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Ad Hoc Commentary

Tuesday April 2nd 2013

Tuesday, April 2nd 2013
USA & EZ: An Ocean Apart Geographically & Economically

In a short note released yesterday we indicated that even though the US ISM reading was 51.3 for March (April 54.2) was lower than the 54 that had been forecast one had to bear in mind that a level greater than 50 signals growth or an expanding base of economic activity. So even if the data was not as sunny as forecast, the US is still steaming ahead. (The note is attached for anyone who missed it.)
Now hop on a Trans-Atlantic flight and look at the the same data point in the Eurozone...what a contrast is revealed by the Markit PMI's for manufacturing.
Eurozone PMI:
 
The downturn in the Eurozone manufacturing sector deepened in March. At 46.8, down from 47.9 in February, the seasonally adjusted Markit Final Eurozone Manufacturing PMI fell to reach a three month low and has now remained below the neutral 50.0 mark since August 2011.
Across the single currency area the manufacturing base has contracted at the fastest pace YTD; corporations are suffering from steady declines in new orders, (the 22nd consecutive month). Output fell everywhere in the Eurozone apart from Germany which is at best stagnant. The future is hardly bright as the ratio of New Orders: Finished Inventories fell to a three month low.
 
Looking at the four leading economies of the Eurozone the March and (February) PMI numbers make for harrowing reading.
 
#1 Germany 49.0 (50.3) #2 France 44.0 (43.9) #3 Italy 44.5 (45.8) #4 Spain 44.2 (46.8)
For France the Q1 2013 average is 43.6 the lowest since Q3 2009 at 43.1. The Italian reading is < the 20 month moving average and Spain this was the lowest reading since October 2012; it represented the 23rd successive deterioration of business conditions in the sector.
 
The key takeaway from these data points are that as new orders dry up a vicious circle is building as the demand for new raw materials or semi finished goods is evaporating and hence the lead time for any new order to be completed and delivered is extending. From this simple observation it is clear that there is absolutely no pressure on operating capacity...in fact at its basic level the factors of production, Capital and Labour (K,L) are being heavily under utilised.
 
The Eurozone is suffering a hefty negative output gap as it operates a long way from the production possibility frontier. With national governments so encumbered by high debt; and as the economy stagnates the ratio of Public Debt:GDP is rising, the old traditional pump priming Keynesian tool of increased government expenditure is simply not available.
 
Surely these data points coming as they do in the week when the ECB will meet must open the door for ECB President Mario Draghi to cut the refinancing rate.
 
If the star by which the good ship ECB set its compass bearing is "INFLATION", that star is nowhere to be seen. CPI is 2013 is set to be under 2.0% at 1.9%...now is the time for the ECB to be bold and cut rates and create a disincentive for banks to hold cash balances above the capital adequacy requirements they must adhere to.
  • If rates are not cut this week then the ECB will lose credibility.
  • A little inflation is better than defaltion and depression.
 
By the same token now more than ever is the moment for the elected leaders and the Brussels elite to let rip with supply side policies.
  • There is no future unless we can fix what is broken.
These are desperate times in the Eurozone, but hats off to it it still survives. However, is not correct to liken the single currency to a pattern welded or folded steel blade, rather the quick fixes, extended deadlines and electorally driven manipulations mean that now we have a deepening economic decline the appropriate policy response for each individual nation is either not available (devaluation) or region wide not being enacted (doctrine and dogma).
The world needs a vibrant Eurozone, however, it looks as though the world will have to wait.
Steve
Stephen Pope
Managing Partner ~ Spotlight Ideas
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Twitter: @pope_stephen

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