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The current resurgence of the virus in Europe is evidently having negative economic consequences, as demonstrated by the latest purchasing managers’ indices (PMIs). The PMIs are forward-looking indicators meant to signal the direction of activity in the broad services and manufacturing sectors. They are based on sub-indices, such as output, new orders, employment, pricing, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth—and vice versa. IHS Markit, the company that compiles the data, has released its flash (preliminary) estimates of the PMIs for October. In the Eurozone, the PMI for services revealed declining activity while the PMI for manufacturing indicated continued growth.
Here are the numbers: The PMI for services in the Eurozone fell from 48.0 in September to 46.2 in October, a number that indicates a significant decline in activity. It is the lowest reading in five months. The sub-index for services output declined to the lowest level in eight years. Conversely, manufacturing in the Eurozone is doing very well. The manufacturing PMI increased from 53.7 in September to 54.4 in October, a 26-month high. Markit commented that, “The survey revealed a tale of two economies, with manufacturers enjoying the fastest growth since early-2018 as orders surged higher amid rising global demand, but intensifying COVID-19 restrictions took an increasing toll on the services sector, led by weakening demand in the hard-hit hospitality industry.”
Moreover, there was regional divergence, with Germany doing well and the rest of the Eurozone facing difficulty. In Germany, the manufacturing PMI was 58.0 in October, the highest in 30 months and a level indicating rapid growth of activity. The services PMI was 48.9, only slightly below 50 and indicating a modest decline. However, in France the manufacturing PMI in October was 51.0, indicating only modest growth in activity. The services PMI was 46.5, indicating a sharp decline in activity. The difference is, in part, due to the recent surge in infections in France, something that is also happening in Spain. Regarding France, Markit commented that, “The recent rise in COVID-19 cases and subsequent tightening of restrictions has had a notable negative impact on business conditions. The rate of private sector output contraction accelerated in October, with service providers posting another marked reduction.” The hope now is that the new restrictions in France and Spain will suppress the virus, setting the stage for a robust recovery. However, as Markit commented, “With the European winter fast approaching, the prospect of a sharp drop in new positive cases and a full reopening of the economy seems unlikely. The festive period, usually so important for wide range of business, is set to be a difficult one.”
Outside of the Eurozone, the PMIs for the United Kingdom were reasonably good. The numbers were recorded just as the new economic restrictions in response to the latest surge in infections were implemented. Specifically, the manufacturing PMI declined from 54.1 in September to 53.3 in October, indicating continued moderate growth of activity. The services PMI, however, declined sharply from 56.1 in September to 52.3 in October, a number indicating modest growth in activity. Thus, although these indicators point to continued moderate growth in October, it is clear that the direction is negative. As Markit noted, “The pace of UK economic growth slowed in October to the weakest since the recovery from the national COVID-19 lockdown began. Not surprisingly, the weakening is most pronounced in the hospitality and transport sectors, as firms reported falling demand due to renewed lockdown measures and customers being deterred by worries over rising case numbers.” It was also noted that things would have been even worse if not for the strength of British exports. That, in turn, reflected the fact that “overseas customers sought to secure orders before potential supply disruptions as Brexit draws closer.”
For Europe overall, manufacturing is doing reasonably well, fueled in part by strong demand for durable goods and improving demand for exports. The services sector, however, has been hurt by the resurgence of the virus and the consequent weakening of demand for consumer-facing services. The result is an increasing risk of a W-shaped recovery, or double dip downturn.
Michela Coppola, Senior Economist at Deloitte’s EMEA Research Center, reports on our latest survey of European CFOs.
Nine months into the COVID-19 pandemic, the path of recovery of the European economy it remains unclear. The Deloitte European CFO Survey—which garnered responses from over 1,550 CFOs across 18 countries in September—reveals a patchy pattern. Yet even in an uncertain economic environment, many companies are making efforts to complete their digital transformation.
Business sentiment of Europe’s CFOs has bounced back after hitting a record low in spring. Half of the CFOs surveyed across Europe report feeling more optimistic than three months ago about the financial prospects for their company—this number is five times the number in March. Sentiment improved in all countries surveyed, although CFOs in Italy and Spain who feel less optimistic still outnumber those who are optimistic, and the net balance remains negative.
Companies’ revenue expectations also reflect an improved mood in Europe, with 54% of CFOs expecting their revenues to increase over the next 12 months. However, the upturn in confidence cannot mask the fact that the crisis has inflicted a heavy blow and business leaders remain concerned about the solidity of the recovery.
Most businesses have yet to return to their prepandemic revenue level. While 23% of businesses are operating at or above their preCOVID level and 13% expect to return to precrisis levels by the end of the year, 44% expect that to happen in a year’s time at the earliest. There are large differences between countries, however. While 53% of CFOs in Germany expect their revenues to recover fully by the end of the year, only 21% of UK CFOs expect so. Differences across sectors are even larger: only 4% of CFOs in tourism and travel expect a full recovery by the end of 2020, whereas that is the case for 43% of CFOs in retail.
The number of CFOs who expect a decline in their workforce over the next 12 months has dropped, but only slightly since March. A resurgence in infections forcing new local restrictions could lead to more layoffs and thus a drop in domestic demand, which in fact remains one of the top three concerns for CFOs in three-quarters of the countries surveyed.
Therefore, investment intentions remain unsurprisingly subdued across the region, with 38% of CFOs planning to reduce capital expenditures over the next 12 months, against 26% expecting to increase them. Nevertheless, about 60% of CFOs do plan to invest more in business process improvements, such as automation, and 47% intend to increase their investment in software, data, and IT networks. The COVID-19 pandemic has slowed down economic growth but has certainly accelerated the rise of the digital economy.
You can visit the European CFO Survey Autumn 2020 page to download the full report and explore the country-specific data on our interactive dashboard.
The Chinese economy continues to perform well according to the latest data released by the government. Most notable was the strong growth of real GDP in the third quarter. However, as strong as it was, growth in the third quarter was slower than many analysts expected, largely due to slower-than-anticipated growth of consumer spending. Specifically, real (inflation-adjusted) GDP in the third quarter was up 4.9% from a year earlier. Many analysts had expected growth closer to 6%. Moreover, real GDP was up 3.2% from the previous quarter (for an annualized rate of 18.3%). The major drivers of growth were investment and exports. Consumer spending increased, but not as much.
Most experts now expect that, for 2020, China’s real GDP will increase from the previous year. As such, China will be the only major economy to experience positive real GDP growth this year. Most importantly, real GDP is now almost where it might have been without the crisis. Real GDP was growing around 6% year-over-year and is now almost 5% above a year ago. Still, the economy continues to face a variety of challenges and downside risks. Among these are rising debt, fraught trade relations with the United States and Europe, and the continued threat of the virus.
The government also released other data that provides greater detail about the performance of the economy. First, retail sales were up 3.3% in September versus a year earlier. This follows growth of 0.5% in August after seven consecutive months of decline. This was the biggest annual increase in retail spending since December of last year. Some categories saw especially strong growth. For example, sales of automobiles were up 11.2%, clothing and footwear were up 8.3%, food and drinks were up 7.8%, personal care products were up 10.7%, cosmetics were up 13.7%, and jewelry was up 13.1%. In contrast, sales were down for telecom equipment, furniture, and home appliances.
Meanwhile, China’s industrial production expanded rapidly in September, rising 6.9% from a year earlier, the fastest growth since December 2019. This included a 7.9% gain in manufacturing output, a 2.2% increase in mining output, and a 4.5% increase in utility output. Some categories grew very strongly, which included machinery (up 15.9%), general equipment (up 12.5%), communication (up 8.0%), and metals (up 9.0%). However, production of transport equipment rose a more modest 4.9%. Output of textiles was up 5.6%. Industrial output was driven, in part, by strong government support for infrastructure and bank lending to state-owned enterprises.
Overall fixed asset investment grew modestly, but investment by the public sector was strong. Specifically, investment in the first nine months of the year was up 0.8% from a year earlier, the first increase since the end of last year. Public investment was up 4.0%, while private sector investment fell 1.5%. Property investment was up 5.6%.
Early in the pandemic, shipping companies cancelled many scheduled sailings due to a sharp drop in demand, disruption of supply chains, and fear that the virus would stifle economic activity for a prolonged period. Now, with the US economy in a modest recovery, companies are eager to obtain goods from overseas to meet expected consumer demand during the upcoming holiday season. Optimism about consumer demand was confirmed by the strength of retail sales in September, despite consumer income having declined after the expiration of government stimulus. The result is that the cost of using container ships to transport goods from Asia to the United States has soared in the past month. The cost of shipping goods to the West Coast of the United States is up 63% from a year ago, with much of the increase having taken place in the past month. The strength of demand reflects both expectations of strong consumer demand and the fact that inventories have been depleted. Plus, companies might be wary that the current surge in virus infections could spiral out of control, thereby once again disrupting supply chains. Thus, boosting inventories is of paramount importance.
The rise in shipping costs also reflects the challenge that shipping companies face in meeting the increased demand after a period of disruption. However, if the virus does spiral out of control, and if there is no government stimulus in the near future, there is a risk that consumer demand could weaken substantially. If that happens, there could be a much bigger increase in inventories than anticipated, eating into profits. Meanwhile, a shortage of container shipping space has led some companies to seek air transport. The result is that the cost of air transport has risen 20% since July. This is also due to a decline in air capacity given that airlines have reduced the number of passenger planes crossing the Pacific Ocean.
The OECD, which is effectively the club of affluent nations, has warned that the COVID-19 crisis has led to a sharp decline in migration, thereby likely having a negative impact on global economic growth. Specifically, the OECD said that, in 2019, member countries accepted 5.4 million permanent migrants. It expects that, in 2020, that number will decline by 46%. This reflects immigration restrictions due to the virus as well as weaker economies generating fewer employment opportunities. As such, 2020 is likely to see the lowest level of migration for OECD countries in modern times. This is significant because, already, immigrants and their offspring account for roughly a fifth of the population in OECD countries. If migration falls for a prolonged period, it could significantly reduce population growth and, consequently economic growth. It could also create more stress for government pension plans. And it is worth noting that immigrants tend to be more entrepreneurial than the native born. Thus, a decline in immigration could stymie business creation. Moreover, this issue extends beyond the OECD. For example, Saudi Arabia has seen a 90% drop in immigration because of the virus. The same is likely true in other countries that rely heavily on migrants.
Aside from the negative economic consequences of reduced migration, the OECD points out that migrants tend to be at greater risk of contracting COVID-19 because of poorer living conditions, poor hygienic conditions, and less access to medical care. Existing migrants have been at greater risk of losing jobs during the crisis and many have not had the opportunity to return to their home countries. This has created a humanitarian crisis in some countries. Interestingly, in the United States, the unemployment rate for migrants was considerably lower than that of the overall population before the crisis but is now higher.
During this crisis, most affluent nations have engaged in some form of fiscal stimulus. This, combined with a sharp decline in revenue due to economic contraction, has led to a surge in government debt. For example, the ratio of publicly held government debt to GDP in the United States has risen from 84% in 2019 to 107% this year. In Germany, the figures are 38% and 49% respectively. In the United Kingdom, they are 75% and 86%, respectively. In Japan, the ratios are 154% and 169%, respectively. In my interaction with clients, I am often asked whether this increase is sustainable and what should be done about it. My answer is that the debt is likely sustainable, that it needn’t lead to higher taxes or reduced spending, and that policies meant to reduce the debt could be counterproductive. Many leading organizations and economists also agree. Specifically, consider the views of the International Monetary Fund (IMF), which historically has been strong advocate of fiscal probity. It often recommends that countries run primary surpluses (whereby the budget balance excluding interest payments is in surplus) and often conditions assistance on a country’s fiscal discipline.
In this case, however, the IMF says that, for affluent countries, austerity will not be necessary and could be counterproductive. The key will be borrowing costs, which the IMF expects will remain below economic growth rates. If, following the crisis, countries can return to modest primary deficits, and assuming borrowing costs remain low, then countries will not see their debt-to-GDP ratios spiral out of control. Rather, they can stabilize, even if economic growth rates are modest. Recall that, following World War II, the debt-to-GDP ratio for the United States fell quickly as the economy grew at a healthy pace and inflation was modest. What the IMF is saying is that, even with slower economic growth, the debt-to-GDP ratio is not likely to rise and will likely fall. As an IMF official said, “The [public debt] ratio in our projections stabilizes and even declines slightly towards the end of our projections, which shows that COVID-19 is a one-off jump up in debt and, with low interest rates, the debt dynamics stabilize.”
Thus, there is no need for an austerity policy that would entail debt consolidation through higher taxes and reduced spending. That, in turn, could have negative effects on growth. Moreover, the IMF worries that fiscal stimulus will be withdrawn too soon, thereby stifling the current recovery. Specifically, the IMF official said, “We believe there is a risk of prematurely withdrawing fiscal support and policymakers that have a choice would be well-advised to be very gradual and to maintain fiscal support until the recovery is on a sound footing and the long-run scarring impacts from COVID-19 are perceived to be under control.”
The IMF is not alone in this assessment. A similar sentiment has been expressed by the World Bank, the OECD, leading central banks, and well-known academics. Jason Furman of the Peterson Institute notes that, despite a sharp rise in debt, debt service payments as a share of GDP have not risen in most affluent countries during this crisis due to very low interest rates. Moreover, forecasts suggest that debt service costs will remain historically low, despite an unusually high level of debt. Thus, the debt is not currently onerous. It is useful to examine the numbers. In the US, fiscal stimulus has been about 14% of GDP, the highest since World War II (when stimulus was roughly 25% of GDP). The US stimulus is among the highest in the world. Among major economies, only Germany’s was marginally higher in the past year. Stimulus was significantly smaller in other Eurozone countries. Yet despite the vast size, this stimulus is temporary and not as large as what took place during the war.
Regarding policy, there is evidently a growing global consensus among experts that more stimulus is required immediately and that, in the longer term, it will not be necessary to engage in onerous austerity policies. Such policies were deleterious to economic growth in Europe a decade ago. Rather, there is also a consensus that the focus of longer-term policy ought to be on generating stronger productivity growth in order to boost living standards and to adjust to a post ̶ COVID-19 world. This might entail more public investment in infrastructure, especially digital and green infrastructure; more investment in human capital so that the labor force can be prepared for the transition to the kinds of jobs that are likely to be created in a post ̶ COVID-19 world; liberalization of trade and capital flows so that the global economy can derive the efficiency benefits from trade; and a better global regulatory framework for the implementation of new technologies. It is not clear, however, if political leaders in many countries accept this agenda. In various countries, there remains support for protectionism and austerity.
Japan’s government is worried that Japanese manufacturing companies are excessively dependent on Chinese supply chains. The disruption of supply chains early in the coronavirus crisis severely hurt Japanese companies and created increased uncertainty. Then, deteriorating trade and political relations between the United States and China added fuel to the fire. Hence, the Japanese government implemented subsidies meant to encourage Japanese companies to transfer resources out of China and either into Japan or toward Southeast Asia. Now, the Japanese government is strengthening this policy by offering enhanced subsidies to companies that move facilities to Southeast Asia. Specifically, the government pledged to cover up to half of the cost of moving facilities for large companies, and up to two-thirds of the cost for smaller companies. The stated goal is not to discriminate against China. Rather, it is to encourage companies to diversify their supply chains and not be dependent on just one country. However, the effect will clearly be to reduce dependence on China.
Moreover, it is not simply about diversification. The reality is that manufacturing production wages in much of Southeast Asia are considerably below those in China. Wages in Vietnam and Indonesia are 60% and 40% below those in China, respectively. The subsidies will not only apply to companies that move. They will also apply to companies that boost capacity by investing in Southeast Asia, thereby diversifying their overall footprint. For countries in Southeast Asia, this could be quite lucrative, potentially contributing to a significant increase in manufacturing output and exports. Despite the significance of this program, it remains much smaller than a similar program meant to encourage manufacturing investment in Japan itself.
For much of its existence, the International Monetary Fund (IMF) has been a paragon of fiscal rectitude, often telling member countries to cut spending in order to avoid accumulation of debt. After all, part of the IMF’s job has been to help member countries avoid financial crises. Yet in this coronavirus crisis, the IMF is singing a different tune. Specifically, in a recent external publication, the IMF took the stand that affluent nations should worry less about debt levels and more about setting the foundations for a sustained recovery from this crisis. It expressed support for increased spending, provided that such spending involves public investments that assist recovery. This could include investment in digital infrastructure and clean energy. The IMF noted that, prior to the crisis, public investment as a share of GDP had been declining in many rich nations and that investment in infrastructure was inadequate. Thus, there was already a need. Moreover, with private investment weak and borrowing costs historically low, governments can afford to invest heavily and are likely to see a high return on their investment. The IMF noted that “scaling up of quality public investment can have a powerful impact on employment and activity, crowd in private investment, and absorb excess private savings without causing a rise in borrowing costs.” If the IMF is correct in its view that increased public investment will accelerate economic growth, the result could be that the debt-to-GDP ratio will decline more rapidly and that governments needn’t be vexed by the recent accumulation of debt. This assumes, however, that governments use their borrowing power effectively and not to provide transfers or tax cuts to households or to subsidize troubled enterprises.
The IMF managing director Kristalina Georgieva said that the “calamity is far from over” and that governments should not withdraw support prematurely. She said that rich nations should do “whatever it takes” and that poor nations should do “whatever is possible.” She said that failure to support the economy during the pandemic risks “severe economic scarring from job losses, bankruptcies, and the disruption of education.” Still, the chances of more fiscal stimulus in the United States and Europe appear low.
Meanwhile, the World Bank is thinking about what emerging nations ought to do. Carmen Reinhart is the new chief economist of the World Bank. She achieved considerable attention when, with Kenneth Rogoff, she published a book called This Time is Different in which she argued that too much sovereign debt can retard economic growth. Thus, it is notable that, during this pandemic, she is now arguing that emerging nations should put caution aside and take on new debt in order to fight the pandemic and protect their economies. Specifically, she said, “While the disease is raging, what else are you going to do? First you worry about fighting the war, then you figure out how to pay for it.” A similar point of view has been offered by the IMF, traditionally a bastion of fiscal conservatism. Despite calling for more borrowing, Reinhart acknowledged that, once the crisis is over, emerging nations could face serious problems in servicing their debts. She worries that there could be defaults or, at the least, slower economic growth as a consequence of excessive debt. As such, she has suggested that creditor nations should seriously consider debt write-offs.
Without such write-offs, many poorer countries will likely struggle to service debts, especially if their exports are weakened or, in the case of commodity exporting countries, if commodity prices remain suppressed. The fear of trouble has already led to a decline in the values of emerging market currencies, thereby further exacerbating the problem of servicing debts that are denominated in dollars or euros. Reinhart also noted that a lack of transparency has made it difficult to know the exact magnitude of the problem. For example, China’s emergence as a major creditor to poor nations, especially through the Belt and Road Initiative, has largely involved debts with non-disclosure clauses. Thus, the scale and terms of Chinese lending is not known. Another issue is that much of the debt taken on by poor nations is owed to private sector players rather than governments. Such debts cannot easily be written off without large banks taking losses. Already there has been a spate of ratings downgrades of such debts. Whatever happens, the challenge of emerging market debt will be a key issue in a post ̶ COVID-19 world.
There has been much discussion lately about whether the dominant role of the US dollar in the global economy will be lessened in the coming years. Among the factors that might reduce use of the dollar are the increasing weaponization of the dollar by the US government, thereby encouraging China and/or the Eurozone to encourage more trading in their respective currencies; the vast increase in the US money supply that has already led to a sharp depreciation of the dollar; the rising external debt of the United States, which is likely to necessitate a decline in the value of the dollar; and efforts by the Chinese and Eurozone governments to increase the size and liquidity of their sovereign debt markets. Meanwhile, there are plenty of reasons for the dollar to remain dominant. These include the vast relative size and liquidity of the market for US government debt; the relative transparency of US financial markets and financial regulation; investor confidence in the stability of the US economy; and concerns about stability elsewhere. For example, investors might be concerned about the ability of the Eurozone to self-govern, or about the fact that the Eurozone lacks a central fiscal authority. Investors might also be concerned about the willingness of China’s authorities to liberalize financial markets if that entails less control over capital flows.
This is the context for what appears to be a changing investor attitude toward Chinese finance. Specifically, this year there has been very strong global investor demand for debt issued in China. Evidently, investors are attracted to the relatively high yield on Chinese debt. In addition, investors are likely pleased by the strength of the Chinese economy and China’s evident success in quashing the coronavirus, thereby setting the stage for a relatively robust recovery. This is in contrast to the failure of the United States to fully suppress the virus or to manage a sustained recovery. What makes this important is that it potentially sets the stage for Chinese assets to play a bigger role in global finance. If that happens, it could ultimately lead to a bigger role for the renminbi in global trade and capital flows. Indeed, China’s central bank said that it expects “more foreign central banks and monetary authorities to hold renminbi assets as reserve assets.” The use of a currency as a reserve asset is often a prerequisite for global dominance. That is, if the renminbi were widely used as a reserve currency, then traders and investors would feel more comfortable transacting in renminbi.
Why is this important? The answer is that, when a currency dominates global finance, the country that issues that currency has what is often called an “exorbitant privilege.” That is, the country can issue foreign debt in its own currency and thereby avoid exchange rate risk. It can run large external deficits without risk of default. It can exact political concessions from others or impose costs on them—as the United States has done. If the renminbi were to become dominant, it would mean that China could boost living standards by running large external deficits. It would mean that China’s geopolitical footprint would be much bigger. And it would mean that the United States would no longer have an exorbitant privilege. As such, the United States would necessarily have either higher borrowing costs and/or a lower valued dollar. The latter would mean higher import prices and, consequently, a lower living standard.
Will any of this happen? It is too early to say. We could be at an inflection point, heading toward a world less dominated by the dollar. That said, the dollar might remain dominant during the first half of this century. Nothing lasts forever, and the dominant role of the dollar will likely eventually stop. But possibly not in my lifetime.
In Europe, real (inflation-adjusted) retail sales grew strongly in August after having stalled in July. Real retail sales were up significantly from a year earlier, suggesting that the European consumer sector has made a strong recovery and is on a path similar to what might have happened without the crisis. Nonetheless, the recent surge in the virus outbreak is clearly taking a toll. Retail sales in Spain, where the recent outbreak has been most prevalent, have not returned to pre-crisis levels. Here are the details.
In the Eurozone, real retail sales were up 4.4% from July to August and were up 3.7% from a year earlier. The numbers were similar for the larger European Union (EU). Most categories were up from a year earlier, with apparel retailing being a notable exception. For apparel retailers, real sales were up 7.7% from July to August but were down 14.1% from a year earlier. This might reflect less purchasing of clothing because people are mostly not going anywhere, certainly not to the office. Moreover, it might reflect a shift to online shopping. Indeed, online retail sales were up 12.4% from July to August and up 23.8% from a year earlier.
Performance varied by country, with Northern European countries performing better. In Germany, real retail sales were up 7.2% from a year earlier, reflecting Germany’s success in suppressing the virus outbreak through mass testing. This has led many consumers to feel comfortable in engaging in controlled interaction. Likewise, real retail sales in France were up 3.0% from a year earlier. In the Netherlands, sales were up 8.3%, and in Belgium, sales were up 12.9%. Finland’s sales were up 4.2%. However, sales were down 2.9% from a year earlier in Spain. This likely reflects the negative impact of the second surge of the virus outbreak that especially hit Spain. Sales were down 4.4% in Portugal. Data was not available for Italy and Greece.
The latest Purchasing Managers’ Indices (PMIs) for services in the Eurozone indicate that activity declined in September, likely due to the surge in the virus. Activity weakened across Europe but fell especially sharply in Spain where the virus was a major problem. The PMIs, which are compiled by IHS Markit, are forward-looking indicators meant to signal the direction of activity in the broad services sector. Services encompasses most non-construction and non-manufacturing sectors, such as retail, wholesale, transportation, telecoms, finance, professional services, tourism, health care, and education. The PMIs are based on sub-indices, such as output, new orders, export orders, employment, pricing, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth.
The Eurozone PMI for services fell from 50.5 in August to 48.0 in September, the lowest level since May. This number indicates declining activity. Moreover, it appears that there is a bifurcation under way in Europe, with Northern Europe being in somewhat better shape. The services PMI for Germany fell from 52.5 in August to 50.6 in September, indicating that activity barely grew. Still, of the Eurozone’s four major economies, Germany was the only one to experience growth of services activity. The services PMIs were 47.5 in France, 48.8 in Italy, and 42.4 in Spain. As Markit pointed out, “Spain has been especially hard-hit as rising COVID-19 case numbers led to further disruptions to daily life. Spain’s service-sector contraction in September was the largest recorded since November 2012.” With respect to the near stalling of activity in Germany, Markit noted that it reflected “the broad-based geographical spread of the worsening service-sector picture.” Markit expressed concern about what might happen in the near future, suggesting that the ability to suppress the virus will be key. It noted that there is a risk of another wave of COVID-19 outbreak.
In the United Kingdom, the services PMI fell, but remained at a very elevated level in September. Specifically, the PMI fell from 58.8 in August to 56.1 in September, a level indicating strong growth of activity. The strength of UK services came mainly from growth of business-to-business activities rather than business-to-consumer activities. Thus, financial services did well while hotels and restaurants did not. Moreover, it was in September that the government introduced new economic restrictions and ended subsidies for the restaurant industry—actions that were taken due to a renewal of the virus outbreak. Despite the strong number for September, Markit warned that “companies grew increasingly worried about the impact of a second wave of virus infections and the gradual withdrawal of government support, especially the furlough scheme. Brexit worries are also rising again, causing hesitancy in spending and investment decisions. While the third quarter will inevitably see a strong economic rebound, growth in the fourth quarter looks likely to be far less impressive.”
The second round of the viral outbreak in Europe is having a large impact on Spain, France, United Kingdom, and Czech Republic. In the latter, 15% of all infections in the country have taken place in just three days. Meanwhile, in Spain the outbreak is so severe that the government has imposed restrictions on people entering or leaving the capital city of Madrid. The restrictions were imposed by the national government but are opposed by the local government in Madrid. It is interesting that Spain is seeing such a large outbreak while Italy, which along with Spain, had the worst initial outbreak in April, is doing quite well, with limited infections and a relatively strong economy. It is reported that public health experts attribute the relative success of Italy to having imposed economic restrictions for a longer period of time than in Spain. They say that Spain might have been too early to lift restrictions, thus enabling community transmission to continue. In the United Kingdom, the government is extending some forms of stimulus to protect the economy as the virus surge takes place.
Even in Germany, where the number of cases remains relatively low, there has lately been a surge in infections. In the last few days, the number of daily new infections increased to a level not seen since April. A German government official blamed the surge on young people who are not taking the virus seriously and, as a result, are not taking adequate precautions regarding social distancing. The latest surge led the government to impose restrictions on domestic tourism. Overall, the renewed outbreak in Europe threatens to undermine the economic recovery. Some governments are imposing restrictions. But even in those countries that don’t implement restrictions, the fear is that consumers will likely shy away from social interaction, thereby limiting spending.
As for Italy, its industrial production grew strongly in August, reaching a level comparable to one year ago, something not true of other major European countries. Specifically, Italian output was up 7.7% from July to August. This was the fourth consecutive month in which output was up more than 7.0% from the previous month. By August, output was up 0.3% from a year earlier. This compares to a decline of 10% in Germany and a decline of 6% in both France and the United Kingdom. Italy’s strong rebound was largely due to a big gain in output of consumer durable products. This was consistent with the 8% increase in Italian retail sales from July to August. Also, production of fashion goods was up 36% from July to August. Often the laggard among European economies, Italy is now a star performer. In part this reflects its success in suppressing the virus through a draconian and prolonged lockdown earlier this year.
In the United States, the expiration of government stimulus measures at the end of July was expected to significantly reduce consumer income and, ultimately, consumer spending. Last week, we learned what happened in August: Personal income fell sharply, entirely due to the expiration of government transfers to households. However, spending decelerated only modestly even as households significantly reduced and dipped into their savings. The personal savings rate fell to the lowest level since March. Although Treasury Secretary Steven Mnuchin and House Speaker Nancy Pelosi are reported to be in discussions, it still appears unlikely that the Congress and the White House will agree to a new stimulus package before the end of the year. Therefore, it is likely that household spending will continue to weaken in the months ahead in the absence of a surge in employment. While households have adjusted to the decline in income by dipping into their savings, there is a limit to how far this can go. As such, the expiration of stimulus at the end of July set the stage for a substantial weakening of economic activity in the fourth quarter. Here are the details of the latest report:
In August, total personal income fell 2.7% from July after having risen in the previous month. The fall was entirely due to a 14.8% decline in government transfers to households, which, in turn mainly resulted from the expiration of the program of enhanced unemployment insurance. Meanwhile, wage income was up 1.3% as employment continued to rise. After accounting for inflation and taxes, real disposable personal income fell 3.5% from July to August. Yet real consumer spending increased 0.7% from July to August. Real spending on durable goods was flat, spending on non-durable goods fell 0.2%, and spending on services increased 1.1% as people continued to return to restaurants and other consumer-facing businesses. The overall change in spending was the weakest since the height of the crisis in April when it fell sharply. The fact that spending increased even as income fell was a result of consumers saving much less than earlier. Specifically, household saving fell from 17.7% of disposable income in July to 14.1% in August.
It is interesting to compare what happened in August with the situation a year earlier. In August, real disposable income was 4.0% higher than the previous year. At the same time, real spending was 3.2% below the level a year earlier. This was entirely due to a 7.2% decline in real spending on consumer services. Spending on goods was up 5.8% from the previous year, including an 11.2% increase in spending on durable goods such as automobiles, appliances, and furniture. In part, this likely reflected the strength of the housing market.
In September, the US job market slowed considerably, according to the latest employment reports from the government. The number of new jobs created was the lowest since April, with most of the new jobs being in low-wage, consumer-facing industries. In addition, there was a sharp decline in employment at state and local governments. Overall employment remained far below the level in the previous year. Meanwhile, the number of people actively participating in the labor force fell sharply in September and the participation rate declined commensurately. With fewer people seeking work and some finding work, the unemployment rate fell to 7.9%, the lowest level since before the crisis. Still, this is the highest September unemployment rate prior to a presidential election in the post-war era. This alone poses a huge obstacle to the president’s hopes for reelection. The unemployment rate is also much higher than prior to the crisis. The slowdown in job growth might be attributable to the expiration of government stimulus at the end of July, which led to a slowdown in the growth of consumer spending. In addition, businesses are likely wary of a potential revival of the virus as the weather turns colder and people spend more time indoors. As such, many businesses could be reluctant to hire, given the uncertainty about the future of demand.
The US government publishes two employment reports, one based on a survey of establishments and the other based on a survey of households. Here are some of the details from these reports:
Going forward, the state of the labor market will depend on several factors. The expiration of fiscal stimulus is having a negative impact. If stimulus is renewed—perhaps after the election—it would likely have a positive impact on job growth. However, the most important factor is the path of the virus. Introduction of a vaccine would be a game changer, likely leading to a significant resurgence in aggregate demand in the economy. This, in turn, would probably fuel more hiring. Without a vaccine or treatment, the risk of further waves of viral outbreaks remains, each of which could have a negative impact on consumer spending and mobility. If the crisis is prolonged, many consumer-facing businesses could fail or, at the least, be forced to significantly downsize. This, in turn, would mean more permanent job dismissals.
An index of pending home sales in the United States has increased sharply. This index is meant to measure housing activity. It is based on contract signings for existing homes. The index, which is released by the National Association of Realtors (NAR), was up 8.8% from July to August and 24.2% from a year earlier. The index hit the highest level on record. Clearly, the US housing market is on fire. The NAR said, “Tremendously low mortgage rates—below 3%—have again helped pending home sales climb in August. Additionally, the Fed intends to hold short-term fed funds rates near 0% for the foreseeable future, which should, in the absence of inflationary pressure, keep mortgage rates low, and that will undoubtably aid homebuyers continuing to enter the marketplace.”
Indeed, home prices are rising. In addition to the positive impact of low-mortgage interest rates, there is also evidence that many upper-income households are interested in purchasing larger homes in order to telecommute with ease. Also, it might be the case that increased demand for housing reflects a belief that housing is now a good investment, especially if one believes equities are over-valued.
European Central Bank (ECB) officials are concerned that that the eurozone faces disinflationary or even deflationary pressures, especially as the euro has been rising in value against the US dollar. A rising currency means lower import prices, thereby suppressing overall inflation. Low inflation means higher real (inflation-adjusted) interest rates, thereby hurting credit market activity. Indeed, the latest quantitative evidence demonstrates that inflation in Europe is waning. Consumer prices fell 0.3% in August versus a year earlier after having fallen 0.2% in the previous month. Prices were up 0.1% from the previous month. When volatile food and energy prices are excluded, core prices were up 0.2% in August versus a year earlier. The difference between headline and core inflation is explained by the sharp decline in energy prices. By country, overall prices were down 0.4% in Germany, unchanged in France, down 0.9% in Italy, and down 0.6% in Spain. The sharpest decline took place in Greece where prices fell 2.3%.
The weak inflation environment has led the ECB to consider a shift in policy, similar to what was enunciated by the US Federal Reserve recently. That is, the Fed wants to boost inflation above its long-term goal, at least for a prolonged—but temporary—period. The idea is that this would help to stabilize the otherwise-weak economic environment. In the case of the ECB, President Christine Lagarde said, “If credible, such a strategy can strengthen the capacity of monetary policy to stabilize the economy. This is because the promise of inflation overshooting raises inflation expectations and therefore lowers real interest rates.” She suggested that the ECB might shift from targeting an inflation rate of just below 2.0% to one in which 2.0% would be the average. While Lagarde has discussed this, no new policy has been decided upon. It could be challenging to achieve consensus among ECB leaders. Specifically, Germany’s Jens Weidmann, who heads the Bundesbank, has often been at odds with other ECB leaders on such issues. In this case, Weidmann believes there are risks to an overly easy monetary policy. He said, “The more widely we interpret our mandate, the greater the risk that we will become entangled with politics and overburden ourselves with too many tasks.”
Craig Alexander, chief economist of Deloitte Canada, reports on the latest monthly GDP release from the government:
The latest data from Statistics Canada shows that the Canadian economy continues to recover, but the pace of recovery is slowing. Real GDP grew by 3.0% in July in the wake of a 6.5% increase in June. Preliminary numbers for August suggest another gain but at a much-reduced pace of 1%. Based on the July numbers and preliminary estimates for August, the economy is on track to grow by approximately 10% (non-annualized) in the third quarter of 2020, reversing much of the 11.5% drop in the second quarter.
The loss of momentum in the recovery not surprising, and there is still a long way to go in overcoming the damage done to the economy. Even with the massive rebound since April, the level of economic activity is still 6% below pre-COVID-19 levels. Now that the initial reopening impact has passed, the economic scars in terms of high unemployment and the blow to business balance sheets will become more apparent. In our latest economic forecast, we projected that economic activity wouldn’t return to pre-pandemic levels until the second half of 2021.
Having said that, one key risk to economic recovery is the timing of the future scaling back of government income support programs, but this risk has diminished. The Speech from the Throne made it clear that federal income support will remain in place even as unemployed workers are transitioned onto Employment Insurance or the Canadian Response Benefit. The wage subsidy for business was also extended. This creates an upside risk to our economic projections but a worse fiscal balance. Meanwhile, there is an increased downside risk from the rising infection rates across the countries. We anticipated this, but did not build in significant renewed lockdowns. Time will tell how the health risks evolve.
In terms of the industry picture, all 20 major sectors of the economy posted gains in July. With the gains in that month, agriculture, finance and insurance, and real estate and leasing sectors all surpassed the February levels. The retail trade sector surpassed pre-pandemic levels in June.
The manufacturing sector grew 5.9% in July compared to 15.1% in June. Production of autos and parts saw particularly strong growth and these sectors are now operating just below pre-pandemic levels as plants attempt to recuperate from shutdowns in April and May. Despite the increase, the manufacturing sector remains 6% below February levels.
Accommodation and food services saw a substantial increase of 20.1% in July. Accommodation is benefiting from increased domestic tourism as international travel remains restricted. Foods services also performed well as Canadians continued to make use of patios. Despite the strong growth in both these sectors over the last several months, accommodation output remains 43% below pre-pandemic levels while food services remain 29% lower.
The mining sector grew 2.4% as non-energy mining continued to see strong growth. However, oil and gas extraction fell 2.9%. This was the fourth decline in the last five months. Oil and gas extraction remain 11% below February levels.
Overall, the release points to broad-based growth in the economy with every sector posting gains in July. However, the preliminary data for August showed a sharp deceleration in growth, providing more evidence that we have entered the protracted and likely uneven growth phase of the recovery that we discussed in our latest forecast. Indeed, the recent announcement that some businesses in Quebec will have to temporarily close or reduce services to slow the spread of the virus is the type of economic headwind that will weigh on the recovery over the months to come.
In the debate on what to do about climate change, there has long been a divergence between rich nations and not-so-rich nations. The rich nations have often said that everyone must agree to cutting back significantly on carbon emissions. The failure of large emerging nations to do so would negate the positive impact of carbon reduction in rich countries. On the other hand, poor and middle-income nations have said they should not be required to reduce carbon emissions dramatically because they are still developing and do not want to stymie living standards for those who have yet to emerge from poverty. This disagreement was latched onto by some political leaders in the United States. They said the country should not be required to cut emissions unless China, Russia, and India are compelled to do likewise. Their perspective was informed by the notion that cutting emissions would necessarily entail a decline in economic growth.
However, there is increasingly a view that, done properly, the transition to clean energy needn’t entail a cutback in living standards. After all, the transition is not simply about burning less fossil fuel. Moreover, there is increasingly another view that climate change will reduce living standards if it’s not addressed. This newer way of thinking may have influenced the Chinese government to take a new stance on the issue. Specifically, Beijing has set a goal of achieving carbon neutrality by 2060. Previously, China had argued that it should not be held to the same standards as rich nations because it has not yet enjoyed the full benefits that accrue from burning carbon-based fuels.
China’s change of attitude took many observers by surprise. Why did China change its mind? There are several possibilities: First, it is increasingly clear that climate change will do harm to China and to the wider world. Moreover, if China is to become as mobile a society as richer nations, it will not be able to rely on fossil fuels. Electric vehicles will be key. Second, the economics of clean energy are rapidly changing. It is increasingly evident that a shift to clean energy needn’t entail economic loss. In addition, the switch to clean energy might even boost economic growth because it would involve investments that improve productivity. Third, it is likely that China’s leaders see this issue as an opportunity for China to boost its geopolitical footprint. Taking a lead in this issue would enable China to set global standards and improve relationships with other countries.