Untill September, the order books of German Manufacturers (which can be considered the motor of the European economy) were still strong, the European Industrial Production showed monthly ups and downs -at least as many ups as downs-, the inflation was mainly due to factors that end-customers could ultimately control, and the financial crisis I thought was a good opportunity to get rid of certain excesses that characterized the Financial sector for quite a while.
I was not blind to the effect the Financial crisis could have on the 'real economy': tighter lending criteria would ultimately affect non-financial companies as well. But looking at the official figures from the European Central Bank (ECB) on the total amount of loans outstanding, both by corporations and citizens, one could only conclude that there was no effect at all, in other words: that there was no ‘Credit Crunch’ at all in Europe and that the financial crisis had only a limited effect on the ‘real economy’.
Well, given the latest figures released this month, I must admit I was wrong !
The figures in this table show the growth in terms of GDP Volume, basically measuring what has been produced and consumed, rather than the value of it.
Still, this table shows a 2 quarter consecutive decline of economic activity for a number of European countries: Germany, Italy and Sweden. Other countries don’t look in good shape neither.
So what happened ?
Starting in October, we started to see a huge amount of negative news from non-financial companies, as if they all waited for the same moment to bring negative news out. Substantial lay-offs, (temporary) factory closures, profit warnings, they all made the news headlines since then.
As often, this mechanism is self-feeding: if you look at the company financials as stated in their last Financial reports, one can see that most of them remain in solid financial health. The actions undertook by most of those companies are pre-emptive, preparing for a future that appears to be gloomy, because everybody is preparing for such a gloomy future.
For sure, there are some concrete negative trends affecting specific companies and industries at large. Consumer spending is declining, which has an effect on most Retail Companies; Industrial production is put on hold, which in turn has an impact on the order books of Machinery Manufacturers; etc.
But again, looking at financial statements of companies in each industry, you see a very mixed view, with some companies clearly suffering from the downturn, others being able to sustain or even grow substantially. With the exception of certain industries like Car Manufacturers or –obviously- the Financial Industry, there doesn’t seem to be an industry-wide trend affecting all the companies in it.
Where is this all heading ?
To put it quite bluntly: I don't think anybody knows.
Looking at all the predictions from bright economists from the IMF, the OECD, Eurostat, EIU (Economist Intelligence Unit) of the last year, going from a mild, short-lived recession that wouldn’t impact Europe or the Emerging Markets, to a ‘double dip’ scenario for the US, none of the scenario’s has materialized.
Back in March, everybody was certain that the US were going through a serious recession in Q2 –at least all the leading indicators pointed to that direction. In June, when the actual figures were released, the US economy appeared to have grown twice as fast as the European economy. And now, economists are telling us that the US is in a recession since Q4 last year !
My personal feeling is that we are dealing with a number of key uncertainties in the current environment. Each of these uncertainties is complicating any forecasting model in its own way, but the combination of these key uncertainties –and the way each of them has moved in recent months- has put the level of complexity and doubt to an unprecedented level –one that no econometric model can currently cope with.
To highlight just a couple of those key uncertainties:
1. If it happens, this would be the first truly global recession ever.
While this would certainly not be the first serious recession ever, the one that everybody is announcing now might become the first ever global recession. As shown on the long term GDP trend from IMF, in the past the major countries have shown some different growth patterns.
Take the ’93 recession as an example. You will see from the chart that, while the biggest European Countries –and Western Europe as a whole- dipped at the same time, the UK was recovering strongly from a serious recession in ’91, and the Worldwide economy was at the verge of an exponential growth that would last until ’97 !
Compare this with the projected situation of 2009, you will see that all the economies are expected to experience the same dip, at the same scale, and the same length.
We can model what might happen in such a scenario, but we cannot know for sure due to a lack of experience with it.
2. Where is the bottom of the Financial Crisis ?
Here again, nobody really knows. True, governments all over the world are maximizing their efforts to save(mostly their own country’s) financial institutions from a ‘worst case scenario’. But the effectiveness of those actions still needs to be proved.
By injecting cash on the balance sheets of banks, or by guaranteeing the deposits as well as their new lending, governments are certainly taking the right actions, but will it pay-off ?
In modern banking –and this is where the crisis began- trust is the real currency that matters. Banks all over the world used to lend –sometimes overnight- huge amounts of money to each other, without really knowing what that money was used for –normally this money is crucial for sustaining the core activities of a bank, but in recent times it was also used to invest in risky equities.
With the balance sheets of banks starting to look faulty, that trust –and the money it bought- quickly evaporated. So the Million Dollar question now is: will the government money on the balance sheets be sufficient to restore trust ?
My guess: it won’t, just as long as there is no worldwide regulation limiting the use of ‘interbanking’ loans, or at least an obligation to tell where that money will be used for.
3. Will Keynes work in the current world ?
Hard to imagine, but John Maynard Keynes is back in business. 62 years after his death, he’s headlining newspapers and magazines. All for good reasons, his medicine for recession was successful in the past, and is currently implemented by most major countries: invest in public infrastructure, job-creation, low-skill industries… all to make sure a maximum amount of people keep on working… and spending…
This worked well in the past, but it’s not quite certain whether it will work in the current world, for two major reasons:
First, in the globalized world each industry is internationally fragmented, there is no such thing as a ‘national champion industry’ to protect or save by injecting money into anymore. Even the traditional activities that are subject to the Keynes medicine, like construction or infrastructure projects, are dependent on the worldwide markets. So any money the governments poor into such an industry, will ultimately benefit the economies of other countries as well –though it’s very hard to tell to what extend it will.
Secondly, the European governments are drawing quite some different conclusions from the Keynes doctrine. By lacking to understand the global scope of their industries and their challenges, and by engineering plans that lack coherence throughout the European countries, national governments might be poring money into an endless hole.
What to take from all this ?
My stance here is to show that in the current environment no prediction holds the ultimate truth. Despite all the alarming news and dramatic statements, the situation might as well turn favorably quite soon. Never forget that a lot of economic constituents are benefiting from chaos and panic…
Since the beginning of the financial crisis –almost a year ago- I had the feeling that this would be a period to which, in a year or two from now, we’ll look back and ask ourselves ‘what was all this fuzz about’. But then, we all know that people (including myself) have short memories.
And then again, this is just one likely scenario.
The key message is: no panic ! This is NOT a complete meltdown of the economy, this is NOT a return to the dark ages, this is NOT a situation comparable to the big crisis of the '30ies of last century. This IS a crisis, for sure, but it is a crisis like we've been trough in the past, and though the impact of certain factors are unknown, we do have the knowledge and the tools to cope with the current situation.
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