World manufacturing picture

The collapse of manufacturing | The Economist

The collapse of manufacturing

Feb 19th 2009
From The Economist print edition
The financial crisis has created an industrial crisis. What should governments do about it?



$0.00, not counting fuel and handling: that is the cheapest quote right now if you want to ship a container from southern China to Europe. Back in the summer of 2007 the shipper would have charged $1,400. Half-empty freighters are just one sign of a worldwide collapse in manufacturing. In Germany December’s machine-tool orders were 40% lower than a year earlier. Half of China’s 9,000 or so toy exporters have gone bust. Taiwan’s shipments of notebook computers fell by a third in the month of January. The number of cars being assembled in America was 60% below January 2008.

The destructive global power of the financial crisis became clear last year. The immensity of the manufacturing crisis is still sinking in, largely because it is seen in national terms—indeed, often nationalistic ones. In fact manufacturing is also caught up in a global whirlwind.
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Industrial production fell in the latest three months by 3.6% and 4.4% respectively in America and Britain (equivalent to annual declines of 13.8% and 16.4%). Some locals blame that on Wall Street and the City. But the collapse is much worse in countries more dependent on manufacturing exports, which have come to rely on consumers in debtor countries. Germany’s industrial production in the fourth quarter fell by 6.8%; Taiwan’s by 21.7%; Japan’s by 12%—which helps to explain why GDP is falling even faster there than it did in the early 1990s (see article). Industrial production is volatile, but the world has not seen a contraction like this since the first oil shock in the 1970s—and even that was not so widespread. Industry is collapsing in eastern Europe, as it is in Brazil, Malaysia and Turkey. Thousands of factories in southern China are now abandoned. Their workers went home to the countryside for the new year in January. Millions never came back (see article).
Factories floored

Having bailed out the financial system, governments are now being called on to save industry, too. Next to scheming bankers, factory workers look positively deserving. Manufacturing is still a big employer and it tends to be a very visible one, concentrated in places like Detroit, Stuttgart and Guangzhou. The failure of a famous manufacturer like General Motors (GM) would be a severe blow to people’s faith in their own prospects when a lack of confidence is already dragging down the economy. So surely it is right to give industry special support?

Despite manufacturing’s woes, the answer is no. There are no painless choices, but industrial aid suffers from two big drawbacks. One is that government programmes, which are slow to design and amend, are too cumbersome to deal with the varied, constantly changing difficulties of the world’s manufacturing industries. Part of the problem has been a drying-up of trade finance. Nobody knows how long that will last. Another part has come as firms have run down their inventories (in China some of these were stockpiles amassed before the Beijing Olympics). The inventory effect should be temporary, but, again, nobody knows how big or lasting it will be.

The other drawback is that sectoral aid does not address the underlying cause of the crisis—a fall in demand, not just for manufactured goods, but for everything. Because there is too much capacity (far too much in the car industry), some businesses must close however much aid the government pumps in. How can governments know which firms to save or the “right” size of any industry? That is for consumers to decide. Giving money to the industries with the loudest voices and cleverest lobbyists would be unjust and wasteful. Shifting demand to the fortunate sector that has won aid from the unfortunate one that has not will only exacerbate the upheaval. One country’s preference for a given industry risks provoking a protectionist backlash abroad and will slow the long-run growth rate at home by locking up resources in inefficient firms.
Nothing to lose but their supply chains

Some say that manufacturing is special, because the rest of the economy depends on it. In fact, the economy is more like a network in which everything is connected to everything else, and in which every producer is also a consumer. The important distinction is not between manufacturing and services, but between productive and unproductive jobs.

Some manufacturers accept that, but proceed immediately to another argument: that the current crisis is needlessly endangering productive, highly skilled manufacturing jobs. Nowadays each link in the supply chain depends on all the others. Carmakers cite GM’s new Camaro, threatened after a firm that makes moulded-plastic parts went bankrupt. The car industry argues that the loss of GM itself would permanently wreck the North American supply chain (see article). Aid, they say, can save good firms to fight another day.

Although some supply chains have choke points, that is a weak general argument for sectoral aid. As a rule, suppliers with several customers, and customers with several suppliers, should be more resilient than if they were a dependent captive of a large group. The evidence from China is that today’s lack of demand creates the spare capacity that allows customers to find a new supplier quickly if theirs goes out of business. When that is hard, because a parts supplier is highly specialised, say, good management is likely to be more effective than state aid. The best firms monitor their vital suppliers closely and buy parts from more than one source, even if it costs money. In the extreme, firms can support vulnerable suppliers by helping them raise cash or by investing in them.

If sectoral aid is wasteful, why then save the banking system? Not for the sake of the bankers, certainly; nor because state aid will create an efficient financial industry. Even flawed bank rescues and stimulus plans, like the one Barack Obama signed into law this week, are aimed at the roots of the economy’s problems: saving the banks, no matter how undeserving they are, is supposed to keep finance flowing to all firms; fiscal stimulus is supposed to lift demand across the board. As manufacturing collapses, governments should not fiddle with sectoral plans. Their proper task is broader but no less urgent: to get on with spending and with freeing up finance.

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China keeps going down

China nears deflation trap as rail freight collapses - Telegraph

China nears deflation trap as rail freight collapses
Railway freight in China’s Shanghai region plunged 31pc in January and industrial production fell 12pc, dashing hopes that Beijing’s stimulus policies will soon begin to fuel recovery.


By Ambrose Evans-Pritchard


The country’s central bank said the economic outlook was going to bad to worse was still gathering pace, rains the risk that China could tip into a Japan-style deflation trap.

“External demand is shrinking, some sectors have overcapacity, and urban unemployment is rising. Downward pressure on economic growth is increasing. There exists a big risk of deflation,” said the bank. Factory gate inflation has dropped to minus 3.3pc.

“We will use various tools, including interest rates and banks’ reserve requirement ratios, to ensure reasonable monetary and credit growth,” it said. The bank has cut interest rates and relaxed credit rules fives times since September.

China’s economy continued to eke out headline growth of 6.8pc in the fourth quarter of 2008 but all the rise was in the early part of the year. On a month-to-month basis the economy has been flat for several months, and may even have started to contract. Electricity use has fallen sharply

The Shanghai industrial data is being watched closely as a proxy for the country since there is no nationwide data for January owing to the Lunar New Year. The output fall is adjusted for the holidays. The fall in absolute terms was 21pc, year-on-year.

The figures tally with the catastrophic drop in exports from Japan, Korea, Taiwan, and Singapore over the last three months. These countries are an integral part of the supply chain for Chinese industry.

Taiwan said yesterday that export orders to China fell 55pc in January, suggesting that Asian trade will remain trapped in depression deep into Spring. The fall in total orders was 41pc, while industrial output fell 43pc.

Separately, Japan’s finance minister Kaoru Yosano said Tokyo is examining plans to a special body to buy shares in banks to help shore up the stock market after the Nikkei index fell to a 26-year low.

“Excessive stock falls are undesirable. The government will consider what it can do if stock prices fall too much,” he said.

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US Home prices

RGE Monitor

# The S&P/Case-Shiller Index fell 18.5% y/y in Dec-08, (fastest on record) driven by climbing foreclosures and declining home sales. All 20 cities covered in the survey showed a decrease in prices, with 8 of the 20 areas showing record rates of annual decline in excess of 20% y/y.
# As of Dec 2008, average home prices are at similar levels to what they were in Q1 2004. From their peak in mid-2006, the 10-City Composite is down 28.3% and the 20-City Composite is down 27%.
# Q4 2008: The decline in the S&P/Case-Shiller U.S. National Home Price Index recorded an 18.2% decline in Q4 2008 versus Q3 2008, largest in the series' history. This has increased from the annual declines of 16.6% and 15.1%, reported for the Q3 and Q2 2008, respectively.
# Kiesel: U.S. housing prices, despite having fallen roughly 20% from their peak back in the second quarter of 2006, remain 10%–15% overvalued based on long-term historical measures such as price-to-income, price-to-rent and price-to-economic growth. In addition, total new and existing inventories of 4.7 million units are higher now than at the beginning of the year, and roughly 12 million homes are now in a negative equity position in which homeowners owe more on their mortgage than the home is worth. More challenging credit markets also mean fewer potential buyers. As a result, in terms of housing’s total peak-to-trough decline, a 30%–35% total decline from peak now looks possible
# RGE Monitor: based on a range of indicators (real home price index by Shiller 2006, price rent ratio and price/income ratio) the fall in home prices from their peak will be in the 30-40% range
# CEPR: Nominal prices have now declined 19.5 percent from their peak two years ago, which implies a real decline of approximately 27 percent. This means that the bubble is approximately 60 percent deflated. This corresponds to a loss of more than $5 trillion in real housing wealth
# OFHEO index fell 0.6% m/m in July and it is down 5.3% on a y/y basis. This is the sharpest decline for this cycle and on record
# Fitch (via Calculated Risk): expecting home prices to decline by an average of 25 percent in real terms at the national level over the next five years, starting from the Q2 2008
# Wachovia:the S&P/Case-Shiller 10-city composite index will fall 28.6% on a peak-to-trough basis. OFHEO purchase only index will decline around 22%
# IMF: the baseline scenario for the U.S. economy assumes a 14–22% drop in house prices during 2007–08
# PMI Group: U.S. home price declines will probably double to a national average of 20 percent by next year, with lower values most likely in metropolitan areas in California, Florida, Arizona and Nevada
# Krugman: My preferred metric is the ratio of home prices to rental rates. By that measure, average home prices nationally got way too high. We'll probably basically retrace all that. So that's about a 25% decline in overall home prices (CNN)
# Davis, Lehnert and Martin: prices would have to fall 15% over five years - assuming rents rose 4% a year - to bring rent/price ratio back to its long-term average
# Goldman Sachs (Calculated Risk): Home prices to fall 15% w/o recession and 30% in case of a recession
# Shiller: home prices to fall up to 50% in some areas

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Deflation first, then inflation

Irving Fisher, the forgotten economist | Out of Keynes's shadow | The Economist

Irving Fisher
Out of Keynes's shadow

Feb 12th 2009 | WASHINGTON, DC
From The Economist print edition
Today’s crisis has given new relevance to the ideas of another great economist of the Depression era



SHORTLY after he was elected president, Barack Obama sounded a warning: “We are facing an economic crisis of historic proportions…We now risk falling into a deflationary spiral that could increase our massive debt even further.” The address evoked not just the horror of the Depression, but one of the era’s most important thinkers: Irving Fisher.

Though once America’s most famous economist, Fisher is now almost forgotten by the public. If he is remembered, it is usually for perhaps the worst stockmarket call in history. In October 1929 he declared that stocks had reached a “permanently high plateau”. Today it is John Maynard Keynes, his British contemporary, who is cited, debated and followed. Yet Fisher laid the foundation for much of modern monetary economics; Keynes called Fisher the “great-grandparent” of his own theories on how monetary forces influenced the real economy. (They first met in London in 1912 and reportedly got along well.)

As parallels to the 1930s multiply, Fisher is relevant again. As it was then, the United States is now awash in debt. No matter that it is mostly “inside” or “internal” debt—owed by Americans to other Americans. As the underlying collateral declines in value and incomes shrink, the real burden of debt rises. Debts go bad, weakening banks, forcing asset sales and driving prices down further. Fisher showed how such a spiral could turn mere busts into depressions. In 1933 he wrote:

Over investment and over speculation are often important; but they would have far less serious results were they not conducted with borrowed money. The very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate…the more debtors pay, the more they owe. The more the economic boat tips, the more it tends to tip.

Though they seldom invoke Fisher, policymakers in America are applying his ideas. In academia Ben Bernanke, now the chairman of the Federal Reserve, sought to formalise Fisher’s debt-deflation theory. His research has shaped his response to this crisis. He decided to bail out Bear Stearns in March 2008 partly so that a sudden liquidation of the investment bank’s positions did not trigger a cycle of falling asset prices and default. Indeed, some say the Fed has learnt Fisher too well: from 2001 to 2004, to contain the deflationary shock waves of the tech-stock collapse, it kept interest rates low and thus helped to inflate a new bubble, in property.

Were Fisher alive today, “he would tell us we have to avoid deflation, and to worry about all that inside debt,” says Robert Dimand, an economist at Brock University in Canada, who has studied Fisher in depth. “The ideal thing is to avoid these situations. Unfortunately, we are in one.”

Fisher was born in 1867 and earned his PhD from Yale in 1891. In 1898 he nearly died of tuberculosis, an experience that turned him into a lifelong crusader for diet, fresh air, Prohibition and public health. For a while he also promoted eugenics. His causes, both healthy and repugnant, combined with a lack of humour and high self-regard, did not make him popular.

In 1894, on a trip to Switzerland, he saw, in water cascading into mountain pools, a way to “define precisely the relationships among wealth, capital, interest and income,” Robert Loring Allen, a biographer of Fisher, wrote. “The flowing water, moving into the pool at a certain volume per unit of time, was income. The pool, a given volume of water at a particular moment, became capital.” Over the next 30 years he established many of the central concepts of financial economics.

In 1911, in “The Purchasing Power of Money”, Fisher formalised the quantity theory of money, which holds that the supply of money times its velocity—the rate at which a dollar circulates through the market—is equal to output multiplied by the price level. Perhaps more important, he explained how changing velocity and prices could cause real interest rates to deviate from nominal ones. In this way, monetary forces could produce booms and busts, although they had no long-run effect on output. Furthermore, Fisher held that the dollar’s value should be maintained relative not to gold but to a basket of commodities, making him the spiritual father of all modern central banks that target price stability.

During the 1920s Fisher became rich from the invention and sale of a card-index system. He used the money to buy stocks on margin, and by 1929 was worth $10m. He was also a prominent financial guru. Alas, two weeks after he saw the “plateau” the stockmarket crashed.

To his cost, Fisher remained optimistic as the Depression wore on. He lost his fortune and his home and lived out his life on the generosity of his sister-in-law and Yale. But his work continued. He was prominent among the 1,028 economists who in vain petitioned Herbert Hoover to veto the infamous Smoot-Hawley tariff of 1930. And he developed his debt-deflation theory. In 1933 in Econometrica, published by the Econometric Society, which he co-founded, he described debt deflation as a sequence of distress-selling, falling asset prices, rising real interest rates, more distress-selling, falling velocity, declining net worth, rising bankruptcies, bank runs, curtailment of credit, dumping of assets by banks, growing distrust and hoarding. Chart 1 is his: it shows how deflation increased the burden of debt.

Fisher was adamant that ending deflation required abandoning the gold standard, and repeatedly implored Franklin Roosevelt to do so. (Keynes was of similar mind.) Roosevelt devalued the dollar soon after becoming president in 1933. The devaluation and a bank holiday marked the bottom of the Depression, though true recovery was still far off. But Fisher had at best a slight influence on Roosevelt’s decision. His reputation had fallen so far that even fellow academics ignored him.

Contemporary critics did poke a hole in his debt-deflation hypothesis: rising real debt makes debtors worse off but creditors better off, so the net effect should be nil. Mr Bernanke plugged this in the 1980s. “Collateral facilitates credit extension,” he said in June 2007, just before the crisis began in earnest. “However, in the 1930s, declining output and falling prices (which increased real debt burdens) led to widespread financial distress among borrowers, lessening their capacity to pledge collateral…Borrowers’ cash flows and liquidity were also impaired, which likewise increased the risks to lenders.” Mr Bernanke and Mark Gertler of New York University dubbed this “the financial accelerator”.

The downward spiral can start even when inflation remains positive—for example, when it drops unexpectedly. Consider a borrower who expects inflation of 2% and takes out a loan with a 5% interest rate. If instead inflation falls to 1%, the real interest rate rises from 3% to 4%, increasing the burden of repayment.

Asset deflation can do much the same thing. If house prices are expected to rise by 10% a year, a buyer willingly borrows the whole purchase price, because his home will soon be worth more than the loan. A lender is happy to make the loan for the same reason. But if prices fall by 10% instead, the house will soon be worth less than the loan. Both homeowner and lender face a greater risk of bankruptcy.

Today, debt in America excluding that of financial institutions and the federal government is about 190% of GDP, the highest since the 1930s, according to the Bank Credit Analyst, a financial-research journal (see chart 2). There are important differences between then and now. Debt was lower at the start of the Depression, at 164% of GDP. Mortgage debt was modest relative to home values, and prices were not notably bloated: they fell by 24% between 1929 and 1933, says Edward Pinto, a consultant, so were roughly flat in real terms. Debt burdens shot up because of deflation and shrinking output; nominal GDP fell by 46% between 1929 and 1933.

Debt burdens are high today mostly because so much was borrowed in the recent past. This began as a logical response to declining real interest rates, low inflation, rising asset prices and less frequent recessions, all of which made leverage less dangerous. But rising leverage eventually bred easy credit and overvalued homes.

Even without recession, falling home prices would have impaired enough mortgage debt to destabilise the financial system (see chart 3). Recession makes those dynamics more virulent; deflation could do similar damage. Broad price indices fell in late 2008. Granted, that was caused in part by a one-off fall in petrol costs; but America’s core inflation rate, which excludes food and energy, has fallen from 2.5% in September to 1.8%. Goldman Sachs sees it falling to 0.25% in the next two years.

That is low enough to mean falling wages for many households and falling prices for many firms. More widespread and deeper deflation would mean that property prices would have to fall even further to restore equilibrium with household incomes, creating another round of delinquencies, defaults and foreclosures.

What is the solution? Fisher wrote that it was “always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted.” Alas, reflation is not so simple. Although stabilising nominal home prices would help short-circuit the debt-deflation dynamics now under way, any effort to maintain them at unrealistically high levels (where they still are in many cities) is likely to fail. Higher inflation could help bring down real home prices while allowing nominal home prices to stabilise, and reduce real debt burdens. But creating inflation is easier said than done: it requires boosting aggregate demand enough to consume existing economic slack, through either monetary or fiscal policy.

Though the Fed does not expect deflation, last month it did say that “inflation could persist for a time below” optimal levels. It is mulling a formal inflation target which, by encouraging people to expect positive inflation, would make deflation less likely. But its practical tools for preventing deflation are limited. In December its short-term interest-rate target in effect hit zero. The Taylor rule, a popular rule of thumb, suggests it should be six percentage points below. The Fed is now trying to push down long-term interest rates by buying mortgage-backed and perhaps Treasury securities. With conventional monetary ammunition spent, fiscal policy has become more important.

In 2002 Mr Bernanke argued the government could ultimately always generate inflation by having the Fed finance large increases in government spending directly, by purchasing Treasury debt. Martin Barnes of the Bank Credit Analyst thinks this highly unlikely: “You’d have capital flight out of the dollar. The only way it works is if every country is doing it, or with capital controls.”

Fisher died in 1947, a year after Keynes, and remains in his shadow. Mr Dimand notes that Fisher never pulled the many strands of his thought together into a grand synthesis as Keynes did in “The General Theory of Employment, Interest and Money”. More important, Keynes’s advocacy of aggressive fiscal policy overcame the limitations of Fisher’s purely monetary remedies for the Depression.

Yet Fisher’s insights remain vital. They have filtered, perhaps unconsciously, into the thinking of today’s policymakers. On February 8th Lawrence Summers, Mr Obama’s principal economic adviser, called for the rapid passage of a fiscal stimulus “to contain what is a very damaging and potentially deflationary spiral.” His advice bridges Fisher and Keynes.

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China not looking so good

Asia Times Online :: China News, China Business News, Taiwan and Hong Kong News and Business.

Last week, Chinese officials admitted that at least 20 million migrant workers - one out of every six - who journeyed back to their hometowns this lunar new year won't have a job to return to. Compare that to roughly three-and-half million American job losses so far. For the moment, China's army of unemployed seems disheartened rather than angry. Many of them took extended holidays among family back home and only now, out of desperation, are resuming their job hunts in earnest. No one knows how long their patience will last, or how much larger their ranks will grow in coming months.

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Monetize Fiscal Deficit

RGE Monitor

# BoJ and BoE urged in February by advisors and politicians to print money to fund more aggressive economic stimulus measures. SNB noted in December that it may buy up bonds to influence long-term interest rates
# Dec 1 Bernanke speech and Jan 28 FOMC statement signaled readiness of Fed to buy long-term Treasuries. Feb 9, Fisher cautioned the Fed must "be very careful to avoid the perception that it is monetizing the explosion of fiscal deficits"
# Buiter: When the government provides a fiscal stimulus to demand, the Treasury has to issue additional debt. If this debt is not bought by the central bank, it will have be be held willingly by the domestic private sector and the public sector. The only way to ensure that larger public sector deficits do not add to the sovereign default risk premia is for the central bank to buy the additional government debt. Assuming the central bank does not finance this purchase of public debt by selling private securities but instead by increasing the monetary base, the deficit is monetized and no financial crowding out occurs
# Buiter: The commitment to both price stability and debt monetization is possible if 1) the central bank will de-monetise again when liquidity preference shrinks, and 2) the government(s) will act countercyclically in good times as in bad times and will raise taxes or cut public spending as soon as the economy is back to normal
# Roubini, Christiano/Fitzgerald: The "fiscal theory of the price level" suggests that fiscal deficits may or may not lead to high inflation depending on whether there is "fiscal dominance" or "monetary dominance". If there is "fiscal dominance", the deficit policies of a fiscal authority will eventually force the central bank to monetize the deficit, i.e. to increase seignorage and use the inflation tax to finance an exogenous fiscal deficit path. If there is "monetary dominance", the central bank commits not to monetize the deficits and the fiscal authority is forced to adjust its budget policy (i.e. cut spending or raise taxes) to satisfy its intertemporal budget constrain

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BDI prospects

Dry bulk freight surge 'could be shortlived' - Lloydslist.com

Dry bulk freight surge 'could be shortlived'

Marcus Hand, Singapore - Friday 6 February 2009
THE surge in dry bulk freight driven by a jump in Chinese iron ore imports could be shortlived warns a report Macquarie Research.

The Baltic Dry Index jumped 14% yesterday, pushed up by renewed demand for capesize vessels. The cost of shipping iron ore from Brazil to China has risen from a low $6.80 per tonne in mid-December to $21.60 per tonne. Rates from Australia are around $7.90 per tonne compared with a low $3.90 in mid-December.

“What it reflects is a more general recovery in Chinese steel production from the lows of June-October 2008 following an end to steel destocking and a flurry of trader-buying of steel,” said a report by Macquarie.

“In addition, temporary iron ore shortages appeared to develop at the end of 2008, following a collapse in domestic iron ore production and a reduction in port stocks.”

This has resulted in restocking by Chinese steel mills, with 55 vessels now reported to be outside China ports waiting to unload cargoes.

The recovery could prove to be a shortlived one, as there is no evidence of an increase in demand for steel in China. A major downturn in iron ore imports continues in Japan and Europe as hefty steel production cuts are implemented.

“There is also a risk that Chinese iron ore stocks will start rising, which could reduce short-term demand for ships, and this may soon cap the mini-rally in freight,” the report said.

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Roubini says US now 33% chance of near depression

RGE - Is the U.S. a Japan 2? The Return of Japan’s “Free Fallin” Stag-Deflation and the Risks of a U.S.

Thus, even if the US were to do everything right and fast enough (on the monetary, fiscal, bank cleanup and household debt reduction) we would still have a severe two year U-shaped recession until early 2010 with a weak recovery of growth (1% or so that feels like a recession even if you are technically out of it) in 2010-2011. But if the US does not do it right this severe U-shaped US and global recession may turn into a nasty multi-year L-shaped near depression like the one experienced by Japan. We don’t have to go back to the Great Depression (when output fell over 20% and unemployment peaked over 25%); even a stag-deflation and Near-Depression like the Japanese one would be most severe for the US and the global economy. And while six months ago I was putting the odds of this L-shaped near-depression at 10% or so such odds have now risen to one third. So time is of the essence and the clock is working against US and global policy makers. The time to stop dithering is well past; and the time to implement a program of forceful, coherent, credible, globally-coordinated monetary, fiscal, financial clean-up and debt-resolution is now. The US and global economy are truly risking a near-depression if the policy reaction is not bold, aggressive, sustainable and credible.

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