I have added the piece below (with my emphasis) ...

Let me attempt, perhaps foolhardily, to map out a scenario of how the global economic crisis could evolve in continental Europe.

Even if we assume a recovery elsewhere, Europe’s economy may be stuck at low growth for some time. To understand why, it is perhaps best to look at sectoral balances for households, companies and the public sector.

The current account can be expressed as the difference between national savings and investments. Of the world’s 10 largest economies, the US, the UK and Spain used to run the largest current account deficits before the crisis. The US household sector has been shifting from a negative savings rate before the crisis to a positive rate of 4 per cent of disposable income now. The US corporate sector used to have a large negative savings rate, but this has almost disappeared. So far, the increase in net savings in the US private sector has been balanced by increased borrowing from the US government.

I am making three assumptions: the first is that the return to a positive US household savings rate is permanent – even under a scenario of a strong economic recovery. US households will take time to repair their balance sheets after the housing and credit disaster. Second, I also expect US companies not to return to the high level of borrowings that prevailed before the crisis. Third, I expect the US government to reduce its deficit after 2010. The recent rise in long-term bond yields should serve as a reminder that deficits cannot go on rising forever.

Taking all three factors together, the US will shift from a strongly negative current account balance towards neutrality, perhaps even a small surplus for a short period. I expect similar shifts in the UK and Spain at different magnitudes.

Among countries with large current account surpluses, the three biggest are China, Japan and Germany. I am focusing on Germany here. The German household sector will maintain its high savings rate. The German government increased its deficit during the crisis, but is now looking for a quick fiscal exit strategy. The Bundestag has recently voted through a constitutional balanced-budget clause, which requires cuts in the deficit almost right away. Japan will probably maintain its larger fiscal deficit for longer, but if we take Germany, China and Japan together, we will not see a sufficient and sustained fiscal expansion to compensate for the sectoral shifts elsewhere.

Global current account surpluses and deficits add up to zero. So if everybody is saving more, who will be dissaving? It will have to be the corporate sector in the countries with large net exports. So if the US, the UK and Spain are heading for a more balanced current account in the future, so will the surplus countries.

The current account balance can also be expressed as the sum of the trade balance, net earnings on foreign assets, and unilateral financial transfers. In several countries, including the US and Germany, the gap between exports and imports serves as a good proxy for the current account. A fall in the trade deficit in the US, UK and Spain implies a fall in the combined trade surplus elsewhere. And as some of the shifts in the US and the UK are likely to be structural, this will have long-term effects on others. In particular, it means the export model on which Germany, China and Japan rely, could suffer a cardiac arrest.

What about the argument that a large part of German exports goes to the rest of the eurozone? This is true, but there are imbalances within the eurozone too. Spain has been running a current account deficit of close to 10 per cent of gross domestic product. As that comes down, so will Germany’s equally unsustainable intra-eurozone surplus.

Through what mechanism will this export-sector meltdown come about? My guess is that in Europe it will happen through a violent increase in the euro’s exchange rate against the US dollar, and possibly the pound and other free-floating currencies.

Exchange rate devaluation would greatly help the US and others to reduce their current account deficits, but it will impair the economic recovery in countries with large trade surpluses and free-floating exchange rates. Last week’s remarks by Angela Merkel, who criticised the Federal Reserve and other central banks for running inflationary policies, sharpened investor perceptions of transatlantic policy divergence and decoupling. Many investors are now starting to bet on a strong appreciation of the euro – the last thing Ms Merkel wants.

Neither Germany nor Japan is politically equipped to deal with an exchange rate shock. China may continue to manage its exchange rate, but the Europeans are much less likely to intervene in foreign exchange markets. For the time being, the governments of the classic export nations cling on to their export-based economic model, the model they know best. Their only strategy, if you call it that, is to hope for a miraculous bail-out from the US consumer – which is not going to happen this time.

If my predictions prove correct, Germany will be down and out for a long time with a huge and still unresolved banking crisis, an overshooting exchange rate and lower net exports, presided over by politicians who panic about domestic inflation. This will not end well.

Really, what people need to think about here is the important of deleveraging on a macroeconomic level and what this will mean for aggregate global demand. As I have pointed out before, emerging markets such as Brazil, Turkey, India, Chile, etc are coming (and fast too), but will they be able to provide enough capacity of to suck up the massive increase in desired savings we are going to observe? Well, this is of course only one of the questions here and what we really need is a sound theoretical framework to explain all this and as you might have guessed by now it is crucial that we allow demographics to enter the equation as a driving force for the propensity (desire) to run an external surplus and thus to maintain excess savings vis-à-vis the rest of the world.

If you add the effects of the continuing demographic shifts to the obvious need for economies such as the UK, the US, etc to correct (regardless of underlying demographis) you end up with a problem and specifically a problem of excess saving relative to the willingness and ability to absorb these savings through aggregate demand or if you will productive investment. In terms of (wonkish) economic theory we can think about ageing on a macroeconomic level as the crowding towards one end of the intertemporal spectrum of consumption and saving. Consequently, one can expect (and show) why ageing economies, in stead of simply accepting the inevitable decline through dissaving, will have an intertemporal preference to push forward dissaving (consumption) relative to maintaining a surplus on their external accounts as a cushion againts dissaving. 

I will have much more on the theoretical front here as we move forward.

General Motors Corp. (GM) reportedly found a buyer for its majority stake in German unit Opel a day after the struggling automaker said it does not plan to repay a $1 billion debt due June 1.

Citing sources familiar with the matter, German magazine Der Spiegel reported that Fiat SpA was close to a deal to buy a large chunk of GM's European business. The Italian carmaker is already in talks to buy a stake in Chrysler LLC with an April 30 deadline for the transaction.

A unit of Canadian auto parts manufacturer Magna International Inc. (MGA) is also reported to have shown interest in the Ruesselsheim-based Opel. However, none of the parties confirmed these reports.

GM needs to sell a large stake in Opel to get about $4.30 billion in German government loan guarantees to keep the unit afloat. The Detroit auto giant also needs to persuade bondholders to restructure $27.5 billion in unsecured debt to avoid bankruptcy filing.

Earlier this week, the company had said it would temporarily idle most of its U.S. factories and lay off another 1,600 employees. Although GM does not have a large impact on the market, its bankruptcy filing could have broader ramifications for the economy. Shares of the company were down more than 3% to $1.63 in morning trade on the New York Stock Exchange.

According to provisional results of the Federal Statistical Office (Destatis), turnover in retail trade in Germany in September 2008 was in nominal terms 4.1% and in real terms 1.2% larger than that in the corresponding month of the previous year. The number of days open for sale was 26 in September 2008 and 25 in September 2007. When adjusted for calendar and seasonal variations (CENSUS-X-12-ARIMA), the September turnover was in nominal terms 2.5% and in real terms 2.3% smaller than that of the preceding month. Compared with the corresponding period of the previous year, retail turnover was in the first nine months 2008 in nominal terms 2.4% larger and in real terms 0.5% smaller.
Federal Statistics Office

Austria, one of Europe’s stronger economies, cancelled a bond auction on Monday in the latest sign that European governments are facing increasing problems raising debt in the deepening credit crisis.

Market conditions have steadily deteriorated in recent days with the best gauge to credit sentiment, the iTraxx investment grade index, which measures the cost to protect bonds against default in Europe, widening to more than 180 basis points, or a cost of €180,000 to insure €10m of debt over five years, on Monday.

The eurozone countries will raise €925bn ($1,200bn) in 2009, according to Barclays Capital. The UK, which is expected to increase its bond issuance from the current €137.5bn in the 2008-09 financial year, will take the figure above €1,000bn.

``The resources of the IMF may not be sufficient for wider bailouts if needed,'' said Vivek Tawadey, head of credit strategy at BNP Paribas SA in London. ``If it can't raise the money, some of the more distressed emerging markets could end up defaulting.''

Gordon Brown on Tuesday spearheaded calls for a multi-billion pound "bail-out fund" to prevent the global crisis spreading to more countries, and warned of the need to stabilise economies "across eastern Europe".....

The prime minister on Tuesday urged the oil-rich Gulf states and China to provide "substantial" funding to the International Monetary Fund, before flying to France for talks on an increase to the European Union's bail-out fund. The government is keen to emphasise the link between global action and domestic voters' interests, as well as portraying Mr Brown as a world leader.

The prime minister said it was "in every nation's interests and the interests of hard-working families in our country and other countries that financial contagion does not spread". While he did not rule out the UK making a contribution, he insisted the "biggest part can be played by the countries that have got the biggest [balance of payments] surpluses".

The IMF's $250bn (£158bn) bail-out fund "may not be enough" to prevent the crisis destabilising more countries, Mr Brown said. His spokesman added the UK was "looking at a figure in the hundreds of billions of dollars" for the IMF. Mr Brown called for "action on this new fund immediately".

Germany plans to finance part of its 500 billion euro ($636 billion) bank rescue package by issuing bonds to banks in exchange for new preferred stock, according to Finance Agency head Carl Heinz Daube.

``The banks will not be allowed to sell the injected government bonds,'' Daube said in an interview in Tokyo today. ``So far there's obviously not a huge demand for any rescue measures, but this might change in the coming weeks.''

Germany's rescue plan, approved by lawmakers on Oct. 17, amounts to about 20 percent of the gross domestic product of Europe's biggest economy. Chancellor Angela Merkel's administration pledged 80 billion euros to recapitalize distressed banks, with the rest allocated to cover loan guarantees and losses.

....Hypo Real Estate Holding AG, the Munich-based lender that's already had a 50 billion euro bailout, today asked the Deutsche Bundesbank for 15 billion euros to cover short-term liquidity needs. ....Frankfurt-based Deutsche Bank AG may also need 8.9 billion euros of new capital, more than any bank in Europe, Merrill Lynch & Co. analysts Stuart Graham and Alexander Tsirigotis wrote on Oct. 20.

The bailout plan is still being discussed in Berlin and more information will probably be released at the end of this week, Daube said.

Germany may meet additional funding needs for its bank rescue by selling six-month bills before examining options for borrowing using longer-term securities, Daube said. The government plans to offer between 212 billion euros and 215 billion euros of debt through its 2009 program, about the same as the 213 billion euros scheduled for this year.

The debt-for-equity swap will probably have ``next to no effect'' on the country's yield curve because the notes offered to banks won't trade in the so-called secondary market, he said. The yield curve plots the rates of government bonds according to their maturities, and increases indicate higher borrowing costs.

``The government deficit of course will increase, the outstanding volume of bonds will increase as well,'' Daube said. ``The number of outstanding bonds available in the secondary market will stay exactly the same.''

-- The move has set off a rally in European banking stocks.

-- Asian markets were also up this morning. Hong Kong shares shot up over 10%. It was the biggest one-day rise in more than 33 years.

-- Meanwhile, European central banks have promised unlimited dollar funding. This means, according to a statement by the central banks, that banks would "be able to borrow any amount they wish against the appropriate collateral in each jurisdiction."

-- Of course, amid all the blather about "unity" an "coordination" among diplomats and world leaders there still lies a big fat lack of specifics. According to The Washington Post, "Officials from 20 major countries yesterday endorsed a coordinated approach to the financial crisis, but they failed to announce any concrete steps, underscoring the difficulty of crafting a global plan to halt the contagion as it spread to the broader economy."

-- It will be interesting to see if US investors buy into the coordinated effort propaganda. US stock futures rallied on the good news in Europe and Asia. MarketWatch reprots that "S&P 500 futures rose 40.3 points to 931.30 and Nasdaq 100 futures climbed 47.75 poitns to 1,330.20."

-- Oil also jumped today $4.29 to $81.99 a barrel.

-- And the euro rallied against the dollar, climbing 1.7% to $1.3622.

The Dow Jones Industrial Average careened below 10,000 points for the first time since 2004 yesterday, after plummeting 500 points in the first hour of trading. The Dow closed down 369.88 points, or 3.6%, on the day at 9,955.50, after earlier surrendering as much as 800 points.

The Standard & Poor’s 500 Index shed 42.38 points, or 3.95%, to 1,056.85 and the Nasdaq Composite Index tumbled 137.52, or 7%, to close at 1,809.

The Dow has shed more than 1,100 points, or about 10% in slightly more than a week, and the S&P 500 has lost more than 15% in the same period.

Indices around the world suffered similar declines. London’s FTSE 100 index closed down 5.6% yesterday. Germany’s DAX was down 5.2%, and the CAC-40 in Paris lost 5.9%. In Asia, the Nikkei 225 stock average in Tokyo fell 4.3%, the Hong Kong’s Hang Seng index slid 5%, and China’s CSI 300 Index slumped 5.1% coming off a one-week holiday.

The credit crisis that originated in the United States last year has clearly infiltrated economies in Europe and financial institutions throughout the region are beginning to topple.

France’s BNP Paribas SA (OTC: BNPQY) became the Eurozone’s largest bank by deposits after agreeing to buy Fortis NV’s Belgium and Luxembourg divisions, just days after it was partially nationalized by the government of the Netherlands as part of a $16.4 billion resuce plan.

Trading of Fortis shares was suspended Monday after falling to $7.50 on Friday. The company’s shares have plunged roughly 70% this year.

Sunday, the German government was forced into a $68 billion (50 billion euro) rescue of Hypo Real Estate Holding AG – the nation’s second-biggest commercial property lender.
HRE was torpedoed by short-term financing struggles within its Dublin-based subsidiary, Depfa Bank PLC.

Hypo Real Estate fell as much as 76% in Frankfurt trading.

In Italy, shares in bank giant UniCredit SpA were suspended several times yesterday, after the company announced its decision to raise 6.6 billion euros in fresh capital – something the UniCredit’s board previously said it would not do.

“We made some mistakes in evaluating the market scenario, that’s absolutely clear to us,” Chief Executive Officer Alessandro Profumo told Bloomberg News. The company said “waves of market turbulence,” as well as an “unprecedented lack of trust among financial institutions” forced management’s hand.

The fresh round of European collapses was the second domino to fall behind an American contagion that claimed The Bear Stearns Cos. Inc. and Lehman Bros. Holdings Inc. (OTC: LEHMQ), and forced a bailout of mortgage giants Fannie Mae (FNM), Freddie Mac (FRE) and American International Group (AIG).

"Everyone is losing confidence," Mark Tan, who helps manage about $20 billion of equities and bonds at UOB Asset Management in Singapore, told The Associated Press. "The problem now is that the lack of foreign confidence could affect the Asian consumer, which would lead to a bigger slowdown in Asia than expected."

Central Bank Panic

A round of chaotic collapses over the weekend spurred central banks and policymakers around the world into action.

German Chancellor Angela Merkel guaranteed private deposit accounts in a desperate bid to restore confidence after the rescue of Hypo Real Estate. Austria, Denmark, Ireland, and Sweden have all raised the limits on guaranteed savings, and there is growing speculation that the United Kingdom will soon join them.

However, Germany’s decision, in particular, came as a surprise as it came just one day after Chancellor Merkel joined French President Nicolas Sarkozy, U.K. Prime Minister Gordon Brown, and Italian Prime Minister Silvio Berlusconi in condemning Ireland’s decision to offer blanket protection for its deposits.

In fact, EU competition authorities had already agreed to challenge Ireland’s decision as a competition distorting measure.

“It would have been advisable to properly consult other EU authorities on the envisaged legislative plans,” the European Central Bank said yesterday. The ECB is also concerned the guarantee provides the lenders covered by the scheme with “preferential treatment.”

The ECB, the Bank of England and the Swiss National Bank offered more than $60 billion to markets yesterday, hoping to ensure that the financial sector remains well oiled.

The ECB offered $50 billion in overnight money, while the Bank of England offered $10 billion.

Financial institutions borrowed $33.9 billion (24.6 billion euros) on Oct. 3 – the most since February 2001.

Meanwhile, back across the pond, the U.S. Federal Reserve said it would make hundreds of billions of dollars more available through its Term Auction Facility (TAF). The Fed said it would expand its 28-day and 84-day TAF operations to $150 billion each. The central bank will also begin paying interest on bank reserves.

Source: Global Markets Nosedive as Credit Crisis Washes Over Europe

Investors remained wary of emerging-market debt as evidence mounted that most of the major major economies - the U.S., the UK, Japan and the Eurozone - are sliding into recession. This realisation has triggered a major exit from commodities, which are a significant source of export revenue for a large number of developing nations. In particular bonds extended losses on the perception that the $700 billion U.S. bank bailout would not work miracles and thus many developed economies will be struggling to digest the impact of the credit blow-out for some time to come.


Until credibility is restored, we will not see people investing in the numbers that emerging economies like India and Brazil badly need to see. But at the same time, we might ask ourselves, at theis moment in time if they don't invest in India and Brazil, then where are they going to invest? The problem is that in the present global environment people are not simply not willing to take assume what is perceived as "risky" without being paid a large - and from the emerging economy point of view - damaging premium. Of course, the situation is also confused since people are no longer clear what constitutes "risky" and what doesn't - the German government, for example, yesterday found itself forced to offer a blanket guarantee of all domestic bank deposits to head off any risk of flight from German bank accounts.

One result of all this nervousness is that the cost of protecting developing nations' bonds against default has been steadily rising. Five-year credit-default swaps based on Argentina's debt climbed 44 basis points to 12.55 percentage points last week, the highest since at least June 2005. That means it costs $1.255 million to protect $10 million of the country's debt from default. Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.


Emerging Market Stocks

Emerging-market stocks also fell substantially last week, experiencing their the biggest weekly decline in seven years, led by the banks and energy companies. The MSCI Emerging Markets Index dropped 2.3 percent on Friday to 741.73, following a 3.4 percent decline on Thursday. The index lost 10 percent on theweek, the most since the September 2001 terrorist attacks.


Turkey's benchmark index fell the most in three weeks, losing 4.2 percent to 34,553 in the first trading day since Sept. 29. Russia's Micex Index slumped 5.3 percent, extending its annual loss to 51 percent. India's Sensex index slid 4.1 percent to 12,526.32. Reliance Industries Ltd., India's biggest company by market value, slumped 7.6 percent, to its lowest in a year.

Inflation Falls

But while India's financial system has been taking a beating, Indian inflation, almost un-noticed -slipped back to a 13-week low in late September, giving the central bank some breathing space to keep interest rates unchanged and lossen the liquidity strings when it next meets at the end of this month. Wholesale prices rose 11.99 percent in the week to Sept. 20 from a year earlier after gaining 12.14 percent in the previous week, the commerce ministry said in a statement in New Delhi on Thursday.



Reserve Bank of India Governor Duvvuri Subbarao is under pressure to boost money supply as a local stock sell-off triggered by the global credit crunch has drained funds from the banking system, increasing borrowing costs. Subbarao will undoubtedly seek to steer a middle course, since, given that inflation is still double the central bank's target he will not want to seem to be "soft", while on the other hand he will want to be prudent and will try to head off an excessively rapid credit tightening on the back of the global crunch. In addition, the peak of global inflation has now undoubtedly past, and we are now likely to see growing deflationary (rather than inflationary) headwinds as capacity levels exceed demand across the whole global economy and commodity prices tumble, as Claus Vistesen explains in this excellent and timely post.

The Indian central bank had been busy tightening, and had raised the cash reserve ratio, or the proportion of deposits that lenders maintain with it as reserves, by 400 basis points to 9 percent during the period between December 2006 and July 2008 in an ongoing battle to contain inflation. The bank will make the outcome of its next meeting in Mumbai known on Oct. 24, but we can be pretty sure that the "bias" will now have shifted towards loosening liquidity conditions rather than tightening them, as the priorities have changed, and the big priority now is to avoid any systemic bank problems, to keep the cost of borrowing for Indian companies down, and to prevent consumer credit slowing too dramatically.

The Indian banking system has been under increasing strain in recent days, and one symptom of this is that the rate at which Indian banks lend to each other reached an 18-month high of 17.5 percent on Oct. 1. Indian banks borrowed an average 413 billion rupees a day from the central bank in September, almost twice the amount in August, further indicating a shortage of funds in the banking system.


Commodities Down

Commodities, as measured by the Reuters/Jefferies CRB Index of 19 raw materials, tumbled 9.9 percent last week, the most since at least 1956.

Crude oil has lost 12 percent during the week, the most since 2004. The contract for November delivery traded at $94.47 a barrel, up 0.5 percent, as of 12:11 p.m. London time. Copper fell as much as 3.1 percent to $5,670 a ton on the London Metal Exchange, the lowest since February 2007 and was down 12% on the week.

Such downward movement in commodity prices has a double-edged impact on emerging economies. On the one hand inflation, which has in large part been driven up by rising commodity prices, will reduce significantly, but on the other hand many emerging economies are dependent on revenue from commodity sales to finance growth and development. Really this is a situation which will sort the "men" from the "boys", since those emerging economies which are really going to emerge will be in a position to switch the driving force of growth from commodity and agricultural dependence to industrialisation and domestic investment and consumer demand. It is my firm belief that India is now decidedly inside the group which is in the process of making this transition.


Stocks Down

Indian stocks fell during the week, with the benchmark Sensex stock index declining to its lowest in 18 months. The Bombay Stock Exchange's Sensitive Index, dropped 529.35, or 4.1 percent, to 12,526.32, its lowest since April 2, 2007. The index posted its second weekly decline, falling 4.4 percent. The S&P CNX Nifty Index on the National Stock Exchange fell 3.4 percent to 3,818.30. The BSE 200 Index declined 3.8 percent to 1,515.29. Nifty futures for October delivery fell 2.9 percent to 3,853.


Overseas investors bought a net 845 billion rupees ($18 million) of Indian stocks on Sept. 30, trimming their net outflow this year from equities to $9.1 billion, the nation's stock market regulator said.


Forex Reserves

India's foreign exchange reserves fell marginally by USD 153 million to USD 291.819billion for the week ended September 26 from USD 291.972 billion in the previous week. Reserves had jumped by USD 2.511 billion in the previous week. Foreign currency assets (FCA), during the week, dropped to USD 282.652 billion from USD 282.811 billion a week ago, according to data issued by the RBI on Friday.

Rupee

India's rupee slumped to the lowest since 2003, adding to speculation investors will take continue taking money out of the currency. The currency completed its eighth weekly loss, the longest drop since December 2005. The rupee was down 1 percent on the day to 47.085 per dollar, the lowest since June 2003, as of the 5 p.m. close in Mumbai on Friday. The currency lost 1.15 percent this week.

September Global Manufacturing PMI Shows Sharp Contraction

September seems to have been the ultimate "mensis horribilis" for industrial output internationally - and thus it is only natural to assume that Indian industry was also adversly affected - with global manufacturing activity contracting for the fourth consecutive month, and output falling to its weakest level in over seven years according to the JP Morgan Global Manufacturing PMI, which at 44.2 hit its strongest rate of contraction since November 2001, down from 48.6 in August (Please see the end of this post for some information about countries included and the JP Morgan methodology).


According to the JP Morgan report the retrenchment of the manufacturing sector mainly reflected marked deteriorations in the trends for production, new orders and employment. The declines in output and new work received were the second most severe in the survey history, while staffing levels fell at the fastest pace for over six-and-a-half years. The Global Manufacturing Output Index registered 42.7 in September, well below the 48.5 posted for August.

The sharpest decline in production was recorded for Spain, followed by the US, Japan and then the UK. Although the Eurozone Output Index sank to its second-lowest reading in the survey history, it was above the global average for the first time in four months. Within the euro area, France and Spain saw output fall at survey record rates, while in Italy and Ireland the contractions were the second and third most marked in their respective series. Germany, which until recently was the main growth engine of the Eurozone, saw production fall for the second month running and to the greatest extent for six years. Manufacturing activity in Japan fell to the lowest in over 6- years with the Nomura/JMMA Japan Purchasing Managers Index declining to a seasonally adjusted 44.3 in September from 46.9 in August.

At 40.8 in September, the Global Manufacturing New Orders Index posted a reading well below the neutral 50.0 mark. JP Morgan noted that the trends in new work received were especially weak in Spain, the UK, France and the US, with the all bar the latter seeing new orders fall at a series record pace (for the US it was the strongest drop since January 2001). The downturn of the sector led to further job losses in September, with the rate of reduction in employment the fastest since February 2002. Conditions in the Spanish, the UK and the US manufacturing labour markets were especially weak.

Russian manufacturing shrank for a second month in September, and in so doing registered its first back-to-back contraction since November 1998, as companies cut jobs and growth in new orders slowed, according to the latest VTB Bank Europe Purchasing Managers Report. The PMI came in at a seasonally adjusted 49.8, compared with 49.4 in August. The August reading was the lowest figure in three and a half years, according to the bank statement. On such indexes a figure above 50 indicates growth while one below 50 indicates a contraction.

Manufacturing in China contracted for a second month in August, underscoring the risk of a slump in the world's fourth-biggest economy. The Purchasing Managers' Index was a seasonally adjusted 48.4, unchanged from July, the China Federation of Logistics and Purchasing said today in an e-mailed statement.




Brazil's industrial output fell a seasonally-adjusted 1.3 percent in August, the largest monthly drop this year, bolstering expectations the central bank will ease monetary tightening in response to slowing economic growth. On an annual basis, output rose 2 percent, the slowest pace since March, according to data from the national statistics agency in Rio de Janeiro.

And the situation seems to have deteriorated further in August, since the headline seasonally adjusted Banco Real Purchasing Managers’ Index (PMI) registered a 25-month low of 50.4, down from 51.1 in August.

So basically this is where we get to learn what a global credit crunch means in terms of output and economic growth.

India's Industrial Output Weakens Too

India's industrial output growth bounced back again in July (the last month for which we have official data), reaching a five-month year on year expansion rate high of 7.1%. This follows a noted slowdown where output only rose by 5.4 percent gain in June, and 4.1% in May, according to data from the Central Statistical Organisation.


But if we come to look at the manufacturing PMI we will see that India's manufacturing output has also slowed somewhat, and expanded at its slowest pace in 14 months in September according to the ABN AMRO Bank purchasing managers' index. The PMI reading - which is based on a survey of 500 companies operating in India - fell to a seasonally adjusted 57.3 in September from 57.9 in August. This reading was the lowest since July 2007. Still 57.3 still suggests Indian industry continues to grow quite vigoursly, although the report did highlight the fact that the drop in the index was mainly the result of a decline in growth of new orders, and implied a deterioration in demand conditions, both locally as well as in export markets.


Current Account and Trade Deficit

The Rupee has also been dropping in reaction to India's deteriorating current account situation. The current account deficit rocketed to $10.7 billion in the three months from April to June, up from a $1.04 billion gap in the previous quarter,according to data from the Reserve Bank of India last week.

India's trade deficit almost doubled to a record in August as a surge in crude oil prices increased the import bill and overseas sales of goods slowed. The trade deficit widened to $13.9 billion from $7.2 billion a year earlier, according to data from the Ministry of Commerce and Industry. Imports grew 51 percent, the fastest gain in seven months, to $29.9 billion, while exports expanded 27 percent to $16 billion.

A near doubling of oil prices has boosted import costs, since India relies on overseas purchases for three-quarters of its energy needs. India paid an average $8 billion a month this year for oil imports, up from $5.5 billion in 2007, as crude oil costs surged to a record $147 a barrel on July 11. In India's case the 35 percent drop in oil prices we have seen since July has been partially offset by the decline in the rupee to a five-year low.

India's oil imports in August rose 77 percent to $10.9 billion as refiners paid more for crude oil purchased overseas. Non-oil imports gained 40 percent to $18.9 billion. Imports in the five months ended August 31 rose 38 percent to $130.3 billion from $94.6 billion a year ago. That took the trade deficit to $49.2 billion, compared with $34.5 billion in the same period a year earlier. Overseas sales of Indian goods in the five months to August 31 grew 35 percent to $81.2 billion, compared with $60.1 billion, the statement said.

India and Brazil Critical Weathervanes

What I have been arguing in this post is not that everything about India's economy is perfect - far from it, but neither is it the "perfect storm" disaster which current knee jerk reactions among international investors would seem to suggest. The problems which are hitting the Indian economy at the moment, from the rapid rise in inflation to the sudden withdrawal of sentiment have a common origin: the dynamics of the global economy, and it is to these we must now look if we are to be able to sort the wood from the trees about what happens next. Basically, when the dust settles, I think it will be apparent that there are few economies left sufficiently well standing (not Russia certainly, and probably not China, given the export dependence on the developed economies) and with sufficient energy to bounce back. Many may be sceptical that Brazil and India are going to lead the coming charge (this recession cannot, after all, last forever), but I ask you, if it isn't Brazil and India, who is it going to be?

JP Morgan Global Manufacturing PMI Methodology


The Global Report on Manufacturing is compiled by Markit Economics based on the results of surveys covering over 7,500 purchasing executives in 26 countries. Together these countries account for an estimated 83% of global manufacturing output. Questions are asked about real events and are not opinion based. Data are presented in the form of diffusion indices, where an index reading above 50.0 indicates an increase in the variable since the previous month and below 50.0 a decrease.

The countries included are listed below by size of global GDP share, and the figures in brackets are the % og global GDP in each case (World Bank Data).

United States (30.5), Eurozone (18.7), Japan (13.9), Germany (5.6), China (4.9),United Kingdom (4.5), France (4.0), Italy (3.2), Spain(1.9), Brazil (1.9),India (1.7), Australia (1.3), Netherlands (1.1), Russia (0.9), Switzerland (0.7), Turkey (0.7), Austria (0.6), Poland (0.5), Denmark (0.5), South Africa (0.4), Greece (0.4), Israel (0.3), Ireland (0.3), Singapore (0.3), Czech Republic (0.2), New Zealand (0.2), Hungary 0.2.

``Refinancing of all subsidiaries including Eurohypo is centrally organized and secured over the long term,'' according to Reiner Rossmann, a spokesman for Commerzbank, Germany's second-biggest bank by assets. ``Refinancing needs for 2008 are already covered'' and the bank's deposits provide a ``stable'' refinancing source, he added.

``In a nationalization, shareholders get wiped out,'' .........``That's just the risk investors take.''

``We're absolutely confident about our position, even in this hectic market
scenario,'' Profumo wrote in a letter to employees.

Asked yesterday if Unicredit expectations for the year would be changed, Alessandro Profumo replied: "I can't possibly say given the way the market is going and the widening of spreads."

UniCredit has forecast earnings per share of 52-56 euro cents this year and a stretching Core Tier 1 ratio (this is a measure of capital held against risky assets) of 6.2 percent based on Basel II requirements, up from 5.7 percent at the end of June. In fact this is not the first time this year Profumo has had to roll-back on targets, and the pressure on shares seems to be due to market questioning of how he is going to reach the Core Tier 1 target without a further capital increase, despite repeated denials of any recourse to investors for funds. As I say, this would not be the first time Profumo has had to change course, since back in March he dropped an earnings target of 66 euro cents per share, citing market volatility.


In terms of lending against deposits, Unicredit's current ratio is 97 percent for 2008, below Intesa Sanpaolo's 104 percent. Both the Italian majors have LtD ratios below the European bank average which is estimated to stand at about 129 percent. Five-year senior credit default swaps on UniCredit were up 14 basis points at about 121 basis points yesterday, according to Markit data.

Europe Wide Response?


So what now? Well, as much of the press seems to be noting, all that "NINJA mortgage ha ha ha" stuff from the EU politicians is now starting to look pretty silly (Peer Steinbrueck may well have been the worst case scenario here - being actively seen to gloat with his "ninja loans" quip - short for "no income, no job, (and no) assets." - but I think before anyone laughs too loudly we should just wait and see what happens to the German economy if the run on the Russian financial system continues). Europe's leaders have really been extremely foolhardy in giving the impression to their electorates that the European economy was completely sound and that Europe's banks would avoid any fallout from the global housing bust. If a whole generation of new financial products are suddenly withdrawn from the market (rather like all that "tainted" Chinese milk) it should be obvious that property prices and the construction industry everywhere will feel something, and those banks who didn't have a local property boom to fund, well they simply got involved in buying securities issued by others who did, via the so called "global wholesale money markets".To take just one simple example - of the estimated $591 billion in losses and writedowns so far recorded by global banks since the start of 2007, 39 percent have been accounted for by European institutions.

Yet despite all of this, some European politicians are still at it. Italian Prime Minister Silvio Berlusconi was busying himself yesterday trying to vaunt it over the United States for just this sort of reason. While Italy's financial stability panel, which met for the third time in 10 days yesterday, discretely limited itself to saying what it was supposed to say - namely that the impact of the global financial crisis on Italy's banking and insurance system remains limited and Italian banks had enough liquidity - Berlusconi was busy proclaiming that Italy was far better placed to handle its problems than the United States was: "I am not pessimistic about the future ..." he is quoted as saying "because our financial situation is less fragile than that of the United States,". This, I think remains to be seen, and such bravado in making comparisons hardly befits a Prime Minister whose country has just enetered its fourth recession in eight years and which looks set to contract across whole year 2008.

And the President of Spain's government, José Luis Rodriguez Zapatero, doesn't seem to be much better, since he seized the opportunity provided by his recent United States trip to tell a group of businessmen that the Spanish financial system, unlike its US counterpart, was in extremely good health. Not satisfied with simply making himself look ridiculous, he went further, stating that the extent of Spain's growth had depressed Silvio Berlusconi (his traditional "enemy"), and even suggested that Spain would overtake France in terms of per capita income within three or four years. If someone else hadn't used the phrase already this week, I would have said that what we had here was a clear case of "whom the gods would destroy they first make mad", as it is I will simply have to limit myself to saying that the condition of the patient with Artemio Cruz Syndrome is evidently detiorating.

What Can The EU Do?

However, recognising that we will need some sort of concerted intervention to address the developing problem is one thing, and deciding what that intervention should be is quite another (as we can see from what is happening in the United States right now, getting consensus on any sort of major intervention is far from easy). In theory, the 27-nation EU structure should offer a ready means of coordinating policy. But while the EU has unified laws on areas like trade and labour standards (and in the near future on immigration) more broad-reaching policy harmonisation (such as fiscal coordination) has long been resisted, and the recent sorry attempts to introduce a basic constitution provide clear evidence of the difficulties which lie ahead. The EU has no institutional equivalent of the US Treasury, which is why all the initiatives which we have seen to date - for all the European "feel" about them - have been either ad hoc bi- or tri- lateral arrangements. US NBER head Marty Feldstein has long been on record as pointing out that the greatest weakness in the eurosystem architecture from the start has been the absence of a common fiscal system, and the inability to correct the problems caused by deficits in one country drawing on surpluses in another. Feldstein was thinking about asymetric recessionary processes, and I doubt was thinking about a problem of the severity of the one we now face at the time, but in the longer run he has been proved right, this sort of problem was always going to arise at some point or another.

And we also need to think about the budget deficits issue. If certain of the national governments move back on the commitment to balance the budgets by 2011 then we will only start to shift from banking instition downgrades to soverign rating ones.

At the present time the European Commission seems to be limiting itself to talking about regulatory issues for the future, and new legislation proposals are expected later this week aimed at strengthening bank monitoring across borders, but such moves will hardly serve to resolve the present issue. Up to now European governments seem to have only agreed to a concerted supervision framework which is set to come into effect in 2012, pledging themselves to cooperate as required in managing any crisis, but they have most meticulously resisted devising any kind of formula for splitting the bill in the event that a cross-border bailout should become necessary, or that the problems of one country (and Spain immediately comes to mind here) should become to great for any single member to handle alone.

Daniel Gros, director of the Centre for European Policy Studies in Brussels, in particular has come out and stated that European governments ultimately will have to put capital into their banks, which he calculates are more leveraged than their U.S. rivals.

``These are highly leveraged institutions which need to have support from the
public purse,'' according to Gros.

Daniel Gros also suggested that EU governments assign the European Investment Bank, the EU's financial arm, the job of infusing 250 billion euros to support the region's banks, in return for an equity stake. The quantity he mentions seems rather small by my calculations (I think more than this will be needed in Spain alone), but he is undoubtedly scratching around in the right area.

Good day... And a Terrific Tuesday to you! Well... Guess who was wrong AGAIN! That's right, King Henry Paulson, he of the U.S. Treasury Sec. throne... He told the world on Friday, that the bailout package was a "done deal"... And he told us again on Sunday that it was a "done deal"... The markets rejoiced, the stock jockeys danced in the streets, the karma flowed and all the stars were in alignment... And then... A (not so) funny thing happened on the way to the forum...

King Henry's men revolted, and the bailout package did NOT have the votes to pass it, and the "done deal" was "undone"! Once again this man has led investors down the wrong path. I've documented the wrong statements by this man in the past year, and still, investors hang on every word by King Henry... When will they ever learn? When, will, they, ev-er learn?

The Dow posted its biggest one point drop ever... 777 points... It wasn't the biggest percentage drop in one day ever, that belongs to the Crash of October 1987, but still, that was enormous! There needed to be a tourniquet to stop the bleeding, and not one was given to the stock market. The S&P 500 suffered too...

And... Was the bailout package the "only" reason stocks dropped like a rock? Difficult to say... But let me say this so you can hear me now and listen to me later... Even in the face of the other bailout plans (remember Bear Stearns, Fannie & Freddie, AIG, the mortgage bill?) stocks had a difficult time putting together a rally that would last a couple of days... There's an underlying problem here folks... And if you ask me, and I know you didn't, but you'll get my answer anyway! I think it's the recession we're in, but no one wants to admit it. We're so deep into a recession that the NBER doesn't know their way out, much less call it for what it is!

I had a reader chastising me because his currencies aren't going through the roof. Hmmmm... Let's look around the bar room, and take stock of what's going on here... Currencies are performing better than stocks... Bonds... Mutual funds... Housing... Commodities... I wonder where it would have been better to have money? I'm sure there's somewhere... But, for the most point, Currencies may be down... But they are outperforming most other investments!

OK... I had to get that off my chest! So... As I left you yesterday, the dollar was rallying... But that rally was stopped in its tracks early in the U.S. session, as it looked as though the votes would not count up in favor of a bailout package passing. The rally by the euro and other currencies was strong for about an hour, and then range trading set in. However, as I turn on the currency screens this morning, they are back to trading in yesterday's clothes, with the dollar swinging the hammer again.

Some of euro's problem in maintaining a well bid rally the last few days is the rot that's being found in European Banks. As I said yesterday, I thought the Fortis (FORB) problem wasn't going to be a one and done, but I thought the rot on the vine wouldn't be as bad as in the U.S. Well, this morning there's another one Dexia (DEXB)...

The Big Boss, Frank Trotter, sent me a story he found that was quite interesting, as the German Finance Minister was interviewed regarding the financial meltdown... This was a great story, and I can't give you all of it, but, I've put in the highlights... Here we go!

SPIEGEL spoke with German Finance Minister Peer Steinbrück about the roots of the US credit disaster, whether Germany is in grave danger and what the future has in store for world banking.

Steinbrück: We are experiencing the most severe financial crisis in decades, although one should be careful about historic comparisons with 1929. One thing is clear: After this crisis, the world will no longer be the same. The financial architecture will change globally.

SPIEGEL: And is the United States completely to blame?

Steinbrück: The source and focus of the problems are clearly in the United States. There are many causes. After 9/11, a great deal of cheap money was tossed into the market. Apparently some of that money went to people with poor creditworthiness. This led to the growth of the real estate bubble. The banks embarked on a race over profit margins. Then speculation spun completely out of control…

SPIEGEL: The German government is unwilling to participate in America's $700 billion bailout package. Is this your final word?

Steinbrück: I see neither the need for nor the possibility of taking on the responsibility for American banks. Besides, our situation is more robust.

So... There you go... Some statements from the German Finance Minister, who did say at one point regarding the AIG bailout... "We were all staring into the abyss"...

Long time friend and colleague, Ed Bonawitz, sent this note to me yesterday... "Given today's events in Washington and on Wall St.; the winner of the presidential election will probably ask for a re-count!"

Yes, funny... But oh-so-true! The bailout package, if passed, was going to leave a lot of important decisions in the hands of the next president. I can't imagine why anyone would want that job!

Looks like the Senate will try to revive the bailout package, after watching the carnage in stocks yesterday...

The Japanese yen pushed the envelope VS the dollar yesterday while stocks were circling the bowl, yen was in favor... This is a classic example of risk trades, like the Carry Trade, getting unwound during times like this... And when Carry Trades get unwound, the Japanese yen rallies. I would think that we should expect more of this... But then, I've thought that for almost a year now... Last November, speaking at the New Orleans Investment Conference, I emphasized that I expected risk events to be in play in 2008, and that would unwind Carry Trades. This was repeated in February at the Orlando Money Show, and every speaking engagement since...

Yesterday... Personal Income and Spending data was a little skewed, but here it is anyway... Personal Income for August "jumped" .5%, gaining back some of July's -.6% loss... Personal Spending failed to rise, and July's number was revised down...

Personal Income is still volatile due to the stimulus checks, etc. but the spending figures are encouraging and disheartening at the same time... Encouraging because maybe, we, as Americans, have stopped spending what we don't have or shouldn't be buying... But disheartening, because consumer spending makes up a huge chunk of GDP... Without consumer spending, economic growth is left with Government spending... That's no way to grow an economy!

Today, we'll see the color of July's S&P CaseShiller Home Price Index, which is expected to continue its fall. The Chicago Purchasing Manager Index (Manufacturing) will show a weaker print... And Consumer Confidence for this month is expected to weaken... Shoot Rudy, this data should fall through the trap door of falsely supported data! We'll have to see if the markets pay attention to the data today... I kind of think they will continue to be focused on the bailout package.

Gold sure shot up yesterday, gaining $30 and going back over $900... But that was short-lived... The shiny metal has given back $15 in the London market this morning. Profit taking? I would certainly think that has something to do with it. I just keep coming back to the conversations I hear on the desk every day from our metals traders, Kristin and Jen... They can't find coins or bars in Gold or Silver anywhere! There's a shortage folks... And there's no price adjustment in Gold or Silver going on! This has the all the makings of the PPT keeping the prices low...

I know, I don't like thinking that this isn't a "free market" any more than the next guy... But that's exactly what's going on, eh? There's no such thing as a shortage, it's merely in need of a price adjustment... And if there's no price adjustment, then it's being held down artificially... But by who? There's only one choice... The Plunge Protection Team... PPT...

This is no solace to Gold & Silver holders... They want their holdings to rise in value in a free market environment! Our free market, as we know it, may be the thing going into the abyss in my opinion... Think about what's happened since March... And then tell me if you think this is a free market, or one that is controlled by the Gov't...

OK, I'll get down from my soapbox now... Just think a little about that today, OK? Wow! I can really get off on tangents, eh?

So... Wachovia (WB) actually went to the highest bidder, Citicorp (C)... Yesterday morning, the Wall Street Journal was reporting that Wells Fargo was the "winner"... Well, that fell through, and Citicorp came riding in on the white horse. Citicorp bought Wachovia's banking operations... I wonder what happens to the old St. Louis Brokerage, A.G. Edwards, that was purchased by Wachovia last year? I know people that work at the brokerage, so this hits home a bit.

The dollar has gained another 1/2 cent VS the euro since I've been here this morning, so this is getting ugly... Something has to turn this around and get this ship headed in the right direction again!

And... Finally... Don't look for this to be reflected at your gas station any time soon... But the price of Oil has fallen below $100!

Currencies today 9/30/08: A$ .8065, kiwi .6760, C$ .9550, euro 1.4325, sterling 1.7990, Swiss .9080, ISK 102.20, rand 8.30, krone 5.80, SEK 6.8325, forint 169.60, zloty 2.3780, koruna 17.22, yen 104.90, baht 33.88, sing 1.4290, HKD 7.77, INR 45.97, China 6.8460, pesos 11, BRL 1.9630, dollar index 78.20, Oil $98.89, Silver $12.92, and Gold... $894

Chuck Butler

Source: King Henry Was Wrong Again!

Schroeder has been adamant in his insistence that Georgia was at fault and the chief protagonist in its recent conflict with Russia. In light of these comments, however, Schroeder, who developed close ties with Moscow during his seven years in office, has come under fire himself, with observers insisting he has a vested interest in EU-Russia relations.

In addition all the main sentiment indicators are now down (including the EU Composite Economic Sentiment Indicator, which came in at 101.5 in June, its lowest level since January 2006). The latest Ifo institute business climate index fell to 101.3 in June (again its lowest level since January 2006) down from 103.5 in May, and the Sentix institute index (released this morning) fell to minus 9.3 from a positive 5.2 in June. That's the lowest since June 2005 and the biggest one-month drop since the start of the index in February 2001.

The GFK consumer confidence index was also down this month, with the forward looking index for July dropping to 3.9 from a revised 4.7 in June. Again this is the lowest reading in quite some time. In particular in their monthly report GFK highlighted how continuing high inflation was eroding income expectations and the consumer propensity to buy. According to the latest flash estimate from the German federal statistics office, inflation is thought to have hit 3.3% annually in June, and if confirmed this will be the largest price increase since December 1993.




German manufacturing orders declined in May, the sixth straight month that orders have been down. Orders, adjusted for seasonal changes and inflation, fell 0.9 percent from April, according to data from the Economy Ministry last week.

And The Real Economy Is Faltering

So much for the sentiment indexes, but what about the real economy? Well if we look at retail sales these were up by 0.7% in real terms in May over May 2007. However, if we look at a longer term time series, we can see that, despite the comparatively positive general economic environment, sales have not been strong for some time now, and in fact they have only registered monthly year on year increases five times since January 2007.

Despite the fact that May saw quite a sharp increse over April - 1.3% in real terms m-o-m sales seem to have contracted again markedly in June according to the last Bloomberg retail PMI reading. The index slumped from May's eighteen-month high of 56.6 to the low level of 44.9 (remember that on the PMIs 50 marks the neutral point, with readings over that level indicating expansion, and below contraction. Looked at this way it would seem sales were contracting almost as fast in June as they were expanding in May).

If we look at the monthly (seasonally adjusted) sales index we find ouselves with a very clear before and after picture, with the sharp pre tax-increase spike in December 2006 being followed by a huge trough in January 2007 following the 3% VAT hike. After that retail sales have never really fully recovered, suggesting that raising consumer taxes may not be as harmless a move as many seem to have thought, and is certainly not the most advisable way to finance the fiscal liabilities presented by population ageing.




If we now turn to industrial production - which, as I say has really been at the heart of the current German expansion - we find that output declined for a third consecutive month in May. Seasonal and inflation adjusted output was down 2.4 percent from April, when it fell 0.2 percent, according to data from the Economy Ministry in Berlin this morning. That is the larges month on month fall since February 1999. Output was up 0.8 percent on May 2007, on a working day adjusted basis.



Manufacturing output was down 2.6% month on month, while construction was up 1% from April, but construction in April was already at a very low level. The seasonally adjusted index peaked in February, and has since been declining, as can be seen in the chart below.

Coming to employment, German unemployment declined in again in June, pushing the jobless rate to its lowest level in almost 16 years. The number of people out of work, adjusted for seasonal changes, fell 38,000 from May to 3.27 million.



And employment is still increasing. There were a total of 40.19 million people employed in Germany in May, an increase of 619,000 (or 1.6%) on May 2007. Compared with April 2008, the number of persons in employment was by 111,000 ( or 0.3%).




Thus the German job creation machine continued to function in May, although at a slightly slower pace than in previous months. From January to March this year, the number of persons in employment each month was by 1.8% higher than in the corresponding month of the previous year, while in April and May 2008 the increase had dropped slightly to 1.6% on April and May 2007. It is too early at this point to decide definitevely whether the current trend can be considered to mark a general slowdown on the labour market. At least part of the slowdown can probably be explained by the fact that the winter months had been unusually employment-friendly because of the mild weather, so that the usual upturn in spring was smaller, although of course this also means that growth in the earlier months of the year was not as stong as appears at first sight.

When looking at the unemployment numbers it is also important to bear in mind that the German labour force is now near its historic peak, and will now steadily decline. An indication of this can be found in the chart below where it can be seen that the rapid growth in the population available for work which characterised the years between 1997 and 2005 has now come to an end, and since 2005 the numbers have been stagnating.



This stagnation in the potential labour force (before an eventual decline if immigration is not leveraged to facilitate growth) is also a reflection of the fact that Gernamy's population is now, slowly but steadly, declining, and has been declining since Q4 2004, as can be seen in the chart below.



The only way to really swim against the stream in these conditions and to continue to achieve sustained GDP growth is by raising labour productivity, but this has been one of the weak spots in the current expansion. Overall labour productivity (price-adjusted gross domestic product per person in employment) rose only very slightly - by 0.1% - in Q1 2008 as compared with a year earlier, although as measured per hour worked, there was an increase by 0.8% (this is because the number of hours worked by those in employment rose much less than the number of persons in employment). The bootom line here is that a lot of the new jobs Germany has been creating are part time and temporary work, often in relatively low value activities.


Exports


The core of the German economy, and the principal driver of its GDP growth, is its export sector. Basically, as a crude first approximation, when German exports do well, the German economy grows, and when they don't it falters. In part this is simply the natural corrolary of the fact that German household consumption has remained congenitally weak. The chart below should make this relative co-movement reasonably clear.




Now in April, which is the latest month for which we have data, German exports continued to grow on a year on year basis, led by demand from countries outside the 27-member European Union. Sales abroad, on a seasonal and working day adjusted basis were up 1.2 percent in April over March, when they had fallen back 0.8 percent on February. April exports rose 14 percent on a year on year basis.



One interesting data point is that during the period January to April exports to countries outside the EU increased 11.6 percent from a year earlier (and by 18% April on April) while exports to EU countries rose 5.8% percent, and to the eurozone alone only 4.6%.

If we go back to 2007, which is the last period for which we really have a detailed breakdown of the export data, about three quarters of German exports went to European countries, and 65% went to the member states of the European Union. The second market after Europe was Asia with a share of about 11%, followed closely followed by the United States, with a share of approximately 10%.

So Europe (whether inside the EU or not) is the key to German growth, and this, of course, is one of the reasons why German exports have been so resilient to the rising value of the euro, since (at least until the problems of the property slowdown started to hit the value of the pound sterling) even those coutries who did not share the common currency (like the UK or most of Eastern Europe) had currencies which had by and large appreciated side by side with the euro itself. Of course all of this has now started to change, the UK has its own problems, and inside the eurozone, Spain and Italy are no longer increasing the volume of German products they buy in the way they were even six months ago.

On the other hand, even as some of the traditional customers have begun to falter, new ones have arrived to take their place to some extent, and in particular here new members of the European Union and Russia. To put things in perspective a little, in 2007, and despite all the talk about the "China factor", Germany exported roughly the same quantity of products to the Czech Republic ( 26,026.6 million euro) - population circa 10 million - as it did to China (29,922.7) - population circa 1.3 billion.

A detailed comparison of relative performance between 2006 and 2007 is even more revealing. Of particular interest is, for example, the fact that exports to China only increased by 8.7% in 2007 while exports to the Czech Republic rose at almost double the Chinese rate ( 16.9%). The importance of United States as an export destination, on the other hand, declined, since exports to the US were down from 78 billion euro in 2006 to 73.3 billion euro in 2007, a decrease of 6%. Exports to Poland (another important destination for German exports with 36 billion euro in 2007) were up 25.2%. Spain was also up considerably (as was Italy), rising from 42 billion euro in 2006 to 48 billion euro in 2007 (up 14.2%). The Russian Federation also stands out outside the EU, with exports there rising from 23 billion euro in 2006 to 28 billion euro in 2007, that is an increase of 20.6%. It is clear that the rate of increase of German exports to Russia has accelerated even further during 2008.

Now the list I have just gone through is scarecly a randomly chosen one. The decline in importance of the United States as an export destination for both Germany and Japan - which are the world's No 3 and No2 economies respectively (and both are CA surplus export-driven economies) - surely has some implications for the whole decoupling-recoupling debate.



Also, the dependence of the German economy for exports growth on Poland, the Czech Republic, Russia, Italy and Spain - all of which may find themselves with economic issues in 2008 of greater or lesser importance - is surely more than a minor detail, and the evolution of the east european and latin economies needs to be closely monitored for what they can tell us about the future path of the German one. At this point it is clear that German exports have been labouring in recent months more under the difficulties produced by the slowdown in Spain, Ireland and the UK than they have been suffering the direct consequences of reduced demand in the US.





Q1 2008 GDP

As I reported in detail here, the German economy started 2008 with what seemed on the face of it to be considerable momentum, since on a price, seasonal and calendar adjusted basis gross domestic product (GDP) was up by a very large 1.5% in the first quarter of 2008 over Q4 2007.




Perhaps rather surprisingly, economic growth in the first quarter of 2008 was primarily supported, not by exports, but by gross fixed capital formation. Compared with the fourth quarter of 2007, investment in machinery and equipment was up by 4%, and capital formation in construction by 4.5%. The latter, it has been suggested, being partly the result of a comparatively mild winter. Overall final consumption expenditure increased by 0.5% q-o-q, the first such rise in over a year, however breaking this down we find that government final consumption expenditure was up markedly (+1.3% q-o-q), while the final consumption expenditure of households showed a rather smaller increase (+0.3% q-o-q). But the big "little secret" of the German Q1 2008 data is that inventory levels were up sharply, and inventory building added a substantial 0.7% points (of the 1.5% total) to growth in the first quarter. Obviously this situation is most likely to be corrected in Q2, and this, together with the steady slowing of general economic momentum, is undoubtedly the reason Deputy Economy Minister Walther Otremba is predicting a contraction in Q2.

Exports continued to grow (+2.4%) but since imports rose even more strongly (+3.5%), foreign trade actually had a downward effect on gross domestic product in Q1 2008 when compared with the preceding quarter. So whatever else the Q1 headline number was about, for once this was not an exports story.

So we can draw two conclusions from all this rigmorole: firstly it would be far from in order to announce the Q1 2008 result as strong evidence for anything very important about the Germany economy or its future trajectory, and secondly, given that the inventory correction is virtually bound to take place (and that early construction momentum has almost certainly not been maintained - construction output was down 2.9% in April over March and by 2.3% over April 2007, and only bounced back 1% in May over April, so was still under the March level) we should not interpret a negative number in Q2 as meaning that Germany is actually entering recession at this point. Global trade is still growing (not as fast as previously, but still growing) and German exports are still sufficiently resilient at this point for this eventuality to be very likely.

For the German economy to enter recession the global economy will need to slow further - which all the signs are that it most probably will do, as country after country falls into the grip of higher inflation and increased central bank monetary tightening.

The important point to understand about the export sensitivity of the German economy is that this is a by-product of permanently weak household demand, which is, in my opinion, associated with the progressiving ageing and numerical stagnation of the German population.

Government Debt

Among the sources of support for the German economy in the coming quarters we should not count on the possibility of fiscal loosening. Germans debt to GDP ratio was 65% in 2007, down significantly from the 67.8% peak hit in 2005, and Germany has been gradually move the fiscal books back into balance (0% deficit in 2007) after four years of breaching the EU's 3% deficit limit (2002-2005). We should not expect any enthusiasm from the German government for hitting reverse gear at this point.




Indeed Finance Minister Peer Steinbrück is forecast this week to unveil a even tighter-than-expected 2009 budget in an attempt to stay on track with the target of completely eradicating the federal deficit by 2011. The draft budget will be put to the German cabinet on Wednesday and is thought to envision total federal spending in 2009 of €288.4bn, up 1.8 per cent from this year. The deficit is forecast to fall by €1.4bn to €10.5bn. The finance ministry’s four-year fiscal plan is said to be little changed from earlier versions and foresees a fall in the deficit to €6bn in 2010 and zero from 2011 onwards despite an average yearly increase in spending of 1.5 per cent.



Forecasts

There seems to be a general consenus at the present time that the German economy is slowing. Where there is no real consensus is over the rate at which it is slowing and where and when the slowdown will settle. It is already clear, however, that GDP growth in 2008 will be below the heady 2.9% annual rate achieved in 2006, or the 2.5% clocked up in 2007.

The median of five forecasts published in June by the major German economic institutes sees growth in the German economy this year of 2.2%. This really now seems a highly optimistic number, especially bearing in mind the economy may in fact have shrunk in the second quarter after expanding 1.5 percent in the first three months, according to the recent statement of Deputy Economy Minister Walther Otremba.

I personally will be very surprised if we see growth at or near the 2.2% the institutes are forecasting (and much less the 2.5% put forward in the now somewhat dated EU commission April forecast, although Eurostat now have a 1.8% forecast pencilled into their database). I even consider the 1.7% from the OECD and 1.9% from Morgan Stanley to be still on the high side given the extent of downside risk and the sort of real economy data we are now seeing.

At the start of the year the German government was reckoning on a growth rate of 1.7 per cent, while Peer Steinbrück is basing himself on 1.2% for the draft budget.

“Now the president of the Bundesbank told the cabinet it might be 2 per cent, to my surprise,” Peer Steinbrück informed the Financial Times in an interview this week. “For my 2009 budget, I estimated growth at around 1.2 per cent, which accounts for all the downside risk ... Some people say it might be 1.4 or 1.5.”

Obviously I am one of the people in question, since I would go much nearer to the 1.4% rate forecast by the IMF in its April World Economic Outlook forecast, and my reasoning would be as follows. We have already had 1.5% growth in the first quarter, but we may have a negative number to put next to it in Q2. Lets make a guess: -0.2%. That brings us back to around 1.3% (its not as simple as this in practice, but bear with me for a second). So then, what if we get, say, a reasonably positive Q3: 0.4% expansion, say. But what then if we get a contraction in Q4? Then everything would depend on the rate of contraction.

Well, there's a lot of guessing going on here, and we will be a little clearer when we get the Q2 number, but the basic structure of the situation is, I think, the one I am suggesting here. Very weak (and possibly negative) growth in Q2 followed by a "bounce back" in Q3, and then a second negative quarter in Q4, a quarter which could well by that point be the first of two consecutive quarters of negative growth, that is the first part of a recession.

In addition all the indications suggest that German consumption will continue to be weak throughout 2008. So if consumer consumption is at best flat, government consumption equally so, and investment and construction weakening, we are simply lefy with export growth, and here the outlook is definitely more negative in 2008 than it was in 2007. So I would say that, based on current data, 1.4% growth in Germany in 2008 looks to be a reasonable estimate at this point, and if there is risk to this call, then I would say that it was mainly downside.