Saturday, January 31, 2009

A Critique Of Freidman and Schwartz's A Monetary History of The United States

by Christopher Dow
(pages 211-214)

Since Friedmann and Schwartz's Monetary History (1963) has had such a major impact on the debate about the causes of the Great Depression, it seems desireable to explain at greater length than possible in the body of my text my reasons for finding their explanations unsatisfactory and implausible.

Interpretations of the theoretical aspects of the book is rendered difficult by its being primarily a historical and not a theoretical work. It provides a dense and scholarly account of monetary development and the evolution of policy in the ninety three years after 1867. The four depression years take 120 pages of the 700 pages of the book (a fifth of the space being footnotes). Within that are around 40 passages varying in length from a paragraph to a sentence which state or imply a view about the causality of the depression. In addition there are about 20 more such passages in the final chapter. These passages are scattered and embedded in not difficult, but dense and demanding, discussions of statistical developments and conflicting views and personalities, themselves requiring attentive reading: they are therefore difficult to do justice to on a first reading, or to extract and collate afterwards.

The massive nature of F&S's history is dictated by the structure of each of its main chapters. Chapter 7 on the Great Depression starts with a general review, covering almost everything discussed later. Section 2 appears to be constructed on the plan of discussing chronologically different monetary aggregates and sub aggregates and the relations between them (ratios and identities); but much else is included within that framework. Section 3 is about bank failures, already discussed once; and section 4 about financial events abroad. Then come two sections discussing, first, monetary policy and contemporary discussions of it, and, second, Friedman's comments thereon. Repetition in analytic narrative is impossible to avoid, but F&S have allowed many layers of it to remain.

The steady thoroughness of their prose acts to induce acceptance of preannounced propositions long before evidence in support of them comes into sight. Chapter 8, for example, is entitled "The Great Contraction", and since that phrase is used in a dual sense, it functions as a suggestion of causal connection. The Great Contraction can apply, on the one hand, to the great decline in real output, but it can apply also (and more aptly) to the contraction of the money stock. The impression given is thus that the two were inextricably intertwined, and that the monetary contraction was the essence of it. That is indeed what F&S believe, and say on the third page; but to which they never later give precision, or, even by the end, much evidential support.

The title of the final section of Chapter 7 is equally indicative. On emight have expected here a connected discussion of whether monetary contraction might have been not cause but the effect of the real contraction, a question of which the authors are aware: had that been the case, it could have been difficult for the authorities to stop money contracting. Instead, the question is begged. The title of the final section is "Why Was Monetary Policy So Inept", - as if by this time the authors had earned their licence to drop the appearance of scholarly caution and objectivity - and we are given an explanation (of something that has never been shown to require explanation) in terms of a "shift in power" within the Federal Reserve System (p 411).

In the following paragraphs I try to analyse F&S's argument by collating statements made at different points. I will discuss it under four headings:

1) why the real depression occured;
2) why the monetary contraction occured;
3) the effects of bank failures, capital adequacy and the flight to cash;
4) the authors identification of three occassions on which in their view the Federal Reserve acted in a sharply restricted fashion

Underlying everything that F&S say on the occassion of The Depression is the assumption that (in the short term as well as the long) the "velocity" of money reflects the "money holding propensities of the community" (p679). Under the normal ceteris paribus procedure, tastes can be taken to be unchanged. By this logic, the authors are enabled to write as though a movement of the monetary aggregate itself implied a simple and direct sympathetic influence on real output.

To one of another way of thinking, this line of argument appears tendentious. In my view, clarity of thought requires recognition of the fact that money supplied by the banking system is not necessarily in equilibrium with the stock the public want to hold, and that in the short term therefore velocity is no more than a ratio between two magnitudes determined in partial independence.F&S's view is connected with the fact, discussed further below, that they give little or no weight to the role of banks as lending institutions.

1/. Though the general tone of what F&S say about the great depression clearly implies that it was caused by the monetary contraction, their statements are often hedged and unclear, and appear at times contradictory. (for instance in the opening to the Chapter on "The Great Contraction" after discussing the changes in attitude to the question whether "money matters" they remark that the "contraction is in fact a tragic testimonial to the importance of money forces" (p. 300). It is tragic presumeably becuase of the poverty and unemployment it caused, and the implication clearly is that that was due or largely due to "monetary forces".

One statement is:

prevention or moderation of the decline in the stock of money, let alone the substitution of monetary expansion, would have reduced the contraction's severity, and almost as certainly its duration. The contraction might still have been relatively severe. But it is hardly conceivable that money income could have declined [as much as it did]. (p301).

This statement however comes just after another one that seems to run in the other sense:

True, as events unfolded, the decline in the stock of money, and the near collapse of the banking system can be regarded as a consequence of non-monetary forces in the United States, and monetary and non-monetary forces in the rest of the world.(p300)

But by the end of the book they appear quite clear.

there is..... only one sense in which a case can be made for the proposition that the monetary decline was a consequence of the economic decline. (p691, also p694).

This is a view which they say is possible only if the Federal Reserve System is held to have been a prisoner of contemporary opinion. That, as they say, is not a matter of economic inter-relations, and is not what we are concerned with.

A Monetary History does not provide a connected view of why, in the authors opinion, the depression happened.

2/. F&S for the most part take a simple and extreme view of the cause of monetary contraction:

the monetary authorities could have prevented the decline in the stock of money - indeed could have produced almost any desired increase in the stock of money. (P.301: note the almost]. The monetary decline from 1929 to 1933 was not an inevitable consequence of what had gone before. It was the result of policies followed during those years (p.699).

On the question of how the authorities could have controlled the money stock, they answer, by "extensive open market purchases" as a means to increase bank reserves: What they say of the first year of the depression seems to express their view:

It has been contended with respect to later years (particularly during the years after 1934....) that increases in high-powered money, through expansion of Federal Reserve credit or other means, would simply have added to bank reserves and would not have been used to increase the money stock.... we shall argue later that the contention is invalid, even for the later period. It is clearly not relevant to the period from August 1929 to October 1930. During that period, additional reserves would almost certainly have been put to use promptly. Hence the decline in the stock of money is not only arithmetically to the decline in federal Reserve credit outstanding: it is economically a direct result of that decline. (pp341-2)

F&S, however, never seriously consider the possibility that they were held back by factors other than their reserve position. That is becuase they take practically no note of the asset side of banks' balance sheets. It is striking that, though the book contains many charts and table of bank liabilities it has only one table of bank assets (and then for selected years only). Their conceptual picture allows little place for the role of banks as financial intermediaries who live by striking a balance between the needs of two types of client: depositors (the public as asset owners) and borrowers (the public as investors and debtors). Nor does it allow for the fact that banks as intermediaries operate in a world of uncertainty, that banks' assessment of their client's creditworthiness varies, and that in the short term their lending determines the size of the money stock.

If these effects are accepted as important, the stock of money has to be seen as determined at least in large part by the business situation. On my view, the scale of bank lending during the Great Depression must have been greatly restrained by banks' bad debts, by banks' increased caution in lending to customers whose profit expectations had deteriorated drastically, and by capital inadequacy. It must have been these considerations, not the size of bank reserves, that imposed a limit on the size of the money stock.

(F&S admit that capital adequacy was a serious problem (p330) but argue that the authorities could and should have remedied this by buying securities to raise their price (hence increasing bank capital) and lending to banks after 1932 through the Reconstruction Finance Corporation. But the former would have been only partial indirect help, and the latter would have augmented banks' capital only if the authorities had taken bad assets in exchange for good.

On this view, the fact that the banks' reserves even by the end of the depression had fallen little, though banks' total assets/liabilities fell by about a third is presumptive evidence that reserves remained on the whole ample. (I admit that there may have been particular episodes when banks were constrained by reserve shortage: see further below).

F&S comment exclusively from their own point of view, and can see no force in the opinions of the authorities at the time based on considerations which they dismiss. They quote, for instance, the exchange of views inside the Federal Reserve System in May and June 1930, when most governors felt that there was already "an abundance of funds in the market" (p. 371): as one observed "we have been putting out credit in a period of depression where it was not wanted and could not be used" (p.373). F&S remark "these views seem to us...confused and misguided". To me they seem common sense. Again in it's report for 1930 the Reserve Board described its policy as one of "monetary ease". This draws from F&S the comment that "this is a striking illustration of the ambiguity of the terms "monetary ease" and tightness..... it seems paradoxical to describe as "monetary ease" a policy which permitted the stock of money to decline in fourteen months [as much as it did], (p. 375). But if one admits that the powers of the authorities are limited, it is not paradoxical at all.

3/. Though F&S rightly devote a good deal of space to the three successive waves of bank failures, these do not take a central place in their argument. At times they speak of their having had a contractional effect on the stock of money. But it becomes clear that what is meant is that the crises drained banks of reserves which depressed the money stock only because (in their view) the monetary authorities did not offset this effect so as to maintain bank reserves.

(The second banking crisis had far more severe effects on the stock of money than the first. P.314, see also P.648).

Hence they can say:

the bank failures were important not primarily in their own right but because of their indirect effect. If they had occured to precisely the same extent without producing a drastic effect on the stock of money, they would have been notable but not crucial. If they had not occurred, but a correspondingly sharp decline had been produced in the stock of money by some other means, the contraction would have been at least equally severe and probably more so. (p. 352, see also p. 357).

I have argued in the main text that the bank failures did indeed have a major effect in accuating the depression, but quite largely by reducing the amount of bank credit available to business - a question that F&S do not consider.

F&S have a curious argument which runs like this. The bank failures provoked a flight from deposits to currency: the former deposits-currency ratio had originally been preferred; hence the flight to cash must have made money less attractive and thus must have reduced the demand for money (that is, deposits and currency). Paradoxically, therefore, the bank failures, by their effect on the demand for money, offset some of the harm they did by their effect on the supply of money. That is why we say that if the same reduction in the stock of money had been produced in some other way, it would probably have involved an even larger fall in income than the catastrophic fall that did occur (p. 353). To be consistent they should also argue that if bank failures had been prevented from causing the money stock to fall (which, as they have already argued, could, and should have been done), then the effect would have been to raise income. The paradox in this argument springs I think from Freidman's practice of treating velocity as if it represented tastes and propensities, and was an independent force. In my view, velocity changes because the banks adjust lending, and thus the stock of money, to changes in income with a lag of several years: only in the very long term does velocity inter alia depend on the demand to hold money.

4/. At the very end of their book there is a passage in which they identify three crucial episodes in US history when the authorities took what is held to be incontrovertibly contractive action. The passage is worth discussing in detail because it is difficult to reconcile with others of their statements, and hence reveals more of their lines of thought: and also becuase it leads me to qualify what I have said already.

After first commenting that "it is often impossible and always difficult to identify accurately the effects of the actions of the monetary authorities, they then proceed:

on three occasions the system deliberately took steps of major magnitude which cannot be regarded as necessary or inevitable economic consequences of necessary changes in money income and prices. The dates are January to June 1920, October 1931, and July 1936 to January 1937. These are the three occasions - and the only three - when the Reserve system engaged in acts of commission that were sharply restrictive: in January 1920 by raising the discount rate from 4.75 per cent to six per cent, and then in June 1920 to 7%, at a time when member banks were borrowing from Reserve banks more than the total of their reserve balances: in October 1931 by raising the rediscount rate from 1.5 per cent to 3.5 per cent within a two week period, at a time when a wave of failures was engulfing commercial banks.... and indebtedness was growing: in July 1936 and January 1937, by announcing the doubling of reserve requirements in three stages, the last effective on May 1 1937, at a time when the Treasury was engaged in gold sterilisation, which was the equivalent of a large-scale restrictive open market operation. There is no other occasion in Federal Reserve history when it has taken explicit restrictive measures of comparable magnitude - we cannot even suggest possible parallels (p 688-9).

It seems that the restrictive action by the authorities in 1931 which F&S have in mind is not high interest rates as such (for the discount rate was low in 1931), but the authorities acting in a way that put further pressure on the banks at a time when, being already short of reserves, they were particularly vulnerable to pressure. This is perhaps the same point as that made in several passages that discuss bank failures in 1929-33, which blame the authorities for allowing bank reserves to fall (see pp 318 and 356).

In looking at any particular critical juncture it must be impossible for a commentator or historian to tell whether a) reserves where adequate because bank lending had fallen first and reduced the need for reserves; or, (b) reserves were at some stage indeed inadequate, and that had forced banks to curtail their lending, and thus to exert a restrictive effect on output. In looking at the whole span of the depression, I have already expressed doubt about whether the banks could have been short of reserves (since, over the whole period, the ratio of reserves to deposits rose). F&S are, however, here speaking of a critical period, in which banks were being drained of reserves by the flight to cash. Banks were therefore particularly dependent on action by the authorities to replenish reserves, and it is quite conceivable that the authorities were insensitive to their needs at this juncture. If that is the criticism, I could see some force in it - though it hardly seems to qualify as what F&S describe as "explicit restrictive measures" of a major sort. But (as I argue in the text) it was in any case perhaps chiefly the nature of existing financial institutional arrangements that was to blame.

Having dealt with vaious particular steps in F&S's particular argument, I will in conclusion give two broad general reasons for discounting a monetarist explanation of the Great Depression.

First, F&S at times admit that there were non-monetary influences at work; but they never explain how these can be integrated into a monetarist explanation. The point is that one must believe that the fall in income had a major effect on personal consumption, and the great fall in output a major influence on business investment, and the interaction of the two (once the process started) a dominating influence. At most, then, monetary influences could have initiated the depression, or worsened it when it started, but they could not have been the sole dominating influence through its course. The parallel fall in the money stock cannot then be taken as evidence of the latter's causal significance.

Second, there is an international dimension which F&S do not face up to which creates a similar difficulty for their argument. Depression in the United States was so deep that it must, be held to have largely determined the coincident depressions in other countries; and in the transmission process non-monetary channels (international trade) must have been important. Now in other countries also there was coincidentally monetary contraction. Does this mean that in other countries the causation ran from non-money to money (the opposite of what is said to have happened in the USA)? Or is it argued that monetary authorities in all countries coincidentally made identical mistakes?

This comes from this link.

Tuesday, January 27, 2009

More Greek Woes

Athens cautions banks on transfers to Balkans
By Kerin Hope in Athens and Stefan Wagstyl in London

Published: January 27 2009 17:20 | Last updated: January 27 2009 17:20

Greece has warned its banks against transferring funds from a €28bn government support package to their Balkan subsidiaries, because of growing fears of financial turmoil in these countries.

George Provopoulos, governor of the Bank of Greece, told the Financial Times he was concerned about the impact of the global crisis in countries – including Romania, Bulgaria and Serbia – that had experienced recent foreign currency lending booms.

I have advised the banks to be more prudent and to lend on the basis of availability of local funding, taking into careful consideration local economic conditions,” he said.

The warning comes after about 10 international banks, including Greece’s EFG Eurobank, urged European Union governments not to discriminate in their anti-crisis policies against states outside the eurozone and EU.

They were supported by the European Bank for Reconstruction and Development, the multilateral lender, which on Tuesday cut its 2009 growth forecast for the region from 2.5 per cent to 0.1 per cent. Erik Berglof, EBRD chief economist, said the danger of west European countries preparing bank support packages that discriminated against foreign countries was “a very big worry”.

The European Commission has welcomed the international banks’ initiative. The European Central Bank has already given liquidity support to EU members, notably Hungary, but has responded cautiously to proposals for assisting countries outside the union.

Bankers are particularly concerned about steep local currency declines, which have squeezed borrowers with foreign currency loans. Foreign exchange lending accounts for more than 70 per cent of loans in Serbia, 60 per cent in Hungary and in excess of 50 per cent in Romania and Bulgaria.

Mr Provopoulos said: “If economic conditions in these countries were to significantly weaken, Greek banks might find themselves exposed not just to credit risk but also to exchange rate risk.”

Banks with big market shares in south-east Europe include Italy’s Unicredit, Austria’s Raiffeisen International and Erste Bank, and Greece’s EFG, Alpha Bank and National Bank of Greece.

Meanwhile, some south-east European officials are concerned about the danger of foreign banks taking funds from the region.

Radovan Jelasic, Serbia’s central bank governor, told the FT this happened in Belgrade in December when he relaxed banks’ reserve requirements to release €600m ($780m, £564m) in local foreign exchange liquidity. Officials were dismayed to see €600m transferred out of the country by international banks in the following two weeks, he said. Foreign banks contacted by the FT in Belgrade declined to comment.

Elsewhere, Romania’s central bank said inflows from foreign owners were expected to slow, but not reverse. Some 39 per cent of the financing made available to Romanian subsidiaries of international banks was due for repayment this year but there was a “high probability” that about 80 per cent of this would be renewed, the bank said.

In Hungary, foreign banks poured in funds in October when the country faced a crisis and the International Monetary Fund launched an emergency package. Banks injected €2.8bn compared with a previous monthly average of €500m-€600m. Inflows have since dropped below the monthly average but the the central bank says “not a single bank is seeing an outflow”.

Farmers tighten stranglehold on Greece
By Kerin Hope in Athens

Published: January 27 2009 14:38 | Last updated: January 27 2009 18:13

Greek farmers on Tuesday extended a blockade of the country’s main roads that is starving the capital of food and medicine, stalling exports and straining relations with neighbouring countries.

More than 9,000 tractors have blocked the main route for trucks carrying goods to and from western Europe. Farmers are demanding that the government increases a €500m ($660m, £465m) support package.

The eight-day blockade is gradually moving closer to Athens. It highlights widening social unrest in Greece as the centre-right government of Costas Karamanlis, prime minister, struggles to restore credibility following last month’s student riots in Athens.

Mr Karamanlis said the government was “open to dialogue” but only when the roads were open again.

“You cannot hold prisoner a whole society that works to provide the resources to subsidise farming, and burden the economy even further,” he said.

Wholesalers in Athens warned on Tuesday that supermarkets and pharmacies were starting to run short of supplies.

Kostas Michalos, chairman of the Athens chamber of commerce, said: “Exports and trade generally are taking a disastrous hit. Other sectors of the economy should be allowed to meet contracts in these difficult economic times.”

The Bulgarian government appealed to the European Commission to intervene to lift the blockade after tractors surrounded customs posts at all three border crossings with Greece, leaving more than 500 trucks on the Bulgarian side.

Transit traffic at crossings with Macedonia and Turkey were also affected. Customs officials at the Kipi crossing with Turkey said on Tuesday that scuffles had broken out between lorry drivers and farmers.

Bulgaria’s truckers’ association said that it would take legal action against Greek authorities if the protests continued.

The government’s offer to farmers consists of €300m in compensation for crop damage caused by fires and floods last year, and another €200m of extra subsidies for olive oil, wheat and cotton growers who are facing increased input costs.

The farmers want the package to be increased. They also want it to exclude people who cultivate small landholdings in time off from other jobs. About 12 per cent of the Greek workforce are registered as farmers but this number includes many “urban farmers” who have second jobs in the public sector or in tourism.

Greece’s system of fragmented holdings makes farming uncompetitive compared with other Mediterranean producers such as Spain and Italy.

Large tracts of land that were once used mainly for olive growing in southern Greece have been abandoned or offered for building second homes as young people have left for service sector jobs in the cities.

Thursday, January 22, 2009

Banks ask for crisis funds for E Europe

Banks ask for crisis funds for E Europe
By Stefan Wagstyl in Vienna

Published: January 21 2009 23:36 | Last updated: January 22 2009 09:52

Leading international banks operating in central and eastern Europe have clubbed together to lobby the European Union and the European Central Bank to extend their anti-crisis policies to ease the credit crunch in the region.

The group of ten, which wants action to ease liquidity shortages and help revive lending, is urging Brussels and the ECB to extend support beyond the EU’s new member states, such as Poland, to prospective members, such as Serbia, and to Ukraine, which has few prospects of joining the bloc soon.

Herbert Stepic, chief executive of Raiffeisen International, the Austrian bank, who brought the group together, said it was important that any action to support banks was not limited to western Europe.

“We fought for 50 years, many of us, to get these countries away from communism and now we have a free market economy in the region, we can’t leave them alone when there is an extremely harsh wind blowing,” he said.

The group has kept a low profile until now, but Mr Stepic told the Financial Times he was speaking out “because of the deteriorating economic circumstances”.

He said the costs of possible support would be “relatively” modest in comparison with the huge sums pledged to assist western European banks. The total gross domestic product of formerly communist central Europe was €740bn and for south-east Europe €270bn. This compared with €290bn for Austria alone.

His remarks come amid a week of fresh turmoil in the financial markets and a darkening economic outlook. The European Commission released a forecast of a 1.8 per cent decline in EU economic output for 2009, its gloomiest prediction in years, while Moody’s, the credit ratings agency, on Wednesday said the outlook for the Ukrainian banking system was negative.

EU institutions have already played a role in the emergency financial packages assembled by the International Monetary Fund in the region. The ECB has extended liquidity support to Hungary and the EU is contributing to Latvia’s bail-out. The ECB has also extended liquidity support to Poland, where the IMF has not been involved.

But the international banks want Brussels and the ECB to make clear that they stand ready to assist vulnerable non-EU members. Mr Stepic declined to specify which countries might need such support but bankers said they could include those with high external financing needs, including Serbia and Bosnia, as well as Ukraine.

As well as Raiffeisen, the banks involved are Italy’s Unicredit and Intesa Sanpaolo, Austria’s Erste Bank, Société Générale from France, Belgium’s KBC, German Bayern Landesbank, Sweden’s Swedbank and SEB and EFG Eurobank from Greece.

Wednesday, January 21, 2009

Japan's Grim And Bear It 2009 Outlook

Things in Japan are looking grim. They keep getting grimmer, and it doesn't seem they will be getting less grim anytime soon. To give you some idea of what this means, only this week we learnt that Japan’s steel production fell 28 percent in December. This was the steepest decline in no less than six decades. Meanwhile Hiroshi Yoshikawa, Tokyo University professor and head of the Japanese government business cycle measurement committee said that Japan’s present recession may become the longest in the postwar era. “We’d better get ready for a three-year recession,” he said in an interview with the press this week. The decline “will be very severe, not only in terms of duration but also depth”.

And those famous exports, which dropped by an astonishing annual 35% in December, accounted for 61 percent of the growth in the last expansion, an expansion which was the longest in over 60 years. What this means, bluntly put, is that until exports recover there isn't much likelihood of any more general economic recovery, and exports won't recover till global trade starts to expand again, and the bank and credit crisis is over, which means you can pretty much forget about 2009 as far as I can see.

Thus we are over to "do the best you can under the circumstances" mode, and to applying some sort of fiscal stimulus. And of course, Prime Minister Taro Aso has not been backward in coming forward in this regard (especially with elections looming at some point), and his second stimulus package has now been passed by the Lower House. But here comes the shocker - the package provides for an actual increase in deficit spending of a mere 1% of GDP - a drop in the bucket when you are talking about your worst recession since WWII. Even worse, the proposed fiscal 2009 budget - which begins on April 1 - provides no new stimulus. Newspaper reports which mention an increase in spending of 6.5% are misleading since they compare the proposed budget for fiscal 2009 with the initial budget for fiscal 2008. But the final budget for fiscal 2008, actually included two supplementary budgets, and the final readout ended up being a tad higher than what is currently proposed for 2009.

However even with spending staying flat (on the rather dubious assumption of no further packages) the Japanese government will still need to sell 33.3 trillion yen of new debt, the most in four years, since the economic contraction means there will be a revenue shortfall. The so-called primary budget deficit, the excess of spending over revenue excluding bond sales and interest payments, will balloon to 13.1 trillion yen from this year’s 5.2 trillion yen. And here we have Japan's dilemma, since something needs to be done to soften the blow of this recession, but with debt having been allowed to expand so rapidly over the last decade (see chart below), there really are limits on how much can responsibly be done.

The most obvious problem is that increasing spending at a time when tax revenue is falling threatens the government’s goal of balancing the budget by 2011. But Aso has already indicated that the government shouldn’t prioritize fiscal discipline when the economy is ailing, and so far as it goes the argument is reasonable. This is a "once in a lifetime" crisis (we hope) and so once in a lifetime measures are in order. It's just that Japan has now been busily taking "once in a lifetime measures" for over a decade, and we still don't seem to be getting anywhere. But we are ballooning government debt. Many quibble with the widely quoted 2008 OECD debt to GDP number of 182%, since it is a figure for gross debt (which the OECD can easily justify for reasons that we don't need to get into here). But look at the green line above which shows net debt, this has also been rising and rising, and is now near to 100% of GDP on IMF data. The point is we have just been through the longest expansion in over 60 years, and yet at no point did net debt to GDP start to fall. This is the real core of the problem that Japan faces in 2009, that previous fiscal policy did not attack the growing fiscal deficit in the good times, so there is little room to manoeuvre in the bad ones. Which is why the Japan economic outlook in 2009 is grim, grim and nothing but grim.

Tuesday, January 13, 2009

"Carry" Me Away Captivity - To The Land Of The Rising Sun

"Carried us away in captivity
Requireing of us a song
Now how shall we sing the lord's song in a strange land?"
Boney M

One question which many people in Japan are asking themselves right now is why it is the level of JPY/USD is so high. Not so long ago many of those very same people were busy asking themselves why it was that the yen was so cheap, and why all those imported products (like French mayonaise) were so expensive. Only a year or so ago the currency was trading somewhere in the 105 to 110 yen to 1 US$ range, yet last month it hit a 13 year high against the dollar and is currently hovering around 90 yen to 1 US$ mark - up 15% in just 12 months. In the meantime, as I pointed out in my last post, Japanese exports plummet (down 16.2% y-o-y in November), and with them the rest of the economy.

Indeed so seriously is the problem being taken that Bank of Japan governor Masaaki Shirakawa has made it plain that currency-market intervention is a distinct possibility at some point, and indeed Japan seems to have received a "fire at will" green-light-mandate at the last G8 meeting to do just this as and when it feels such action would be appropriate. "The strong yen at a time of rapid decline in the global economy has a big negative impact on our economy in the short term," Shirakawa said recently. Of particular concern here is the financial health of major Japanese exporters such as Toyota, Honda and Sony. Many of Japan's most important companies are really feeling the pain caused by collapsing external demand and the soaring yen, since a strong yen makes Japanese products more expensive, and hence less competitive, in overseas markets.

Just why the yen is so strong at the present time (as opposed to the Japanese economy which is so weak) can be seen in the above chart. The recent rapid rise in the dollar value of the yen has been the by-product of two distinct but inter-related processes: a decline in global risk appetite on the part of investors and the unwinding of what is known as the yen carry trade. For those not in the know the term "carry trade" is a euphemism for the widespread practice among investors of taking advantage of the yield differential offered by Japan's ultra-low interest rates and borrowing in yen in order to invest in currencies paying substantially higher ones. Some of the higher profile recipients of such funds have been the Icelandic krona, the New Zealand "kiwi" dollar and the Turkish lira, but in fact the practice was fairly extensive, with large inflows of funds being seen in emerging economies from India to Brazil.

The abrupt drop in carry trade activity, and hence the rapid drop in demand for yen denominated loans, can be seen in the chart (the JPMorgan EMBI+ index) which shows the price of emerging market bonds. As we can see, starting in early September, and coinciding with the bankruptcy of Lehman Brothers, the demand for emerging market bonds fell off a cliff (as the yield demanded by investors shot up, the relationship between bond prices and yields is an invese one), all of which lead to a very rapid "liquidation" in yen positions, as a result a lot of yen had to be bought to pay down the loans. Hence the rise in the yen. The situation has now recovered somewhat since the end of November, and hence the yen has eased back slightly, especially in relation to the euro.

Of course people didn't only borrow to invest in emerging markets, US treasuries were also an attractive proposition for some time for those borrowing in or having Japanese yen. The difference between one-year US and Japanese government bond yields was around 4.6% in mid-2006 (5.2% vs. 0.6%), and it thus paid to invest in US government bonds, driving up the demand for dollars and pushing down demand for yen. This particular carry ride has since disappeared though - as the current differential has fallen to very close to zero (0.43% for the US and 0.28% for Japan earlier this week). There is thus no great advantage at the present time in borrowing in yen to invest in US securities, and indeed one of the really interesting questions as Ben Bernanke moves steadily towards his own version of quantitative easing is whether the US dollar may not take over the poll carry position from the yen.

The carry trade is effectively an enormous by-product of financial globalisation and the impact of the kind of massive unwind we have recently seen is very hard to counteract, which is why Japanese officials haven't intervened in currency markets so far. Of course, with Japanese interest rates coming down to even lower levels, and a return to quantitative easing seeming a distinct possibility in coming months, it is quite likely that as the recovery takes hold in a number of key emerging markets we will once more see a revival in risk appetite and an increase in demand for emerging market bonds, and with all this a rise in yen carry and a fall in the value of the yen. It is this expectation, perhaps more than any other factor which has lead the Japanese authorities to hold back so far on intervention, since they are obviously anticipating the problem will solve itself as the global economy rebounds. Let's just hope they are right.

Wednesday, January 7, 2009

Inflation Targeting At The Fed?

Fed Officials Revive Discussion of Explicit Inflation Target

By Craig Torres and Steve Matthews

Jan. 7 (Bloomberg) -- Federal Reserve officials revived the prospect of setting an explicit target for inflation to counter the risk that the worst economic slump in the postwar era will trigger a broad decline in prices.

The Federal Open Market Committee at its Dec. 15-16 meeting discussed ways to avert deflation while approving a reduction in the benchmark interest rate to as low as zero, according to minutes of the gathering released yesterday. The FOMC also considered increasing emergency loans that have doubled the Fed’s balance sheet to $2.3 trillion in the past year.

Policy makers “face considerable uncertainty about how inflation expectations could evolve,” said Brian Sack, deputy director at Macroeconomic Advisers LLC in Washington and a former Fed economist. “That enhances the argument for taking the further step and adopting an explicit inflation objective.”

By setting a goal for price increases, the central bank would adopt a measure that the U.K., Sweden and other countries have used to anchor policy and build credibility with the public. Chairman Ben S. Bernanke made a target one of his priorities when he took the helm three years ago, though a 2007 review of Fed communications stopped short of that objective. Now, with inflation retreating and the economy contracting, a target could be used to justify a more expansive policy.

One measure of inflation, the personal consumption expenditures price index, minus food and energy, could rise at less than 1 percent this year, and only 0.5 percent in 2010, according to forecasts by Sack’s firm.

‘More Explicit’

Central bank officials discussed providing “a more explicit indication of their views on what longer-run rate of inflation would best promote their goals of maximum employment and price stability,” the minutes said. Such a target may “help forestall the development of expectations that inflation would decline below desired levels, and hence keep real interest rates low.”

An inflation goal would reinforce expectations that the central bank will make a commitment to withdraw cash when the economy shows signs of a recovery.

Some policy makers last month saw “significant risks that inflation could decline and persist for a time at uncomfortably low levels,” the minutes said. Price increases will probably “continue to abate because of the emergence of substantial slack in resource utilization and diminishing pricing power.”

Fed officials saw “substantial” risks to the slumping economy last month and indicated “the economic outlook would remain weak for a time and the downside risks to economic activity would be substantial,” according to the minutes.

‘Dark Document’

“Rates are going to be low for a long time,” said Vincent Reinhart, former director of the Fed’s Division of Monetary Affairs, who is now a visiting scholar at the American Enterprise Institute in Washington. “They see the economy as extremely weak. It is a dark document.”

Economic growth declined in the third quarter at the fastest rate since 2001 as unemployment rose and home values, housing starts, auto production and consumer spending fell. Analysts downgraded forecasts last month, with economists at Morgan Stanley and JPMorgan Chase & Co. predicting a contraction in gross domestic product of about 6 percent for the fourth quarter, the biggest decline in 26 years.

“The current downturn is likely to be far longer and deeper than the ‘garden-variety’ recession,” Federal Reserve Bank of San Francisco President Janet Yellen said in a Jan. 4 speech. “It’s worth pulling out all the stops” in a fiscal stimulus.

U.S. employment fell by 500,000 jobs in December, bringing last year’s decline to 2.4 million, the most since 1945, according to the median estimate of economists surveyed by Bloomberg News ahead of Labor Department figures due Jan. 9.

Alternative Tools

Policy makers discussed an array of alternative policy tools at the meeting last month, including communicating their expectations for interest-rate changes and expanding the balance sheet by taking on more loans and bonds that private creditors refuse to hold.

The FOMC also discussed setting a target for growth in measures of money, such as the monetary base. While a “few” policy makers favored a numerical goal for money growth, most preferred a more open-ended “close cooperation and consultation” with the Fed board on how to expand assets and liabilities.

“Going forward, consideration will be given to whether various quantitative measures would be useful in calibrating and communicating the stance of monetary policy,” the minutes said.

The central bank will have difficulty scaling back its auction of loans and other emergency programs without upsetting the bond market, former St. Louis Fed President William Poole said in a Bloomberg Television interview.

‘Substantial Reaction’

“The market will take that as being a signal that monetary policy is tightening and that is going to set off substantial reaction in the bond market, maybe the equity markets too,” Poole said.

President-elect Barack Obama yesterday called for a record stimulus to prevent the recession from deepening. His plan aims to create or save 3 million jobs and may cost about $775 billion.

Policy makers discussed “possible refinements to the committee’s approach to projections,” including providing more information about individual views on “longer-run sustainable rates” of unemployment, inflation and economic growth.

The committee, after Bernanke’s urging, started publishing three-year forecasts for growth, inflation and unemployment in the minutes of the October 2007 FOMC meeting.

The third year of those projections is viewed by analysts as a signal of policy makers’ preferences for prices, unemployment and growth. The third-year projection may be less valuable in communicating goals because slack in the economy may continue to depress inflation through 2011, Sack said.

Fed considers setting inflation target
By Krishna Guha in Washington

Published: January 6 2009 21:45 | Last updated: January 6 2009 21:45

The Federal Reserve is eyeing establishing a de facto inflation
target, minutes of its groundbreaking December policy meeting revealed
on Tuesday.

The idea would be to shore up the public expectations of positive
inflation and so make it less likely that a deflationary dynamic could
take hold as the US recession deepens.

Policymakers discussed the possibility of offering a "more explicit
indication of their views on what longer-run rate of inflation would
best promote their goals of maximum employment and price stability".

They reasoned that the "added clarity in that regard might help
forestall the development of expectations that inflation would decline
below desired levels".

The minutes provide further insight into the meeting at which the Fed
cut its target interest rate to virtually zero and laid out its
strategy for unconventional easing.

They also reveal that Fed staff economists now expect the US economy
to contract in 2009 as a whole, with a sharp decline in the first half
and a slow recovery in the second.

Fed policymakers "generally agreed" that the "downside risks to even
this weak trajectory for economic activity were a serious concern".
Some thought there was a "distinct possibility of a prolonged

They were "uncertain about the extent to which inflation would fall" –
with some worried that it might decline to levels inconsistent with
medium-term price stability.

The minutes also show the committee wanted the public to know that it
expects short-term interest rates "to stay exceptionally low for some
time" – but that this statement was conditional, based on the
evolution of the economic outlook.

Officials debated whether it might be helpful to set a target for the
quantity of bank reserves – as in Japan during its period of
quantitative easing in the early 2000s – and resolved to consider this

However, the minutes make it clear that their policy is driven by the
"quantity and the composition of Federal Reserve assets" – loans and
asset purchases – rather than reserves and other liabilities.

Officials discussed the merits of purchasing large quantities of
securities issued by Fannie Mae and Freddie Mac, the
government-controlled mortgage giants, and Treasuries. They reasoned
that such purchases would indirectly reduce borrowing costs for
private borrowers – but "participants were uncertain as to the likely
size of those effects".

Tuesday, January 6, 2009

Japan Badly Needs One New Year's Resolution

In a week when we learn that Toyota plans to suspend production at all 12 of its Japanese plants for 11 days over the next couple of months, news which follows hot on the tails of last week's report that industrial output shrank at the fastest pace since at least 1953 in November (16.2% y-o-y), with December's Purchasing Manager Index survey - described in JPMorgan's Global Report as the weakest performance registered by any of the 26 countries they track - showing only more and worse to of the same to come, we might like to ask ourselves whether 2009 is likely to hold anything in the way of good news in store for Japan?

Certainly at this point it doesn't look that way. Output and GDP are both falling at almost unprecedented rates, unemployment is set to rise, and that long "historic" recovery we were hearing so much about only a few short months ago now looks as if it belonged to another epoch. Even deflation may well start to raise its ugly head over the months to come, as "core-core" consumer price inflation brushes tantalisingly along the zero percent line.

And, of course, inflation isn't the only thing that's hitting zero in Japan at the moment, since the latest decision by the bank of Japan also took interest rates (0.1%) to a point where they are eerily poised yet again just above the bottom rung of the ladder.

But just why should Japan's economy prove to be so vulnerable to a global downturn? Well, you don't have to look too far to find the answer, it's called export dependence. If you are dependent on exports for your economic growth then you really don't have much choice (as China may also be finding out right now), as your customers go down, then down you go too.

But why is Japan so export dependent? Well here you will find explanations to suit every palate, but if I can just add my 5 cents worth, I would say that the fact that Japan's population currently has the highest median age on the planet is not simply an incidental correlate (nor is the fact that Germany has the second highest median age and is currently struggling with the same problem simply another incidental detail). So something needs to be done to slow down the rapid ageing of the Japanese population, and as far as I know there are only two ways to do that, get fertility up, and open the doors to immigration.

In this context it is interesting to note that an 80-strong group of economically liberal politicians in the ruling Liberal Democratic Party (LDP), led by Hidenao Nakagawa, a former LDP secretary-general, are pushing for a change in immigration policy (full story in the Economist here). These venerable gentlemen are calling for the number of foreigners living and working in Japan to rise to 10m over the next half century, and for many of these immigrants to become naturalised Japanese. In addition the Keidanren, the association of large manufacturers, is also shifting position, and last autumn called for a more active immigration policy to bring in more highly skilled foreign workers. The Keidanren estimates the present number to be a mere 180,000. The Economist refers to these moves as bold, I would rather term then "baby steps" in the right direction, although we must wait and see what material outcome such pressures lead to, for good intentions have often been expressed in this regard in the past.

As for fertility, again there is a lot of debate about how to encourage people to have more children, and I am sure there is no easy answer here, but I can think of one thing which would help, and that is a change in the national mindset. You see, maybe it isn't true to say that countries like France, the United States and Sweden will have no problems with population aging, but they will certainly have a lot less than many others, since their underlying pyramids are much more stable. And you know what? Few people in these three countries would question the fact that having enough children to maintain national economic stability is important, while in the worst affected countries - Japan, Germany, Italy, Russia, China etc - we find precisely the opposite situation, with few people thinking of the fertility topic as an important one. Indeed many people in very low fertility countries attempt - often vociferously - to deny that long term demography has any economic significance at all. No wonder then, that people in these countries have less children! Perhaps this would be the best national new year's resolution for the Japanese to collectively make, to push the fertility issue higher up the list of national strategic priorities. Which puts me in mind of that old saying "where there's a will, there's a way". I can't think of a better example of a case where this maxim is just waiting to be applied.

Friday, January 2, 2009

More On Charts

China’s manufacturing contracted for a fifth month in December as recessions in the U.S., Europe and Japan sapped demand for exports, a survey showed. The CLSA China Purchasing Managers’ Index stood at a seasonally adjusted 41.2, compared with a record low of 40.9 in November. A reading below 50 reflects a contraction.

“Chinese manufacturing was very weak in December,” said Eric Fishwick, head of economic research at CLSA in Singapore. “With five back-to-back PMIs signaling contraction, the manufacturing sector, which accounts for 43 percent of the Chinese economy, is close to technical recession.”

The output index fell to a record low of 38.6 last month from 39.2 in November, while the measure of new orders rose to 37 from 36.1. The index of export orders jumped to 33.6 from 28.2, CLSA said.

Chinese manufacturers reduced the size of their workforces at the fastest rate recorded by the series to date, according to the report report. An employment index tracked by CLSA has contracted for five consecutive months to 45.2 in December.

Central Europe

The Czech Purchasing Managers' Index dropped to 32.7 in December, from 37.8 in November, falling below the critical 50.0 mark for the sixth consecutive month, according to the latest report from Markit Economics and ABN Amro. Czech output dropped to a new historic low of 27.4 for the fastest contraction in any period since the survey began in July, 2001. Markit said the overall decline in business conditions was the worst in the survey's history, and anecdotal evidence linked it to worsening domestic and export demand. I think I now have a recession call out on the CR, either they will have the first of two consecutive quarters of contraction in Q4 2008, or in Q1 2009. This is very sharp, and quite dramatic. Country specific post to come as and when I get the time.

Poland's dropped to 38.3 in December from 40.5 in November, this is its lowest level since the series began in June 1998 and the eighth month running of contraction in the sector. Recession is coming in Poland, I just wouldn't like to say at this point (without going over the data more thoroughly) when. The downturn in manufacturing is slower at this point than in the CR, which most probably means domestic demand was more robust, but that's just a guess.

New business indicators dropped at the fastest rate in survey history in December, with the new orders index falling to 32.2 in December from 35.6 in November, and new export orders decreasing to 31.4 from 40.1. December's total manufacturing output index fell for the seventh straight month, to 36.3 from 40.2 in November, while industrial companies cut employment for the eight consecutive month since May, with the December employment index dropping to 40.7 from 42.4 in November.


Russian manufacturing shrank at a record pace in December as slumping foreign and domestic demand led to production and jobs cuts, VTB Bank Europe said.

VTB’s Purchasing Managers’ Index contracted for a fifth month to 33.8, from 39.8 in November, the bank said in an e-mailed statement today. That is lower than at any time during the 1998 economic collapse, when the government dropped its support of the ruble and defaulted on $40 billion of domestic debt. A figure above 50 means growth, below 50 a contraction. The bank surveyed 300 purchasing executives.

A 72 percent drop in the RTS Index made it the worst stock index among the world’s 20 biggest equity markets in 2008 and gave investors in the country their biggest losses since Russia defaulted on its debt 10 years ago.

The ruble lost 15 percent against the dollar-euro currency basket in 2008, weakening the most since the measure’s introduction in 2005. The ruble fell 16 percent against the dollar, the currency’s worst performance since 1999 as the economy was battered by a 75 percent plunge in oil.

The central bank used 27 percent of its foreign-currency reserves, the world’s third-largest, to prop up the ruble. Reserves fell to $438.2 billion. More than $200 billion has left the country’s economy and currency since August, according to BNP Paribas SA.

Indian Manufacturing Contracts

There was neither respite or reprieve for the Indian manufacturing sector in December, and the PMI survey continued to show falling output and new order levels following the initial contraction registered in November. Having said that, India is still faring significantly better than most. Nevertheless the headline ABN AMRO Purchasing Managers’ Index fell for the fourth consecutive month to give a new low of 44.4, and register the second month of contraction.

Although new order levels were down considerably for both the domestic and export sectors, the accelerated fall in new export orders since November was far stronger. Thus, as might be expected, internal demand in India is proving to be a little more robust than it is in China.


The headline seasonally adjusted Banco Real Purchasing Managers’ Index (PMI) – a composite indicator designed to provide a single-figure snapshot of the performance of the manufacturing economy – dropped to a new low of 40.0 in December, pointing to a sharp deterioration in the health of the sector. The PMI has now registered below the no-change mark of 50.0 for three consecutive months.


December’s seasonally adjusted Nomura/JMMA Japan Manufacturing Purchasing Managers’ Index remained below the critical 50.0 no-change mark for a 10th successive month in December to signal a further deterioration of operating conditions in the Japanese manufacturing sector. Moreover, the headline index posted its lowest level in the survey history, recording 30.8, down sharply from 36.7 in November.

Japanese manufacturing production declined at by far the steepest rate in the survey history in December. Falling output levels have now been registered for 10 consecutive months. The latest contraction generally reflected rapidly declining new order volumes and extremely adverse market conditions.

Volumes of new orders received by Japanese manufacturers fell at the most marked rate recorded by the series to date. Panelists cited a sharp reduction in client demand as the principal contributor to the latest contraction. In line with rapid declines in both new business and output, volumes of new export orders contracted at the sharpest rate since the inception of the series in October 2001. Anecdotal evidence attributed lower export receipts to severe reductions in overseas demand, reflecting the deteriorating health of the global economic environment.

In December, average input prices fell for the first time since September 2003. This was in sharp contrast to the strong rates of inflation recorded throughput much of 2008 so far. There were widespread reports that a number of raw materials had fallen in price, while several panelists linked lower input costs to stagnant market conditions.


The Spanish manufacturing sector shrank at a record pace for the fourth month running in December due to a lack of new business as the country entered recession, the Markit Purchasing Managers Index showed on Friday. The indicator fell to 28.5 from a previous low of 29.4 in November and marked the lowest level in the near 11-year history of the survey.

Around 43 percent of Spanish manufacturers in the PMI survey said they cut jobs in December to compensate for falling production, marking the highest level of layoffs in the series history and taking the employment indicator to a low of 29.4.
"The truly horrendous PMI data for December mean that Spanish manufacturing heads into the new year with little reason for optimism - 2009 is all set to be a very difficult year," said Markit economist Andrew Harker.

December PMI data showed the second steepest contractions on record for new domestic and foreign orders, with cancellations from the United Kingdom, France and Germany
Jobs have now been cut in the Spanish manufacturing sector for 16 consecutive months.


Italian manufacturing activity contracted sharply in December for the 10th month running, though at a marginally slower rate than November's series record low, the latest Markit/ADACI PMI survey showed on Friday. The Markit Purchasing Managers Index edged up to 35.5 from 34.9 in November but was still the second lowest level in the survey's 11-and-a-half year history.

Staff were shed at the fastest rate on record, with the relevant sub-index falling for the fourth consecutive month as Italy's recession-hit manufacturing sector continued to suffer from the effects of the international financial crisis.
The PMI was above expectations. The median forecast in a Reuters poll had pointed to a reading of 34.0.

"The Italian manufacturing sector remained mired in recession during December as output, new orders, new export orders, backlogs, employment and purchasing activity all contracted," Markit said. PMI has not been above the 50 mark which separates growth from contraction since February and the latest data offered no sign of recovery. Exporters were particularly hard hit by the global downturn, with new orders from abroad falling at the fastest pace since the survey began in 1997.
One glimmer of good news for the economy is the decline in inflation, though this reflects the weakness of demand as well as the drop in the price of oil and other raw materials.

The PMI showed input prices for manufacturers fell in December for the second month running, signalling the strongest rate of deflation in the survey's history.
Prices charged also posted their steepest drop on record, showing firms have little or no pricing power to pass on earlier higher costs. Most independent forecasters expect Italy's economy to contract by around 0.5 percent in 2008 and by around 1 percent this year, which would be the first consecutive years of falling GDP since World War Two


Collapsing orders sent Germany's manufacturing sector into its biggest contraction in more than 12 years in December, even though a slump in input costs allowed producers to cut their prices, a survey showed on Friday.
The headline index in the Markit Purchasing Managers' Index (PMI) for Europe's biggest economy fell to 32.7 in December from 35.7 in November. The fall took the index deeper below the 50 threshold separating contraction from expansion.
The reading, which showed a sector contraction for the fifth month running, was the lowest since the series began in April 1996 and was below a flash estimate of 33.5 released on Dec. 16. A sub-index on new orders also fell to a series record low.
"There is no doubt that the German manufacturing sector nosedived in the final three months of 2008, and the December data suggest that firms are suffering more than at any other time since reunification," said Markit economist Tim Moore.
"Rapidly falling input prices seem to be the symptom rather than the cure for manufacturers," he added.
A sub-index on input prices fell to 30.8 from 39.2 in November. The survey also showed that a drop in output prices in December was the most marked for five years.
The slump in costs chimed with other recent data showing price pressures have eased in the euro zone, where inflation plunged by 1.1 percentage points to 2.1 percent in November.
European Central Bank policymakers have said there is still room for the bank to cut interest rates, though some have talked down major cuts. Last month, the ECB slashed its main interest rate by 75 basis points to a 2-1/2 year low of 2.50 percent.
Anecdotal evidence from the PMI survey suggested that a rapid contraction of demand in the auto sector was a key factor leading to lower workloads in December, Markit said.
In November, German carmaker BMW reported a 25.4-percent drop in group vehicle sales, and rival Mercedes-Benz said sales at its cars division fell 25.2 percent.
Reflecting weaker demand, a PMI output sub-index fell to its lowest level since the series was first compiled in April 1996.


December data highlighted another dismal month for French manufacturers, as the economic climate worsened further and led to steep reductions in output and new orders. The headline Purchasing Managers’ Index (PMI) – a seasonally adjusted index designed to measure the performance of the manufacturing economy – dropped to a new series low of 34.9, from 37.3 in November and lower than the earlier flash estimate of 35.9.

Bleak conditions in the manufacturing sector reflected the ongoing slump in demand, as customers cut back on discretionary spending amid a sharp downturn in the economy and associated heightened uncertainty. The result was a further rapid contraction of new orders, with the rate of decline accelerating to a fresh survey record. While panelists reported that demand from the domestic market remained depressed, export sales were also down considerably in line with the weakening global trade environment.

Markedly lower new work led French manufacturers to lower production for a seventh consecutive month in December. Furthermore, the pace of contraction was the fastest in the series history. Nevertheless, the fall in output was insufficient to prevent a series record fall in backlogs of work. Efforts to reduce spare capacity led firms to make further cutbacks to employment in December. The latest drop in staffing levels was the eighth in successive months and the strongest registered by the survey to date.

Stocks of finished goods declined for a second straight month in December, albeit only marginally. Anecdotal evidence suggested that many firms had implemented destocking policies in line with forecasts for lower demand, although their attempts to do so were often hampered by weaker-than-expected sales.

French manufacturers also reported a fall in stocks of inputs, as they adjusted inventory levels in line with diminished expectations for future output. The latest reduction in pre-production stocks was the fifth in consecutive months and the sharpest since the inception of the survey in April 1998.

Purchasing activity was lowered substantially, alleviating pressure on suppliers and contributing to a further improvement in lead times.

Deflationary pressures were signaled on both the input and output price measures for the second month running in December. Average input costs decreased at the fastest rate since February 2002, with panelists highlighting the impact of lower prices for raw materials such as oil and metals. Meanwhile, weak demand and competitive pressures were cited as key factors underlying a solid decline in factory gate prices.

Commenting on the Markit/CDAF France Manufacturing PMI final data, Jack Kennedy, economist at Markit, said: “The French manufacturing sector ended the year in tailspin as demand continued to rapidly contract. The sharp downward trajectory in all key variables, allied to clear deflation of costs and output prices, points the way to further ECB policy rate easing.”