Tuesday, March 18, 2003

Schroder Struggles to Convince

This, anyway is the Economist view of things.They are worried by the reform appetitite and the will to change of the German Chancellor. I am worried about the diagnosis.

To be sure the German panorama does not look exactly appetising. After years of sub par growth, followed by a series of failed sallies on the part of the larger communications and technology enterprises into the new economy and the internet, and accompanied by deteriorating demographics and resistance to immigration, now, with deflation knocking on the door, Chancellor Schroder is for the first time seriously talking about addressing the problem of reform.

The Chancellor's main proposals, none of which come as a surprise, are aimed at making it easier for employers to fire workers, reducing the length of time unemployed people can receive benefits and eliminating some of the costs of the national welfare system. The program also includes proposals to increase public works spending, to make it easier for small businesses to hire temporary workers and to require unemployed people who have received welfare payments for a year or more to accept jobs, even if undesirable, that are offered to them by the state employment agencies.

Many of these reforms may well be necessary, and long overdue. The question is will they have the impact intended. My feeling is that the majority of the measures, in the short run, can only make the problem worse. Most Germans will feel more, not less, insecure. Meantime euro zone interest rates are way above what is required to treat the German malady (which could well turn out only to be a new variant of the Japanese one).

Germany needs a change of direction and a change of mentality. In particular there is a need on the part of politicians, employers, unions, civil society, in fact almost everyone for a recognition that fundamental change is needed. Changes in attitude to innovation and risk, to the internet, to the relations between the English and German languages, to patterns and styles of work. Despite all the talk of knowledge-based and information societies, there is little imagination being exercised in the search for change. For example, one of the consequences of the increased acces to and sharing of information through the internet and distinuted, SETI style, computing, is that tthe whole R&D situation has changed dramatically. The EU governments, however, still think in terms of the 'old' model of large scale, state-subsidised research. Isn't the key to change in Germany about motivating a new generation of young people with different values. Isn't it time they woke up to the fact that 'sharing' is about more than MP3. Wouldn't they do better subsidising high speed internet for the young people, and actively promoting on-line collaborative communities?

Above all Germany needs to recognise that it cannot do this alone. There is still a window of opportunity open for Germany, but passing through it means opening the doors to all those young people worldwide which Germany so badly needs. It means a new approach to German identity, to multiculturalism and diversity. For one thing is clear. This, not a new employment law, is the structural change Germany badly needs. Without it the future, as I said, does not look appetising.

CORNERED must be how Gerhard Schröder feels these days. With his opinion-poll ratings plummeting, and desperate to rescue his political reputation, the German chancellor unveiled a new package of economic reforms in parliament on March 14th...... About the diagnosis, there is no longer much debate. The largest economy in Europe is in deep trouble. It is, once again, teetering on the brink of recession, with growth forecasts for this year slashed to nearly zero. Unemployment is climbing—at 4.7m it is now well above the level that Mr Schröder inherited in 1998 and which he pledged to tackle in his first four-year term. Germany’s labour laws discourage companies from hiring workers in the first place: both because pension and other add-on costs make it expensive and because it can be difficult to slim down the workforce if business declines. The country’s generous but hugely expensive welfare system has become unsustainable and is putting great strain on the government’s finances.

In the past, tough talk of reform has petered out—proposals have been watered down or abandoned. Germans are anxious about the state of their economy. But many are also strongly attached to the generous welfare provisions which the state provides. On the streets, Germany still feels like an affluent country. Not everyone is yet convinced of the need for urgency or radical change—a situation not unlike Japan in some respects. Mr Schröder’s political position was further undermined by defeats in two crucial state elections in February. These gave the opposition a clear majority in the upper house—one that they used on March 14th to block changes to the tax system which the government wanted to push through. Unusually, there are only two further state elections this year, in May and September, which might give the chancellor some breathing space to show he can deliver his economic reforms. The changes he has now proposed are an absolute minimum, and might not be sufficient to rescue what is left of the chancellor’s reputation. Any backtracking now could fatally undermine his position and would probably revive talk of a new election or of a grand coalition in the national interest between the two main parties. It seems unlikely that Mr Schröder would survive in either case. For him, as well as for the German economy, the stakes are high.
Source: The Economist

Schroder Unveils German Reform Package

The Financial Times views this package as bold. I'm not so sure. It's a stick, but where's the carrot? Remember German's are saving and not consuming sufficiently. Promises to cut pensions, while they may be inevitable, are hardly going to change this tendency. It is really time for some imaginative thinking. Perhaps the most revealing part of his speech was the declaration that: "either we modernise, or we will be modernised by the unremitting force of the markets". I need time to think about this. I'll try and blog something more over the weekend.

Gerhard Schröder, the German chancellor, committed his government to a bold programme of reforms in a landmark speech to parliament that went beyond the measures leaked widely in the past week. Mr Schröder told a packed Bundestag that Germany had to adjust its social welfare and health system to straightened circumstances, while the stretched state pensions cover would require further changes to meet the challenges of an ageing population and falling birthrate.

All three areas are currently subject to thorough review procedures. The health ministry is due to produce wide ranging suggestions in May, while a special commission on social welfare and pensions should report by early summer. But it was the chancellor's comments on the labour market that went beyond the cautious steps expected and provoked unease among traditionalists in his Social Democratic party and their trade union backers.

Mr Schröder, as expected, said the government would propose legislation to soften Germany's rigid rules on job protection in an attempt to raise incentives for smaller companies to hire new labour. Compensation procedures for job losses will also be simplified to try to avoid the complex court actions that often accompany dismissals. The chancellor also met expectations of some cuts in unemployment benefit, with a simplification of the current system governing payments to the longer term out of work. Where he surprised observers was in also announcing a significant reduction in the duration of the main unemployment benefit, to 12 or 18 months, depending on the age of the recipient, from a maximum 32 months at present.Mr Schröder also went significantly further than expected in telling workers and employers they should consider ways around Germany's inflexible national pay bargaining system in favour of one-off local level arrangements in special circumstances.
Source: Financial Times

Monday, March 17, 2003

Euro Zone Monetary Conditions Have in Fact Tightened

This unusual point is made by the economist. The rise in the trade weighted value of the euro is in fact equivalent to a 0.5% rate increase.

Since the ECB cut interest rates in December, the euro's trade-weighted value has risen by 6%, equivalent in terms of its impact on inflation to a rise in interest rates of more than half a point. Policy has, in effect, tightened this year, even though the economic outlook has deteriorated; and the euro area's core inflation rate (excluding food, energy and tobacco) has dropped below 2%. Fiscal policy has also tightened slightly because of the straitjacket imposed by the stability pact, which is forcing Germany to increase taxes in the midst of recession. Tighter fiscal policy increases the case for monetary easing.
Source: The Economist

German Dax Decline now equals that of 1929

The news from global stock markets gets grimmer every day. It is probably going to get worse before it gets better. Which leaves us with the question: how much permanent damage is all this likely to cause?

Another bout of turbulence on world markets Wednesday sent share prices tumbling, at one stage pushing Germany's Dax index down to a level 73 per cent below its peak - a scale of decline last seen in the 1929 crash. War jitters, bad corporate news and rumours surrounding the future of Tony Blair, British prime minister, drove a sell-off across Europe. Some analysts speculated that markets are now approaching the point of "capitulation" - the final stage of a bear market characterised by rapid selling.In London indiscriminate selling sent the FTSE 100 on its seventh biggest daily fall - down 5 per cent to 3,287, its lowest level since April 1995. The dividend yield on the UK equity market has also risen above the yield on benchmark government bonds for the first time since 1957. Frankfurt's Dax index fell 4.9 per cent to 2,192 in early evening trade - its lowest point for seven years. It closed at 2,202.96. In Paris, the CAC index slid 3.6 per cent to another six-year low.
Source: Financial Times

German Pensions Warning

Well the bad news from Germany continues, as it will, I'm afraid, continue. This time it's pensions. When will we learn 1980 - 2000 we were on the virtuous circle. Now we're on the other one, the vicious kind. All the pension numbers go out of the window if economic growth drops near zero. This fall in pensions expectations produces a fall in consumption as people try to save more (the so called Ricardian effect). The decrease in consumption causes a fall in profitability, which causes equity (and hence pension fund values) to fall. All of which reduces economic growth expectations, which reduces pensions expectations, which........

Meantime house prices start to fall, and then we really are mired in it. No, I know it's not that simple. But why, oh why doesn't someone older and wiser than me try to examine this process a bit more rigourously (I think this is a kinda unveiled hint for Paul Krugman). Well everybody: did you enjoy the ride up?

German economic reform efforts will face a further setback on Thursday when its leading pensions association warns that statutory contributions will have to increase sharply to cover a looming gap caused by feeble growth in Europe's biggest economy.The VDR association of statutory pension funds, an advisory body that influences government policy, will say increasing contributions to the state-run pay-as-you-go pension system from 19.5 to 19.9 per cent of gross wages may be unavoidable given the weak economy and high unemployment.

The warning comes as a bruising blow to Gerhardt Schröder, the German chancellor, who will deliver a keynote parliamentary speech on Friday aimed at reducing the non-wage labour costs borne by employers. An increase in pension contributions, shared by employers and employees, would further push up costs, increasing the competitive pressures on the economy. An increase of 0.4 percentage points is equivalent to €3.5bn. Any increase in pension costs will also fuel tensions between Mr Schröder's Social Democrats and the Greens, the junior coalition partners. Green opposition to the increase to 19.5 per cent last year was overruled. The forecast of higher costs came as the opposition Christian Democrats threatened to withhold crucial support for Mr Schröder's reforms unless he used Friday's speech to present a far-reaching "master plan" for recovery. Mr Schröder has promised a package of labour market and social security reforms. He said last night the measures would involve "sacrifices by many people".
Source: Financial Times

More Fuel for the Pensions Fire

We all know it's coming, but we try not to think about it. The 'it' in question this time: the looming pensions crisis.This week it's the turn of the European Financial Services Round Table, an entity which represents such institutional lynchpins as Deutsche Bank, ABN-Amro, Axa and Barclays, to enter the fray by writing to European leaders urging them to speed up the creation of a single market in financial services to try to help solve the European pensions problem. Of course whether these estimates are in any way realistic, and whether private pension plans, depending as they normally do on equity values, offer any security or solution, this is another matter. (See my arguments: eg here).

Europeans need to save an extra €456bn (£315bn) a year to preserve the level of retirement benefits while holding down the cost of public pensions, Europe’s leading financial services companies claim. Pehr Gyllenhammar, chairman of the Round Table and of Aviva, the UK’s largest insurer, said: “This is a call for very urgent action. If European governments deliberately want to erode the livelihood of 377m and more people because they dare not touch the pensions bomb, that is not responsible behaviour.” European Union government figures show that if policies remain unchanged, the cost of state pensions in the EU is expected to rise from 10.4 per cent of gross domestic product in 2000 to 13.6 per cent by 2040.

For its estimate, the Round Table supposed that the cost to the state in each EU country were capped at its 2000 share of GDP, but pensioners were still to receive the same level of benefits. Based on the current best projections, private savings for the next four decades would have to be 456bn a year higher - about 5 per cent of the EU’s GDP in 2002. The greatest need for increased savings is in France, which according to the Round Table needs an extra €137bn a year. Mr Gyllenhammar said making personal pensions portable within the EU, opening national markets to competition and allowing greater economies of scale were essential to encourage private saving. The Round Table calculates that the European fund management industry could save 10bn a year in administration if the average EU fund was were as large as the average US fund. The attempt to create a single market in financial services has been seen as one of the relatively successful elements of the economic reform programme that the EU committed itself to at the Lisbon summit in 2000. Of the 42 measures in the financial services action plan, 32 have so far been signed off. But Mr Gyllenhammar said progress had been slow, with the directives only rarely translated into genuinely open markets.
Source: Financial Times

Monday, March 10, 2003

Germany: All Bets Are Off

Stephen Roach lambasts the bureaucrats at the ECB for their inability to respond in kind to the magnitude of the problem which faces them. But as he says when deflationary pressures arise in the eurozones biggest economy, then all bets may be of. That is, the one size fits all policy may need to be adapted to give priority to Germany's special needs: as anyone who has read my last two posts will already know, I wholeheartedly agree. However I don't think anyone is likely to be willing to listen. There's too much political cudos at stake, and the inflation 'sinners' would complain like hell.

But there’s an added wrinkle to Europe’s conundrum. Germany, its largest economy, is probably already in recession. Unfortunately, Germany has entered this recession with only a 1% inflation rate, implying that it wouldn’t take much of a contraction to tip fully one-third of the Euroland economy into deflation. Yet there doesn’t seem to be much leeway in the rigid EMU policy framework to give Germany special treatment. That’s precisely the problem. For a nation whose current structural dilemma goes back to the uneconomic terms of German reunification in 1990 — a one-for-one exchange rate between the high-productivity West and the low-productivity East — some policy flexibility is essential. Yet focused on backward looking gauges of pan-European inflation that were still flashing an estimated 2.3% y-o-y increase in February 2003, the ECB’s latest incremental move suggests that it remains wedded to its formulistic approach of targeting price stability in the 0 to 2% zone.

Therein could lie Europe’s biggest pitfall. From the start, the European Monetary Union has been framed around the “one size fits all” credo. In other words, what’s good for Europe is presumed to be good for Germany. This approach may work fine under most circumstances. But when deflationary pressures emerge in the largest economy in the region, all bets could be off. At such extremes, Germany’s dominant share in the Euroland economy may well require precisely the special treatment that the ECB refuses to offer. To do otherwise may well risk a contagion of German deflation quickly to the rest of the region. Consequently, in an effort to set policies for the region as a whole, the ECB may be neglecting not only the biggest link in the chain, but also the weakest. To be sure, the outcome is hardly known with precision. But the risks of a German-led deflation in Europe are now rising. In my view, incrementalism under those circumstances may well be a recipe for disaster.
Source: Morgan Stanley Global Economic Forum

Duisenberg Fiddles, While...German Unemployment Soars

Up to now I've been constrained by decency and caution. I really think that the euro cannot work, but I have been willing to let those who think they know better give it a try. But looking at the panorama that is unfolding in Germany, I think it is time to put the Spain, Greece, Portugal inflation preoccupations on the back burner (they have, after all, had plenty of warning about where they are headed) and try to put the German fire out as a matter of top priority. If not the whole eurozone risks sinking with them.

Unemployment in Germany has risen to 4.7 million. At 11.3 percent of the available workforce, it's the highest level since Chancellor Gerhard Schroeder's Social Democrats were first elected in 1998. Between January and February a further 83,000 people became jobless. And, compared to the level one year ago, there are 410,000 more out of work. Economy Minister Wolfgang Clement, who wants modernised labour laws, urged Schroeder to break with the past in a Bundestag speech he will deliver next Friday. It was time to act, not talk, Clement added. An opposition conservative deputy leader Friedrich Merz spoke of a disaster and government wrangles leading to inertia. The deputy chairwoman of the German trade union federation, Ursula Engelen-Kefer warned against rumoured cuts in allowances for long- term unemployed. Employers' association president Dieter Hundt said a shake-up was needed on tax, welfare and consultative bargaining.
Source: Deutsche Welle

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Why So Small?

Those of us brought up on the humour of Mel Brooks and Blazing Saddles may feel constained by propriety from putting this most obvious of questions to Mr Duisenberg. The Economist, however, has no such reticence. I would say they have got the worst of both worlds, and that this is a result of decision by committee. You get the inevitable compromise. Either they should have followed Greenspans earlier more daring example, and made a bigger cut, or they should have waited to see if there is to be a war, and then cut dramatically. This way they waste amunition, have little meaningful effect and then have limited capacity down river. Talk about wasting your options. but I guess that just about sums up the noble history of the ECB: wasted options and missed opportunities. Meanwhile they are always at the ready to 'act decisively'.

WHY so small? That is the question many economists and businesses were asking after the announcement by the European Central Bank (ECB) on March 6th that it was lowering interest rates by a quarter of a percentage point. With the ECB’s benchmark rate now down to 2.5%, European interest rates are at their lowest level for more than three years. But the modest reduction came as the Swiss National Bank cut rates by half a percentage point. It will not silence the critics who believe that the ECB has moved too slowly to ease monetary policy.

This time, at least, the euro area’s central bank cannot be accused of trying to catch people out. The latest cut—the first since a 0.5% reduction last December—was widely expected after heavy hints from Wim Duisenberg, the president of the ECB, and some of his colleagues. Given the ECB’s longstanding reluctance to reduce rates, few seriously expected a larger cut, however much they might have hoped for it. But just as the bank is showing signs of improved communications skills, it has opened itself to the accusation that the substance of its policy is misguided.For all the moans, many economists reckon that, until recently, the ECB had managed European monetary policy rather better than its critics were willing to acknowledge. There has long been a gap between what the bank has said and what it has done. Thus the ECB’s repeated emphasis on the need to meet its inflation target—below 2%—has often been at odds with decisions to reduce interest rates when inflation was above target. In fact, prices have been rising faster than the target rate for more than half of the ECB’s existence. That has not stopped the bank from reducing interest rates in the past—even if the cuts have not been as frequent or as large as those made by the Federal Reserve, America’s central bank.

Central bankers always find themselves juggling priorities, even when, as in the ECB’s case, they have a clearly defined mandate to focus on a single policy objective. The Fed is legally obliged to worry about growth as well as inflation. The ECB is supposed only to ensure price stability as defined by its own governing board. In practice, though, the ECB has shown itself ready to act for other reasons: in September 2001, for instance, it joined the Fed in cutting interest rates in an effort to restore confidence to the financial markets. Public comments from Mr Duisenberg and other ECB officials have underlined how concerned they are about sluggish growth in the euro area—though speaking after this week’s rate cut, Mr Duisenberg said the main driving force for recovery would have to be a restoration of confidence. He made it clear that the ECB stood ready to “act decisively” if global uncertainty made that necessary.

But the context in which the ECB takes its decisions is rather different to that in which the Fed operates—and that, say the critics, is one of the problems. The ECB is a supranational organisation. Mindful of the problems that could result from exposing differences among national members of the governing board, the ECB prefers to operate by consensus.
Source: The Economist

Saturday, March 01, 2003

The Durably Deflationary World

Now Morgan Stanley's Eric Chaney argues the point: Europe is risking a very close call with generalised deflation. Top of the 'at risk' list: Germany. Gee, their boss, Stephen Roach, is really getting through to them.

From 1973 to the late-1990s, a popular macro game between industrialised economies was to export inflationist pressures. The strong-dollar policy in the Reagan period and also during the Rubin one, and the strong Deutsche Mark policy in the boom years that accompanied the German unification were textbook examples of this not really zero-sum game. Nowadays, in a durably deflationary world, the game is different. Its name is "exporting deflation" and I am afraid that Europe could be on the wrong side, this time. The analytical case is three-folded. First, the euro is already non-competitive, on a unit labour cost basis. This is particularly flagrant for Germany. Second, three years of sub-par growth have widened and continue to widen considerably the output gap. Third, the euro might rise even higher, if the US economy does not recover convincingly and oil prices stay high.

In other terms, even at 95 cents, the euro was slightly overvalued, from a pure productivity-adjusted costs standpoint. Euroland manufacturers could have lived with that. For a region where restructuring is a compelling necessity, a 10% over-valuation of the currency is not that bad, in our view. But at today's rate, 107, Euroland relative labour costs (ULCs) stand at 123. A 20% to 25% over-evaluation of the currency is clearly excessive for a sector already in recession. Put simply, it is deflationary for Europe. Note that, for Germany alone, things are much worse: on the same estimates, German ULCs are now 38% higher than US ones.

As the decline of the US dollar carries on — the US currency is only half-way on its way down, according to my colleague Stephen Jen — the situation will get even worse if the euro is the only counterpart to bear the burden of the rebalancing of the US economy. Well, it seems that this is the case, since most Asian currencies are practically linked to the USD. Using the weights used by the Fed for its own currency basket, it appears that a 10% effective depreciation of the USD would require a 50% rise of the EUR/USD rate. If only half of this is behind us, there is more pain coming for Europe. In addition, it seems that the well-established correlation between oil prices and the USD exchange rate is now inverted and that, practically, the euro has now taken the status of "petro-currency." Just imagine what would happen if crude oil prices stayed around $40 for some time. As the US and Asia export their own internal deflation risks, Europe seems to be the main recipient of this poisoned calice. Has Europe the means to absorb deflation? The answer is clearly negative, given the still very high rigidities most regional labour markets suffer from.
Source: Morgan Stanley Global Economic Forum