Thursday, December 31, 2009

Economics 31/12/2009: Bond markets

Food for thought: rummaging through backlogged papers, I cam across 3 notes from our heroic stockbrokers' bonds desks singing songs about the right timings for investment in bonds. These trace back to June and October 2009.

So I asked myself the following question: should I have listened to your brokers' advice to buy Irish or US bonds in 2009?

Well, here are two tables giving a breakdown on bond price sensitivities to changes in interest rates. The US table:And the Irish table is here:Now, in darker blue I marked the cells corresponding to the reasonably plausible scenario for yields for 2010. In lighter blue - the next best predictions. So go figures - should you have listened to anyone pushing Irish or US bonds onto you?

Think of the following numbers - I don't have the same for the Irish markets - in the US, cash inflows into bond funds markets amounted to some USD313 billion in 2009, as yields kept on dropping to artificially low levels on the back of the US Fed buying up Federal paper. At the same time, as stock markets rallied, just USD2 billion net was added to stocks funds. (Numbers are to November 1, 2009). Some has been fooled.

So a Happy New Year for all and best wishes for the new decade!

My next post will be already in 2010 and will show comparative performance for Irish banking sector relative to other EU states - the latest data - for 2008.

Tuesday, December 29, 2009

Economics 30/12/2009: Competitiveness - it's a long term thingy

We hear often about the loss of competitiveness in Ireland over time. Can we illustrate it? And if so, what can we learn from it?

Here are the charts. Do keep in mind - higher values reflect lower competitiveness.
In terms of unit labour costs, Ireland has not been competitive relative to its peers within the EU15 since Q2 2004 when we crossed over the Netherlands. I ignore Luxembourg here as it is a statistical aberration. We've managed to lose all competitiveness gains incurred since Q1 1999 by Q1 2003. Majority of our peers have done so only 5 years later. while our competitiveness has deteriorated by a massive 22% since 1999 (and this is reflective of the significant gains in competitiveness over the course of 2008-2009), the average for peer countries was 6.2% and absent Ireland and Lux from the sample the rise was just 3%.

Oh, and by the way - there is no evidence that we were competitive in 1995-1999 either...

Chart above also shows that we have not posted a stellar performance against the latest additions to the Euro area. While Slovakia beats us hands down in terms of decline in competitiveness, remember - these are normalised series, so having started from a much lower cost basis than Ireland in 1999, they have been gaining significantly faster in terms of unit labour costs. Of course, notice that before 1999, Ireland was starting from a higher cost point in 1995 than Slovakia.

Is the cost of labour all there is to competitiveness? Well, no.
Consumer prices draw another comparative. But strangely enough, the picture is virtually identical. Except, here pre-1999, more specifically in 1993-1995 - we were performing really pretty well. Having gone off the rails slightly during the mad days of the IT bubble - end of 1996- end of 1998, we then again performed rather well in terms of CPI until things gone out of control for us in the end of 2002.

And just for completeness - a chart on the new entries into the Euro zone:
So what can we really learn from these four charts?
  1. Ireland's loss of competitiveness is dramatic and at this stage, seemingly irreversible;
  2. Ireland's loss of competitiveness is concentrated in the labour costs/productivity area where deterioration in competitiveness was much more pronounced compared to the Euro area average than in the CPI component;
  3. Ireland's loss of competitiveness is not a new phenomena - it has been accelerating since around 2002 and it was firmly in sight of our policymakers at the time;
  4. Ireland's loss of competitiveness is a long-term problem and requires long-term solutions - not a one-off cut in wages.

On a different train of thought: an interesting idea that can be explored in 2010. Can we use the proceeds from our carbon tax to supply a long-term economic stimulus to the private sector economy? Here is a thought going in the right direction.

Carbon tax in theory should be behavior-altering, so as consumers and producers reduce their emissions, the tax revenue should decline. To incentivise such behavior, carbon tax induces higher costs on energy use from non-renewable resources. But the revenue raised from the tax can be used to further enhance the incentives - if it is rebated back on the basis of lower emissions. This can also be done within a Cap-and-Trade system.

In the case of Ireland, such a system would involve the following:
  • Using revenue from carbon tax to provide direct income tax credits to households proportional to their annual per-capita heating, electricity and gas bills shortfall on the average. Having put into place a system for capturing data on such transactions, a rebate allowance can be estimated for each household at the end the year and this can be credited against the annual income tax.
  • The system will provide net subsidy to those who use less CO2 emitting resources.
The main advantage of the system is that it will allow to offset some of the regressive effects of the carbon tax:
  • Younger households with children can obtain a rebate that is reflective of the larger size of the household;
  • One-off housing and remotely located households will benefit from all and any renewable energy production they can generate on their properties;
  • Urban households - who actually do have an option of altering their behavior significantly - will be rewarded for doing so - incentivising more growth in the higher value-adding urban economies;
  • Businesses will also be allowed to obtain a rebate, implying lower cost for doing business and investing in new technologies precisely for companies in the more productive services exports and modern manufacturing sectors.
Best of all - the Exchequer will not get to treat carbon tax as just another regressive tax revenue raising measures that will simply increase the cost of living and working in Ireland. Of course, those not in the tax net should also receive the deductions, implying that some of them will become net earners from the tax system. As long as they are not enjoying lower cost of overall energy-related expenditure courtesy of state subsidies.

Economics 29/12/2009: Looking back at 2009

For those of you who missed my article in the Sunday Times last weekend (December 27, 2009) here is, per usual, an unedited version of the text.

By all possible measures 2009 will go down as yet another annus horribilis
in the history of Ireland. Some 29 months since the inception of the crisis there is hardly any sight of the end of our depression – the worst on the record that any Euro area state has endured in modern history.

In 2008-2009 Irish economy has lost a compound 9.6% of GDP and a whooping 13.2% of our GNP. Over the same period of time, Eurozone economy has contracted by the total of 3.3%.

Based on Department of Finance latest projections, by the end of 2010, our gross domestic output will fall 10.8% and GNP will have declined by 14.7%, against the European Commission forecast for the Euro area income contracting by 2.65% on 2007 levels

Put into perspective, assuming the current crisis runs its course as projected by analysts, the US will regain the 2007 levels of real annual income in late 2010. For Euro area, this moment will arrive in 2012-2013. Ireland is going to return to the 2007 level of prosperity in 2015 in terms of GDP and 2016-2017 in terms of GNP. And this is under optimistic assumptions of relatively robust growth post-2011

These figures only begin to describe the extent of our economy’s collapse in 2009. It is now a common realization amongst the economic forecasters that whatever growth we might achieve in the next few years, unemployment will remain at extremely elevated levels

In Q3 2009 official employment fell 40,200 on Q2 2009. This means that in 12 months to the end of September 2009, Irish economy shed some 183,400 jobs - the highest rate of jobs destruction on the record. In the course of this recession, we have now lost some 236,300 jobs

Back in December 2007, the live register stood at 173,200. A year later, it rose to 293,000, up 119,800 or 69.2% in 12 months period. This December, live register is lingering at 423,400 – an increase of 44.5% on 2008 levels. Sounds like an improvement? Not really. Such is the nature of statistical optics that an 8.8% rise in the number of people on unemployment benefits looks like an improvement in the rate of unemployment growth.

If in the mid 2008 Irish economy had 17th highest unemployment rate in the EU27, by the middle of this year it was the 5th highest

Do the math: the above jobs losses imply that in 2009 some €13.5 billion was lost in employment-related economic activity in Ireland. This translates into an additional €4-5 billion in lost private consumption while our welfare bill rose by some €3.5 billion

All of these jobs losses (save for ca 5,900 jobs eliminated through natural attrition in the public sector excluding health services between the end of 2007 and the end of 2009) came out of the private sector. In terms of the drain on Exchequer revenue these losses simply cannot be offset through wage bill cuts imposed by Budget 2010 onto public sector.

Even more problematic is the trend of falling labour force participation rate which has contracted from 64.2% to 62.5% in a year to Q3 2009. This change is extremely hard to reverse within a given generation. Much of the fall in 2009 has been driven by rising long-term unemployment, pushing people into permanent welfare traps, and net emigration.

In 2009, some 45,000 non-Irish nationals left the country. I would estimate that at least 20,000 Irish natives did the same. On the net, CSO data shows that while unemployment climbed by roughly 120,000 over the last 12 months, the actual fall in employment was 185,000

These people have left their productive employment in this state and moved on to work elsewhere. Many worked in the construction and domestic services sector and had skills beyond their jobs. Many worked in industry – where their skills and future productivity were being enhanced by on-the-job training and through experience. In Q3 2009, industry displaced construction as the leasing source of new unemployment. Quarter on quarter, industry lost 12,200 jobs in Q3 2009 relative to Q2 2009, while construction sector lost 8,700

But scores of those who are now emigrating out of Ireland worked in traded services and here the losses to our productive potential are even greater. 2,300 jobs were lost in professional, scientific and technical activities in Q3 alone. The future of Irish economy is in traded services – the elusive 'knowledge' economy we've been pursuing. This economy requires more people with cultural, linguistic and skills sets that are distinct from our 'national' averages. Given that we cannot hope to retrain lower skilled workers to take up jobs in professional services exports, the loss of junior non-national staff in finance, professional services and ICT is doing irreparable damage to our international competitiveness.

The good news, of course, is that we are now starting to see some re-hiring in financial services (600 net jobs created in Q3 2009 relative to Q2 2009) and MNCs-supported employment remains strong. The bad news is that serious layoffs are yet to materialize in the state-supported banking.

Lastly, 2009 was another year of banking sector disasters. Irish banks began 2009 teetering on the verge of full blow bankruptcy – with our third largest bank falling into the hands of the state and two largest banks seeing their shareholders’ capital virtually wiped out. The crisis of the early months of 2009 was temporarily resolved by the introduction of Nama, leading to a robust, but short-lived rally in banks shares. The real problems – weak balance sheets, pressured deposits, precipitously collapsing asset valuations, rapidly deteriorating loans performance and dwindling capital reserves – remain unaddressed

Thus, as was predicted by this column in May 2009, the Nama solution turned out to be nothing more than an expensive means for delaying the inevitable. It is by now an accepted consensus that nationalization of the main Irish banks is an inevitable denouement to the saga of misguided banks rescue measures that began with the regulatory Green-Jerseying of the banking sector against the short-sellers in the late 2007, progressing to the wholesale banks guarantee scheme in September 2008, and via nationalization of the Anglo Irish Bank, on to Nama passage in 2009

All along, Irish Government and banking sector have made all efforts to evade and silence critical independent analysis of the causes of the current crisis: inept regulation and enforcement, reckless risk-taking in lending and funding, and wrong-footed solutions advanced by the State. The Irish taxpayers are now facing a bill of tens of billions of Euros, as well as the decade-long prospect of zombie banking, development and property markets and construction sectors – courtesy of Nama

Just as in the end of 2008, only the stock markets are now capable of reflecting the extent of the expected Nama damages back to the economy. AIB shares are now trading some 36% down on their January 2, 2009 levels and 67% down from their 12-months peak. Bank of Ireland shares, having gained 32% on January prices are still down 66% on the 12-months peak

As Winston Churchill said once: “Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen.” One can only wish our policymakers discover the second half of this dictum in the New Year


Per latest CSO data, average weekly earnings in the Public Sector (ex Health) rose by 2.5% in 12 months to September 2009, reaching €969.11 per week. While the lower rate of increase is a welcome sign of some moderation in public sector pay, the numbers reveal a farcical nature of the Government’s efforts to date to control its own expenditure

Weekly earnings for the Regional Bodies rose by 4.6% (from €815.58 to €852.71), the Education Sector by 3.0%, from €944.49 to €973.10. An Garda Síochána weekly earnings excluding overtime decreased slightly by 0.1% from €1,077.55 to €1,076.22 for the same period. Now, compare this record with the rates of increases between September 2005 and September 2009 when average weekly earnings in the Public Sector (excluding Health) rose by 14.2% from €848.94 to €969.11 per week

The same lack of progress on reducing public expenditure is manifested in the numbers employed in the sector. Natural attrition with recruitment bans has produced a decline in Public Sector employment from 369,100 in September 2008 to 360,900 in September 2009. Just 8,200 or 2.22% fewer people worked in the Public Sector in this country despite the nearly total collapse in the Exchequer revenue. In the four years to September 2009, employment in the Public Sector rose by 17,300 to 360,90

If Ireland’s public sector employment pay and numbers were to be benchmarked against the UK levels, it would take some 15-20 years before these rates of ‘moderation’ bear the fruit of reaching parity with our next door neighbors.

Monday, December 28, 2009

Economics 28/12/2009: Few articles worth reading

Few loose ends:

Casey Mulligan's excellent defense of Chicago School is now in print in Berkeley's Economic Press (here) - a must read.

Another interesting read is on Bloomberg (here) - hat tip to Patrick. My personal view - 3-3.5% growth for 2010 is possible for the US. Major risk factors to these figures are -
  1. unemployment - rampant and stubborn;
  2. interest rates reversion upward; and
  3. resets of Alt-A mortgages - peaking in 2010...
Two major plus factors (pushing from 2.75-3% upward to 3.5%) are:
  1. Mortgage defaults continuing - these put families off the track of paying 2-2.5K monthly in mortgage costs for negative equity dwellings and into renting same properties for 1-1.2K per month, generating disposable income increases of up to 1,050 per month (once interest relief is counted); and
  2. The Federales are yet to inject some 50% of the allocated economic stimulus.

Related to Alt-A's and ARMs is another article in Berkeley's Economic Press latest issue of the Economists' Voice (here) - few charts from it tell the story of the rising tide of ARMs hitting the fan:
The above are going strong and are not contributing to the 'disposable income events' I mentioned above. But the next chart shows the problem of defaults in ARMs and Alt-As still being there:
So the charts above show US middle class freeing itself from the shackles of negative equity via foreclosures - and in the process regaining back financial safety and confidence. This is exactly what is missing in Ireland, where a debt jail awaits anyone who dares to default on negative equity home mortgage. While this approach reduces moral hazard, it destroys any chance for a households-led recovery in Ireland.

Economics 28/12/2009: More evidence against Ireland's travel tax


My favorite topic is back... travel figures. RTE reports on industry estimates of 12% fall off in the number of foreign tourists (not visitors) to Ireland (here). More interesting data is courtesy of Ryanair release (these guys really should win a transparency award for publishing the data that some parts of the public sector do not want us - the public - to know).

Dublin Airport’s seat capacity has slumped from 10 to 17 ranked in a league of EU airports this winter. The report, by RDC Aviation, also shows that Dublin Airport has suffered the largest capacity cuts of any of Europe’s 25 largest airports. This slump proves that the Govt’s €10 tourist tax has devastated Irish traffic and tourism in 2009 and disproves the Dept of Transport’s false claims that Dublin Airport’s traffic collapse is “an international phenomenon” (per Ryanair statement).

Notice that table above (reproduced from the RDC raw data) clearly shows that Dublin Airport traffic fall off in 2009 relative to 2007 is also out of line with other leading airports. Table below stresses this point:
Notice airports that outperformed Dublin (in blue above) - all selected on the basis of their traffic similarity with Dublin - localized, regional traffic with smaller share of transit passengers for international connections.

Now, ANOVA for the above: while Dublin numbers changes do belong in the sample for 2008, the same is not true for 2009. This tends to support the argument that changes in Dublin capacity are not consistent with overall deterioration in economic conditions internationally.
So here we have it - another source of evidence to support 'Gurdgiev-Ryanair' conjecture that airport taxes and charges are undermining Irish airlines and travel sectors. Note - the fact that airlines are being hurt is evidenced by the fact that all major airlines present at the Dublin Airport - not only Ryanair, but also Aer Lingus, EasyJet and BMI - have made such a claim to the Government.

Per Kevin's very incisive comment (see in comments section) several points worth addressing:

"First of all you have to consider the timing of the tax, to what extent does it coincide with the fall in numbers."

This is precisely what is addressed in 2007-2008 and 2008-2009 growth rates that I added to the data. Full impact of travel tax took place in 2009. Notice the discrepancy in the rates of decline at Dublin and the differences in the Anova table - they show that 2009 regime was completely different from the 2007 and 2008 regimes.

"Then you need to allow for any other taxes/charges in these other places and their change."

Actually, no - I do not need to do so. If other places had any change in their travel tax rates, there will be an effect on these airports in the first order, and on Dublin airport at the very best in the second order. The first order effect, I would assume, will be simply much larger. Furthermore, several airports on the list have lowered their charges and several governments have repealed their travel tax. I do not control for this precisely to err on the skeptics side. Re-weighting figures by removing from the sample those airports where charges and taxes were reduced in 2009 actually changes the Anova bands by less than 0.2 points, without altering the conclusions.

"And of course you need to control for any other factors that differentially impact on capacity which may or may not be correlated with the variable you are interested in."

True. But what these might be? Macro shocks are suggested. Ok, take the logic here - the figures are bi-lateral capacity. So, if, say, potential Italian tourists to Ireland were less adversely impacted by macro shocks, their propensity to travel to Ireland would be less adversely effected by income shocks. Since Ireland experienced the worst 'macro shocks' of the entire Eurozone, then the differences in macro shocks will act to improve traffic through Dublin Airport.

What other forces can be acting here? Higher airfares? Not really - Dublin offers some of the lowest airfares, net of taxes and charges in the EU15. And it is being compared against other full cost (not low cost) airports. So price effects, again, are acting to strengthen my argument, not to weaken it.

Optimally, an econometric exercise should be carried out, alas, two obstacles prevent this from being performed:
  1. lack of coherent data across various airports; and
  2. lack of time dimension post-tax introduction.
So we can wait for another 10 years to get the data sufficient to test causality (if we do get it - remember - Dublin Airport alongside Tourism Ireland and DofT are actively attempting to suppress public releases of data on tourism flows through Dublin). Or we can just settle for the second best - an Anova.

Finally, as in medicine, economic policy should always err on the side of upholding the principle of inflicting no harm. this means, that absent full analysis of economic feasibility, no tax policy change should take place. Can anyone point me to such analysis in the case of our travel tax?

Economics 28/12/2009: Investment Funds in Ireland & other

Two recent datasets: CB's Investment Funds in Ireland and ECB's Financial Stability Review for December 2009.

Central Bank of Ireland has published new data series on Investment Funds in Ireland in December 2009. The data is reproduced in the table below with my analysis added:
This data, of course, covers IFSC-based funds which dominate (vastly) the entire sample. Overall funds issuance is up robust 16.6% (although activity on transactions side is falling - we cannot tell anything about seasonality here, as the CB just started collecting data). Real estate funds are out of fashion. Clearly so. Mixed funds and hedge funds are relatively flat and judging by the collapse in transactions are still in batten-the-hatches mode. Equity funds are in long-only mode, on a buying spree. Nice sign of renewed confidence in the global markets. Bonds funds are steady rising, albeit not at spectacular rates, which, of course, is a sign on IFSC missing on bonds over-buying activity going on worldwide.

Chart below shows how the market shares evolved over time.

ECB's latest (December 2009) financial stability report throws some interesting comparisons for Ireland. Focusing on the charts: first consider the extent of deleveraging going on in the financial systems:
So the US leads, as per IMF GFSR, with most writedowns in quantity and relative to the system. The UK comes second. Emergent markets are catching up. Japan has much smaller problem, unless yen carry trades unwind dramatically. These are on track to complete writedowns in 2010. But EU states are lagging. Ireland's figures are skewed by IFSC institutions taking serious writedowns. But overall, we still have some distance to travel on domestic banks front.

Next chart shows just how advantageous our low profit margins on the lending side have been in terms of yielding lower burden of debt servicing. This can change very fast in the New Year as retail interest rates are bound to rise. No top-up mortgages here or car loans and personal loans secured against house assets, etc. And also note that these refer to the 2005 benchmark, plus, of course, these are percentages of gross income. Given our households are now faced with some of the highest income taxes in the Euro area, good luck sustaining this low burden into 2010.
And another issue - notice how significant is the rise in burden for lower income households. Guess which households are also facing higher rates of unemployment?
Table above shows the deterioration in house prices in Ireland relative to other countries. We are now 21.1% down on 2007 figures, or at 90.9% of 2005 level of nominal prices. The worst performance of all countries, including such bubble-lovelies as Spain.
And on the commercial real estate side, we are an outlier by all measures (remember, unlike Spain, our total banking sector includes non-domestic banks as well). That is another mountain yet to be scaled in this crisis.

Economics 28/12/2009: Irish Earners - amongst highest taxed

Ireland now has some of the highest tax rates in the developed world, and this tax burden shows one of the highest rates of progressivity when it comes to the state dipping into higher earners incomes. Table below illustrates (source here):
Note how dramatic is the tax burden for higher earners in Ireland.

Now, give it a thought. We want to build a 'knowledge' economy. The main input into such an economy is individual skills of the employees. This high skills-intensity of production in the 'knowledge' economy means paying key employees more than in the 'dumb' traditional economy, where physical capital takes up much larger share of total value added. In other words, 'knowledge' economy must compete globally for human capital. The higher the quality of the talent, the greater is the intensity of competition and thus, the more important are the tax rates charged on such labour. Our tax rates simply are inconsistent with such competitiveness.

Funny thing is that most of our media - especially the Irish Times and RTE - keep on banging about the need for creating a vibrant 'knowledge' economy, while at the same time calling for higher taxes on top earners in the private sector.

Given that both papers have absolutely no real economics analysts on board, this contradiction is not surprising - it takes a real economist, with a wide knowledge of economic theory and empirical analysis, to understand the complex nature of productivity and returns to various forms of capital. Ex-banks folks and ex-political correspondents simply won't do here.

Economics 28/12/2009: Euro area forecast for growth

New Eurocoin is out and signaling improvement of the Euro area economy, albeit at a slowing rate. Inputs first:
Industrial production is tapering off through November - despite some seasonal pressure to rebuild stocks pre-sales season. Ditto for PMIs:
France and Spain continue to worry in the above due to clearly weakening domestic demand, while Italy and Germany are showing signs of advanced orders falling slightly off - future exports might be challenged.

Consumer weaknesses are highlighted below:
Loud and clear!

So forecast is for moderation in Eurocoin rise and thus a slowdown in the increase in growth into Q2 2010. Will Q1 2010 be the strongest bounce of 2010?
Forecast still to the upside in Q1 and Q2 2010, but this depends on Q4 2009 results, which

Saturday, December 26, 2009

Economics 26/12/2009: Interest rates direction - US, Europe and China

One near-certainty that awaits us in 2010 is the return of the higher cost of borrowing. The growth killer pill o higher interest rates will pass into the system before countries like Ireland get to experience growth. And a double-dip, or an extremely prolonged slog at the bottom of a U will be looming for the US and Europe.

Here is how I know: the forces keeping pressures on the policymakers to keep rates low are declining, while the forces that will push rates higher are already in the making.

Two drivers helped to push US and global rates down since 2007. These are the US Fed’s financial crisis busting injections of liquidity and the Chinese desire to keep yuan pegged to the dollar on the way down. The former fuels the liquidity trap in the US, while the latter fuels the circular pump that converts dollar surpluses on trade and investment side into dollar-denominated paper recycling cash back to Uncle Sam.

US drivers

In effect, the Fed has created a massive and unsustainable demand for US Treasuries via:

  • Direct purchase of US bonds (over the last two months this amounted to some 22% of the entire pool of newly minted US debt – some US$65 billion, driving the yield to near zero once again. The Fed bought some US$300bn worth of longer-term Treasuries at the end of October), and
  • Indirect purchases of US debt via primary dealers and via its balance sheet operations (between January 2008 and December 2009 assets on Fed’s balance sheet grew some 142% to a whooping US$2,240 billion, or more than 16.7% of the entire US GDP).

Now, do the maths: over the last two years, the Fed bought into over US$300 billion in Treasuries purchased directly, some US$600 billion more went into indirect purchasing of Treasuries and the balance of roughly US$1,300 billion is sitting in the illiquid and largely non-performing assets such as US$901 billion worth of MBSs. The Fed has US$350 billion more of toxic stuff to buy before reaching its target by the end of Q1 2009. There after, unwinding of liquidity supports will be on order. And this process has already started with the Fed scaling back some 10 asset purchasing programmes.

Aptly, the hosting of the spending party is shifting from the Fed to FedG, or the Federal Government. Per Bloomberg, the amount the Fed and US agencies have lent, spent or guaranteed has fallen 15% to $8.2 trillion between September and mid December, “the lowest in a year”. The FedG spending on infrastructure, tax breaks and other fiscal measures accounts for 52% of the new total, up from 39% in March 2009. So far, the Government spent some US$4,200 billion – or 30% of the US economic output – in 2009. And last week, the US Congress approved a further increase in the Federal debt ceiling – raising it by US$290 billion to US$12,400 billion.

One problem is that this substitution of the Fed with the Federal Government is the sign of the end of the road nearing for massive money creation exercise in the US. While the Fed can print money as long as there is no significant inflation (in the US terms – anything below 4% per annum in the short term will probably be acceptable with current levels of unemployment), the Federales will have to tax their way out of the deficit hole one day. Inflation is a manageable thing, though for now: US consumer prices were up 1.8% yoy in November – well below the 2.6% annual average recorded over the 2000-2009 period.

But the fiscal hole is a formidable one – the US has managed to run 14 consecutive months of budget deficits since December 2007. The only positive on this front is that the Government still holds on to about 50% of the entire stimulus package allocated earlier in 2009 – some US$787 billion in unspent funding. Don’t bank on Democrats-controlled executive and legislature not burning through that in 2010.

Another problem is that reselling the toxic securities pilled up in Fed’s vaults back into the economy will risk draining liquidity out of the system. The Fed might think that’s ok in the short term, since the US banks are now less prone to tap into Fed’s window for liquidity: the Fed stated that since mid-August 2009 there has been no new borrowing at the Term Securities Lending Facility, while Primary Dealer Credit Facility had seen no clients since mid-May 2009. The Asset-Backed Commercial Paper Money Market has been inoperative since May 2009. These programmes, plus the Commercial Paper Funding Facility, the Primary Dealer Credit Facility and other are now set for a phase-out starting with February 2010. And the Fed is set to shorten maturity profile of its primary credit loans from 90 days to 28 days as of January 14, 2010. TALF (Term Asset-Backed Securities Loan Facility) will close on June 1, 2010. More? The Money market Investor Funding Facility (MMIFF) was discontinued on October 30.

China's conundrum

Obviously, the Fed could have swapped these fine ‘assets’ for Treasuries and sold the Treasuries on to the Chinese in a financial scheme that would have allowed it to retain dollar supply intact. Alas, things are much less promising for such a transaction today than they were a couple of years back.

Chart below (from here) shows just how dynamic China’s refusal to buy more into the US assets has been in recent months.
And the next two charts confirm the same,
except the last one is an even scarier thing. It shows that even as the Chinese FX reserves were rising, their willingness to buy US Treasuries has been falling. Might it be the case that China has decided to recycle US dollars earned from the trade surpluses back into the global economy? Buying gold or even Euro?

Why not? The latter two operations offer Chinese a happy trip to a devaluation room – push supply of dollars globally up and the value of the dollar goes down. With it, the value of yuan, improving further Chinese exports competitiveness.

The side benefit to this for China is that their anti-dollar rhetoric backed by gold and euro buying also pushes the country reputation as a ‘counterweight to the US hegemony’. Naive Europeans keen on showing euro’s strengths are loving that not seeing that China has no love for the EU or for the euro, just an addiction to cheap yuan. Europeans are not even at the frontline as observers, obsessed with ‘strong euro = alternative reserve currency’ pipe dream.

This beggar-the-US position pays off for China in so many ways with such handsome returns that I am amazed no one so far has pointed out to the internal consistency of what the Chinese are doing through the concerted efforts of their monetary, exports and diplomatic/political pillars.

One spanner in the wheels is that the Chinese trade surplus vis-à-vis the US and Europe is now shrinking, and shrinking rapidly. According to China's General Administration of Customs, country exports in 10 months to November 1, 2009 dropped by 20.5% yoy and 14.8% vis-à-vis the US. Its terms of trade (the export price relative to imports) have fallen over 5%. China’s exports to the EU have fallen even faster – down 18.7% in value in the first 10 months of 2009, opening up a gap in its euro earnings relative to dollars.

This gap implies that any rebalancing of the FX reserves into euros away from the dollar will require direct purchases of euros and selling of dollar reserves. Now, China holds some US$2,270 billion worth of FX reserves – some 33% of this in US dollars, marking a 19% rise in the proportion of FX reserves allocated to dollars within the last 12 months. And China holds some US$791 billion worth of US Treasuries.

So this is another marker suggesting the reduction of China’s appetite for dollar-denominated assets going forward.

As US-China trade deficit shrinks from US$268 billion in 2008 to US$188.5 billion in 2009 China will have four powerful reasons not to buy much more of US Treasuries:

  • Falling supply of dollars and even faster falling supply of euros;
  • Falling appetite for Treasuries;
  • Falling returns to both dollars and Treasuries, and
  • Rising demand for gold and euro, both requiring sales of dollar-denominated assets and cash.

Summing it up

With record deficit in works for 2010, the supply of Treasuries is bound to go up – some US$1,300 billion will be pumped into the global markets next year alone, plus some US$2,000 maturing will have to be rolled over.

Meanwhile, the demand from the Fed is gone almost completely and the demand from China is dramatically cut back, if not turned negative. Last week, Morgan Stanley boys estimated that by June 2010, potential excess supply of newly minted Treasuries over demand will be US$598 billion or 33% of the new issuance for the year.

Prices are likely to collapse and yields to rise. The US has no other option, but to push yields even higher in order to rid itself of the surplus Treasuries. Overshooting of the rates will follow.

Now, considering the amount of paper already issued during the crisis, we are looking at a bond prices cycle of some 20-30 years (traditional cycle is 18-26 years). In other words, the era of low rates is now over. Firmly.

While back in the Euroland, elves and fairies are…

Oh, well, inhabiting the imaginary universe where the Grand Plan for world monetary domination requires strong euro (even if at the expense of dead exporters) boys in Frankfurt are happy with the dollar and sterling slide. To them, the game is about turning the euro into a worldwide reserve currency – the stuff held by everyone, from grey and black economy’s ‘entrepreneurs’ (why else would a monetary union with anemic income growth need a 1,000 euro note for?) to legitimate sovereigns. This requires stability of value and, as a side-effect, low inflation. It also requires systemic undermining of European exports competitiveness and, as a side effect, higher unemployment.

In the land of elves and fairies, even with a prospect of continued weaknesses in the financial system still looming over the euro area banks (which have so far failed to pass the 50% mark of expected writedowns), the ECB is already on the tightening path. Earlier this month the ECB raised long-term cost of borrowing under its 12-month lending programme and told the markets it will cease lending under this maturity at the end of Q1 2010.

These measures will have a double whammy effect on euro area interest rates – first, pushing the rates directly by forcing the banks back into the direct interbank lending markets, and second – by forcing the banks to rely on milking their borrowers through higher rates and fees and charges to raise funds to repair their balancesheets.

The global changes – particularly those discussed above – will aid the ECB intentions. As the US raises rates, the euro is bound to ease off relative to the US dollar, opening up some more room for interest rates rising in the euro area. As China switches into buying euro to displace its dollar holdings, and cuts purchases of the US Treasuries, euro will be pushed up in value against other currencies, leading to a deterioration in the EU trade balance. Higher rates will help here too, offsetting falling trade surplus with rising capital account position.

In other words, the ECB is an accidental co-traveler on the road to the higher interest rates. A New Brave World that awaits us in the near future is likely to be the one with high, very high cost of capital.

Friday, December 25, 2009

Economics 26/12/2009: Green differences - EU vs US

An interesting piece of research came across my desk recently from Quant Express (can't find any links to this) which sites nVision Research data on attitudes to environment. The most interesting aspects of it, from my point of view, is the slightly psychotic nature of analysis which first accuses Americans of being environmentally backward relative to Europeans, then shows that they are actually environmentally ahead of the average EU27 and within the top performers in the EU15... Enjoy...

Chart above is claimed to represent just how far behind American consumers are from their more environmentally conscious European counterparts. But here is an interesting thingy - do these answers actually support such a conclusion?

Take question 1: Companies should be penalized for failing to care for the environment. Since no conditioning references are given to the legal nature of such a failure, one can assume two possible meanings - (A) "Companies should be penalized for failing to care for the environment over and above the confines of the law" and (B) "Companies should be penalized for failing to care for the environment within confines of what is allowed by law".

In case (A), the question asks whether companies should be penalized for carrying out legally permissible actions, in case (B) for carrying out legally prohibited actions.

If you live in a society with well-protected legal rights and directly accountable judiciary, you would be more likely to lend no support to case (A) while case (B) will be trivially true. If you live in a society where that which is not prohibited explicitly is permissible, as the US, you would say No.

In EU, where judiciary is far less directly accountable and laws are often more arbitrarily and less transparently imposed and politically intertwined with ethics and even aesthetics, a person would more likely to assume that the question refers to case (B), which supports an answer 'Yes'.

How great is the margin of difference between two? Is it enough to erase most of the difference shown so 'conclusively' in the graph? I don't know.

Take question 3 which also links up to question 6. If air travel is a more accepted mode of transport
  • within a given geography (which, of course, is a function of geophysics - more conducive to supporting air travel over larger territories, like the US than over more compact and less internally mobile regions, such as Europe)
  • as well as cultures (with the marginal value of time higher in the US than in Europe), and
  • demographics (younger countries are more mobile),
both questions will warrant fewer 'Yes' votes. Has this anything to do with environmental attitudes? Or has it more to do with balancing out the cost to the environment with the cost to quality of life? Is it a decision on the margin or a decision on the absolute?

Why does air travel warranted two out of six questions in the entire set? Because it contributes more CO2s than other? No, airlines account for roughly 2-3% of the total global CO2 emissions. And this combines domestic air travel and international air travel. And yet they managed to get 33% of the entire questionnaire.

The key here is the idea of the airlines as being a perfect target for a tax. The logic here is to charge passengers to change their behaviour.

There is problem however, with the question as it assumes that higher taxes mean lower emissions. This might be what passes for prohibitions-based economics in Europe and the UK, but it might not be consistent with what Americans might think about positive and negative incentives.

Americans generally think of going for the Big Return measures/investments first, and only later for the marginal measures. Hence, the lack of support for Kyoto in the US, given that it excludes some of the world's largest polluters - like China. Europeans always prefer going for the 'cute' policies - the Alessi Environmentalism of cute and loud NGO-supported and advanced-marketing measures.

And Americans might be right in their approach. Switching, say, 20% of China's electricity production into nuclear might actually do more good to the environment than banning all air travel outright. Americans would know this. Europeans (save for the French) would not, as anti-nuclear hysteria of the 1980s has spelled taboo on public debates on nuclear energy in most of Europe throughout the previous two decades. Or switching world coal powered stations to clean coal. Or using advanced capture and sequestration technologies to remove CO2 emissions, or using smart approach to managing existent systems rather than blindly building windmills and setting excessively populist targets. All of these more efficient applications are spearheaded by the US. Not by Europe.

There is another aspect to the questions - as a younger society, America is much more mobile than Europe. And it is the younger generations that hold power in determining mobility-focused legislative initiatives there. In Europe, older generations are immobile and they hold political power. So taxing younger Italians and Frenchmen and Spanish women moving between their jobs and home or to study abroad is kosher for European populace, because life in Europe is about preserving status quo of wealth distribution (old hold all, young hold none, when it comes to capital and income).

How do I know that the above figures are simply bonkers when it comes to assessing the environmental attitudes of Americans relative to Europeans and Britons? Well, the same research group found that:

"From a list of twelve behaviours – including washing clothes at lower temperatures and avoiding products with excess packaging – we have defined a consumer as behaving in a distinctly green manner if they do at least six. Under this definition we find that 43% of Americans are seriously green compared to 53% of Britons and just 29% of Europeans. In fact, the whole environmental trend has held together well over the course of the downturn with slight increases in the propensity to engage in green behaviour in Britain and America and flat
growth in Europe."

So let me run through this quickly - charts above show Europeans to be about as 'green' as the UK, with Americans lagging far behind. The numbers above show this to be untrue. And despite the US consumers changing their behavior most dramatically during the downturn, their propensity to behave green has not diminished.

"Our European figures mask significant regional variation. For example, 59% of Danish consumers qualify as green under our definition compared to just 13% of Hungarians. The
proportion of 43% in the United States means that the popularity of environmental behavior
there is most similar to that found in the Netherlands or France." Ahem, so environmentally lagging Americans are just as good/bad as environmentally sound Netherlands and France?..

And this is more than just words. "If we examine whether or not consumers who say they are environmentally friendly do actually behave in a green way, we see some interesting transnational patterns. The map below shows the proportion of consumers who say they are concerned about what they personally can do to help the environment who also behave in a green way under our definition."
Note: I have no idea as to how they managed to mark Ireland as the best-performing country in the entire sample. I guess they thought our travel tax (and DAA extortionate charges), plus Carbon Tax and VRT - all of which have nothing to do with the environment and everything to do with fueling the Exchequer coffers - mean that we are 'green'...

"As you can see, the British Isles and the Nordic nations lead the way in terms of “practising
what they preach” but the United States is not too far behind. It is most of Central, Eastern
and Southern Europe that really lag behind; in Spain, for example, only 13% of those who
claim to be motivated by eco-concerns actually go beyond this and behave in a measurably
green fashion."

So what's the EU average 'greeness', then? Above the US or below? Given the US is not far behind the leaders within the EU?..

Hmmm... it all started with telling us just how environmentally backward Americans are...

Economics 26/12/2009: Irish banks - twinned by crisis

A picture worth a thousand words:
Let me quickly explain - these are close price correlations (1 month moving) for AIB and Bank of Ireland. I divided the entire time horizon into 4 zones:
  • Zone 1: through December 2004 - the tail end of the pre-credit bubble conditions, when Irish economy still had some residual Celtic Tiger growth in it. And, aptly, the banks were still financing growth in real economic activities. Thus, we clearly have periods where correlations fall below 0.3 levels, signaling some differences between the two banks. And they occasionally were reaching below zero, signaling substantial differences between the banks.
  • Zone 2: January 2005-July 2007 - the credit bubble. During this period, the two banks worked hard on erasing any significant differences. One went to the UK, another followed. One landed in 100% mortgages, another followed. One started to throw money after cowboy developers. The other followed. And so on. If in the previous period, min-min correlations envelope (the extent of diversification offered by the shares pair) ranged from -33% to -37% and to -47% (implying occasional flight to hedge opportunities of substantial degree and rising though out the period), in the Zone 2 period, min-min envelope ranged from -28% to -6.4%, shrinking the flight to hedge opportunities. In other words, the two shares were much poorer diversification instruments against each other.
  • Zone 3: August 2007 - January 2009 - the credit bubble bursting period. Here, the two shares converged to telling virtually an identical story. It was, indeed, true that by the end of this period, BofI and AIB became virtually indistinguishable. One's own risk was matched by the other risk. And the min-min envelope shrunk from 37% to 41%, getting dangerously close to that 50% mark.
  • Zone 4: Since February 2009, the min-min envelope has contracted to 79.3% signaling that in effect the two shares have no substantial differentiation between them. In other words, from the point of risk hedging or risk-return consideration (e.g. under mean-variance criterion-based models) there is no reason to hold both stocks in a diversified portfolio. The surprising, indeed amazing, stability of these correlations since February 2009 suggests that the markets have reached the new equilibrium - or the New Long Term, where the markets no longer are caring for separating BofI from AIB.
One more thing is worth adding. You'd think that a look at pairwise correlations between two largest banks in this country would be warranted for our technically apt and smart stockbrokers... You'd be wrong - as far as I know, none seemed to have been bothered to send their clients a simple chart on correlations between the two banks.

Economics 26/12/2009: Commoners Amongst Our Foreigners

Merry Christmas to all and a Happy New Year.

To start off the post-Christmas season on an interesting note, here is a different look at the CSO's data on PPS allocations.
Cumulative PPS allocations over 2002-2008 show clearly the magnitude (absolute and relative) of migration from Poland to Ireland. It is worth highlighting the fact that the number of people moving to Ireland from the countries with strong historical links to this country is smaller than that from Poland, and close to that from the 3 Baltic States. Of course, the relative potential pool of migrants from the historically important destinations for Irish emigrants in the past is of magnitude of 100 times greater than that of the Baltic 3 entire populations.
Total immigration figures are impressive, peaking in 2006 and falling in 2008 to the average of 2004-2005 levels.
Looking at the same in terms of countries, the above graph shows again how dramatic was immigration from Poland relative to other countries. In 2005, tiny Lithuania sent more people into Ireland than any other country save for UK and Poland. However, as credit bubble blossomed back in the Baltics, Lithuanian and Latvian migration started to decline after 2005, as was the case with Slovakia post 2006.
A messy chart above shows several interesting trends in migration from other countries. Nigeria - a clear decline post Michael McDowell-led reforms of the free-for-all asylum processes. Brazil - massive increase between 2004 and 2008. Whatever the reasons might be? Philippines - no dramatic slowdown in inflows, save for 2002-2004 period. In other words, given that the Philippines is the leading country supplying nursing staff to HSE, there is really no evidence here that Filipino nurses stopped coming to Ireland (remember the claims made by the trade unions). There are many other interesting things going on in the chart, so feel free to interpret/speculate.
Some more trends in PPS allocations in 2002-2008 above. As percentage of the total, Poland's weight was still increasing in 2008, relative to all other major destinations sending immigrants to Ireland.
Cumulative allocations as shares of total allocations above. And next, same by broader region:
Here is a funny thing - 3 Baltic states accounted for more allocations in 2004-2006 than the UK, the rest of the EU15, the US and even the rest of the world. Amazing, given these three countries are about 1/100th of the EU27 population. And, given that incomes were raising in these countries at very high rates, why would these three countries attract such a massive migration to Ireland? Perhaps the reason is coincident with the anecdotal evidence that vast majority of migrants from these 3 states were Russian speaking. Of course, if this is true, it would represent a small embarrassment to these countries' leaderships, because it would illustrate dramatically how prosecution of Russian-speaking minorities in these countries was pushing people to emigrate. But, again, this is speculative at this point in time, as we never bothered to ask these people their ethnicity, as opposed to their citizenship.

Now, next, look at the dynamics of allocations of PPS numbers to foreign nationals:
Note the dramatic dynamics for the EU10 - virtually none in 2003, jump in 2004 and on to peaking in 2006. what does it tell us about these workers? Prior to 2004, they had to compete with the rest of non-EU employees for jobs. And they were not very good at it, apparently. Post 2004, they no longer had to face real competition. And they became, overnight, very good at getting jobs. Suspicious? Me too. Just shows how arbitrary the world is out there - your skills, your aptitude, your knowledge - all these matter as a secondary differential at the very best. Your passport is what determines who you are, can be and will be to a greater extent.
Total allocations to foreign nationals above.

Now, on to two very interesting graphs:
The above chart shows that overall, the groups with no employment activity were dominated not by the EU10 citizens, but by the UK, EU15, and US migrants. Why, you might ask? Well, citizens of these countries came to Ireland for many reasons, some of which were simply not available to those from EU10 - retirement would be one, second homes would be another one. In other words, it is not that the citizens of these countries had lower propensity to work in Ireland, they simply were more heterogeneous (age wise and occupation/income wise).
Chart above dispels several myths:
  • EU10 citizens propensity to drop out of labour market activities was no more dramatic than that of other major groups of migrants. However, this must be interpreted with care, as the EU10 migrants do not include second home owners or retirees (which makes their drop-out rates higher than average for EU15, UK and US migrants) and they have no restrictions on spouses employment here (which makes their rates of dropping out more significant than those for the rest of the world migrants);
  • US migrants have the lowest rate of decline in labour market activities;
  • EU10 numbers for 2008 also conceal the fact that many of those migrants probably moved into gray economy (cash payments) and into sub-contracting, both not recorded by PAYE system. This increases the rate of non-participation for these immigrants.
So despite a massively different levels of migration from the EU10 over 2004-2008, there is little evidence so far to suggest that these migrants were dramatically different from other groups of migrants. In some areas they were somewhat distinct, but one cannot conclude that these differences were dramatic...

Wednesday, December 23, 2009

Economics 23/12/2009: Couple more points on Ireland's trade data

Wading through CSO latest data, table below shows just how important the MNCs are to our trade and GDP:
Absent MNCs-led sectors in our economy, we would be running massive deficits even accounting for the wholesale collapse of consumer imports. And note that as our own economy is shrinking, net contribution of MNC's own trade balance to our GDP is rising in importance.

Let's look at geography:
  1. Overall exports are declining faster in September than they were over the last 9 months
  2. Exports to Great Britain, EU overall, and Euro area are falling faster in September 2009 than over the first 9 months of 2009
  3. Exports to France are falling slower in September 2009 than over the first 9 months of 2009
  4. Exports to Germany, Italy, the Netherlands, Spain and Sweden are falling faster in September 2009 than over the first 9 months of 2009
  5. Exports to Australia, China, Japan, Switzerland, and the USA are significantly improving over September 2009 relative to the first 9 months of 2009 – a strange result, given these exports are subject to dollar – euro exchange rate fluctuations.
And another way of looking at it is through the trade balance by country:
And one caveat - the cases where dramatic improvements in trade balance do not match those in exports are, of course, reflective of the collapse in imports.

Economics 23/12/2009: Ending 2009 in Red

As 2009 is drawing to a close, let's take a quick look at the broad shares performance in Ireland. starting with a 10-year picture for ISEQ, S&P500 and Nasdaq:
This clearly shows just how dreadful the crisis has been for Ireland - in terms of total decline on the peak valuations. A five-year view confirms this:
But it also shows that 2008 was much worse for Ireland Inc than it was for the benchmarks. And despite the deceptive nature of statistics (remember - we started 2009 at a much lower valuation than other indices, so we could have expected a much stronger bounce from the bottom over 2009 bear rally), we remain heavy underperformers over 5 year horizon.
Ditto over the two year horizon although much closer/tighter view on the 2009 alone:
And if you were swayed by the 'buy' signals from our ever-optimistic brokers in the H2 2009, here is what you've been aiming for:
Yeeeks... At the beginning of the year, I predicted that the markets will continue discounting Ireland throughout 2009 on the back of the adverse news flow (deeper recession, failures in fiscal governance and collapse of banking) relative to the broader global indices. Clearly, they did.

Oh and one more reminder - back in July-August 2008 an MD of our top-5 stockbrokerage firms issued a fanfare-sounding Green Jersey note telling his clients that 'markets come back'.
Were we to listen - we would be buying ISEQ at 5,070 and valuing it today at under 3,000 - a 40.8% drop. Some price for a Green Jersey.

Oh, and it wasn't exactly a ride for the risk-averse, even compared to the scary trender like Nasdaq:
So markets do come back, don't take me wrong - except in their own time and at their own speed. Better luck in 2010, folks!