PMIs and ponzies

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The weakness of the Chinese and European (flash May) PMIs tells an interesting Macro story. With a bit of imagination, it is possible to see hints that the European recession is showing up in China. From there, the next step is for it to show up as lower demand for Australian Exports – and hence lower (or slower) investment demand, and therefore slower Australian GDP growth.

In May, the headline Chinese Manu PMI declined a modest 0.6pts to 48.7pts, making the seventh consecutive month below the break-even level of 50. The detail was poor, with supplier delivery times shortening (typically a sign that there are fewer other customers who are ordering products), stocks of finished goods rising, and new orders declining.

My conjecture is that at least some of the weakness on the new orders side is due to weak final demand due to the recession in Europe. The concurrent weakness of new export orders is a key part of this judgement. 

It makes sense that Chinese export orders would be slow. Europe is China’s largest trading partner, and business is slow in Europe (and has been slowing for some time). Consistent with this, employment prospects have been weak – and weakening – in Europe.

This is exactly the sort of environment in which one would expect to see an increase in household saving – and my conjecture (it will be a few months before we have the trade data) is that declining final demand in Europe is also playing a part in the slow-down in new export orders for the Chinese manufacturing sector.

I judge that it is this slow-down that will feed through to Australia, via lower investment plans: we have started to see this, but I expect that there will be more high-profile cancellations (Olympic Dam, for example, seems unlikely to go ahead).

If sustained, the EUR Composite PMI is consistent with European GDP contracting by ~0.75%q/q in Q2. With no resolution in sight, and monetary policy already maxed out, it’s easy to see a 2% contraction in 2012.

German PMIs are consistent with only a modest pace of contraction, however the PMIs suggest a much more severe contraction in the rest of Europe.

Note, this is no longer just the periphery – pretty much all of Europe, except Germany, looks very weak.

Most surprising to me is the recently terrible performance of France. The PMI suggests a pace of contraction of ~0.75%q/q …

If this is the case, France will soon be downgraded once again (S&P cut them to AA+ with a negative outlook in Jan’12, and Moody’s has them AAA / negative).

Other Sovereigns, such as Belgium (AA / negative) and the netherlands (AAA / negative) are also likely to be downgraded.

Further downgrades to France and other ‘better quality’ European Sovereigns will reduce the operational capability of the various ‘firewall’ mechanisms. To a greater or lessor extent, these mechanisms depend on the ability to issue bonds to raise ‘firewall’ capital. Without an AAA rating, the bozooka is going to be short a bit of ammo.

In my view, European credit’s achilles is now the growth problem. Without growth, they have unstable debt dynamics, because they have primary deficits (for the most part) and must pay high interest rates. The Austerity required to retain their credit ratings, and hence market access, is reducing growth – as the uncertainty surrounding the EUR’s future is making firms too nervous to take risk and fill the space left by the contracting public (and finance and property) sectors.

The high level of yields, and the recessionary growth outlook, means that Italian and Spanish debt dynamics may be already unstable.

The best we can hope for now is that Greece defaults (again) but does not leave the EUR – so that we merely get a severe credit crunch. In that case, we merely have a nasty European recession, rather than a financial crisis – but at these yields, Spanish and Italian debt dynamics are probably already on an unstable path, even if there is no crisis.


  1. How about convincing the Krauts they should have say 4% inflation for a while?

    At worst the counties could increase the VAT of their countries and cut their payroll tax which would enable an internal devlauation.

    Would necessary labour market changes (and other micro-economic measures) increase growth enough?

    1. I think that changes in the growth rate would have dramatic impacts on sustainability, particularly in italy, where there is lots of scope for catchup growth.

      It would certainly work for Italy, France and Belgium. And maybe for Spain – which has low debt to GDP but a large deficit and horrible growth outlook.

      Sent from my iPad

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