Opposing forces pull the economy

The economy is currently being influenced by two diametrically opposed forces. On the positive side, the reopening of the economy with the end of the corona restrictions is boosting spending and activity. This is offset by the effects of the war: higher energy prices, great uncertainty, a decline in exports to Russia and Ukraine and the new disruption of supply chains.

Last week I wrote about the strongest drop ever recorded (figures go back to 1991) in the ZEW index for Germany. It measures the expectations of analysts and economists. The problem with such surveys is that people who fill out the questionnaires sometimes allow their emotions to be guided by questions that require judgment. Moreover, analysts and economists are actually 'on the sidelines' of the economy. They are only spectators and do not stand with their paws in the clay.

People who complete the monthly IHS Markit Purchasing Managers' Index survey have their feet in the clay. The preliminary results of the March version were published yesterday. Those numbers were really good. In the eurozone, business confidence measured in this way declined only slightly in March: for manufacturing it went from 58,2 to 57,0; for the service sector from 55,5 to 54,8. When you consider that anything above 50 implies growth, these are remarkably good results.

When I read the accompanying press release, I became less enthusiastic. Export orders fell in March for the first time in 21 months, while price increases reached a new all-time high (figures go back to 1998). It very likely means that consumer-level inflation will certainly not fall for the foreseeable future. Companies also say that delivery times, which have become shorter in recent months, have become longer again. The supply chains, which have been severely disrupted by the pandemic, have thus been given another blow as a result of the war. The fact that new lockdowns have been introduced here and there in China may also play a role in this. The fact that employment is continuing to grow shows that entrepreneurs are certainly not yet in a panic.

The picture that the German Ifo index paints is clearly more gloomy than the figures of IHS Markit. On the website of the Ifo Institute it is called: "Krie in the Ukraine lässt ifo Histäftsclima index abstürss". This measure of business confidence in Germany fell from 98,5 in February to 90,8 in March, which is significant. The expectation component, which is usually the most valued, experienced the largest monthly decline ever (my numbers go back to 2005). Entrepreneurs are also more negative about the current situation, but the decline in that sub-index in March is actually very limited: from 98,6 in February to 97,0. Entrepreneurs also indicate that the outlook is extremely uncertain.

The war is quite far away for the US
Business confidence in the US actually rose in March, according to figures from IHS Markit, and it was already strong. The differences with the EU are of course also large. The war is much further away for the Americans, American gas prices are much lower and have risen much less than ours, the US is on balance energy self-sufficient and therefore suffers no loss of terms of trade due to higher energy prices, and the American economy is considerably less open than ours and therefore suffer less from shocks in world trade.

American companies also continue to invest more and more. The labor market is extremely tight and companies may be trying to solve that problem by investing more in labour-saving technology. The following picture shows the dollar value of the capital goods shipped each month (excluding defense and aircraft). These figures give an indication of the development of business investment. This time I show the full series going back to the end of 1991. I find it very remarkable that between say 2000 and 2020 the movement is mainly sideways with on balance a small degree of increase, but that since the pandemic there has been strong growth . It is conceivable that capital goods prices are now rising more strongly than in the past and that this chart is overestimating the volume of actual investment. However, the strong investment growth is confirmed in the national accounts.

Powell and his seven-mile boots
Fed Chairman Powell said in a speech this week that there is a good chance that the Fed will raise interest rates in 50 basis point increments in the coming months. That was, of course, thick. US inflation has gotten pretty out of hand and the Fed has let it happen. They are now far 'behind the curve', as economists say, and obviously need to catch up. I wouldn't lose sleep over it. A more important question than how big the rate hikes will be is how far the Fed will go.

Spectacular improvement in Dutch public finances
The Central Economic Plan that the CPB recently published (on 9 March) assumed a government deficit of 2021% of GDP in 4,4, after a deficit of 4,2% in 2020. quarterly and therefore also for the whole of 2021. The deficit now appears to be only 2,5% of GDP. I thought it might have to do with differences in definitions, but according to Statistics Netherlands, there is no difference.

This means that government finances were in much better shape at the end of last year than previously thought. Rutte-4 will therefore start from a much stronger financial position. Whether that will lead to (even) more generosity, we'll see.

Consumer confidence takes a hit
Dutch consumer confidence had already fallen for five months in a row up to and including March. This was undoubtedly related to the high and persistent inflation. After the outbreak of the war in Europe, this confidence index continued to fall again. According to this measure, confidence is now weaker than after the outbreak of the pandemic, but still fractionally higher than in two months of 2013 at the time of the euro crisis.

The economic outlook is highly uncertain. That was already the case before the war because it was completely unclear how quickly supply chain disruptions would decrease, whether transport costs would fall from the extremely high levels that seem to have become normal after the outbreak of the pandemic, and how energy prices would continue to develop. . Now there are the uncertainties caused by the war.

A few weeks ago I wrote that the chances of a recession are probably higher than 50% if the war continues. Opinions are strongly divided. I see that my former colleagues at ABN Amro think otherwise and consider the risk of a recession to be small. Their reasoning does not change my mind. They think that consumers will spend the money saved during the pandemic, so that the economy will continue to grow. It could be, but consumer confidence doesn't indicate it at all.

For me there are two crucial considerations. Firstly, the high inflation, which will remain high for the time being due to the increased energy prices, is eroding purchasing power so much that I cannot imagine that consumer spending will grow strongly in volume.

There are also logistical disruptions. They are difficult to measure. But anecdotal evidence suggests that disruption is increasing again for the time being. That should almost lead to shrinking production. If I read the IHS Markit and Ifo reports correctly, this is already the case in the automotive sector.

As far as I'm concerned, the most spectacular figures of the week are those from Statistics Netherlands on public finances in our country. The government deficit fell unexpectedly last year and turned out to be much lower than previously thought. For example, the 'money issuers' of Rutte-4 unexpectedly have a lot of room to spend even more. Not that that is positive in advance of course…

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.