BIS Does Us All a Favour

Nothing is more admired from a distance than quietly-maintained financial repression. We in the Anglo-Saxon world look out and envy the high household savings rate which deliver a seemingly endless supply of savings with which to finance sparkling new infrastructure and a manufacturing sector alive with the purr of new machinery. Why can't we be prudent like that?

The answer, of course, is that the corollary of financial repression is almost always an economy in which savings are allocated far more widely by banks or, worse, governments, than by capital markets. And in turn that tends to result in lower returns on capital, and, in time, more debt than in non-financially repressed economies.

We tend to forget this partly because it seems so counter-intuitive – how can all those hard-saving Japanese (or Dutch for that matter) end up carrying more debt that us financially-incontinent Brits and Americans?

But of course, most countries have very little idea about how indebted, in a relative sense, they are. Thus, even in the aftermath of August's financial panic, it is still uncommon to find Europeans who know that Europe is carrying a far heavier debt-load than the US.

So the Bank of International Settlements' work on debt levels is extremely valuable if only because it gives us the comparative data we simply don't yet know instinctively. Rather than simply trot out the usual government debt/GDP numbers, BIS has tallied up all debt of the non-financial sector – that's government, corporate and household debt.

You can find the results here, and they bear illustration. For example, they show that the average European economy is carrying a debt/GDP load 43 percentage points higher than the US.

But that's not Greece. For, out of 18 OECD countries surveyed by the Bank for International Settlements, Greece is the sixth-least indebted of the lot – indeed it's debt/GDP ratio is three quarters of a standard deviation below the average! I'm quite sure that Finland isn't prepared to learn that Greek debt/GDP levels are only three percentage points higher than its own. I doubt that France, the UK, the Netherlands will already know that, all-told, they are more indebted than Greece.

But whilst the individual readings are sometimes eye-opening - the US is the fourth-least indebted of OECD countries (so much for the 'hopeless case' rhetoric), there are other things to notice. First, although capital markets are currently pricing sharply for differences in debt-load, most of the developed world is clustered around 300-350% of GDP. In fact, there's an average debt load of 312% of GDP, with a standard deviation of 54 percentage points.

The world's debt-profile used to be neither so large, nor so clustered. Here's how it looked in 1980: the average debt/GDP was 167%, but with a standard deviation of 50 percentage-points – virtually the same spread as now, but on a much lower base. Then, the potential debt-problem nations were Japan (the perennial winner in this class), Canada, Sweden and the Netherlands. By contrast, we can clearly identify the prudent and financially cautious as . . . . Greece and Italy.

By 1990, Germany had won a reputation for debt-avoidance, but it was still joined at the bottom of the league by Greece and Portugal. Meanwhile, the average had jumped to 210% of GDP, with a standard deviation of 64 percentage points.

At the turn of the century, the average debt/GDP ratio had risen to 255%, with a standard deviation of 55 percentage points.

Is it too facile to attribute the noticeable convergence of debt levels to the globalization of capital markets and/or the convergence of interest rates which occurred in the years prior to the introduction of the Euro? It shouldn't be: after all, the logic of the single currency is that high net-saving countries (such as Germany) get higher bond-yields than their savings/investment balance ought to deliver; whilst countries that are investing far more than their domestic savings-flows could finance discover they have lower bond-yields than they might otherwise legitimately expect. In these circumstances, one should expect a convergence of 'financial thickening'. Unfortunately, the financial logic behind this goes no way at all to undermine the perpetual truth of banking – that no banking system can grow its assets by 30% a year without making dreadful errors. 

Anyway, as we watch the Euro Doomsday Machine go about its work of devastation over the coming months, bear these data-sets in mind, because they illustrate some of the truths that are at work in our lives. 

Shocks and Surprises, Week Ending August 26

The whole point of Shocks and Surprises is to spot how the consensus is likely to change by tracking where current assumptions and forecasts are being proved wrong.

Judging from the last fortnight's Shocks and Surprises, it seems we may have got to the point where economists' assumptions (and by extension stockmarket pricing) are proving overly pessimistic. In my round-up last week I noticed that signals from the world's industrial economies were now more often surprising on the upside than shocking on the downside. The same was true this week, and particularly for Europe and the US – generally perceived as the most vulnerable parts of the world economy.

Take Europe: this last week gave us a rash of PMI readings for the Eurozone – readings which economists had by and large expected to show significant deterioration. Some did – France's manufacturing PMI, and Germany's services PMI, for example. But most simply didn't. Not only did the Eurozone Composite PMI, the Eurozone Services PMI, Germany's Manufacturing PMI and France's Services PMI turn out to be better than the range of surveyed expectations, but they almost all actually told a tale of market conditions which had improved during the month. The message was repeated outside the Eurozone, with British order books and consumer confidence readings beating both consensus and the range of expectations.

Something similar, but a little less dramatic, happened in the US, where durable goods orders jumped 4% MoM (and popped the S&P about 20 points) unexpectedly, where 2Q personal consumption growth was revised up from 0.1% QoQ to 0.4%, and where continuing unemployment insurance claims fell unexpectedly (a result obscured by a rise in initial claims generated by industrial disputes). On top of that, the Chicago Fed National Activity Index also came in far stronger than expected – though grazing the ceiling of the most optimistic expectations.

In all, then, the West produced 10 positive surprises, and only eight shocks. And the shocks weren't even difficult to predict – four of them stemmed from the wholesale collapse of German investor confidence tracked by the ZEW Survey. Frankly, ZEW need hardly have bothered: I could have told you that for free. (Indeed, I do.)

More worrying, and much more worth tracking, was the deterioration beyond expectations of Eurozone monetary aggregates. M3 rose only 2.0% YoY, vs an expectation of 2.2% and a range of expectation of 2.1% to 2.3%. Twenty basis points below expectations may not seem a big deal, but the details underlying it are horrible (repos up 20.1% YoY, money market institutions down 12.7%, private sector credit up only 1.9%). Moreover, as I explained here, Eurozone monetary velocity is flat on its back, so if Eurozone financial institutions no longer have the capital to buy or create financial assets, that strain will quickly show up in nominal GDP.

The economist in me worries about this a lot – so much so I'd be adding my weight to those consensus forecasts which are currently still proving too pessimistic.

If it has been a data-heavy week in the West, it's been data-light in Asia. Moreover, as far as China and NE Asia is concerned, there were few surprises. Almost all growth-related forecasts were about right: China MNI Business Conditions Survey, China HSBC Flash Manufacturing PMI , Taiwan IP, Taiwan commercial sales, leading/coincident indicators, Korea consumer confidence – all came in about as expected. That's the good news, the bad news is that the consensus expected stability or a modest continuing deterioration in conditions, and that's what happened.

Within that context, however, Hong Kong's trade data for July was a moderately unpleasant shock: not only did export growth of 9.3% YoY and import growth of 10.2% YoY undershoot expectations of 14.2% and 14.9% respectively (and the range of estimates too), but for both exports and imports, a MoM slowdown in the China-trade was to blame.

Foreign Banks in US Prepare for Armageddon

Sit down, I have a data-story to tell. 

You'll not be surprised to learn that it's extremely difficult to extract the sort of timely data about the state of Europe's banking system from the European Central Bank. But across the Atlantic, we have weekly updates about how foreign banks are managing their US operations, courtesy of the Fed.

And the results are a quite startling picture of how banks prepare for the absolute worst: being shut out of interbank markets, and being besieged by panicking depositors. More cautious by far than even in the aftermath of the Lehman collapse, more cautious than seems consistent with commercial banking operations, even. Indeed, the picture is so extreme that you need to know where you can check and follow the data for yourself: it comes from the US Federal Reserve's statistics page (here), Table H8, Pages 18 and 19 – Assets and Liabilities of Foreign-Related Institutions in the US.

The first chart suggests the difficulties foreign banks now have in accessing US money markets, or perhaps just expect to have. Traditionally, foreign banks in the US have raised money in the US, and channelled back to other overseas offices (head office, usually). At the beginning of 2008, this net lending back home was running at US$445b, but in the immediate aftermath of the interbank breakdown of 2008 this net lending dwindled to US$135 billion (Dec 08). The traditional patterns revived, and by the beginning of 2010 the net lending to o'seas office amounted to US$398 billion.

No longer: the pattern of funding has reversed spectacularly. Between the end of 2010 and the middle of August this year, those overseas offices have net repaid US$571 billion to their US operations, and are currently funding them to the tune of US$174 billion. US$200b of that money has arrived since June. It is as if US money markets were no longer open to foreign banks, or at least potentially no longer open to foreign banks, so they have to rely on funding from their head office.

It's even more remarkable when you realize this reversal of funding is taking place against the backdrop of a sharply weakening dollar.

The second chart is even more extreme, and it maps the staggering build-up of cash holdings by foreign banks in the US. Foreign banks' holdings of cash are now equivalent to 103.4% of their entire deposit liabilities. That's right, foreign banks in the US are now in a position to pay out every depositor they have in full, and still have cash left over. Cash holdings now amount to just under half these banks' total assets.

In short, the way foreign banks have restructured their balance sheets in the US suggests one of two possibilities. Either the Fed has demanded it of them, or their head offices want at least to preserve their US operations if Armageddon hits at home.

Flow Essentials: Scaffolding for the Cycle

Today I publish my Flow Essentials booklet for 2Q for the US, the Eurozone, China and Japan. It tracks those fundamental ratios which are scaffolding for my view on the cyclical state of these economies, and their likely near-term future. The pdf file can be downloaded here.

The charts look at return on capital, labour productivity, banking system leverage trends, private sector savings surpluses/deficits, and terms of trade. They also look at the changing relationships people and their money (liquidity preference), and between money and the economy (monetary velocity).

I believe how these ratios and indicators change tell us a great deal about what's really happening in these economies, above and beyond the noise of the monthly data-tide. Moreover, they uncover cyclical potentialities and perils which would otherwise be largely hidden. Given the extreme financial risk-aversion we're currently suffering, and the underlying economic scepticism and/or fear they reflect, an examination of the roots of the world's leading economies' business cycles feels unusually timely.

Here's what they reveal:

In the US, the charts shed a light on the profound divorce between current cyclical indicators, and financial fears. If you look at what's happening to the factors of production, it's pretty clear that both ROCs and labour productivity growth are still very positive – having survived the 1H downturn with ease. But – and this I find astonishing, if only in retrospect – something profound happened in 2Q. For the first time in 12 quarters, the US private sector ran a savings deficit during 2Q. This deficit was equivalent to 0.9% of GDP, and compares to a surplus of 6.1% in 2Q10, and a 12m savings surplus of 4.3%.

In one sense, this is a shocking reversal of cashflows – for the first time since 2Q08, the US private sector has had to attract a cashflow from the financial system in order to maintain its current level of consumption and investment. And it's no illusion: precisely during the same period, the US banking system's net foreign liabilities increased for the first time since the end of 2008 – precisely what you'd expect if the banking system were having suddenly to find cash, rather than allocate it. Against this background, the weakness of the dollar is hardly surprising.

But in another sense, this is merely a restoration of normal seasonal patterns, after three years interruption-by-crisis. I calculate the PSSS using non-seasonalized data for the current account and the fiscal deficit, and it's those seasonalities which caused the 2Q plunge into deficit. We can be almost certain that a surplus (probably declining) will be resumed in 3Q and 4Q, and that the equilibrium between the US private sector and foreign savers will be effected on easier terms as the year wears on.

The other factor which is very striking is the way monetary velocity has collapsed back almost to levels seen during the worst stretches of 2009. I am inclined to believe that this represents the continuing substitution of deposits for 'riskier' financial assets – nonetheless, the less-efficient allocation of savings that implies must surely be a drag on growth. Looked at in a positive light, however, it seems unlikely that monetary velocity will fall much further – which in turn argues that nominal GDP growth is probably bottoming out just about now (at around 3.7% YoY).

As in the US, so in the Eurozone the cyclical growth factors were actually improving during 1H – ROC was rising gently albeit not yet to pre-crisis levels, and this was allowing a modest expansion of capital stock. There is much better news from labour productivity: real output per worker, adjusted for capital per worker, is now rising for the first time in recent Eurozone history, so labour markets are likely to be more resilient than might immediately be suspected. However, deleveraging is painfully slow, with bank private sector LDRs only dribbling down to around 105% (vs c82% fdor the US). Over 10% of gross foreign liabilities have quit the Eurozone banking system, with the result that even a reasonably large private sector savings surplus (about 5%) isn't delivering sufficient cash to allow much lending-growth. Added to which, monetary velocity has flatlined in Europe now since the end of 2008, with no sign of a pickup. As a result, with deposit growth slowing to under 4%, it seems unlikely Europe's nominal GDP growth will outpace that of the US any time in the near future.

For all the handringing and introspection, the story told by China's fundamental ratios is one of more of the same. Most ratios are disappointing, but not so much as to precipitate either a crisis or a major policy change. Thus, ROC is probably slightly worse in 2011 than 2010, whilst growth of capital stock is probably slightly higher in 2011 than in 2010. Monetary velocity is flatlining, as it has been for 18 months now. Terms of trade continue to decline, albeit gently.

Together the unaddressed inefficiencies are undermining China's cashflows – China's 12m PSSS probably declined to around 5.6% in 1H11 from 6.3% in 1H10 – but the pace of decline makes no dent at all in the financial sector's cashflows. In fact, by July, the banking system's LDR had fallen to 66%, which is actually down from 66.5% in July 2010. This underlying liquidity was, of course, sucked out of the system by PBOC's repeated raising of reserve requirements: once these were taken into account, the banking system's effective LDR was shunted up to just under 84%, it's highest rate since early 2004. The stress, though, is entirely policy-induced. China's real cyclical challenges are political, rather than financial or economic. (That probably makes them more real, more consequential, not less).

There's a challenge in interpreting the ratios for Japan. That challenge is first to separate out the impressive early recovery from the March 11 catastophe, from the real lasting damage done to Japan's economic infrastructure, and then secondly, to remember that even had March 11 not happened, Japan's economy would in any case be only in a mediocre position to prosper cyclically.

The disasters of March have taken a sharp toll on the factors of production: the rise in ROC was abruptly snuffed out, and previously sharp-gains in labour productivity were scaled back. Monetary velocity also collapsed. We can expect all these to bounce back to some extent during the rest of the year. But other problems cannot be attributed to March 11: for example, the unabated collapse of terms of trade – the effects of which are excacerbated by the rise in the Yen. This is also reflected in the slow decline of the private sector savings surplus, which started well before March 11, and has continued after it. The real problem is that this economy still looks fundamentally deflationary, and whilst monetary velocity will probably bounce back in 2H, there remains no reason to think it will or can return to pre-2008 levels. In which case, the long-term contraction of nominal GDP must be expected to continue in the medium to long term.

Finally, there's no real encouragement anywhere for operating margins: terms of trade have fallen sharply everywhere. In the Eurozone and Japan, they have fallen right back to the previous lows of 2008. Things aren't quite so bad in the US and China – but in both cases, comparisons are going to get tougher throughout the rest of this year.  

Shocks and Surprises - Implications

Looking back at the Shocks and Surprises of the last couple of weeks, there's what might be called a Broad Surprise: actually, the evidence from the world's industrial economy is, by and large, surprisingly good. The trade cycle continues to flow practically unabated: over the last two weeks we've had positive surprises from China's trade numbers, Taiwan's trade numbers, and this week Taiwan's export orders. Europe's trade numbers were pretty much as expected. The only negative trade shock has come from Singapore – which is too small to be truly representative. We've also had leading indicators rising in the US and also in China.

We've also had positive surprises from US industrial production, and capacity utilization. Perhaps it's in this context we should also note the positive surprises coming from US labour markets, UK wage settlements (?), and the surge in Japanese machinery orders.

Can we really dismiss all these as just lagging indicators in a world economy which is currently being mugged by a collapse in financial confidence and the vanities of Eurozone politicians? Should we ignore what we know of the structural foundations of this cycle: that pretty much everywhere outside China asset turns, labour productivity, and ROCs are rising, but that the resulting positive cyclical impulse is being moderated and governed by households bent on mending over-extended household balance sheets?

In the short to medium term, the answer to that question will turn largely on developments in credit markets. Will the stockmarket losses of the last fortnight scupper deposit growth in the months to come, as the ability to substitute one set of financial assets for another is lost? And if this source of M2 growth is lost, will banks' ability to create/buy financial assets collapse with it? And finally, even if the supply of credit is maintained, how long will today's presumed collapse in loan demand persist?

For the next few weeks, I daresay we'll see Shocks and Surprises enough from real economy readings. But the ones that will need close watching are the Shocks and Surprises from the world's monetary systems.  

Shocks and Surprises, Week Ending August 19

Sometimes the worst shocks leave an imprint on the stockmarket charts. This week it happened on Thursday when the Philadelphia Fed business outlook survey diffusion index collapsed to minus 30.7, from plus 3.2 in the previous month. This was off the charts, being way below anyone's surveyed expectations, and the worst reading since March 2009. The S&P had opened very weak, and promptly lurched down again on this news, and at the time of writing hasn't recovered. So dramatic and thorough-going was this fall – huge falls in all the subindexes – the Philly Fed accompanied it with something that was almost an apology: 'The collection period ran from Aug 8 to Aug 16, overlapping a week of unusually high volatility in both domestic and international financial markets.'

The Philly shocker was presaged earlier in the week by the Empire State Manufacturing survey, which at minus 7.72 was also far below consensus, and which told a sorry sale of dwindling work backlogs, new orders and inventories. Finally, the 3.5% MoM fall in sales of existing homes wasn't foreseen, but its shock-value was mitigated by housing starts and building permits data which was very much as expected.

Since this week will be remembered in the US (and probably elsewhere) for Philadelphia's contribution to financial panic, it's pretty certain that we'll forget that this week also delivered some positive surprises from the US. Yes, no-one had expected industrial production to rise 0.9% MoM, but it did (thanks mainly to a 5.9% MoM increase in auto-production), and no-one had expected capacity utilization rates to climb to 77.5% either. In other environments, the news that capacity utilization was running at its highest levels since 3Q2008 might have been noted and remembered for its likely impact on the investment cycle.

For form, I should also mention the surprisingly positive 0.5% MoM rise in the US' Leading Indicators. But there's a big caveat to this: the surprise was generated almost wholly by rises in M2, stockmarkets (yes!), and the steepening of the yield curve. So there's no doubt what next month's Leading Indicator is going to look like. Be warned.

At its highest level, I take the politico/diplomatic news from the Eurozone as being genuinely trivial. A Merkel/Sarkozy meeting produced ever-more fantastic declarations of dedication to maintaining the existence of the Euro Doomsday Machine. There comes a point at which these statements seem not merely incredible or ill-advised, but actually bonkers. I reached that threshold this week. Meanwhile, the Doomsday Machine continues its work: poor numbers from Eurozone 2Q GDP (up 0.2% QoQ) were as expected, as were trade and current account balances. However, Germany's 2Q GDP falling to just 0.1% QoQ, on a fall in net exports, and slower household consumption and construction spending was a shock. Since Germany is thought to be the Western economy best positioned to benefit from global growth, its unexpected slowdown is troubling confirmation that global growth really isn't what we took it to be.

Europe held one rather limp surprise: UK average weekly earnings actually rose 2.6% YoY in the past three months! Does that make anyone feel better? Thought not.

If the West was mired in misery this week, could we at least see some positive surprises from Asia? Well, this was not a week for economic data from China, and what was released was, even though there was no survey to determine consensus, unsurprising. Unsurprising, but could have been worse. The MNI Flash survey of business sentiment in China deteriorated mildly, but in the detail there was a surprising recovery in new orders (best since May), and a financial position subindex which, though bad, was slightly less bad than lasts month. Since the MNI tracks loads of SMEs, I personally hadn't expected this very marginal improvement. The China Conference Board Leading Economic Indicator also rose 1% in June, higher than the 0.6% in May and 0.3% in April: consumer expectations, loan growth and new export orders, apparently helped the rise. I'm sceptical – this survey has a short track record, which includes major revisions.

This doesn't mean that there wasn't something worth noting: Taiwan's export orders, for example, came in very slightly stronger than expected at 11.1%,, but with the problems afflicting the electronics sector, and the slowdown in Taiwan's exports recently, there was every chance this data-point would disappoint – and it didn't. No surprise, then, but certainly a minor relief. This minor relief was offset, however, by Singapore's trade data, which showed non-oil domestic exports down 2.8% YoY - a modest positive YoY had been expected.

Finally to Japan, which surprised nicely with a 2Q GDP result which showed a fall of only 0.3%. This probably wasn't worth cheering too much, since a rise in inventories contributed 0.3 pp to the overall growth, and in any case the sharp fall in Japan's terms of trade flattered the GDP number. When you add back the trading losses (which are counter-intuitively obliterated by the deflators for exports and imports), Gross Domestic Income (rather than Product) fell by 0.8% QoQ. Which, I should say, was about consensus.

What do we take from this week's Shocks and Surprises? I think there are two main lessons. First, the West, and particularly Europe, is slowing. Second, that the perception that it's all bad in the US is actually wrong – the message is more subtle than the cacophony of fear and panic can allow. Third, that perhaps surprisingly, the world's trading environment, and with it China, continues somehow to teeter without falling, yet.

Optimism

The last day of my holidays must be devoted to optimism - after all, on the very day it started, market collapses wrecked my peace of mind, and quite possibly the future I had imagined for myself. With the future so radically uncertain, optimism is indispensable.

Part of my holiday reading has been Kevin Kelly's 'What Technology Wants'. Kelly coined the term 'the technium' to describe the interface of human creativity and technology. He argues that the exponential emergence of the technium is nothing more or less than evolution accelerated.  And like evolution, the technium has its own inherent biases which will tend to influence how (and how fast) it evolves, although, of course, its evolution will also be subject to accident and, perhaps, some element of human constraint. Despite the title, the book is less about technology per se than about evolution. Technology, like just like humanity, is a process, or tendency, not an entity.

I highly recommend it, not least because of its underlying optimism. Right at the very root of the whole technology story is the thorough-going rejection of Malthusianism in all its forms.  The huge and wonderful irony about Malthus is that he formulated his wretched views at the precise moment when technology had finally achieved the sort of take-off speed which would prove him repeatedly, relentlessly and tirelessly wrong ever since.  For me it is a truism: if an argument is basically Malthusian, then it's certain to be wrong.

(Take, for example, the threat of 'peak oil'. I imagine that somewhere in the 17th century, there were a bunch of worriers fretting about 'peak charcoal', armed with forecasts of charcoal demand intersecting 30 years hence with the limit - the total possible forest-covereage of Britain, perhaps.  

Anyway, here's a cause for optimism - a passage by Julian Simon, former Uni of Maryland professor of business administration, quoted in the book:

These are my most important long-run predictions, contingent on there being no global war of political upheaval: 1) People will live longer lives than now; fewer will die young. 2) Families all over the world will have higher incomes and better standards of living than now. 3) The costs of natural resources will be lower than at present. 4) Agricultural land will continue to become less and less important as an economic asset, relative to the total value of all other economic assets. These four predictions are quite certain because the very same predictions, made at all earlier times in history, would have turned out to be right.

I wonder how many of these we have forgotten to believe?

Shocks and Surprises, Week Ending August 12

Each week I check between 50 and 100 separate pieces of economic data from US, Europe, China, Japan and NE Asia. The data-tide never stops, and it serves two distinct purposes. First, for economists it is the raw data from which views and models can be constructed. Second, for the market, it is a source of (negative) shocks and (positive) surprises which might, just might, move the market.  Between them, these two purposes generate a third: the accumulation of shocks and surprises constantly modifies everyone’s expectations.  

So it pays to keep a close eye on Shocks and Surprises, and I intend to summarize them here each weekend.  If you only read one piece of mine every week, this should be it.

First, what constitutes a Shock (negative) or a Surprise (positive)? For those data for which there is a published list of Street estimates,  a Shock or a Surprise is a result which is outside the 1 SD range of the median estimate. For data where no such estimate is available, a Shock or Surprise is 1+ SDs either side of the historic seasonalised expectation.

In the week ending August 12, Shocks and Surprises showed several separate themes. First, and least surprising, was the collapse in confidence seen in the West. In the US, the Uni of Michigan Confidence Index fell to its lowest level since early 1980s, during Jimmy Carter’s Hostage Crisis months; and the Bloomberg Consumer Comfort Index made its worst reading since April 2010. In Europe the Sentix Investor Confidence Index fell to minus 13.5 – by far the gloomiest reading on record. Though economists had expected none of this, who in truth can be surprised that the combination of the Euro Doomsday Machine, and the US Fiscal Poker shredded our nerves? Usually confidence readings tend to tell us more about yesterday than tomorrow – let’s hope so this time.

The second theme is the way the Eurozone is finally producing the sort of Shocks you’d expect now the Doomsday Machine is really hitting its stride. Eurozone industrial production Shocked by falling 0.7% MoM (France down 1.7% MoM and even Germany fell 0.8% MoM).  Add to that, specific misery clustered round France – neither the 0% 2Q GDP preliminary, nor the 1.6% MoM fall in industrial production  was even nearly anticipated by the region’s economists.  

And there is a third series of Shocks coming from China: the trade cycle may still be supporting China, but much else is slowing faster than the Street anticipates. I’ve already written a little about the monetary and banking data (here), which delivered a series of Shocks. But industrial output slowing to 14.0% in July from 15.1% in June constitutes a Shock, and so does the relatively modest (but nonetheless unexpected) slowdown in retail spending to 17.2% in July from 17.7% in June.

But it was not all Shocks, thank God. There were a couple of pleasant Surprises:  first, the world’s trade cycle continues to surprise in its strength. We saw this not just in China’s exports (up 20.4% YoY in July, vs 17.9% in July), but also in Taiwan’s exports (up 17.6% in July vs 10.8% in June) and, across the Pacific, in the US trade deficit, which blew out to US$53.1b.

This dovetails with two other themes: the positive Surprises coming from US labour markets, and the continuing recovery in Japan’s industrial base. The intense gloom generated by the US Fiscal Poker, coupled with the earlier lurid GDP revisions disguises the fact that US labour markets are regaining strength: this week, we had Surprises in initial claims (best since April), continuing claims (biggest drop since Feb), and the highest reading in the JOLTs Job Openings survey since February 2008. Didn’t see that making headlines anywhere this week – but it happened.

Japan’s industrial recovery also continues to generate Surprises: core machinery orders jumped 7.7% MoM – the highest reading since August 2010, and expected by nobody. In addition, Japan’s services industries rose 1.9% MoM,  with the rises broadly based, and also not expected. Finally, despite the gloom out West, Japan’s pavement level Economy Watchers Survey’s reading of the current situation was seriously jolly, rising to its highest level since March 2006.  

China Banks' Negative Cashflow - The Squeeze Intensifies

China's banking numbers,  released on Friday, were genuinely nasty, though not necessarily for the reasons mostly cited (a slight slowdown in monthly loan growth, which, on closer inspection still turned out to be  higher than you'd expect in July). Rather, the problem is deposits, which fell by 670b yuan, or 0.9% MoM, at a time when you'd normally expect deposits to rise about 0.6%. In fact, even before you take seasonal patterns into account, this was still the worst month for deposits since October 07. Probably part of  this retreat is simply a reaction to June's mad dash for deposits to satisfy quarterly and semi-annual inspections by CBRC centred on LDRs. Nonetheless, over the three months to July, the sequential growth of deposits was 1.3 standard deviations below historic trends. 

By itself, that would be a worry. But the funding squeeze on China's banks is far worse than merely that,  because there have been six hikes in reserve ratio requirements this year, with big banks now having to hand over 21.5% of their deposit base. Once you factor in those RR hikes, you'll find that whilst deposits are growing at 15.4% YoY, growth of deposits potentially available for lending or purchase of other assets has now fallen to 8.5% YoY. And this is the slowest rate since - well, my database starts in 1998, and it can show me no similar slowdowns. 

But yuan loans are still growing at a rate of 15.0%, and even though the loan/deposit ratio of China's banking system prints at 66%, that's still means China's banks are now giving out loans far faster than they are taking in deposits available to be lent. 

Over the 12 months to July China's banks took in 10.4 trillion yuan in new deposits, and made 6.76 trillion in new yuan loans - a positive cashflow of 3.64 trillion yuan. However, at the same time, the state commandeered 5.614 trillion yuan of those new deposits. So when you subtract those, the banks' net cashflow situation looks very different - after reserve ratios, the banks made just under 2 trillion yuan more new loans than they took in new and available deposits. In other words to keep lending at this rate, banks need to sell other assets, or take on new liabilities (such as foreign equity or bonds).  They need to do that simply to recreate a cashflow which has been confiscated by the state.

PBOC used this tactic of -  shall we call it redacting the inflow of deposits? - back in 2003/04 and again in 2007/08. But what's happened since September 2010 has been bigger, and sharper, than has ever been seen before in China. 

In 2003/04, the cashflow squeeze peaked in May 04, and for six months after that sequential loan-growth collapsed to 2 SDs below seasonalized trends, with the result that by May 05, loan growth had slowed to single digits (9.2%). 

In 2007/08, the cashflow sqeeze had a double nadir in Oct 07 and Jan 08. Although the subsequent slowdown in loan-growth was not as dramatic as in 2003/04 the subsequent collapse of the domestic economy is a matter of record.  

So even in July 2011 proves to be the absolute nadir of the squeeze, unless we see a concerted relaxation of regulatory and policy pressure, the 16% loan growth target is likely to be missed by a long way this year. My best guess at the moment? Unless something changes. . . . 11%. 

Thinking About Fear . . . . And Measuring Its Impact

‘Nothing to fear but fear itself’. Actually, that can be re-written for today’s media-wrapped world: ‘Yes, we have stuff to fear, but My God, brace yourself for the wave of confirmation bias CEO quotes coming our way.’

That’s perhaps a bit unfair.  But we should recognize that, among other things, we’re now in a period where there’s a ready market for business journalism based on the whining of CEOs ready to tell us how demand for their services/products is disappearing, and the government must do something.

Actually, if you’re prepared to ignore the ticking of the EuroDoomsday Machine, the impact of fear becomes more . . . measurable. Fear postpones purchases, postpones investments, postpones expansion. And it does it for one big reason: households and companies meet fear rationally – by working hard to limit their financial exposure.

Consider first the behaviour of the US corporate sector: in a way, the whining CEOs aren’t kidding – in real life they remain immensely cautious for years after the end of the last recession. We can track this behaviour through the US flow of fund accounts. When recession hits, the corporate sector finds ways to stop the growth of their net exposure to credit markets. That much is obvious: rather less obvious is the amount of time it takes them to get over this fear. Take a look at the chart:

• The 1990/91 mini-recession ended in 1Q91, but it wasn’t until 1Q95 that corporate’s net credit exposure dipped back to pre-recession levels, and started growing once again.
• The 2000-2001 semi-recession was ended in 3Q2001, but it wasn’t until 4Q2004 that companies were prepared to take on more net credit.
• The 2008-2009 recession  officially petered out in 2Q2009, and so far net credit exposures have not returned to pre-recession levels.

Nor, it currently seems safe to say, should we expect a corporate appetite for credit to revive any time soon – previously experience suggests we might wait until 2013 or 2014 for revived credit appetite. It could, of course, be worse this time.  That’s the impact of fear.

Households reacts to economic and financial fear in much the same way – they net-repay debt. I have shown previously (here) how US households have repaid more than half their net debts to banks and credit markets since the cUS$3 trillion nadir of mid-2007. At the current rate of net repayment, the US household sector can expect to be net creditors to credit markets again by around 2015. 

But notice that this net repayment has been made not principally by repaying debts, but rather by shifting the balance of their savings from risky instruments (equities and equity mutual funds) to less risky (deposits).  At the peak of US household financial risk appetite  - during the tech bubble of 2000 – equities etc accounted for 37.2% of all gross household financial assets, whilst deposits etc accounted for just 18.5% at their lowest point.

The subsequent market collapse eroded that share both directly (by prices falling) and indirectly (by people switching out of equities) to reach first 22.8% in 3Q02, and then 20.4% in 1Q09. Notice that the subsequent market recoveries never took that equity proportion back to glory days of the late 1990s. Rather, it seems likely that, post-disillusionment, the proportion meets a ceiling of 28-29%. More likely, the volatilities in these ratios are gradually trending back to pre-1990 norms (ie, deposits representing 30-35% of assets, equities etc representing 15-20% of assets).

We do not yet have the data for 2Q, but there is likely to be little change in equity holdings in 2Q, since the S&P ended June only about 50 points lower than it ended March. To get much of a change in the US$13.84 trillion  holdings of equities and equity mutual funds, you’d need to assume a general exodus of households from equity markets – ie, a change in risk preference. That doesn’t seem particularly likely.

But it does now, doesn’t it? Prior to today’s opening the S&P 500 was loitering around 1,136. Roughly speaking, every 50 points change in the S&P currently represents a change of just under US$500 billion in net household financial assets.  Even with no change in risk appetite, this implies a fall of just under US$2 trillion in the value of households’ equity holdings, and a fall of the same amount in household’s net and gross financial asset – which stood at US$34.97 trillion and US$48.85 trillion respectively at the end of March 11.

This sounds dramatic: but so far, in fact the impact in both dollar and proportionate terms, is rather lower than in previous market collapses – a reflection purely of the more risk-averse construction of household portfolios. Here’s how I think US household net financial assets’ position is likely to have changed since 1Q11: the last two data-points are my estimates – but shouldn’t be far out. 

Unless the S&P has much further to fall, at this point is seems unlikely that the current round of fear will have the impact on household balance sheets that the bear markets of 2000 and 2008 had – the sizes of the financial shock at this point simply are not comparable. Maybe we’ll get there. Or maybe at some point, we’ll remember that the US is still an economy that is creating loads of jobs, and loads of ideas no other society seems capable of producing, and is paying down its debts at a rapid clip. 

Since We're Thinking About the 1930s . . . .

I thought it might be interesting to check whether my return on capital indicator measure managed to hack it as a cyclical indicator during the Depression.  I suspect the business cycle is not about to enter a recession provided returns to capital are rising.  To proxy directional changes in return on capital, as previously explained (here), I look at GDP as a flow stemming from a stock of fixed capital.  A falling ROC indicator might, just might, be a necessary condition for recession.  More likely, it’s just quite tough to fall into recession if ROCs are rising. (Please note, I’m certainly not claiming the converse–economies clearly can keep growing for years whilst enduring a falling ROC directional indicator. Look at China, for example.)

So here’s how it panned out for Britain during the 1920s and 1930s:

• There was a very short but sharp recession in 1926, which was preceded by a sustained fall in the ROC directional indicator.
• And there was the lengthy recession of 1930 to 1932, which was preceded by a sustained fall in the ROC directional indicator.
• After the ROC directional indicator hit bottom in 1931, Britain experienced no further recessions before the Second World War.  A modestly rising ROC directional indicator appeared to inoculate Britain against the worst of the Depression.

Nothing’s  proved, of course. But if we’re worried that we’re tipping into the 1930s again (with ‘preserving the Euro’ standing in as a ‘returning to the Gold Standard’ doomsday machine), we might perhaps take a little comfort from the fact that the US directional indicator is rising, and will most likely continue to rise. 

A Second Look at Double Dip

The first piece in this series laid out the dumb statistical basis for expecting a renewed recession in the US within a year. Those dumb stats tell us that the low-risk bet must now be for recession – and this means that it’s a brave Street economist who in such uncertain times is prepared to spurn the low-risk bet. Among many other factors,  markets right now are anticipating an avalanche of downgrades of economies and earnings which we can assume will follow.

But the second article didn’t allow the data to be dumb – when we got it to talk, it had a tale to tell. It turned out that the pattern of 1Q and 2Q growth was at worst explicable, and at best compatible with renewed growth. The slowdown was largely due to the impact of the supply-jam in the auto sector, the impact of higher fuel prices on fuel consumption, and the predictable (but larger than previously seen) fiscal drags which appear regularly as an economy exits recession. Absent these effects, personal consumption demand is holding up well, investment spending far better. The private sector, in other words, isn’t rolling over.

Nonetheless, we are moving into a period where the statistics very likely to point to a recession. It’s also very likely that the Street will also change its forecasts, and maybe its view, to get into line with the dumb power of the stats.  Later, we must also factor in the impact of a falling stockmarket on household finances.

So is there a case for ‘no recession’ and if so, what is it?

To get a handle on the likely turning points in a business cycle, I look at what’s happening to the return on factors of production. If return on capital is rising, ceteris paribus, it’s unlikely that investment spending will fall. If return on labour (ie, real labour productivity) is rising, it is unlikely that unemployment will rise. If both investment spending and employment continue to grow, it takes something pretty extraordinary to overturn the business cycle. (Although, again,  a complete and prolonged collapse in financial confidence might just do it).

Working out what’s probably happening to return on invested capital isn’t necessarily easy (and conventional economics has shockingly little useful to say about it). What I do is express the flow of GDP as an income from a stock of fixed capital. The trick then is to work out what’s happening to the stock of capital, and this I do by taking a 10yr straight line depreciation over all fixed investment spending. If GDP is rising faster than the stock of capital, then it’s a fair bet that the return on that capital is rising.  This is an unconventional measure, which, as far as I know, I’m alone in calculating/using. However, it has two far more respectable relations. First, it is an attempt to replicate the ‘asset turns’ ratio (total revenues / total assets) used in the Dupont decomposition of return on equity. Second, it is kissing cousins with the ultra-respectable ICOR (Incremental Capital-Output Ratio) so beloved of the World Bank, IMF, OECD etc. Anyone who’s actually tried to work with ICOR will know its drawbacks: but if it helps, think of this measure as an ACOR (Average Capital Output Ratio). 

Here’s how returns to the US factors of production look right now: 

Even after the GDP revisions, return on capital is clearly rising fast, and is probably at its best since the turn of the century. Real labour productivity growth has come off slightly, but is still extraordinarily positive.

Has there ever been a situation in which these readings were so positive, and yet were interrupted by a recession?

Since 1980, we’ve had four recessions: each of them had been preceded by an inflection in this return on capital indicator. Contrariwise, we’ve not had a recession whilst this indicator was rising. It is extremely unlikely that this indicator is going to turn any time soon, since capital stock is still shrinking by around 0.32% YoY, whilst nominal GDP is growing (in 2Q) by 3.7%.  

What about labour? Here the picture is not quite so clear-cut. The three last recessions happened after a period when real labour productivity inflected had downwards, and was  sharply negative. Right now, labour productivity continues to grow very sharply, but it has inflected downwards. This negative inflection seems to have produced a period of labour market softness. However, this is very easy to exaggerate, and I believe it has been very much exaggerated by the seasonal adjustment process. Before seasonal adjustments, non-farm payrolls were growing by 0.9% YoY in June, down from a high of 1.1% in April. They grew 0.5% in May (in line with historic seasonal expectations) and grew 0.3% MoM in June (vs flat historic seasonal expectations). The rising unemployment ratio, of course, masks the continued growth in jobs.

If employment is still growing quite strongly, growth of wages has nonetheless slipped – and it’s this we see showing up flat personal income data.  

Once again, a little historic perspective might be helpful: compensation of employees as % GDP hit a multi-decadal low, nearly 3SDs from historic average, at the end of 2010, it recovered somewhat in 1Q 2011, but was steady during 2Q 2011. Do we think this is proportion has the potential to go lower? If not, then there remains some potential for a positive surprise from wages (and demand).

Notice, once again, that over the last 30 years, recessions have tended to happen after a period when this indicator was rising, or at a high level relative to recent previous experience. At the moment, we seem a very long way from that.  

My conclusion? The dumb stats point to the likelihood of recession. When you get the underlying data to talk, that doesn’t seem like a foregone conclusion. And when you look at what’s happening to returns to factors of production – even after all the revisions – a recession in the next year would be unprecedented in recent US economic history.

So it’s probably right to be brave at this point.  Unfortunately, that leads us straight into the next collision.  “The only thing we have to fear is fear itself.”  Was FDR right?

Growth Scare - What Killed US GDP?

Fear and greed: today, the sharpest fear - fear that takes down the S&P five percentage points in a single day, fear that recoils from the double-dip recession that today seems certainly upon us.

The markets have already done their own forecast revisions, leaving the economists as usual limping behind, blinking and sniffing as we try to understand the path. But as we tinker with our models, the truth is there is a biggish problem: there’s virtually nothing in the high-frequency monthly or weekly data which should have led anyone to anticipate such a collapse in growth during 1Q. That monthly data is statistical history right now, and ought to be safely dead and buried in the databanks. But now, like some bewhiskered Victorian detectives, we need to exhume it to see if, belatedly, it holds clues as to “What Killed 1Q.”

The odds don’t initially seem good. For years whilst in Asia I kept a small momentum model for US domestic demand, tracking employment, wages, retail sales, auto sales and construction orders. For all of these, I compared monthly movements against seasonalised historic patterns, and normalised the ‘error’. The results showed how many standard deviations this data was above or below what you’d normally expect. It’s a crude model, and not one I’d rely on now, but it has rarely been as abominably out of kilter with US GDP growth as it was over the last 12 months to June 2011:

(PS. There are loads of ways I could present this as a more attractive visual fit, either by a bit of quiet smoothing on both indexes, or just presenting the straightforward YoY GDP, rather than the annualized QoQ. But it would be particularly perverse to fiddle the visuals in a piece about how to read the underlying data. Actually, you’re looking at an R score of 61 over 60 observations.)

But when one looks at the personal consumption expenditure portion of GDP, things turn out not to be out of kilter with the underlying data after all:

This tells us immediately that whatever it is that afflicted the recent revisions, it wasn’t a shock about the underlying strength of demand in the US economy.  It’s something else.

In fact, the fall in consumption expenditure in 2Q is not so difficult to trace:  auto sales were down 22.7%  annualized, and it seems reasonable to accept this as a an enforced constriction of consumption with its origins in the disruption of Japanese supply systems post March 11. Gasoline sales were down 6.7% annualized, presumably as consumers adjusted their schedules to higher gasoline prices. Once again, it needs no great leap of imagination to expect this adjustment to have a lagged effect on the rest of consumption. Exclude those two exogenous impacts, and the rest of consumption expenditure was growing by 1.8% annualized in 1Q11, slowing to 1.4% annualized in 2Q11.

And that is about in line with the monthly surveys of personal income and spending, in which spending was running at an annualized 1.2% in 2Q11. It’s not a great result, but, crucially, it is an explicable result, and one which does not necessarily commit us to the early onset of a new recession.  There’s no surprise that the US economy slowed in 2Q – but equally it probably was a slowdown, not a stall.

What about ‘the rest’– the c29% of the US economy which is not accounted for by personal consumption? Here the news for 2Q is surprisingly good: ‘the rest’ grew by an annualized 4.2%, recouping almost all the ground lost in 4Q10 (when it contracted 0.5%) and 1Q11 (when it contracted an annualized 3.7%). Above all, the fluctuations of the last nine months look ‘normal’ – and particularly normal as the economy exits a recession. Look at the chart below, and in particular compare what happened in ‘the rest’ over the last nine months with what happened to it in 2002-2003.

When we look at the detail, things clarify quite quickly: gross capital formation is doing well, rising 7.1% annualized in 2Q after 3.8% in 1Q , with matters looking pretty similar even once you take out the inventory cycle (1.2% in 1Q followed by 5.8% in 2Q). Net exports were up 10.2% annualized in 1Q and down 16.5% in 2Q, but the net figure is so small (around 3% of GDP) that these fluctuations make little impact on the overall GDP total.

 

Which leaves government consumption, which at 18.9% of GDP, or 64% of ‘the rest’, is inevitably the dominant factor.  And the annualized growth trajectories over the last three quarters stand like this: -2.8% in 4Q10, -5.9% in 1Q11, and -1.1% in 2Q11.   I don’t want to antagonize either side of the US debate about the trajectory of government debt but, folks, this is good old-fashioned fiscal drag. As you come out of a recession, tax receipts begin to rise, social security claims begin to fall and before you know it, the pace of the build-up in the national debt begins to moderate, and net government consumption begins to fall. It happened in 2002-03, and it’s happening again now – albeit on the more exaggerated scale with which we are now in other respects familiar.

Yes, it’s snuffling works for dullards, this poking around in details. If you’re still hanging on in there at the end of it all, you deserve the conclusion. Which is simple enough: the presumption of a double dip is today exaggerated hugely by fear. There are shadows across the US economic x-ray, no doubt. But we know what they are, and, to me at least, they don’t look like The Big One. 

US GDP Revisions - Well Below "Stall Speed"

It hasn't happened quite yet, but whilst I'm away on 'holiday' it's a very safe bet that the US Street will be cutting its GDP forecasts for 2011 quite savagely. Quite possibly, the more venturesome of them will alter not just the numbers in the tables, but their underlying view. The onset of these downgrades will come in response not to the debt deal, but rather to the blunderbuss of GDP revisions with which the Bureau of Economic Analysis blasted the accepted version of recent US economic history.

Before we get into details, one bottom line is this: the US economy is approximately US$140 billion smaller than we though it was.

The details matter, though, particularly since the revisions tell us that in 1Q11 the US economy grew only 0.4% annualized, rather than the 1.8% previously recognized, and grew only 1.3% in 2Q (and that's a preliminary reading,too).  This means that the US economy right now remains smaller in real terms than it was immediately prior to the crisis - 0.4% smaller, in fact. Worse, the series of 0.4% followed by 1.3% is ominous, because it means that the US has been growing much slower than 2% now for two consecutive quarters.

This means the US economy is bumping along well below the 2% 'stall speed' which the US Fed economist Jeremy Nalewaik tentatively identified with developing recessions. In a paper for the Fed this May (available here), he observed that statistically since 1947, when two-quarter annualized real GDP growth fell below 2%, recession followed within a year 48% of the time. We're there already.


The odds get worse, however, when YoY real GDP growth falls below 2% in two successive quarters:  recession then follows within a year 70% of the time. We're not yet there yet, but annualized 3Q GDP growth would have to come in around 4% to avoid that fate. I've just checked the Bloomberg consensus, and only three out of 64 surveyed economists expect that (step forward the brave economists of Pierpoint Securities, MFGlobal and First Trust Advisors).

(One possible reason 2% might be a "stall speed" is that that labour productivity growth in the US tends to  average around 2% a year. So if the economy cannot manage to grow at such a pace, employment markets will certainly be slack. As we observe today.)

So economists, who had a consensus forecast for US GDP growth of 2.9% as late as May, and still apparently expect 2.5% growth this year, followed by 2.9% next, are now very firmly on the on the wrong side of historical probabilities.  Unless they can provide convincing reasons why this time is different, the low-risk, high-probability default position should now be for renewed recession in the US, within a year.

A third detail is also worth noting: the toll the financial crisis has taken on the US's stock of capital is greater than previously expected, and the recovery has not yet begun.

Working on a 10yr straight line depreciation schedule, the previous data suggested that by March this year US capital stock had shrunk 0.9% from its 1Q09 peak, but was expected finally to have started growing in 2Q11.  The revised data tells us that the contraction of capital stock has been 1.3% since the peak, and is still contracting in both YoY and QoQ terms. Capital accumulation is a fundamental engine of economic growth - and in the US, it's still now happening.

Holidays in Euro-hell

Later this week, I am going on holiday. To Cyprus.

Yes, Cyprus - which is shaping up nicely not just as the next Eurozone domino, but also as perhaps the first which no-one except Greece really has an overpowering incentive to rescue, and which may even be allowed to fail spectacularly 'pour encourager les autres'.

Where to start? The easy stuff first: Cyprus' collapsing Communist government is running a fiscal deficit of 5.3% of GDP, and that is contributing to a current account deficit running at 7.8% of GDP.

From these numbers, we can tell that its private sector is running a savings deficit of 2.5% of GDP. Which in turn means that the island's banking system must be consistently finding cash with which to keep the private sector's economy running.

So let's have a look at its banking system. Let's start with the loan/deposit position of the banks with Cyprus residents - by June this year it had hit 116%, up from 108% a year ago (as the savings deficit dictates).  But that's only the slightly  bad news.  We need to consider the total size of the banking system, which right now has deposit liabilities equivalent to just over 5X Cyprus' GDP, and has loans outstanding to residents of just under 4X GDP.

You will have spotted, of course, that these sorts of multiples and cashflows dictate Cyprus' banks are funded by a large net foreign liabilities position. Now, the Central Bank of Cyprus isn't publishing data on the banking system's net external bond liabilities, but from what is published, we can discover that the banking system is carrying more foreign deposits than its making foreign loans - a funding mismatch currently worth around 31% of GDP.  Very clearly, the real net foreign liability mismatch will be larger.

Additionally, we simply don't know how much of Cyprus' bank assets are, in fact, Greek 'assets'. However,  the Greek commercial and cultural presence in (South) Cyprus is obvious and omnipresent, so it would be something of a surprise if it turned out Cyprus' banks haven't been lending money to their Greek compatriots. Press reports say the banks have around Eu 5 billion of Greek sovereign debt - that's equivalent to just under 30% of GDP.

And then there's the economy itself, which as a result of being shackled to the Euro, is overpriced for tourists (I'm going there because it's where my parents-in-law live, for now) and sluggish. During 1Q11 it managed nominal GDP growth of 2.6% YoY, which didn't keep pace with the muted 2.9% YoY growth of its capital stock. In other words, return on capital is falling, and as a consequence, so is investment (it fell 2% YoY in 1Q).   Since 2Q nominal GDP will certainly be slower, we can be sure that all these ROC numbers and trends have not yet bottomed.

But in fact, the economy's in much worse shape even than that. For Cyprus is reeling from a catastrophe which, though utterly avoidable, is truly disastrous. Two years ago, Cyprus intercepted and impounded a shipment of high explosives originating from Iran making its way to Gaza. Britain offered its technical aid to help Cyprus store it safely, but this offer was not taken up. Rather, the high explosive was stacked up in 98 containers next to the island's largest power station, which generates about half of Cyprus' electricity. Now, Cyprus is a near-desert island, subject to brush fires during the summer. So the inevitable duly happened:  two weeks ago, the brush fire ignited the high explosives, which took out half of Cyprus' electricity-generating capacity. So we can add power cuts and brownouts to the list of woes.

How will the tourists like that? (And it matters, since the Eu3.8 billion in services surplus is the biggest offset to Cyprus' Eu 4.7 billion trade deficit).  More to the point, who in their right minds would pick  Cyprus as their destination right now - except perhaps for disaster-hunting economists?

I shall be taking a computer, and fear I may find myself reporting from the front line. Damn!