Friday, December 9, 2011

October 2011 Industrial Production

Why is everyone so pessimistic? I understand the concern over Europe, but that’s primarily a financial problem and not yet a real economy problem. It hasn’t come to the point that we need to jump the gun and declare the Malaysian economy is going down the tubes (excerpt):

Slower IPI, export growth expected

PETALING JAYA: There will be further indications of a slowdown in factory output when the Statistics Department releases data on October's industrial production index (IPI) today while export growth is seen slowing when the data on external trade is out tomorrow.

Economists in a Bloomberg survey expect the IPI to grow a median 1.6% on a year-on-year basis versus the 2.5% expansion in September. This would mean manufacturing production would be expanding at the slowest pace since March.

They expect exports to grow by a median 7.3% in October from a year ago after the unexpected 16.6% jump in exports in September.

Luckily, the economy’s not listening to the analysts (log annual and monthly changes; seasonally adjusted; 2000=100):



The main index rose 2.2% on the year in seasonally adjusted log terms although it was flat from September. To twist the knife in further, September numbers were revised upwards (+3.2% in log terms)< partly explaining why seasonally adjusted month on month growth was flat.

I suspect much of the pessimism is due to the fact that most economic analysts are employed in the financial sector, and consequently right in the firing line from a European collapse. Too, looking back at 2008 when financial contagion not real economy factors set off the Great Recession, might have had some influence on thinking.

Consider this: officially Europe is still not yet in recession, and the pullback in growth so far has been mild. But that means current European import demand is still relatively stable, and most of that import demand is in manufactured goods like E&E, which has been declining in importance for Malaysia.

Also, most of Malaysia’s European trade is with the larger countries like Germany, France and the UK, and not the periphery where most of the trouble is concentrated. Last but not least, trade with Europe is just 10% of Malaysia’s total trade. The real economy impact might not be as big as people think, especially since the US and Japan have continued to grow, and the East Asian region itself becoming increasingly integrated.

The US matters; China and Japan matter; Europe, not so much.

I’m not arguing for the decoupling thesis, but the fact of the matter is that the world’s economic centre of gravity is shifting East (see this post by Danny Quah). Malaysia’s sources of external vulnerability has shifted dramatically in the past decade.

Looking ahead, or rather around, the October IPI numbers puts the economy still on track to achieve my forecast of 5.3% for the year:


4Q 2011 GDP should come in at about RM153.3 billion which would give a y-o-y growth of about 6.0%-6.1% and a quarterly SAAR of about 10.6%-10.7% – both indicating that economic growth is accelerating, not slowing down.

Technical Notes:

October 2011 Industrial Production report from the Department of Statistics


  1. Although Europe is not Malaysia's major trading partner, whatever happens in Europe in the next few months will determine the world economy. The credit default swaps between financial institution in US and Europe will cause a major recession and the market in Asia will not be able to avoid that too. Recent slowdown of China and Japan's economy also show signs of recession. I would doubt that Malaysia will be able to get through this easily.

  2. There's a lot of possibles but not probables in your scenario:

    1. You're assuming that there will be a major country default, which is still not a given (Greece/Portugal/Ireland do not count).

    2. This is not 2008 - the crisis has been building up for a year and more. That means the ECB and the Fed are better prepared and more knowledgeable about which financial institutions are at risk. And the financial institutions know which ones are at risk as well. I don't see a sudden collapse scenario a'la AIG.

    3. The ECB is leery of bailing out governments, but they have repeatedly demonstrated no qualms about bailing out the financial sector, or arranging for an orderly dismantling of failed institutions.

    4. A global credit crunch will have less serious effects than in 2008, as loan demand is already poor and corporations are seriously cash rich (both in the US and Europe).

    5. Japan has been on the verge of recession for the last twenty years. If the tsunami didn't cause an Asian recession, I doubt a European break up will.

    You might also want to read this.
    6. Seriously, China in recession? A growth slowdown I believe, an outright recession is not probable - for now.

  3. The thing is that no one is sure how much OTC contracts were signed between financial intermediaries. It would have been more than $4 trillion to $10trillion or even more. It is true that the US companies are well capitalized especially banks but they are as much exposed to CDS as they were capitalized. What they had capitalized is probably not enough to cover the losses. This is actually the main concern that triggers the recession and it is linked to Europe. Example, Goldman Sach forecasted that Greece will default, so in order to hedge against this, Goldman Sach enters a CDS contract with say BNP Paribas. At the same time, Goldman might also sign another CDS contract with any other banks to further reduce the risk and try to make the losses into profit. It would be a sound and logical strategy for Goldman but the same thing can be done by BNP Paribas to mitigate the risk. So it ended up with banks signing CDS with each other and the losses is actually bigger than the actual exposure.

    Financial recession is different from that of a normal recession as it causes liquidity trap. A sudden collapse might not be possible but the effect might be as bad as the one in 2008 as no banks would loan funds. The reason that the demand for loan decreases is not because of less demand but the unwillingness of banks to loan it out. This will definitely cause a global recession. Look closely, what happens now is actually the same thing as 2008. Just that the location is in Europe this time. As for the Fed, they can’t do anything as they can’t print more money. Congress objected the printing of money. Fed’s monetary policy also failed to stimulate the economy and I would doubt ECB can do anything more than Fed as the new president does not want to buy more sovereign debt. There’s also political situation in the US and Europe that I will not elaborate here.

    As for Greece, it is still manageable but Italy is not. Look at the European bonds market; the yield for their treasuries is increasing overtime. This is a sign of market distrust of the country to repay their debts. France is having the same problem now. The bond market is one of the methods that investors used to forecast the economy condition.

    By the way, if you have notice it, a hedge fund syndicate is thought to be behind the driving force of pushing the Euro economy down. First it was Greece, follow by Italy, the next one might be France. You might have mistaken my statement that China in recession. What I meant is the economy slowdown in China and Japan is showing sign of a global recession is coming. Demand for industrial commodities decreases over the last few months.

    All these factors will contribute towards the criteria I used to forecast next year’s economy.

  4. Details count my friend.

    Actually, thanks to Main Streeter and SatD, I've got the value of CDS outstanding - it's US$32.4 trillion, but that's global. There's no breakdown of Euro only CDS.

    I think you're mistaken about how CDS operates - if a bank writes back to back CDS, the credit risk falls ultimately on the final counterparty and not on the bank writing the CDS. The main issue therefore is not the notional value of CDS, as large as it is, but where the credit risk ultimately resides.

    The big difference I see with 2008 is that we don't have a single counterparty backstopping the whole system as we had with AIG (which underwrote something like 70% of the US CDS market). If credit risk is diffused across Europe and the US, a major debt default (such as Italy's) would be bad, but not disastrous. Don't make S&P's mistake and assume total default. Recovery values matter.

    A second factor to consider is that we're here dealing with sovereign debt, not structured products. The big difference is that in 2008, not only did we have AAA rated securities worth junk, but also layer upon layer of synthetic securities built up over the same assets - CDOs, CDO squared, and even CDO cubed. It was that high degree of unknown leverage (and off-balance sheet leverage to boot) over a small base of assets that contributed to the financial uncertainty and panic leading to the global credit crunch.

    You simply don't have that kind of over-leverage and financial sleight-of-hand when dealing with sovereign bonds which are almost always carried on-balance sheet, and whose notional values (and holders) are known.

    Third, the fact that Eurozone companies are making record profits and sitting on cash tells me that they're not borrowing. Households have been saving at a decent rate and they're not borrowing either. Loan officer surveys on the other hand suggest that credit standards have not tightened. Weak loan demand is a factor. And unlike 2008, Europe in aggregate does not have an over-leveraged credit dependent household sector, which would amplify any reduction in loan supply as happened in the US in 2008.

    "Fed’s monetary policy also failed to stimulate the economy..."

    Actually it did...but to my mind they didn't do enough. It's telling that every time the Fed stopped printing money, the US economy tanked.

    The ECB could do the same thing, but they're standing on misguided principle and fiddling while Europe burns. By law, the ECB is barred from directly buying sovereign debt directly from governments. However, it could do more - it's sterilising its bond purchases, which is ridiculous as that effectively negates any benefit of buying those bonds in the first place.

    The ECB can do more - they're not out of ammunition, because they haven't used any yet.

    Fifth, Europe does not suffer from the US' "exorbitant privilege". When the 2008 global credit crunch hit, the US dollar zoomed up. The opposite is happening in Europe - we're seeing an orderly selldown of Euro assets, and a steady depreciation of the Euro. That will cushion the impact of a Eurozone slowdown by adjusting relative prices, indirectly helping out countries such as Greece by making them more competitive internationally.

    I simply don't see a repeat of the 2008 scenario - the risk factors are considerably less. Worse case, I see a drop in global growth to around 2% (which is the criteria for a global recession). In 2008-2009 by contrast, global output actually shrank, the first time that has happened in living memory. In the 1980-82 global recession, which had been the previous worst, global growth dropped to 0.7%. Realistically, that's unlikely to happen again.