From Charles Gave of GaveKal [10] [10]
Southern Europe Walks On Thin Air
Recent economic data releases suggest, on the face of it, that Southern Europe is enjoying an improved outlook. This weekend, Portugal’s government stared into the abyss and chose for the moment not to break the terms of its bailout. Hence, in recent months, GaveKal colleagues such as Francois have argued that economic conditions in the European periphery are stabilizing (see A New Global Growth Story). I would respectfully disagree. Regardless of the patch-up solution that gets worked out in Lisbon, the notion of a bottoming-out process depends on an essential misunderstanding.
What has stabilized, and in some cases turned around, are leading indicators. What manifestly has not improved are actual economic conditions in these economies (e.g., see chart for Italy which shows the divergence in LEI readings and private economic activity).
[11]
I have used OECD leading indicators for many years, but in recent quarters have come to acquire grave doubts about their continued relevance. The indicators were designed at a time when exchange rates and interest rates in euroland economies were determined with reference to market prices (remember, all lower level prices in an economic system derive from these two “anchor” prices).
But extreme manipulation of these anchor prices means that past relationships no longer act as a guide to future outcomes. For example, the stable link which existed between Italy’s LEI and the country’s industrial production has fully broken down; no longer does the indicator provide any meaningful information in calling an economic turnaround. Six months ago the Italian LEI swung positive and yet industrial production is plumbing new lows and seems likely to test its 2009 trough. In addition, Italy’s post-2009 experience shows there is no longer any relationship between the size of the LEI turn around and the scale of the recovery.
[12]
So we are left in the world of Wile E. Coyote who had the habit of dashing off cliffs in the pursuit of the elusive Road Runner, before noticing the thin air below. Plenty of economists and money managers have their eyes fixed on leading indicators and tell me that Southern Europe’s economies are "stabilizing" and "prosperity is around the corner." In reality economic activity in Greece, Portugal, Italy, Spain, and also France, is collapsing.
[13]
For those who cheerily look at Italy’s recovering leading indicator, consider this simple fact; in order for the country's debt-to-GDP to stabilize at 150% of GDP, Italy must run a primary surplus of at least 5% of its GDP for years to come. But let’s not worry; the fellow who organized the false accounting which allowed Italy to join the euro system has made a solemn promise that he will do, “whatever it takes.”