Italy’s comeback, Germany’s industrial decline, major central bank shenanigans & China’s massive new stimulus bazooka.
These are, in my opinion, the most important economic stories that we need to talk about in this economic update.
So, let’s dive into our first story right away, which is about
Italy’s comeback
Which sounds a bit strange, right? Isn’t Italy’s economy supposed to be a basket case?
Yes. Actually this comeback story came about due to a recent data revision in which Italy’s 2023 growth was downgraded. But, it’s 2022 and 2021 growth were both better than previously thought. Therefore, overall, Italy’s economy has now has officially achieved the incredible feat of … rising above it’s 2007 peak. So, essentially, it took Italy 16 years to achieve what France did in 4, and the UK did in 6 years.
Still, this economic ‘comeback’ through a data revision is very important news for Italy because it makes it’s gigantic government debt appear smaller, in relation to GDP, at least.
But, why did Italy perform so badly? And, does this mean that there is now renewed hope for the future?
Well, regarding its terrible performance up to now, I argued in myprevious analysis of Italy’s economy that it was likely a combination of poor productivity caused by Italy’s inefficiently small firms missing the IT revolution and chronic underinvestment, especially in education, which was partially caused by overly harsh austerity measures introduced in response to the Euro crisis of 2011.
That being said, Italy’s economy did actually do relatively well in the last couple of years. Something that can, according to Italy’s statistical office, largely be explained by a massive investment boom due to a insanely generous tax credit on home renovations, where the government would essentially pay people to renovate their homes. This boom is unlikely to last, meaning that I expect to soon again cover stories about Italy’s weak economic performance, given that the country is still underinvesting, and its population continues to age rapidly.
But, in a plot twist few would have seen coming a couple of years ago, that would mean that Italy is in the good company of
Germany, which is facing broad based industrial decline
Indeed, as you can see here, while the growth of Germany’s industrial production has seen some wild swings around Covid, it now seems to have entered a period of steady decline.
This is very worrying because Germany is Europe’s biggest producer by far, and its weak performance is dragging down the Eurozone’s overall production, by quite a lot.
So, why is Germany doing particularly badly?
Well, the obvious answer is that it’s industry was uniquely benefiting from cheap Russian energy, and therefore is now suffering more. A second convincing explanation is that Germany is now being hit hard by a China shock, with Chinese demand for its cars and machines plummeting. At the same time, new Chinese competitors now challenge Germany’s champions with competitive offerings in markets like South-East Asia and Latin America. As a consequence, German exports are now far more reliant on the United States, which largely shut its market to the Chinese.
But, luckily for Germany, the Fed has recently started cutting rates, which may increase US demand, while China announced massive stimulus as well, which may increase Chinese demand.
Which coincidentally is what the next two stories are about. So, let’s first get into
What the big central banks have been up to in September
In short, the ECB and Fed started cutting rates, while the Ba[nk of En](https://www.euronews.com/business/2024/09/19/bank-of-england-reveals-september-interest-rate-decision#:~:text=The%20Bank%20of%20England%20(BoE,a%2025%20basis%20point%20reduction.)gland and Bank of Japan kept them steady. Most of this was expected. Therefore, unlike with the Bank of Japan’s rate hike in August, central banks did not cause another market panic this month.
On the contrary, the Fed rate cut announced on September 18th was actually a bit larger than expected. So, after this U.S. financial markets jumped quite a bit. More importantly for the world, lower US Dollar interest rates mean that other central banks now have more room to lower their own interest rates, without weakening their currencies too much.
But, why are the Fed and ECB lowering rates while the Banks of Japan and England are more cautious?
Mostly it has to do with inflation and, in the case of the US, employment. You see, the Fed has a so-called dual mandate, meaning that it wants BOTH low inflation AND low unemployment. And, because employment data in the US was weaker than expected, the Fed cut rates by half a percentage point and told the world that it will likely cut rates even more soon.
This means that the ECB now has more breathing room to cut rates even more in the October, if weakness in, for example Germany, persists. On the other hand, because the Yen has weakened so much already, the Bank of Japan felt like it could not lower rates further. But, the Fed lowering their interest rates, did mean that the Bank of Japan could keep its interest rates stable instead of raising them more. Finally, the Bank of England has indicated that it intends to keep cutting rates. But, that it has stopped for a bit given that inflation has remained above target.
Overall, my take-away is that it still looks like the West’s big inflation spike is a thing of the past and that central bankers are now likely to continue lowering rates given that Western economies have slowed down considerably.
However, the nature of that slowdown is nothing like what the People’s Bank of China is facing, where
China just announced a massive stimulus bazooka
with the goal of stabilizing its economy and increasing both property and stock prices. So far, the announced package consisted of 5 key parts. First, the Chinese central bank lowered its interest rate from 1.7% to 1.5% and the reserve requirements, which is amount of capital banks need to hold at the central bank, by 7.5% to 7%. Next, to raise stock prices, the Chinese announced a new billion dollar fund that will provide loans to companies to buy stocks. Fourthly, to boost home prices, China’s central bankers announced that they will lower the down payment needed to secure a mortgage on a second home from 25% to 15%, while also making it easier for local governments to sell unsold homes. Finally, the Chinese government announced that it will soon start spending more to stimulate the economy itself.
This new move is extremely relevant for the state of the global economy as a whole because many economists see China’s gigantic exports mainly as a consequence of low demand in China itself. In turn, China’s export surplus was slowly leading to a trade war. So, if China can genuinely stimulate its economy, it could seriously lower global tensions.
But, will this stimulus bazooka work?
Well, unless the fiscal stimulus will be big, I doubt it. Sure, these current measures have already helped to boost asset prices, as immediately after their announcement stocks in China, Hong-Kong and even Europe posted significant gains. However, for me this really reminded me of the stimulus done in both the West and Japan after their respective property bubbles popped. Here research has since shown that central bank stimulus like this largely leads to asset price inflation, which may help some people struggling with debt, but at the same time does not address the fundamental underlying problems that led to the bubble in the first place.
Therefore, China’s new stimulus measures should be seen as part of a broader effort to reshape its future. But understanding the full picture requires deeper insight. Insights that only a publication like The Economist can offer thanks to their in depth coverage of China. For example, their recent article, ‘Anger abounds as China raises its strikingly low retirement age,’ dives into the societal challenges behind its recent move to raise the retirement age, while the article “The Chinese authorities are concealing the state of the economy.” exposes how China increasingly manipulates its economic data.
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