Greece

There are two articles in today's FT dealing with Greece. John Plender argues that the EU attempt to muddle through as best it can to see if Greece's disastrous fiscal position can be rectified. Given that it is so inefficient, there is some hope that it can albeit accompanied by drastic domestic deflation. Martin Wolf demonstrates why the ECB is so adamantly against restructuring because of the damage it will do the EU banking. The Greek banking sector is so dependent on ECB funding that its collapse would threaten the European banking sector as a whole. The threat of excessive financial interconnectedness has raised its ugly head again.

The trouble is that Greece is insolvent. At its current level of relative prices, it cannot grow and if it cannot grow it cannot pay off its debts. The domestic deflation to get unit labour costs/relative prices in line with Germany is probably politically unacceptable, and, anyway, deflation means that the debt burden continues to increase. The Greek people are faced with an unenviable choice - domestic deflation and a surrender of financial sovereignty or a collapse of the economy led by their banks. The experience of Argentina 10 years ago suggests that the latter is the preferable optionl, but neither will be pleasant.

The final issue is the lack of political legitimacy of the EU itself. Closer economic integration has been beneficial for all concerned, but one can only take that so far. When the euro came into being, many analysts warned that you cannot have monetary union without fiscal union. And now, as Martin Wolf points out, you need a European integrated banking system as well. But Europe does not have a mandate for fiscal union or the abolition of national banking systems.

Europe cannot win. There is no way it can force political integration on the unwilling populations of Europe but lending a bankrupt country billions of euros to sustain what is unsustainable won't work either. Another financial crisis is in the offing.

UK economy

The Financial Times described the UK economy as ‘stagnant’ following Wednesday’s announcement of 0.5% growth in the first quarter following on from the fall on 0.5% in the last quarter of last year. In the sense that these figures suggest no overall growth in the last six months, the FT could be just about be right. But this is a very superficial judgment and completely ignores what is happening at the sectoral level. The industrial sector is doing extremely well having grown by a total of 1.2% in the two quarters with manufacturing growing by 2.2% and energy by 0.8%. In contrast, the problem area was construction which contracted by almost 7% in the six months. This paints a picture of an economy that is rebalancing with a vengeance and hardly ‘stagnant’ whatever the headline numbers say.

Global economy

The wall of worry over the state of the global economy is still very much with us. But the pessimism is overdone. The IMF estimates that the global economy will grow at an average of 4.5% per annum between 2010 and 2012, very much in line with its trend. There was a slight slowdown in activity around September/October last year but the monthly surveys (PMIs, OECD lead indicator) show a vigorous pick-up since then. Interestingly, this is concentrated more on manufacturing than services. What seems to be happening is the necessary rebalancing of the global economy as the over-indebted, over-consumed economies divert resources away from consumption and property to manufacturing and trade. This will take time and will not be immediately obvious in the statistics. But it has to happen or else the world will disolve into protectionism. The only real problem lies with those economies whose exchange rates are tied to that of Germany, the economy that is showing everyone else how it should be done. These economies will struggle and will be unable to pay their debts.

UK economy

The 4th quarter GDP figures were revised downwards, from a first estimate of -0.5% to one of -0.6%. Falls in service output were greater than first estimated and growth in industrial production was less. The UK economy is still perceived as being very weak.

The CIPS PMI figures suggest that the gloom is somewhat overdone. The CIPS manufacturing index is now 61.5, which is the highest it has been for a long time. Interesting the CIPS surveys confirm the weakness in the service sector. For once, it is industrial production that is driving the UK economy and as a result growth in the 1st quarter of 2011 should be significantly better than that of the 4th quarter 2010.

The German economy

The German economy grew by remarkable 4.0% in the year to December, levels seen only briefly at the end of 2006 and mid-2000. Contrary to the impression of an externally driven economy, the majority of this growth has come from domestic demand. The biggest driver was investment contributing 1.4%, but private consumption grew by 0.8% and public consumption by 0.6%. Net trade contributed 0.6% as did inventory build. Consumer confidence has improved noticeably throughout 2010 and is at its highest level since early 2007.

The other impressive feature of the economy is unemployment now down to 7.4% well below that of the USA. The number of jobs is growing at 1.5%, although the number of Germans wanting to work is growing at a more sluggish 0.3% (vacancy levels have increased dramatically over the last year).

The outlook for 2011 remains positive and there is no reason why Germany cannot grow at 3% over the year. The risks are twofold; the first is a collapse in demand for German exports from emerging economies and the second is a banking crisis brought on by a PIIGS default. Neither is very likely this year.

UK economy

The UK economy supposedly declined by 0.5% in the 4/Q of 2010, having been expected to grow by that amount. Shock, horror, blame it all on the snow, the MPC and the Government. The bad weather in December will undoubtedly have had an adverse impact particularly on the retail sector but there should be a rebound in the current quarter. But it is more than likely that the figures are a nonsense and that revisions will reverse this to a small gain. The manufacturing PMIs show a completely different picture for the British economy with strong growth from August onwards all the way through to January. It looks as though there is some favourable rebalancing of the economy going on with a shift from consumption to manufacturing, which is all to the good. If the economy were as weak as these figures imply, then we would see weakness in the exchange rate, something that has not materialised. The other thing to remember is that even if the critics are right to lambast the Government for an overly tight fiscal stance, the exchange rate can always take the strain, an option not open to the PIIGS.