Tag Archives: inflation

Europhoria No More

In 2011 and 2012, the Eurozone was on the brink of destruction. Investors were preparing for a Greek exit from the Eurozone and some experts were even questioning the very existence of the European Union. However, in two years, much has changed. Today, the possibility of Greece leaving the Eurozone or of Cyprus becoming insolvent seems like a distant memory and after two years of being in recession, the Euro area has finally generated positive growth. The growth is slow, but is nevertheless positive.

How did the Eurozone manage this turnaround? Well, we can all thank the European Central Bank (ECB) for this. In July of 2012, ECB President Mario Draghi announced that the, “ECB would do whatever it takes to preserve the Euro.” In addition with this speech, the ECB extended the maturities on the loans it gave to European banks (called Long Term Refinancing Operations) and announced a new program (called Outright Monetary Transactions) where for the first time, it promised to purchase the sovereign bonds of financially troubled nations, given that they agree to implement certain fiscal reforms (tax hikes, spending cuts, etc.).

The ECB used a tricky monetary maneuver called sterilization to make sure that LTRO didn’t increase the European money supply the way FED’s QE did and until today, no country in the Eurozone has actually applied for a bailout through Outright Monetary Transactions. However, the mere existence of these programs created a sense of security in the Eurozone and they helped reduce the sovereign bond yields of Eurozone nations that had been inflicted by the crisis. For you bond newbies, the lower the interest rate on a bond, the less riskier it is deemed by the market. The graph below does a good job in visualizing Spanish and Italian bond yields in relation with ECB actions.

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In fact, one could argue that the sovereign bond yields of periphery Eurozone countries have dropped too low. For example, on the day that I have written this post, 10-year Spanish government bonds are yielding 2.68% whereas 10-year German bonds are yielding 1.27% . That means that the spread between the country with the highest unemployment rate in the developed world and the safest economy in the Eurozone is less than 2%. Back in August of 2012, that spread was about 6%. Even when Apple issued 10 year bonds in April of this year, their bonds yielded 3.45%. I think its safe to say that the markets have treated periphery Eurozone nations rather kindly.

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Despite the irregularities in the bond markets, its hard to deny that the Eurozone has been in a honeymoon period for the last two years. However I realized that something is rotten in the state of Denmark, France, Italy, Spain, and all the other Eurozone countries (that was a Shakespeare joke. Read a book people). when a couple of months ago, I got a phone call from my good friend Mario Draghi.

Mario Draghi
“Buddy, I need your help with something. Come on over quick. Party at Merkel’s place afterwards.”

Even though I had a very busy schedule, I couldn’t say no to one of my oldest friends. So I decided to take the trip down to Frankfurt. Here I am outside the ECB.

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I’ve lost count of how many times I’ve been there but I still have to go through security. Its so annoying. Anyway; when I walked into his office, Draghi seemed worried. He told me that the Eurozone is on the brink of negative inflation, otherwise know as deflation. The ECB’s target inflation rate has been 2% for the past several years. However, as the graph below shows, Euro area inflation has been below 1% since November of last year. In fact, just last month, several European countries including Greece, Cyprus and Hungary observed negative rates of inflation.

euro-area-inflation-cpi (2)Even those of us who haven’t received an education in economics have been told to fear inflation. However, deflation can be just as bad, if not worse. I’m pretty sure I explained this in a previous post but deflation has two main negative impacts. First of all, deflation discourages spending. Why should a sensible person purchase something today if he knows that it will be cheaper and more affordable tomorrow. This situation might seem profitable for an individual, but if everyone acts this way, then spending will decrease and the economy will come to a halt. Secondly, inflation has the ability to ease the cost of borrowing. Imagine that I take on a loan. Because of inflation, the amount of money I borrowed becomes less valuable. However, the amount that I borrowed stays the same. Thus, it becomes easier for me to pay back my loan. In cases of deflation when a currency gains in value, the exact opposite happens and debt becomes harder to pay off.

Due to the austerity measures installed in many Eurozone countries following the debt crisis, the Eurozone economy is barely expanding. Draghi fears that deflation could push the Eurozone economy back into recession. One of the reasons that Draghi had his hands tied was because he had already lowered interest rates to nearly 0%. Yet, he was failing in spurring inflation. That was where I stepped in to give Draghi some advice. On June 5th, Draghi listened to everything I had to say and held a press conference. The cameraman zoomed in on Draghi so I didn’t make the shot but I was sitting right next to Draghi during the press conference.

Firstly, I realized that European banks were parking their money at the ECB. Thus, I urged Draghi to set the ECB deposit rate to a negative figure. Negative deposit rates can encourage banks to take their money out of the ECB and perhaps lend it to consumers and companies because they would actually be losing money for depositing their cash at the ECB. This would spur growth and much needed inflation. Draghi followed my advice and lowered the deposit rate to -0.1%. He also lowered the headline inflation rate to 0.15% from 0.25%

Secondly, in the final hours of our meeting, we came with an idea to initiate a new financing program called Targeted Long Term Refinancing Operations (TLTRO)  where banks can borrow money from the ECB equivalent to as much as 7 percent of their outstanding loans to non-financial corporations and households. The loans will be given for 4 years. However, if these institutions don’t lend out the money they get from these loans, we will cut their maturities to two years.

Finally, I told Draghi to always have an ace of spades in his back pocket, in case the worst comes to worst. That ace of spades, would be outright bond purchases, just like Quantitative Easing in the US. We came to the conclusion that its better to wait and see how the Eurozone economy reacts to the policies we came up with that day, but letting the markets now that just like back in 2012, we would do whatever it takes to spur inflation in the Eurozone will help increase inflation expectations. Those are the unorthodox policies that Draghi touched on towards the end of his speech. Bond yields are already very low and QE in the United States has shown that bond purchases don’t necessarily spur inflation. However, the idea of bond purchases being a possibility will definitely play a role in protecting the Euro from appreciating.

After working for hours to come up with these policies, we finally called it a night and decided to go to Angela Merkel’s mansion in Berlin for a wild party. It was strictly BYOB. Apparently Merkel is tired of buying everyone drinks. All those bailouts in Southern Europe may be to blame. I can’t tell you what went down in that party. Lets just say that many world leaders wouldn’t want the pictures to leak to the press.

Popping champagne.
This is only the pregame.

Following Draghi’s press conference in June, Eurozone inflation remained stable at 0.5%. Draghi gave me a phone call last week and thanked me for his help. I told him that he owes me one and I gave him one final piece of advice.  I told him to publish the minutes from the ECB meetings, just like the way the FED does them. This would not only give the ECB some much needed transparency but would also increase the effect that his decisions have on market expectations.

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As you can see, my friend Draghi looks awfully cute when he is happy. I hope his happiness continues and that the Eurozone can get out of this deflationary trend soon. In the globalized world that we live in, our economies are extremely interconnected. Thus, the fate of one large economy can have an effect on all of our countries and all of our lives.

“If we do not resolve the euro crisis, we will all pay the price. And if we do resolve it, we will all benefit”
-Mario Draghi

 

 

 

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Economy in Digits – 02/01/2014

In the past couple of weeks I didn’t see any significant economic indicators in the news. However, we got a lot of data over last week.

United States

Driven by the fastest consumer spending in the last three years and a rise in exports, US GDP increased by 3.2% year-over-year in the 4th quarter.The calculations also showed a 1.9% increase in GDP across all of 2013, compared to 2.8% the previous year. The 2013 figures showed that a significant decrease in government spending due to the shutdown in October had dragged GDP figures down when compared to last year. That was of course accompanied by the extreme cold temperatures in the winter which also hampered the economy. However, the numbers are still positive and despite the continuation of tapering by the FED, the US still remains the safest economic harbor right now. As we’ll discuss soon, Emerging Markets are not doing too well right now.

united-states-gdp-growthTurkey and India

Both the Turkish Central Bank and the Indian Central Bank resorted to drastic interest rate hikes. In Turkey, a corruption probe against government officials had led to the resignation of various cabinet ministers. The following levels saw the Turkish Lira lose significant value and brought the Turkish Lira/US Dollar spot rate to unprecedented levels. To stop the devaluation, the Turkish Central Bank sold parts of its foreign reserves but it was to no avail. Finally, the Central Bank had enough and they raised interest rates sharply. The benchmark interest rate was raised from 4.5% to 10% and the over night lending rate was hiked from 7.5% to 12%. Following the rate hike, the Turkish Lira gained 4% against the US dollar. However, the crisis is yet to be averted. Even though the Lira gained in value after the Central Bank’s decision, the sell off creeped in again. This decision is surely to slow Turkish economic growth and that could prove crucial to determining the outcome of the upcoming local elections in March.

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On to India, another country that required a rate hike this past week. As I stated in an earlier post, India is struggling with high inflation and lackluster growth and just like Turkey, they will be having elections this year. However, the Indian Central Bank let everyone know that they are serious about battling inflation when they increased the repo rate by a quarter point to 8% and announced that they plan to reduce the inflation rate to 6% by 2016. As you can see from the graph below, the latest inflation figure in India is over 11%.

indiainflationGreat Britain

Another GDP figure came from Great Britain as GDP growth was announced to be 0.7% in the 4th quarter of 2013 and by 1.9% in 2013 overall.That figure might seem as slow as Shaq running down a basketball court however that is the fastest growing quarter that Great Britain has had since the 2008 economic crisis. The main force behind the growth was the services and the manufacturing sectors and evidences that slowly, eventually and oh so gradually, the British economy is picking itself up.

Historical Data Chart

EU

The Eurozone had been battling a rather unfamiliar problem, deflation, which is the opposite of inflation. To battle the deflation, the European Central Bank had decided to lower interest rates last month. However, we got new inflation figures from the Eurozone which don’t look so bright. Consumer price inflation across the Eurozone fell from 0.8% in December to 0.7% in January.. Even though the worst of the European debt crisis is behind us, deflation means that firms and individuals are more likely to hold off on spending money until the future, which could take a toll on growth. Even though I see it to be unlikely, European Central Bank officials stated that if matters get worse, they could resort to negative deposit rates for banks’ deposits at the European Central Bank.

Historical Data Chart

That was what made economic headlines this week. Stay tuned for more economic news in Economy in Digits in the following weeks.

“Economics is extremely useful as a form of employment for economists.”
-John Kenneth Galbraith

The Economy in Digits – 01/04/2014

Here are the economic highlights from the week ending January 4th.

Spain

Spanish unemployment fell by 107,570 in the month of December, decreasing the total number of unemployed in the Iberian nation to 4.7 million. With this boost from the December numbers, unemployment in 2013 as a whole decreased by 147,385. That makes 2013 the first year since 2007 in which Spanish unemployment decreased over the calendar year. Spain’s economy, which paid a heavy toll during the European debt crisis, has also been battling with record high unemployment. As of October 2013, Spain’s general unemployment rate sits at 26.7% and its youth unemployment is over 50%.

spain-unemployment-rateEven though the recent spike in employment could be related to temporary hiring during Christmas, it still provides a glimmer of hope that the worst of Spain’s economic crisis is behind them. Maybe they can now run away from their bulls with slightly less angst.

Turkey

The annual inflation rate (as measured by the Consumer Price Index) in Turkey for 2013 was 7.4%. Earlier in the year, the Turkish Central Bank had set a target rate of 6.8% for 2013. However, rising global oil prices and a fall in the Turkish Lira due to political instability throughout the year has caused inflation to exceed expectations.

turkey-inflation-cpiHigh inflation proves especially worrisome for Turkey, as it is also trying to bring its current account deficit under control. Turkish current account deficit currently sits at 6.1% of GDP and a loss in the value of the Lira makes that deficit even harder to lower. Ideally, the Turkish Central Bank should raise interest rates to battle this inflation . However, Turkey will hold local elections in March and it appears that the Central Bank will not play a very active role in the economy until the Turks go to the polls.

“Economics is extremely useful as a form of employment for economists.”
-John Kenneth Galbraith

The Economy in Digits – 12/21/2013

Welcome to Economy in Digits, my new weekly segment that briefly covers significant economic indicators released in the past 7 days. Initially, I didn’t want to write a post for every single indicator that makes the headlines. That would mean that I would have to bombard this blog with post after post of statistical data, which is not why I created this blog. I created it in order to inform my readers about significant global issues AND also keep it interesting and enjoyable at the same time. However, economic indicators are significant and sometimes we receive data that hints where a nation’s economy is headed. Thus, I decided to sum up indicators released in the prior week in a single post.

United States

In the United States, November industrial production, which measures output in the utilities, mining and manufacturing sectors rose 1.1% from the prior month. That was the biggest increase over the last year and brought total US industrial output to its pre-recession levels. The manufacturing sector increase 2.9% from a year earlier thank to rising automobile sales. Meanwhile, the utilities sector expanded by 3.9% due to increased demand in the winter for heating and output in the mining sector increased by 1.7% as several oil rigs that were closed last month due to tropical storm Karen reopened. The graph below depicts total US industrial output for the last 10 years.

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Again in the United States, 3rd quarter GDP growth rates, was revised upward from its initial figure of 3.6% to 4.1% from a year earlier.The revision came mostly due to the adjusted increase in consumer purchases. The graph below depicts quarterly US GDP growth rate over the past 10 years.

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Both the industrial production and the revised GDP figures prove that the American economy is hastening on the road to recovery. The fact that these figures are coming out shortly after a period of fiscal instability is also impressive. However, we also have to see the effects tapering of QE by the FED will have on the economy.

Japan

Despite the push by Prime Minister Shinzo Abe to devalue the Yen and drive exports up, Japan’s trade deficit increased as exports fell by 0.2% and imports rose by 3.5% month on month. When a nation devalues its currency, its exports are supposed to increase and its imports are supposed to decrease. However, there are two possible reasons for Japan’s widening trade deficit. The first reason is due to a concept in economics called the J-Curve, which states that devaluing a national currency will initially increase the trade deficit because trade contracts set in place cannot be adjusted during the short run. Once old contracts are expired or cancelled, new trade agreements will be made given the devalued currency. Another possible reason for Japan’s trade deficit is that Japan closed almost all of its nuclear power plants following the Fukushima disaster in 2011. Thus, Japan imports almost all of its energy now. A devalued currency means that Japan must now pay more to import its energy from abroad.

United Kingdom

In the UK, inflation fell to 2.1% from 2.2% last month due to steady food and energy prices, which bring the figure to its lowest since November 2009. Just two days later, it was also announced that the unemployment figure in the third quarter fell to 7.4%, down from 7.7% in the second quarter. Following the recession, the Bank of England promised to leave interest rates at record low levels until unemployment dropped to 7% and promised to bring inflation down to 2%. Over the past few years, it was failing to achieve both targets. But these two indicators prove that the UK economy is improving and is nearing its twin targets. If inflation and growth follow the same trajectory, we could see a hike in interest rates by the BOE sometime in 2014.

India

In India, wholesale inflation increased by 7.52% from a year earlier, compared to a 7% increase in October. The expected rate by a survey of economists was 7%. Inflation is becoming a serious issue in India where consumer prices also increased by 11%  last month from a year earlier. An even bigger problem is that inflation is being coupled with a slowdown in growth. The RBI predicts India’s economy will expand 5 percent in the 12 months through March 31st, the same pace as the last fiscal year, which was the weakest in a decade. If the RBI hikes interest rates to battle inflation, they will reduce the GDP growth rate even further. High inflation and weak growth can only mean one thing. STAGFLATION

That is all for this week. Tune in next Saturday for the upcoming week’s economic indicators.

Economics is a subject that does not greatly respect one’s wishes
-Nikita Khrushchev