(Oct. 7, 2009 - Erwan Mahe) I will begin with Germany, which this morning published industrial orders for August: Total factory demand increased 1.4%, bringing the annual decline to 21.1%.
We found capital goods and consumer goods orders, which I have represented in the graph, below, to be the most interesting aspect of this publication.
Observe the glaring difference in behaviour between these two sub-indices.
Capital goods orders, the driver of a mercantilist German economy, nose-dived 42.50% between June 2007 and February 2009, bringing them to their level of 1998-1999 (Lost Decade, anyone?).
Since February, they have climbed 15%, which is significant, but they are still in the lows of 2000/2003.
However, I find the behaviour of basic goods particularly worrisome.
After plunging 26%, they rebounded 6.30%, and then lost more than half their gain, pointing in a much less favourable direction.
This situation is terrifying, considering that Germany seemed to have best limited the impact of the recession on households among G7 nations via its system of Kurzarbeit, which kept otherwise redundant staff on company payrolls, with the government picking up the financial tab!
All this is fairly consistent with our macro scenario for the euro-saxon zone which we believe will find it just as hard to shift from an export-dependent system to one centred on household consumption, much like the Chinese will continue having a hard time exporting their bras to the United States.
Oops, sorry for the lapse: I forgot that Mr Weber assured us that there is no deflationist risk in Europe.
Capital & Consumer Goods Manufacturing Orders, Germany
And now, the case of Latvia.
I have purposely avoided examining too directly the problems of the Baltic countries, since it seemed to me that their economic weight on the eurozone made their situation a fairly straightforward matter.
Those who have so ardently persistently emphasised the collapse of these countries’ (real) economy mainly wanted to highlight the fragility of European construction so as to advise betting on the widening of sovereign debt spreads within the eurozone, a view which runs counter to our core scenario (‘Thaler's Corner 09-04-09: Austria panics, the ‘E’CB will crack’).
I am dealing with this issue today because the events of recent days in the Baltics dove-tails perfectly with our analysis of the Debt Deflation process (sorry), which we have been closely monitoring for some time now.
Latvia is still in the negotiations phase of the €7.5bn in loan package proposed late last year by the IMF to the country and its neighbours, including Sweden, whose banks are highly exposed to mortgage loans in the region.
Lenders are demanding that Latvian officials make even deeper budget cuts than those already approved.
The country’s main problem is that the loans granted in the midst of the real estate bubble are just not recoverable, given the hike in unemployment and the decline in economic activity (GDP estimated -18% in 2009) in traditional sectors (e.g. shipping)!
Most of these loans were denominated in euros, which enabled the country to benefit from “risk-free” rates, since the Latvian currency is pegged to the euro!
However, given that the only viable macroeconomic solution for this country is to let its currency float against the euro, the problem is how to make this move without completing suffocating domestic borrowers?
Presto, the Latvian parliament thinks it has found the miracle solution:
transform Latvian mortgages into US style loans, meaning that lending institutions (mostly Swedish banks) will no longer be able to recover more than the market value of outstanding loan principal.
Called Jingle Mail in the US, this approach allows the borrower to abandon his house and mail the keys back to the creditor because the mortgage is worth more than the house itself.
Given that housing prices have already shrunk 70%, you don’t need to be a social scientist to understand how Latvian households will respond, if this bill passes, especially since it contains a provision barring banks from foreclosing on these properties without first find their occupants decent alternative housing!
As such, the consequences of this bill could be hard indeed for the concerned banks some of whom hope that the legislative measure is simply a manoeuvre to improve the country’s position in the current international bank negotiations.
Otherwise, if combined with now possible currency devaluation, such a law could lead to consequences on the eurozone periphery that could be hard to manage.
No change in our investment focus: positive bias toward government debt instruments, especially, on the eurozone 5-10 year segment, which benefits from the ECB's credibility.
With each market rebound, we can see the might of end buyers, who feel suffocated by 0% interest rates, and who will therefore continue to prop up stock indices for a while longer whenever they shows signs of weakness.