June 25, 2012
I am standing outside Selfridges on Oxford Street watching the world go by. What a world it is! There goes an Arabic woman in half hijab with Gucci sunglasses propped on her covered head, carrying two pairs of designer shoes in her distinctive yellow Selfridges bag. Beside her, four Chinese women are similarly laden down, tourists from everywhere are shopping for everything, while London’s newest ethnic minority, the emigrÃ© French middle class, can be heard over everyone.
Is it any wonder that retail sales in Britain bounced strongly in May, with all these people fighting each other in the narrow passage that is Oxford Street?
This zone of London is the ‘ground zero’” of globalisation where goods from everywhere are sold to people from everywhere in a shopping frenzy of everything.
While they carry on obliviously, the frenetic shoppers seem to have no idea what is coming down the road financially or what effect the malignant coincidence of a growth slump in China, a fading recovery in America and Europe’s debt crisis will have on their world.
Let’s deal with China first.
Isn’t it interesting that the only big central bank to slash rates recently in the face of economic crisis has been China?
The ECB is talking about it and will probably introduce another massive bout of easy financing for the banks in the next few weeks, likewise the Federal Reserve. But the Chinese have already acted. Why?
The reason is that the Chinese economy is slowing much more quickly than anyone had expected. The massive property bubble that has been building in China is now reversing – and quickly.
In China, now that the Communist Party has abandoned all its Maoist rhetoric, the only slogan giving it legitimacy is growth. And if growth falters, the Party falters too.
The tricky problem for China is that a faltering investment boom – unlike a faltering consumption boom – can’t be easily reversed by cutting interest rates. If the problem is over-capacity, building more in response to lower interest rates will only produce more capacity, exacerbating the original problem.
Last Thursday, data for the Chinese manufacturing sector, the HSBC PMI Index, recorded its eighth successive monthly decline. On the international markets, the gold sell-off continues, while oil is below $80 a barrel for the first time in eight months.
This sharp slowdown in China is happening at the same time as the US employment recovery – essential for the re-election prospects of Obama – is now fading away.
This means that, while the Federal Reserve may well slash rates, there is a growing sense that the effect of more cuts in nominal rates at a time when real rates are negative is limited.
Look at the following recent releases for May in the US: average earnings minus 0.2 per cent, retail sales minus 0.2 per cent, industrial production minus 0.1 per cent, housing starts minus 4.8 per cent, consumer confidence minus 5.5 per cent and car sales minus 4.5 per cent. What does that tell you about the US recovery?
Of course, we head back to Europe and the extraordinary situation where the only hope that the Europhiles now appear to be clutching at is that the Germans will blink first and bail everyone out. In Spain and Italy, huge problems are being beset by the fact that growth is close to zero while yields are above 6 per cent. There is little chance of either country financing themselves in the months ahead.
Just digest the next fact for a second. In the next year, Italy has to refinance existing debts to the tune of 29 per cent of its GDP. Why would the Germans, who saw their own manufacturing index contract for the third straight month last week, underwrite all this?
Even if they did, prompting the biggest bull market in Spanish and Italian bond markets in years and a massive bear market in Germany’s bond market, it still wouldn’t solve the core of the competitiveness problem. Spain and Italy can’t compete with Germany, full stop. But looking at Spain and Italy misses the point.
There is a very high likelihood that the financial battleground in Europe will follow what I call the ’1944 pattern’.
The 1944 pattern will be a significant battle in Italy superseded by a massive attack on Germany via France. In 1943, the Allies attacked Germany through Italy, but the big invasion was via D-Day and through France.
France is the real weak link, because this country is pretending that it is a slightly shabby version of Germany. It is anything but. Its banking system is very fragile, it runs a large current account deficit and, while politically strong, it is economically weak.
The 1944 pattern will go something like this: Spain and Italy will be locked out of the market in due course (as we have been saying here for a long time). Then Germany’s vulnerability will be on her western borders with France. As French yields rise, Germany will have to decide if she should risk everything for France. The average German will say ‘no way’, but the politicians and strategists deep inside the German establishment will say yes. They are naturally – and for good reason – wedded to the central pillars of EU integration.
Then the discussion will move to the compromise. German politicians will realise that they can save France only by abandoning Italy and Spain. In addition, they can only sell the deal of saving France and the euro to the German people if they make abandoning Spain and Italy a condition of that deal.
As the summer of 2012 rumbles on and defences are broken, just like the summer of 1944, the German high command will not want to be fighting war on two or three fronts.
Globally, with China turning down rapidly – as it will, because a bubble is bursting in the Middle Kingdom, and the US economy is possibly even tipping into negative territory – the Germans will realise that they can’t bank on external support, meaning they will have to act. Remember, they are acting, not to save France or Spain or Italy, but to protect Germany and German savers from having their savings plundered by foreigners.
This is the big one.
All the while, the shoppers of Selfridges spend on, oblivious to what is coming down the line.