Britannia Radio

Two of our best commentators review the situation.  Ambrose Evans-
Pritchard is frankly scared what will happen if goverrnments - 
especially in Asia plus Switzerland - indulge in currency 
manipulation resulting in what would amount to competitive 
devaluation.  .

Roger Bootle examines the few 'green shoots' and is in his own words 
"cautiously pessimistic."
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TELEGRAPH 6.4.09
1. Swiss slide into deflation signals the next chapter of this global 
crisis
Watch Switzerland closely. It is tipping into deflation, the first 
Western country to succumb to Japan's disease.

By Ambrose Evans-Pritchard

Swiss consumer prices fell 0.4pc in March (year-on-year). Swiss CPI 
will be minus 1pc at least by July, nearing the level where spending 
psychology changes. By the time you have a self-feeding spiral, it is 
too late.
"This is something that we must prevent at all costs. The current 
situation is extraordinarily serious," said Philipp Hildebrand, a 
governor of the Swiss National Bank.

The SNB is not easily spooked. It is the world's benchmark bank, the 
keeper of the monetary flame. Yet even the SNB's hard men have thrown 
away the rule book, taking emergency action to force down the 
exchange rate of the Swiss franc.

Here lies the danger. If other countries try to export deflation by 
this means, we will face a second phase of the global crisis. Taiwan 
is already devaluing. Korea, Singapore, and Sweden all seem tempted 
to follow. Japan is chomping at the bit.

"We don't fully realise in the West what a catastrophic collapse 
Japan has suffered," says Albert Edwards, global strategist at 
Société Générale. "The West has dumped a large part of its economic 
downturn onto Japan by devaluing against the yen."

This is about to go into reverse as Tokyo hits the ping-pong ball 
back across the net. "As the unfolding collapse in the yen gathers 
pace, the West will see its green shoots incinerated to dust," he said.

Japan's industrial output fell 38pc in February (year-on-year), 
mostly concentrated into the last four months. No major economy 
imploded at this speed in the 1930s. The country has been hit by a 
double shock. As an export power it has taken the brunt of Anglo-
Saxon belt-tightening: as the world's top creditor it is cursed by a 
"safe-haven" currency that soars in moments of danger - largely 
because the Japanese bring home their wealth till the storm passes. 
Normally, Japan can cope. This time, the yen's rise has pushed the 
economy over a cliff.

The yen must come back down to earth, and soon, or Japanese society 
will start to disintegrate. If necessary, the Bank of Japan will 
force it down by intervention, as occurred in 2003-2004.

Will China stand idly by as Japanese unleashes a shock to the global 
system through competitive devaluation? That depends whether you 
think China's spring recovery is the real thing, or an inventory 
build-up before the next downward slide. The Communist Party says 20m 
jobs have been lost since the bubble burst. This cannot be tolerated 
for long.

It is remarkable that China's fall into deflation has attracted so 
little notice. China's CPI was minus 1.6pc in February. The country 
has built too many factories producing goods that the world cannot 
absorb. The temptation is to shunt this excess capacity abroad. A 
faction of the politburo is already itching to devalue the yuan.

Of course, Britain has already played the currency card. That is 
different. The pound's fall, though welcome, is a side-effect of the 
Bank of England efforts to stem the credit crunch. There has been no 
currency intervention.

Crucially, Britain has a current account deficit. Many countries 
toying with devaluation are exporters with surpluses - 15.4pc of GDP 
for Singapore, 8.4pc for Switzerland, and 6.1pc for China. If these 
countries refuse to let their imbalances correct, world demand must 
implode.

Mr Hildebrand denies that the SNB is pursuing a "beggar-thy-
neighbour' strategy. Like the yen, the franc suffers from the safe-
haven curse: everybody buys it in a storm. This tightens monetary 
conditions. The SNB cannot easily offset this. It has already cut 
interest rates to near zero. There are not enough Swiss government 
bonds in the market to rely on the sort of "QE" asset purchases being 
carried out by the Bank.

Ultimately, I suspect this crisis may mark the moment when the Swiss 
franc loses its safe-haven role. Credit default swaps (CDS) measuring 
risk on five-year government debt have reached 127 for Switzerland, 
higher than Britain at 118. Norway has the world's lowest CDS at 48, 
reflecting its status as a petro-democracy.

Switzerland's banks are over-leveraged. Loans to emerging markets 
equal 50pc of GDP (half to Eastern Europe). Banking secrecy is dying. 
Fortunately for the Swiss, they have built up $700bn in net foreign 
assets for a rainy day. Improvident Britons are less lucky. But that 
is another story. What we risk now is a game of deflation "pass-the-
parcel" worldwide. The economic establishment was caught off guard 
from 2003 to 2007 because it overlooked the way that Asia's 
unbalanced relationship with the West was feeding a credit bubble.

It may be caught again as the same warped structure leads to a chain 
of (panicked) devaluations.

Enjoy the "bear-trap" rally on global bourses this spring. But 
remember, we have only just begun to see the mass lay-offs and 
hardship caused by this slump. The politicians will act to save their 
skins. Markets may not like the result.
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2. Beware talk of recovery as the world economy is not a picture of 
health
The apparent triumph of last week's G20 summit has coincided with a 
more optimistic mood in markets. Is this the moment when we should 
recognise that the worst is over and start looking for recovery?

By Roger Bootle

There has been a flurry of improved economic data. In the US, the ISM 
Manufacturing Index climbed to a four-month high in March. In China, 
according to the official Purchasing Managers Index (PMI), 
manufacturing output has begun to expand again. Europe's composite 
PMI, which takes into account both manufacturing and services, picked 
up a little in March.

The UK also saw a flurry of positive data last week. Nationwide house 
prices were up 0.9pc in March, while mortgage approvals also picked 
up. Meanwhile, the Bank of England reported that lenders expected to 
increase credit availability. What's more, all the survey measures of 
activity for the manufacturing, construction and service sectors 
picked up.

Stock markets have also seen something of a rally in recent weeks. 
The FTSE now stands at about 4,000, some 15pc higher than the nadir 
reached a month ago. In America, the S&P 500, has also rallied, 
finishing the week about 20pc higher than a month ago. Meanwhile, the 
gold price, which is usually a good barometer of anxiety about the 
world's financial system, has fallen back from its high of over 
$1,000 per ounce to about $900 now.

But on these market movements caution is surely in order. The old 
joke about stockmarkets having forecast 10 of the last four 
recoveries remains apposite. And we've already seen at least three 
false stockmarket recoveries in the last year or so. True, this was 
the first up month for Nationwide house prices for 17 months. 
[Halifax disagreed and said they fell! -cs]  Even so, this does not 
assuredly mark the end of the slide. In the 1990s downturn, during 
the housing market's 74-month long downward trend from May 1989 to 
July 1995, there were 22 months in which house prices rose month on 
month. That's a rise roughly once every three months. Indeed, house 
prices rose in four consecutive months between July 1993 and October 
1993, leaving them 2.4pc higher in October than they had been in 
June. But the downward trend then continued for another 21 months.

In this regard, it was deliciously ironic that just as the data from 
the Nationwide gave rise to some cautious optimism about house prices 
so, just a day later, the Halifax announced that over the same month 
prices fell by 1.9pc! Houses remain substantially overvalued and 
probably still have a good way to fall.

Nevertheless, I concede that the outcome of the G20 summit does 
provide some grounds for hope. But not much. At the very least, it 
was not a flop and no one walked out. More than that, there seems to 
have been an impressive agreement about general principles governing 
the way forward.
This is a good start. But it would be unwise to see this as the 
beginning of a new era of international co-operation and amity. The 
summit did not produce a new fiscal stimulus as Gordon Brown had 
hoped it would just a few weeks ago. Nor did it see any yielding on 
the part of the two leading surplus countries, namely China and 
Germany, on the question of what they might do to make more 
contribution to world demand and operate more balanced trade in 
future. Nor did it do anything to revive the stalled Doha round of 
trade talks.
There was a huge increase in the resources of the IMF, but this is 
not the same as a fiscal relaxation. It amounts to an international 
equivalent of quantitative easing, and like the domestic version, it 
may or may not do much good. Moreover, in a way that has come to be 
familiar to all us consumers of New Labour initiatives, much of the 
increase in IMF resources seems to amount to a repackaging of 
increases which had been announced earlier - or aspirations for new 
increases, which may or may not materialise.  [In total that is a 
very definitely negative balance, I'd say -cs]

All along, this economic crisis has fooled people by its severity. At 
first, it was widely imagined that it was only about sub-prime 
mortgage lending, then that it was just about the US, then that 
Europe and subsequently Asia would be relatively immune. It was only 
well into the downturn that it dawned on people that this was a 
global slump. Anticipating an early and easy recovery fits into this 
general pattern.

The crisis has had several phases to it. The first was a banking and 
financial panic. It looks as though that bit is well past the worst, 
as governments and central banks have accepted an obligation to pour 
money into the system to prevent major failures. This has stabilised 
confidence.
Yet the bad news about the financial system is probably not all over 
yet. Banks will be hit by waves of bad debts on plain vanilla loans, 
and it is possible that we will see a major failure by a non-bank 
financial institution which will require more public funds and damage 
confidence.

The second phase of the crisis was a sharp drop in international 
trade and a collapse of industrial production almost everywhere. That 
phase may also be past the worst. This shouldn't be altogether 
surprising, since much of the weakness of industrial production was 
due to producers and retailers around the world deciding to carry 
less stock and accordingly cutting back their orders sharply. But 
once you have cut your stock that is it. Orders bounce back. All 
along, the weakness of industrial production was giving an 
exaggeratedly dire impression of how bad the overall economy was.

But now any stabilising of these numbers will probably give an 
exaggeratedly positive message about the turnaround. In fact, large 
parts of the economy have not so far been that badly affected. UK 
consumer spending has only very recently started to turn down. Rising 
unemployment and falling rates of pay increase and, in many cases, 
the absence of any increase at all, will cause consumer spending to 
weaken markedly.

More importantly, we are now moving into the critical phase as 
regards the trade dimensions of the crisis. If China is seen to be 
taking measures to boost its exports to fend off its domestic 
slowdown, you can imagine how that would go down in Congress, which 
is already in a protectionist funk.

I am mindful that during the Great Depression in America, there were 
several false rallies in the stockmarket and there was an apparent 
economic recovery in the mid 1930s which subsequently petered out. 
And there was a continuing supply of nasty surprises and policy 
mistakes. We should be prepared for something like this now.

I don't often hope that my views are wrong. But I do now. I am what 
you might describe as cautiously pessimistic.
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roger.bootle@capitaleconomics.com
Roger Bootle is managing director of Capital Economics and economic 
adviser to Deloitte.