?
70
The US Federal Reserve continues its programme of
60
quantitative easing. Since the beginning of the year, the Fed
50
has bought USD 54 billion in Treasury securities, USD 41
40
billion in Agency debt (securities issued by government-
30
sponsored enterprises such as Freddie Mac) and USD 355
20
billion in mortgage-backed securities (MBS). Nevertheless, the
10
Fed withdrew liquidity from the system through other balance
0
sheet items and the total balance sheet actually shrunk by
2005 2006 2007 2008 2009
USD 89 billion. I cannot really see how you can call that
Source: Bloomberg quantitative easing. Granted, since the Fed formally
announced in mid-March that it was embarking on quant
Another modestly positive piece of news came from European easing, its balance sheet has actually expanded by USD 120
car registrations. They were down by 9.1% yoy in March, the billion.
best figure since July last year. There is a significant The ECB is giving mixed signals. Some representatives are
divergence between different countries. Where incentives have saying that 1% on the refi rate should be the bottom, others
been implemented, car sales are doing well. Germany is seem to question that. Not exactly a reflection of harmony.
leading the charge, with sales up by 39.9% yoy, and French ECB president Jean-Claude Trichet has said a couple of times
car sales rose by 8.0%. Sales were also positive in Poland that the central bank will soon announce non-standard
(+2.5%) and the Czech Republic (+0.9%). The countries most measures of monetary policy. But it seems these measures will
affected by the economic downturn continue to show poor be different from the US approach. Trichet keeps saying that
sales numbers: Iceland (-91.5%), Latvia (-80.3%), Estonia the new measures will be focused on the banks rather than
(-67.8%), Romania (-64.8%) and Ireland (-63.8%). specific financial markets. We will have to wait and see.

But not everything is looking good

On the less positive side, US retail sales were weaker than
expected in March, falling by 1.1% mom. This is perhaps

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HAN DE JONG +31 (0)20 628 4201 ECONOMICS DEPARTMENT