The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, decreased from a slightly positive reading of 3.2 in July to -30.7 in August. The index is now at its lowest level since March 2009 (see Chart). The demand for manufactured goods, as measured by the current new orders index, paralleled the decline in the general activity index, falling 27 points. The current shipments index fell 18 points and recorded its first negative reading since September of last year. Suggesting weakening activity, indexes for inventories, unfilled orders, and delivery times were all in negative territory this month.

Firms’ responses suggest a deterioration in the labor market compared with July. The current employment index fell 14 points, recording its first negative reading in 12 months. About 18 percent of the firms reported an increase in employment, but 23 percent reported a decrease. The percentage of firms reporting a shorter workweek (28 percent) was greater than the percentage reporting a longer one (14 percent). The workweek index fell 9 points.

We cut our global GDP growth forecasts to 3.9% in 2011 and 3.8% in 2012, from 4.2% and 4.5%, respectively. DM growth looks set to average only 1.5% this year and next (down from 1.9% and 2.4% previously), making the BBB recovery even more bumpy, below-par and brittle.

EM isn’t immune, but generates 80% of global growth: We now see EM growth decelerating from 7.8% in 2010 to 6.4% (6.6% previously) this year, and further to 6.1% (6.7%) in 2012. Given its 50% (PPP) weight in global GDP, EM generates 80% of global GDP growth. EM policy-makers are likely to cushion domestic growth, but drastic policy stimulus remains unlikely.

A policy-induced slowdown: The main reasons for our growth downgrade, apart from disappointing incoming data, are recent policy errors in the US and Europe plus the prospect of further fiscal tightening there in 2012. This is eroding business and consumer confidence and has weighed down on financial markets. A negative feedback loop between weak growth and soggy asset markets now appears to be in the making.

Dangerously close to recession, but not our base case: Our revised forecasts show the US and the euro area hovering dangerously close to a recession – defined as two consecutive quarters of contraction – over the next 6-12 months. It won’t take much in the form of additional shocks to tip the balance. Still, recession is not our base case because: i) the corporate sector looks healthy; ii) household real incomes will be supported by lower headline inflation; and iii) we expect more action from central banks, including rate cuts and more non-standard easing from the Fed and the ECB.

Why this is not 2008: Initial conditions are better now – household, corporate and bank balance sheets were much weaker, monetary policy was tight, and the Lehman collapse meant that the financial system totally seized up. Any plausible recession scenario in 2011-12 should be much shallower than in 2008-09.

The latest Fed data “could be telltale signs that foreign banks are in need [of dollars] again, or institutional investors are getting concerned about foreign bank credit,” said George Goncalves, a rates strategist for Nomura Securities.

Existing home sales also remain weak according to the latest set of data. July existing home sales unexpectedly fell 3.5%MoM to 4.67m (saar), from an upwardly revised 4.84m in June. This was a surprise: Pending sales, recorded earlier in the purchase process, increased in May and June. This suggested a recovery of existing home sales. The fact that sales fell nonetheless, points to an increasing number of delays and contract cancellations. Mortgage lenders are taking their time and have become more strict. Some deals strand on low appraisals. It is telling that half of the buyers in July paid fully in cash.

Foreclosure activity has also slowed down considerably in recent months. Foreclosures accounted for a quarter of sales in the first months of the year, but are down to 17% of sales in July. At first glance this seems good news: fewer foreclosures mean less downward price pressure. But unfortunately foreclosures are not decreasing because the supply of distressed homes is running out. Instead, foreclosures are stalling because of delays and legal issues in the foreclosure process. Once mortgage lenders have their processes sorted out and legal disputes are settled, foreclosure activity will pick up again. While prices are stabilising now, they may well resume their fall once that happens.

Despite all this bad news, it is some comfort to see that the Conference Board leading indicators continue to point to growth ahead. So things may be bad in some sectors, and in some regions, but the longer term outlook for the whole economy seems to be holding together a little better.

Clearly, markets are in a fearful state right now, and data like this gives them plenty of excuses to panic. Market reactions are less about the data now, than about the degree of panic.

Rob Carnell
Teunis Brosens

Disconcertingly High Level. Unemployment expectations rose sharply to 46% in August from 31% in July. The August level has been sighted before and during each of the past five recessions since 1980. But there have been false signals at the 46% mark. So further deterioration from this point would be more worrisome for the outlook (and vice versa).

Rising Disconcertingly Fast. The 24 percentage point spike in unemployment expectations over the last three months is the fourth largest on record. Three-month gains of 20 points or more happened five other times – Aug 1979, May 1980, Dec 1981, Oct 1990, Feb 2001 – all preceding or during past recessions.

Jobless Claims on Watch. During those five past episodes, claims rose an average 8% in the same month. And in all but one of the past five occurrences (May 1980), claims were an average 10% higher four months later.

His first attempt to control the problem was to introduce a superior currency unit, one made up of much better quality metal. The hope was this would restore faith in the coinage and allow prices to stabilise.

It didn’t work — largely because the new coinage was introduced alongside the inferior one. Not only did it create a liquidity preference for the superior quality coinage, it also added to the money supply.

Diocletian’s second attempt was hardly more succesful. Faced with skyrocketing prices — which debased his soldiers earnings by the day — Diocletian decided to introduce a maximum price edict, punishable by death. (His top priority was, after all, always the trusted faith of his soldiers. If their salaries couldn’t pay for their needs, a mutiny could be at hand — a major risk for any emperor.)

Unfortunately, the edict did little to curb hyper-inflation or the capital destruction that came with it. The empire was too large and resources too low to police the price-lists effectively. The edict was mostly ignored (unless Diocletian himself happened to be in town) and in extreme situations the sword quickly became mightier than the coinage.

Having given up all hope on the currency itself, Diocletian still had the problem of paying his soldiers. To resolve this he developed a system of relative values (or barters), a move which called for an exhuastive cataloguing of the empire’s wealth, labour and land values.

While it arguably started out as a move to quell his soldier’s salary frustrations, it had the lucky side-effect of also restoring some semblance of order back to the Empire’s market prices.

The idea was simple. You started off with one day’s work as a soldier as your base. This entitled you to x amount of bread, x amount of clothing, x amount of wine (et cetera).

One day’s work of a soldier, meanwhile, was equal to two days’ work of an agircultural worker. Three days’ work of a soldier was equal to one day’s work of a lawyer, and so on. (NB – those relative values are hypothetical for the point of illustration only.)

Alongside that everyone’s work featured a taxable capacity too. This was described in terms of the caput. As a homogenous value unit this became a means of exchange in its own right too.

http://www.dallasfed.org/news/speeches/fisher/2011/fs110817.cfm

Fisher’s hawkishness on inflation remains controversial (reasonable people can disagree in this area).

But he is the pre-eminent thinker in the Federal Reserve System who combines theoretical understanding with practical insight (a plaudit he shares on the supervision side with Thomas Hoenig at the Kansas City Fed).

Section 2 of the speech on the reasons for his dissenting vote, and the corrosive role of uncertainty in undermining economic growth, is well worth reading.

Fisher has beaten me to a column on the subject. The uncertainty problem goes quite a bit further than just the issue of the federal budget or regulatory policy. Other corrosive sources of uncertainty cover climate change policy, soaring raw materials costs, questions about the rise of Asia and the decline of the OECD economies, and monetary policy itself.

Conduct a thought experiment. When did you last hear a senior policymaker in North America/Western Europe give an unambiguously positive speech about the outlook for the economy/environment/living standards?

There have been plenty of Churchillian warnings blood sweat and tears ahead, tough adjustments etc. But the end goal is never terribly bright.

Bernanke, Mervyn King and the rest never actually sound optimistic.

Without confidence, uncertainty becomes paralysing. In that respect, President Franklin Roosevelt was right about there being nothing to be afraid of but fear itself.

No amount of monetary and fiscal prestidigitation can offset the confidence deficit. Endlessly twiddling the fiscal and monetary knobs actually becomes a source of uncertainty itself as households worry about inflation, deflation, growth and jobs, all at the same time.

In the medium to long term, only two solutions appear possible: either Europe moves towards much better coordinated economic and fiscal policies, rather than applying ad-hoc measures and financial band aids to manage the crisis, or an eventual restructuring in Italy or Spain becomes increasingly likely. The latter, however, is too risky. This is not a zero-sum game. The costs of restructuring exceed by several orders of magnitude those of increasing economic and fiscal policy coordination, even for Germany. The banking systems of core economies would suffer severe losses that could damage sovereign balance sheets. France and possibly other core countries would be the next target for the market.

We believe an intermediate solution while Europe prepares the steps necessary to flank monetary union with better integrated fiscal and economic policies would help move Spain and Italy away from the bad equilibrium where, on their own, they might be unable to stabilize the reinforcing negative dynamics of spreads and default probabilities.

Our proposal would require a new Euro Area Borrowing Authority (EABA) that would provide credit enhancement to bonds issued by member countries. They could effectively replicate eurobonds (EBs) while EB issuance gets eventual political approval. Crucially, EABA guarantees (and eventually EBs) would be of relevance only for new issuance, as it is the marginal cost of debt that has deteriorated debt dynamics in Italy and Spain. Existing debt would not be guaranteed or swapped into EBs, as it has low average coupons and, thus, does not pose a threat to sustainability. This limits the upfront resources needed for EABA. There would be a ceiling on the flow and stock of EABA guarantees/EBs. Countries with high debt and/or deficit developments would be required to enter a macroeconomic adjustment program with a view to converging to a lower debt ceiling. We believe that programs to bring countries into declining debt-to-GDP paths, including a realistic adjustment path, are likely to be more successful than they have in the past. Debt crises are no longer confined to emerging markets. Europe has suffered first hand the costs of fiscal profligacy, and the related lessons are being learned.

Germany and other core countries have a unique opportunity to use this crisis as leverage to better coordinate economic and fiscal policies and thereby effectively move closer to an economic union. The Franco-German summit on 16 August points in the right direction.