To the Point

Discussion on the economy, by the Chief Economist October 31, 2012

More misery via the media but recent economic indicators actually tell us something
Increasingly, confidence and real outcome indicators point to a deeper downturn in the business cycle than was expected earlier. There is a risk that the slowing of activity will be forceful, with larger effects on labour and well-being. Some blame the media for the dark reports, but it is better to face the truth than to worry that negative articles will be self-fulfilling. Misery indices created from outcome data seem to tell us more than the newer indices counting words of misery in the papers, albeit these can also be informative.

Cecilia Hermansson Group Chief Economist Economic Research Department +46-8-5859 7720 cecilia.hermansson@swedbank.se

The downturn in activity is getting deeper

In the last few months, various economic reports have pointed to a more pronounced downturn in activity than was expected earlier. Some of the indicators actually signal a slowdown almost in line with the one noted during the financial crisis and the global recession in 2008-2009. Is it actually this bad? First, we are not at the extremely low levels seen in the previous recession, but there is a risk that these may be reached since the bottoming out is not yet visible. Second, there is not a liquidity crisis prevailing like the one that started the financial crisis and the shrinking of activity in 2008. Yes, there is credit austerity, especially in Europe, and perhaps in the US a credit squeeze can still be noted in some regions and parts of the banking system. However, there is not the near-death moment observed on the financial markets when trust among the financial actors had disappeared. Central banks have been keen to increase liquidity, and the banking system is building up reserves to cater to the higher capital and liquidity requirements. Third, reports from the real economy differ between sectors as well as between regions. The US is recovering slowly, while Europe is in a recession. Referring to sectors, especially in raw materials, shipping, transport sector (including vehicles) activity is slower. The economic cooling in China is visible in these figures. Also, a structural adjustment in the European car industry is occurring since there will be too much production in relation to European demand in the coming years. In other parts of manufacturing, the situation is somewhat better, and in, e.g., the energy sector and services, the situation is still relatively benign. What do various economic indicators tell us? Some of them focus on the confidence and trust felt among companies and households. If these actors become more pessimistic, often, but not always, hard data on investments, recruitment and consumption will follow suit. Confidence is still holding up fairly well due to the relatively positive development on the stock exchange due to central banks liquidity boost, but increasingly the mood is changing as reports on lay-offs are becoming more and more frequent. Other indicators represent actual outcome data, such as the Purchasing Managers Index (PMI). This index is a mix of production, new orders, recruitment, delivery times and inventories, and is a very early and reliable signal of the status of the manufacturing (and separately for the services sector). There is also a confidence indicator presented on the side, i.e. the production plans of the companies hinting on what will happen in the next six months. It is also possible to analyse trade data. So far, the trade volumes are stagnating and are not close to the fall that we saw in 2008-2009, but the downturn may not be over. The Baltic Dry Freight Index presents the current status of freight, and gives a clue on what is going on in trade and production, but it also includes the situation for shipping. At the moment, there may be too many ships handling too few orders, and the Baltic Dry Index is therefore more of an index of the status of the freight industry than the status of actual freight volumes.

No. 10 2012 10 31

To the Point (continued)

October 31, 2012

Now is not the time to blame the media!

Chart 1: Baltic Dry Freight Index (lhs) and Trade Index (%) (rhs)

With all the information about dark economic developments, there is a concern that the reporting in itself may be self-fulfilling. The darker the articles, the lower the spending and the higher the buffer saving for rainy days. However, those who claim that the media should be careful in the way the information is presented should keep in mind that the reality actually shows a marked downturn, visible in the outcome data. Not reporting this would make it more difficult for the actors who need to be informed about the current situation, such as the employers and employees negotiating salaries, the politicians and central bankers deciding on economic policy, and the households and companies taking a stand on investment and consumption strategies. The media are therefore not to blame. The indicators show what is going on, and it is reasonable that the media communicate the most up-to-date picture of the business cycle. The truth is that misery has increased in some parts of the world, especially in Europe. The original misery index, created by the economist Arthur Okun, was merely a sum of the rates of unemployment and inflation. In the US, this misery index is falling as unemployment, especially, is coming down, and in September the index registered 9.79 (down from above 12 a year ago). In Europe, the misery index is rising, to 13.2 and 14 for the EU and the euro area, respectively, but it is much higher in Spain and Greece than in Germany. Robert Barro, another economist, later expanded the misery index to include the interest rate and the difference between actual and trend GDP growth; he then used this to analyse correlations with crime and other social developments (and, yes, they are correlated). The criticism of the misery index has been that, although unemployment is much more important than inflation to households, they are weighted equally in the index. Another criticism deals with the simplicity of the index, as misery could be related to several other matters as well. Interestingly, other types of misery indices are being developed in which the words representing misery are counted, such as layoffs, recession, depression, and economic crisis. These indices do not deal with actual outcome data of the business cycle, but rather the way actors interpret data in the media or elsewhere. At the moment, the stock exchange, e.g. in the US and in Sweden, has developed better than could have been expected from the reports on demand and profitability. One reason could be the liquidity boost from central banks, but this effect is fading; more and more, equity optimism will move closer to fixed-income pessimism, which is more in line with the reports from the real economy. There is still a chance for more optimism and less misery: better crisis management in the US and in Europe could actually turn the negative mood around. With less uncertainty about the fiscal future, actors could start taking investment and recruitment decisions, especially in the US and in emerging markets. For Europe, the outlook is more like the lyrics of the Beatles song: The long and winding road that leads to your door, will never disappear ... Cecilia Hermansson

Chart 2: Global PMI, S&P 500 and Oil price

Economic Research Department

SE-105 34 Stockholm, Sweden Telephone +46-8-5859 1000 ek.sekr@swedbank.com www.swedbank.com Legally responsible publishers Cecilia Hermansson +46-8-5859 7720

To the Point is published as a service to our customers. We believe that we have used reliable sources and methods in the preparation of the analyses reported in this publication. However, we cannot guarantee the accuracy or completeness of the report and cannot be held responsible for any error or omission in the underlying material or its use. Readers are encouraged to base any (investment) decisions on other material as well. Neither Swedbank nor its employees may be held responsible for losses or damages, direct or indirect, owing to any errors or omissions in To the Point.