The World: Europe’s Slide Accelerating

What a contrast.

The federal government plans to carve billions of dollars from spending in next week's mid year review to achieve a budget surplus in 2012-13 financial year.

But as it prepares to cut, the rest of the world is slowing amid growing signs of a credit freeze that is spreading to Germany, the key economy in the survival of the eurozone and the euro.

This week it has become very clear that things around the world have taken a turn for the worse, except in Australia.

Europe is tumbling towards recession nd credit freeze, while China is slowing, with rising levels of worker unhappiness and strikes.

Germany now seems to be joining other eurozone countries in finding it harder to raise money from the markets and growth in the US economy has been chopped back, even though the signs there are more upbeat than in just about any other major economy.

The most worrying development was the failure of Germany to sell all of a 6 billion euro auction of 10 year bonds this week.

It attracted bids for just over half of that from the market, forcing the Bundesbank (the German central bank) to take up the 39% of the offering that was unsold.

That shocked markets across Europe and the US and sent shares lower, as well as commodities like gold, oil and copper.

Some in the markets attempted to explain the failure away in terms of technicalities, such as an unattractive bond maturity.

But the hard heads said that Germany had now joined the rest of the eurozone in finding it tougher (or impossible in the case of Greece, Ireland etc) to rise money from the markets.

The European debt crisis escalated after a failed German government-bond auction indicated that investors are now demanding higher risk compensation even at the heart of the currency bloc's debt market, according to a quote in the London Telegraph from Robert Brusca, chief economist at FAO Economics.

It was the biggest bond auction failure seen in Germany since the start of the euro almost 12 years ago.

Ewald Nowotny, a European Central Bank policymaker and head of Austria's central bank, was quoted by the Austria Press Agency as saying the German bond sale was an "alarm signal".

Yields on German 10 year bonds, the bellwether security for all of Europe, jumped a nasty 0.20% after the failure to close at 2.08%, still well under the 7% plus on Italian 10 year debt overnight, but a reminder that the most credit worthy economy in Europe is now under increasing suspicion.

Italian debt remained above 7% and Portugal's credit rating was cut to junk by the Fitch ratings group.

Germany now joins the rest of the eurozone in facing higher yields at a time when the various economies are on the brink of recession, after growing slightly in the third quarter.

Almost unnoticed in this was the collapse of a small Spanish savings bank based in Valencia which was taken over the Bank of Spain.

The early loss was put at more than half a billion euros, but reports said the final cost will be double this or more as the bank has thousands of non-performing property loans.

The failure underlined the big continuing headache for Spain's new conservative government: the country's weak domestic savings banks and their billions of dud property loans and deals that will need recapitalising.

Figures out overnight Wednesday showed that industrial orders in the eurozone suffered the biggest single month fall since December 2008, when it and much of the rest of the world was slumping into recession.

New orders plunged by 6.4% in September from August, according to Eurostat, the European Union's statistical office.

It was the biggest month-on-month fall since December 2008, when the global economy was reeling from the collapse of Lehman Brothers investment bank. Then, orders dropped by 10.2%.

Leading the way was Italy where orders fell a terrible 9.2% between August and September.

But France and Spain saw drops of 6.2% and 5.3% respectively, and Germany saw a 4.4% fall as well.

That will translate to lower output and sales in coming months, meaning a fall in the level of activity.

The eurozone purchasing managers' indices for November, also published overnight Wednesday, indicated overall economic activity continues to contract at a significant pace for a third successive month.

The "composite" index, covering manufacturing and services, rose from 46.5 in October to 47.2. - indicating the rate of contraction has steadied for the time being under the 50 level, which divides an expansion in activity from a contraction.

And the Institute of International Finance, the global bankers group, said in their November update:

"The situation in the Euro Area has taken a serious turn for the worse in the past month.

"The economy has tipped into what we believe to be a recession, which will only serve to widen budget deficits and weaken bank asset quality further.

"Policy makers are floundering to deal with this situation, amid very challenging economic and political constraints.

"The rest of the world looks on anxiously.

"Managing the global fallout from abrupt shrinkage in European bank balance sheets will be critical if an untimely re-tightening in global credit conditions is to be avoided."

Fitch Ratings warned that France's triple-A credit rating would be at risk if a further intensification of the euro-zone crisis resulted in a much sharper economic downturn and a material increase in the risk of contingent liabilities.

The ratings company said that additional austerity measures are likely to be necessary for France to achieve its 3% of gross domestic product deficit target by 2013, with Fitch projecting the deficit in 2013 to be around 4% of GDP.

On the positive side, Fitch said that France's triple-A status is "underpinned by a high-value added and diverse economy, broad and stable tax base and its commitment to deficit reduction and stabilising, and eventually reducing, public debt.

News of the fall in eurozone industrial orders came hours after the shock from China with the first reading of the November survey of the country's manufacturing showed a sharp fall to 48 from 51 in October.

It was a move that rattled confidence, with the Financial Times reporting on strikes by around 100,000 workers in factories in the south of the country over pay cuts caused by falling export orders.

It's not that China isn't growing, it is and a 48 reading on the survey gives industrial production at an annual rate of 11% to 12%, according to HSBC economists, and annual growth of 8 to 9%.

But what worried markets was the sharpness of the fall, and then the news of the growing labour unrest in Guandong and other southern industrial areas.

In the US third quarter growth was cut back to an annual 2% (0.5% quarter on quarter) from the first estimate of 2.5%, with weak inventories and imports the biggest reason for the fall.

That would normally be bullish for the US because those depleted inventories would have to be rebuilt in coming months, meaning higher output.

But with Thanksgiving tonight, the start of the huge pre-Christmas retailing surge, analysts say only a spending spree by US consumers will lift output in the first quarter of next year.

But 14 million of those consumers don't have jobs, more than 46 million others are on food stamps and a further 46 million are in poverty.

In Australia, the mid-year budget review will see the mooted spending cuts to make up for the weak growth in tax revenues, especially company taxes.

And, like China, Australia isn't slowing; in fact some economists say we could see third quarter growth of 1% to 1.2% when the data is released in a fortnight's time.

That would put growth at 4% annual, most of it coming from the resources boom of course, but that money is being spread through the wider economy.

On Wednesday we had confirmation of the extent of the boom with a shock surge in the value of construction work done in the quarter with a 12% rise in the three months to $47.5 billion, or six times the market estimate.

That included a 22.6% surge in engineering work to just over $28 billion, 49% up on the third quarter of 2010.

The figures also showed a 1.1% fall in residential construction to $11.4 billion in the quarter, down 3.5% from a year before.

That led some analysts to moan about the two speed economy, but they also know that if we had a booming home building industry and the sort of growth in engineering and construction reported yesterday, then we would have high inflation and much higher interest rates.

The Reserve Bank increased interest rates a year ago to try and get that sort of trade-off between housing and commercial construction, and the gathering pace of construction activity in the resources sector, especially iron ore, LNG in WA, coal seam gas and LNG in Queensland and the coal industry in NSW and Qld.

That we have been able to accommodate the explosion in construction and engineering and see inflation fall in the September quarter, tells us that the Australian economy is better placed than all the moaners and rent seekers concede.

For all the complaints from retailers and property and tourism (David Jones reported an 11.2% plunge in first quarter sales yesterday and forecast a profit fall of up to 20%), the economy must be well balanced to have coped with the explosion in activity in resources in the past year and not trigger the usual Australian inflationary surge which destroys all the gains.

A worsening in Europe will see more rate cuts from the Reserve Bank.

Our ten year bond yields are now around 3.87% and just above the early January, 2009 low of 3.85%.

With the cash rate at 4.50%, speculation is rising the RBA will cut rates regardless next month.

But much of the fall in yields is being driven by rising demand for our limited stock of bonds from big investors here and offshore.

Australia is perceived to be a good credit risk and the bonds are AAA rated, unlike the US.

The dollar's fall to around 97 US cents won't impact that thinking, because the market knows that once fear eases, the dollar will jump back past parity with the greenback.

But that will happen only if the eurozone crisis eases and shows signs of being tackled in a meaningful way by the Europeans.