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Daniel Lacalle

Jul 10
0

The Slow And Painful Path To Jobs Recovery

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The United States recovered 4.8 million jobs in June, adding to May’s 2.5 million jobs rebound. The United States employment recovery is faster and stronger than the Eurozone one, which has over 40 million workers on subsidized jobless schemes added to a 7.4% unemployment that is expected to rise to 11% by September.

However, the positive headlines show important weaknesses that will have to be addressed in the following months. Labor Department data showed that in the week ending 27 June, initial claims for unemployment fell only slightly, to 1.43 million, on the previous week. Additionally, continuing claims remained stubbornly high at 19.29 million and the share of those reporting permanent job losses increased by 588 thousand.

Considering these factors, the trend shows that the United States unemployment rate would fall to 8.5% with a labor force participation rate of 63% at the end of 2020, according to my estimates. Goldman Sachs has improved its unemployment rate outlook to 9% for 2020 from 9.5% a month ago. However, at this rate the United States would only recover the 2019 record-low unemployment at the end of 2021. Still, much faster than the eurozone.

Subsidized jobless schemes, as the eurozone economies are implementing, is costly and generates extraordinarily little impact on consumption. Government spending is rising at the fastest pace in decades to include the increase in healthcare costs, the jobless insurance expenses, and the subsidised jobless programs. However, workers under these schemes know that their positions are at risk and are deciding, wisely, to save as much as they can. Almost 10% of the labor force in the major European economies is under one of these schemes, designed to help businesses navigate the crisis without letting go of employees.

The World Labor Organization estimates that 400 million full-time jobs have been lost in this crisis. Recovering and strengthening the labor market is crucial for developed economies to achieve the estimates of gross domestic product growth expected in 2021 and 2022. Without a strong job market, consumption and growth are likely to stall in 2021, and it will be exceedingly difficult to see investment growth.

How can economies recover the lost employment and continue to create jobs? Unfortunately, many governments would have to do the opposite of what most developed economies are doing. They should stop bailing out zombie firms, as those already had overcapacity in the past five years and are not going to hire more workers soon. Governments should also reduce unnecessary spending to prevent deficits from rising to unmanageable levels and then increase taxes that would reduce investment and job creation. Bloated public budgets are not going to bring employment back. It did not work in the eurozone in the 2009-2012 period and it will not work elsewhere.

The United States government has taken a more effective approach by combining some demand-side measures with more efficient supply-side policies that have supported the job recovery, even if it is still weak. There is a long and painful road ahead, and the rising number of covid-19 cases may harm the economic recovery as lockdown risks return.

Some commentators in Europe have argued that the job recovery in the United States is stronger due to a larger fiscal and monetary stimulus. It could not be further from the truth. The European Central Bank balance sheet is now 52.8% of GDP, 6.2 trillion euro. It started the year at 39.4%, or 4.6 trillion euro. The Federal Reserve balance sheet is 32.6% of GDP. Fiscal stimulus is also much smaller than in eurozone economies. The US fiscal impulse is equivalent to 5.2% of GDP, compared to 38% in Germany, 30% in Italy, 23% in France, and 10% in Spain.

The reason why the US economy is improving faster than the eurozone is a more dynamic and flexible labor market with more resilient businesses. That does not take away the important challenges of the US. It lost 7.9 million jobs in hospitality and leisure, according to the Bureau of Labor Statistics, and the service sector, which saw the biggest employment reductions, is coming back slowly.

If the United States wants to surprise the world with a much quicker return to record employment it needs to address the permanent job loss figure with tax incentives to hire faster and the continuing jobless claims with a robust and effective set of policies that strengthen business creation and allows existing ones to grow, particularly in digitalization and added-value online services for global customers.

At the current pace, the eurozone will not return to the 2019 employment levels until 2023. In the case of the United States, at the end of 2021 or first quarter of 2022. It is not enough. The global economy may fall back into a recession if the conditions for the labor market and business creation to strengthen are not introduced rapidly.

Governments will have t liberalize the labor market, cut red tape, eliminate harmful overregulation and provide a stable and helpful framework for businesses to start and grow, or they will find themselves in a deeper crisis than feared.

Jun 29
0

Deeper Crisis, Weaker Recovery

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Outlook for 2020 and 2021.

Gold and copper.

Equities and bonds.

 

 

If we look at the recovery so far in the majority of economies it is quite less exciting than what many expected, so what we can certainly rule out is the concept of a V-shaped recovery. I think it’s also very uneven. We see that the recovery is quite rapid in those areas that have to do with government spending and weaker in those areas that have to do with travel and leisure. Considering the outlook for 2021, what we believe is that there will be more of an L-shaped type of recovery.

Jun 05
0

Three Risks For European Banks

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The measures implemented by governments in the Eurozone have one common denominator: A massive increase in debt from governments and the private sector. Loans lead the stimulus packages from Germany to Spain. The objective is to give firms and families some leverage to pass the bad months of the confinement and allow the economy to recover strongly in the third and fourth quarter. This bet on a speedy recovery may put the troubled European banking sector in a difficult situation. Read More

May 03
0

Three Reasons Why The Eurozone Recovery Will Be Poor

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The Eurozone economy is expected to collapse in 2020. In countries like Spain and Italy, the decline, more than 9%, will likely be much larger then emerging market economies. However, the key is to understand how and when will the eurozone economies recover.

There are three reasons why we should be concerned:

  1. The eurozone was already in a severe slowdown in 2019. Despite massive fiscal and monetary stimulus, negative rates, and the ECB balance sheet above 40% of GDP, France and Italy showed stagnation in the fourth quarter and Germany narrowly escaped recession. The eurozone weakness started already in 2017 and disappointing economic figures continued throughout the next years. Many governments blamed the weakness on the Brexit and Trade War cards, but it was significantly more structural. The eurozone abandoned all structural reforms in 2014 when the ECB started its quantitative easing program (QE) and expanded the balance sheet to record-levels. Manufacturing PMIs were already in contraction, government spending remained too high and the elevated tax wedge weighed on growth and jobs. In 2019, almost 22% of the eurozone GDP gross added value came from Travel & Leisure, a sector that will unlikely come back anytime soon, while the exporting sector is also likely to suffer a prolonged weakness.
  2. The banking sector is still weak. In the eurozone, 80% of the real economy is financed via the banking channel (compared to less than 15% in the United States). Eurozone banks still have more than 600 billion euro in non-performing loans (3.3% of total assets vs 1% in the U.S.), an almost unprofitable business with a poor return on tangible assets (ROTE) due to negative rates, and a significant challenge ahead, as most of the growth investments, in LatAm in particular, may reduce capital strength significantly in the next months. Most of the eurozone governments are relying on leveraging the banks’ balance sheets in their “recovery plans”. A massive increase in loans, even with some form of state guarantee, is likely to cause significant strains on lending capacity and solvency in the next years, even with massive TLTROs and capital requirement reductions.
  3. Most of the recovery plans go to government current spending, and tax increases will surely impact growth and jobs. The eurozone tax wedge on jobs and investment is already very high. According to the Paying Taxes 2019 report, the majority of eurozone economies show widely uncompetitive taxation levels. As most governments will massively increase deficits to combat the Covid-19 crisis, there is a high likelihood of a massive increase in taxes that will make it more difficult to attract investment growth and jobs. Most of the recovery plans are also aimed at bailing out the past and letting the future die. There are massive bailout packages for traditional conglomerates and industries, but investment in technology and R&D continues to have high burdens and no support. Considering that the eurozone was already in contraction in the middle of the massive Juncker plan (that mobilized more than 400 billion euro in investments) and the large green policies implemented, it is safe to say that relying on a Green New Deal will unlikely boost growth or reduce debt. The main problem of these large investment plans is that they are politically directed and, as such, have a large tendency to fail, as we saw with the Jobs and Growth Plan of 2009.

Almost 30% of the eurozone labor force is expected to be under some form of unemployment scheme, be it temporary, permanent, or self-employed cessation of activity. After a decade of recovery from the past crisis, the eurozone still had almost double the unemployment rate of its large peers, the US, or China. Germany may recover jobs fast, but France, Spain or Italy, with important rigidities and tax burdens on job creation may suffer large unemployment levels for longer.

The eurozone also faces important challenges into a recovery due to its lack of technological and intellectual property leadership. Those two factors will help China and the U.S. recover faster, as well as the reality of having more flexible jobs market and higher support for entrepreneurial activity through attractive taxation. Considering the severity of the crisis, the eurozone is likely to need at last 10% of its GDP o rebuild the economy, but that figure is almost completely absorbed by the traditional sectors (airlines, autos, agriculture, tourism). Furthermore, the New Green deal initiative includes severe restrictions to travel and energy-intensive industries that may act as a brake on future growth.

The ECB policy was already unnecessarily expansionary in the past years, and now it runs out of tools to address the unprecedented challenge of recovery post-Covid-19. With negative rates, targetted liquidity programs, asset purchases of private and public debt, and a balance sheet that exceeds 42% of GDP of the eurozone, the best it can do is to disguise some risk, not eliminate it. We should also warn of adding massive monetary imbalances when demand for euros globally is acceptable but shrinking according to the Bank of International Settlements, and risk of redenomination remains in a politically unstable eurozone.

Our estimates show that, even with large fiscal and monetary stimulus, the eurozone economy will not recover its output and jobs until 2023, and rising debt to record highs as well as monetary imbalances due to massive supply of euros in a diminishing demand environment, may cause significant problems for the stability of the eurozone.

The eurozone needs to understand that if it decides to increase taxes to address the rising debt due to the Covid-19 response, its ability to recover will be irreparably damaged.

Sep 09
0

Why the ECB should raise, not cut rates

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Negative rates are likely one of the reasons behind the lacklustre European growth. Negative rates have worked as a tool to transfer wealth from savers to the indebted governments that have abandoned all structural reforms, while these extremely low rates have also perpetuated overcapacity, incentivised the refinancing of zombie companies and effectively worked as a disguised subsidy on low productivity. Not only those measures have damaged banks, but they have also created very dangerous collateral impacts (read “Negative Rates Have Damaged Banks But This Is Not The Worst Effect”).

In recent weeks we have heard of a likely new stimulus plan that would include a new repurchase program and further rate cuts. A new asset purchase program is completely unnecessary and unlikely to spur growth when all Eurozone countries already have sovereign debt with negative yields in 2-year maturities and the vast majority have negative real or nominal yields in the 10-year bonds.  Why would the ECB repurchase corporate and sovereign bonds when the issuers are already financing themselves at the lowest rates in history?  Furthermore, by reading some statements one would believe that the ECB has stopped supporting the economy. Far from it, when it repurchases all debt maturities in its balance sheet and has implemented another liquidity injection TLTRO in March 2019.

The main problem of those who defend further purchases and more negative rates is one of diagnosis. The central planners believe the Eurozone problems come from lack of demand, and that investment and credit growth are not what they would want them to be only because investors and corporates believe that rates will ultimately rise, leading to defensive positioning.

The eurozone has seen nothing but demand-side stimuli, and after trillions of euros the economy is weakening because of them, not despite them. Because the problem is a supply-side problem that the ECB cannot solve. Rising interventionism and tax wedge that choke the private initiative despite alleged attractive conditions.

The other problem of diagnosis is to believe that credit growth and investment today are insufficient.  There is no evidence that companies are investing less than what they need or that citizens are not taking the credit they desire and are able to repay, rather the opposite. In fact, the rise of zombie companies that the BIS mentions in various papers is precisely a sign of malinvestment and excess capacity. Ultimately, the central planners who believe that credit and investment growth are insufficient think so because they ignore technology and aging of the population. When governments and central banks ignore the diminishing requirement of capital investment that technology creates and the changes in consumption and investment patterns from demographics, their diagnosis of what is adequate investment and consumption is simply wrong. Even worse, when the rationale to support the idea of “lack of investment” and therefore a need for lower rates is based on looking at 2001-2007 as “normal” years, they are always going to make a mistake. Those were years that no one should consider as average, but years of a bubble that burst badly.

A recent analysis made by Scope Ratings showed that “a tiered system of remunerating reserves to mitigate the impact of lower rates on bank profits will have a limited effect. Euro Area banks have already incurred EUR 23.2bn in charges since the negative-rate began policy in 2014, EUR 7.5bn in 2018 alone”. Scope calculates the annualized current running cost of excess liquidity is EUR 6.8bn. Any further cut to the deposit rate would cost EA banks EUR 1.7bn. “In other words, EA bank ROE is c.40bp lower than it would be in the absence of negative rates.

Why should the ECB raise rates by a small 25bps then?

  1. It would show a sign of normalization without any real impact on mortgage, credit or investment growth. It would be a signal of health.
  2. It would stop the bleeding in banks, ultimately supporting the credit transmission mechanism, especially relevant in the eurozone, where banks finance 80% of the real economy.  Read this paper by Urbschat et al “The Good, the Bad, and the Ugly: Impact of Negative Interest Rates and QE on the Profitability and Risk-Taking of 1600 German Banks“. as well as Christensen et al “Negative Rates and Inflation Expectations In Japan“.
  3. Negative interest rates are generating dangerous collateral incentives to take more risk in speculative areas, refinance zombie entities and drive investors to levels of excess risk that many find difficult to understand.Worth reading Palley’s  “The fallacy of the natural rate of interest and zero lower bound economics: why negative interest rates may not remedy Keynesian unemployment“, even if you disagree (as I do) with the idea of “demand shortage”. We have excess supply from demand-side policies, as well as “Global Real Rates, A Secular Approach” by the BIS.
  4. Persisting with Japan-style measures, ignoring technology and demographics, as well as ignoring the side effects of negative rates will only lead the eurozone deeper into stagnation. The paper “Raise Rates to Raise Inflation? Neo-Fisherianism in the New Keynesian Model” by  Garin et al also show that even if you follow the Keynesian principles of central planners, the best way to improve inflation expectations is to mildly raise rates.

The evidence of the last years shows that the eurozone is slowing down in the middle of an unprecedented chain of fiscal and monetary stimuli. The failure to improve growth cannot be detached from the persistence on repeating failed measures. Implementing a larger quantitative easing and deeper rate cut program will not solve it,  because the diagnosis is incorrect.

A small rate hike added to support to those governments that implement structural reforms may help the eurozone. Monetary policy now is dangerously whitewashing populists who feel they can increase imbalances and put further fiscal strains on their countries’ budgets with no real risk, as yields continue to fall, albeit artificially.

A small rate hike would be a healthy signal that may help the ECB understand the real secondary demand for sovereigns, stop the zombification of the economy and improve liquidity transmissions to the real economy. Instead of being an incentive for reckless behavior from deficit-spending governments, it can be the beginning of an incentive to strengthen the private sector and the real economy.