Wednesday, June 30, 2010
Well, it turns out that in the best European tradition, Euro area banks have conveniently decided not to do much about their deteriorating loan books, preferring the Ponzi scheme of monetizing their poor loan books via ECB funding, and ignoring all warning lights.
Per Bloomberg report today: the ECB said it will lend banks €131.9bn more under its 3-mo lending facility. European banks tomorrow will have to repay €442bn in 12-mo funds, assuming ECB wants to preserve the remaining shreds of monetary credibility and shuts down the pyramid game. So, promptly a week after Bank for International Settlements' dire warning that zero interest rates are leading to shortening maturity of banks & sovereign debts, inducing greater maturity mis-match risks for both, we have a roll over of 1/3rd of the ECB quantitatively-eased banks debts into a much shorter maturity instrument.
ECB said that Euro area-wide, 171 banks asked for the 3-mo funds at 1%, with banks allowed to borrow in the market at about 0.76% euribor and rising (again, the theme picked up by this blog ahead of general media attention: here).
And there is not a chance sick-puppies, like Irish, Greek, Spanish or Portuguese banks, can borrow at the euribor rates. Instead, as the Indo reports today, Fitch ratings agency estimates that the Irish banks borrowed a whooping 12% of the €729bn the ECB has lent to all Euro area banks in 2009. Some of this is accounted for by the IFSC-based facilities. But some, undoubtedly, is held by the Irish banks, and their own IFSC affiliates. Not surprisingly, Irish banks shares have been running red in days preceding July 1...
The liquidity fall-off curve is getting curvier for Irish banks, to use Bertie Ahearne's model of dynamic analysis.
Bloxham morning note reports on an interesting development: the Arms index - an index measuring overall bullishness (for values <1.0)>1.0) of the stock markets "rose to one of the highest levels in at least the last seventy years yesterday rising to over 16 before closing at 5.88". This is an extreme move and at these valuations it is consistent with the overall markets bottoming. As Bloxham note states, "what is fascinating is that yesterdays extreme reading was in fact higher than the 11.89 found at the absolute bottom of the 1987 crash. The pullback in February 27th 2007 also ended on an extreme reading of 14.84." Here's the chart - again, from Bloxham's note:
Tuesday, June 29, 2010
Ireland results, as promised.
High level stuff first:
Good move - 1 rank improvement overall, improvements in 3 sub-categories, but slipping in 3 other.
Compared to peers:
Note: New Zealand has shown remarkable consistent gains over the last 10 years, moving to top 10 position this year for the first time.
So to summarize:
- Ireland ranks 17th in connectivity & technology infrastructure, though broadband penetration remains low
- Ireland ranks 17th in business environment in tough market conditions
- Ireland ranks 17th in social & cultural environment despite low innovation scores compared to regional average
- Ireland ranks 22nd in legal environment, the main detractor is electronic ID implementation
- Ireland is in 21st place on Government policy & vision, the major challenge is in ICT spend
- Ireland is doing well and placed at 8th in consumer & business adoption
- Ireland has the lowest score drop in Western Europe from last year, which is only -0.02 (7.84 to 7.82)
- Ireland moved 1 rank up overall compared to 2009 (18 to 17), consumer & business adoption moved 4 ranks up and social & cultural environment up by 3 ranks
- Ireland has made a lot of progress in Government policy & vision scoring 8.40 and up 6 ranks, the progress is highest (+1.10) of all in Western Europe
- Broadband quality and affordability the weakest of connectivity category, scoring low on the quality and drop in affordability measurement
Global Top 10:
Sources: all charts and tables are from IBM analysis of EIU/IBM e-readiness rankings, 2010.
Western Europe results
Overall, regional digital economy score declined in 2010 – from 7.86 in 2009 to 7.70 this year The biggest score decline this year in the connectivity & technology infrastructure (-0.99), which is highest drop of all regions
- Sweden, Finland, Ireland and Spain are up in their overall ranks compared to last year
- The strength lies in all categories being at the top of all regional averages. Also, Western Europe average is higher than Major markets. The score increased for business environment (+0.20) & Govt policy (+0.18) from last year
- Western Europe dropped in all other 4 categories compared to last year (Connectivity, Social environment, Legal environment and Consumer & business adoption)
Clearly, there are two well-defined tiers in Western European regional grouping - countries that score between 1 and 12 globally (challenging top 10 positions in the world) and those lagging at around mid-20s and low 30s.
Ireland results to follow, so stay tuned.
Monday, June 28, 2010
An interesting view here.
Let's put this on record - I think we are now in 50:50 chance of a new recession - Euro area, UK and US, plus Japan. Time horizon - 6 months.
Sunday Business Post printed an excellent article by Professor Colm Kearney of TCD School of Business on the policies for developing a real knowledge economy. The link is here. As those of you who follow my writings would know, I have campaigned for a long time now for proper recognition of the non-hard science fields of social sciences, business research and humanities as contributors to the 'knowledge economy'. See links here, here, here, here, here, and probably most succinctly - here.
Professor Kearney's article is certainly worth a read for anyone interested in the economic future of this country.
Note: Professor Kearney, unbeknown to many in Ireland, advised Australian Government during the period when Australia established one of the most progressive economic and fiscal environments which has resulted in its economy being able to weather the latest global crisis remarkably well.
One just hopes Professor Kearney gets drafted into a policy-making framework in this country, with some real power to change things.
The second story, related to the subject was also published by Sunday Business Post (here). It relates to the issue of collapsing funding for research in Irish leading academic institution - TCD. In the article in early 2009 published by the Sunday Business Post (here) I warned that it is only a matter of time when thousands of Irish post-docs - funded by the EU, Irish Government and minor private sector grants - are going to face a chop. Jobless PhD - as labeled them - are the direct cost of our short-sighted policies for pursuing lab-coats based innovation and knowledge economics.
Another Monday, another set of pear shape stats.
First, we had a farcical conclusion to a farcical meeting of G20. If Pittsburgh summit was a hog wash of disagreements, Toronto summit had a consensus view delivered to us, mere mortals who will pay for G20 policies. This consensus was: G20 leaders called for
- austerity, but not too much (not enough to derail growth, but enough to correct for vast deficits - an impossible task, assuming that public deficit financing has much of stimulating effect in the first place);
- generating economic growth (with no specifics as to how this feat might be achieved);
- increased tax intake (to help correct for deficits); and
- no changes to be made to the global trade and savings imbalances.
Then , on the heels of these utterly incredible (if not outright incompetent) pronouncements by G20, Bank for International Settlements (BIS) came in with a stern warning to the Governments worldwide to cut their budget deficits "decisively", while raising interest rates. Funny thing, BIS didn't really see any irony in cutting deficits, while raising the overall interest bill on public debt. Talking of Aesopian economics - let's pull the cart North and South, in a hope it might travel West.
In many ways, BIS got a point: “...delaying fiscal policy adjustment would only risk renewed financial volatility, market disruptions and funding stress” said BIS general manager Jaime Caruana. Extremely low real interest rates distort investment decisions. They postpone the recognition of losses by the banks, increase risk-taking in the search for (usually fixed) yield, perpetuating nearly economically reckless financing of sovereigns that cannot get their own finances in order, and encourage excessive levels of borrowing by the banks.
Continued water boarding of the western economies with cheap cash through Quantitative Easing operations by the CBs risks creation of zombie banks and companies with sole purpose in life to suck in liquidity from the markets. Alas, the problem is - shut these zombies down and you have no means for monetizing public debt in many countries, especially in the Eurozone. Boom! Like the main protagonists in Stephen King's movies, governments around the world now need zombies to rush into their disorganized homes before the whole plot of deficit financing blows up in their face.
BIS also warned that many economic experts and central banks are underestimating inflation risks. And this is just fine, assuming you are dealing with short term investment horizons. However, for a Central Bank to ignore the possibility of a restart of global inflation - fueled by the emerging markets growth and later also supported by accelerated inflationary pressures in the advanced economies following the re-flow of liquidity out of the bank vaults into the real economy once writedowns are recognized and banks balancesheets stabilise - is a very dangerous game. inflation, you see, is sticky.
And inflation might be coming. Look no further than the Fed (here) and the US Administration insistence on the need for continued debt-financed stimulus.
Or, look no further than the movements in the interbank lending markets:
So the long term Euribor is up, up and away despite all the Euro area leaders' talk about fiscal solidarity funds and tough austerity measures. Think: why? Either the interbank markets don't believe in Euro area's ability to get its own house in order (which they certainly don't) or they believe that future inflation will be higher (which of course they do)...
Hence, shorter maturities are in an even more pronounced push up:
While dynamically, the trends are deteriorating:
Now, think about the Irish banks (Spanish, Portuguese, Greek - etc) that are on life support of interbank markets and ECB. Can they sustain these credit prices?.. While facing continued writedowns?.. Don't tell I did warn you about these.
Sunday, June 27, 2010
"Let’s compare and contrast 2007 and 2010:
- We have lost 7.8 million jobs since then.
- The unemployment rate is 9.7% versus 4.5%.
- Total unemployed workers are now 15.7 million versus 6.5 million.
- Real personal income less government transfers is lower by 6.5%, or $624 billion.
- Real retail sales have rebounded just 4% from their lows and are still down 9% from the 2007 peak.
- Consumer credit for February showed another sharp retrenchment of -5.6B.
- Consumer bankruptcies for March were the highest level since 2005.
- There is a glaring $1.5 TRILLION hole in the consumer balance sheet.
- Home foreclosures surged 19% last month and are at their highest level since 2005.
- The consumer’s largest asset (housing) is down 33% since 2007."
The index closed down at 89.49 this Friday.
This has three implications for Ireland:
- US problems on consumer side pale in comparison with those found here. We had much deeper contractions in housing asset prices, much greater exposure to housing in the overall composition of household assets portfolios, much more severe acceleration in unemployment, much deeper collapse in disposable after-tax incomes (courtesy of twin forces: Government tax policies and indirect tax hikes, plus wages compressions), lack of compensating increases in Government transfers, more restrictive personal bankruptcy laws, greater consumer leveraging, and steeper fall-off in credit availability;
- As I wrote before (here), household investment is the core leading indicator of recoveries and recessions; and
- Our cohort of official commentariate on matter economic has been very eager to drum up the stories about 'return of consumer spending' in recent weeks.
In my view, what we are seeing is a temporary uplift in sales of some items that are overdue replacement (due to amortization) after 3 years of collapsed sales. This, folks, is not a recovery. It is a dead-cat-bounce... When you hit concrete at 100mphs, the bounce can be substantial. But it hardly qualifies as a 'structural improvement'. Looks like some folks might be deluding themselves...
Saturday, June 26, 2010
Bank of Canada estimates that disorderly (or uncoordinated) exit from global stimulus phase of the recession can lead to a loss of up to USD7 trillion worth of output, primarily concentrated in the advanced economies.
However, the story is more complex than the simple issue of whether G20 nations should opt for a fiscal solvency or for a continued monetary and fiscal priming of the pump. Here are the key stats on the leading global economic blocks, revealing the structural imbalances that suggest the real problem faced by the advanced economies is the debt-driven nature of their fiscal and private sector financing.
First chart above shows Current Accounts for the main blocks, including the G20. Two things are self-evident from the chart. Firstly, the crises had a crippling effect on the overall trade flows from the emerging economies to the advanced economies, though this came about mostly at the expense of countries outside Asia Pacific. Second, crisis notwithstanding, IMF forecasts (data is from IMF April 2010 update to WEO database) the trend remains for unsustainable trade deficits for the Advanced Economies. European (read: German) surpluses of the last two decades are going to be wiped out in the post-crisis scenario, but it is clear that the US, as well as other advanced economies, will have to face a much more severe adjustment toward more balanced current account policies in years to come.
These adjustments will have to involve government finances:
Chart above shows government deficits, highlighting the gargantuan size of the fiscal measures deployed by the US and European countries, as well as a massive stimuli used in some 'Tiger' economies and China, over the latest crisis. This puts into perspective the size of the austerity effort that has to be undertaken to bring fiscal policies back to their more sustainable path. You can also see the relative distribution of these adjustments - the gap between the red line and the blue line. This gap is accounted for, primarily, by the UK, Japan and US and is much smaller than the overall Euro area contribution to G7 deficits.
But there is more to the deficits picture than what is shown above. Expressed in terms of percentages of GDP, the figure above obscures the true extent of the problem. So let's look at it in absolute dollar terms:
Now you can clearly see the mountain of debt (deficit financing) deployed in the crisis. Someone, someday will have to pay for this. It will be you, me, our children and grandchildren. Can anyone imagine that things will get back to pre-crisis 'normal' any time soon with this level of deficit overhang on the side of Governments alone?
What is even more disturbing in the picture is the position of Advanced Economies in the period between the two recessions. It is absolutely clear that Advanced Economies have lived beyond their fiscal means, even at the times of plenty, running up massive deficits in the years of the boom.
This puts to the test our leaders (EU and US) claims that the banking system reckless lending was a problem. The banks were not shoving cash at the Clinton-Bush-Obama administrations, or at European Governments. Instead, just as the banks were hosing their domestic economies down with cheap cash, courtesy of low interest rates, Western governments were hosing down their friends and cronies with deficit financing. The two crises might have been inter-related, but both fiscal profligacy and banks reckless risk-taking are to be blamed for our current woes.
Irony has it, neither the banks, nor the political profligates have paid the price for this recklessness.
Hence, the dire state of the governments' structural balances. As chart above shows, in the entire period of 20 years there was not a single year in which advanced economies (G7 or G20 or the Euro zone) have managed to post a structural surplus. Living beyond ones means is the real modus operandi for the advanced economies' sovereigns. Expressed in pure dollar terms:
Now, on to the levels of economic activity:
As I remarked on a number of occasions before, the whole idea of the Advanced Economies decoupling from the world is really a problem for the Euro area first and foremost. want to see this a bit more clearly?
Look at G7 plotted above against the Euro area and ask yourself the following question. G7 includes Japan - a country that is shrinking in its overall importance in the global economy. This contributes significantly to the widening gap between the world income and G7 income. But the region in real trouble is the Euro zone. Again, this puts Euro area problems into perspective:
- Anemic growth
- Poor relative performance in terms of absolute levels of activity
Some revealing stats on savings and investment:
Clearly, chart above shows the opening of the gap between the need for demographically-driven savings growth in the advanced economies, where ageing population is desperately trying to secure some sort of living for the future, and the lack of real savings achieved. It also shows the downward convergence trend in rapidly developing economies, where younger population is finally starting to demand better standard of living in exchange for years of breaking their backs in exports-focused factories.
Yet, as savings rose during the peak in advanced economies (pre-crisis), investment was much less robust and it even declined in rapidly developing economies:
Why? Because of two things: much of domestic savings in Advanced Economies, especially in Europe, was nothing more than the Government revenue uplift during the boom. In other words, instead of European citizens keeping their cash to finance future pensions, Governments were able to increase expenditure out of booming tax revenues and borrowing against the booming savings rates. Ditto in the USofA (although to a smaller extent). In the mean time, Asia Pacific Tigers started to finance increasingly larger proportion of fiscal imbalances in Advanced Economies, driving down their domestic investment pools and shifting their domestic savings into foreign assets. Which, of course, is an exact replica of the Japanese global investment shopping spree of the 1980s - and we know where that has led Japan in the end...
So the scary chart for the last:
The big question for G20 this time around will be not the stated in official press conferences and statements - but will remain unspoken, although evident to all involved: Given that over the last 20 years, advanced economies financed their purchases of exports from the rapidly developing countries by issuing debt monetized through savings of the developing countries, what can be done about the current twin threat of excessive debt burdens in advanced economies and the shrinking savings in emerging economies?
This is a far bigger question that the USD7 trillion one posited by the Bank of Canada. It is a question that will either see some drastic changes in the ways world economy develops into the next 20 years, or the permanent decline of the advanced economies into Japan-styled economic and geo-political obsolescence.
Friday, June 25, 2010
As the result, I am revising my forecast for Eurozone growth for Q2 2010 to between 0.2% and 0% with the risk to the downside from that.
Negative weights coming from declining industrial production activity and composite PMIs, falling consumer sentiment in Germany, France, Italy and Spain, and equity markets declines. Robust growth in exports provides sole positive support.
- Brian 'Nama-crusher' Lucey v Nama 'Tin Man'
- Colm 'Save the Irish Middle Earth' McCarthy v 'Spend your money on Government stuff' Man
- Plus Vincenzo 'Take no prisoners' Brown, Antoin 'History of economic thought' Murphy, etc
Thursday, June 24, 2010
Clearly, exports have rose in April, after a seasonally adjusted decline in March. We are now again above the trend line, and since January 2009, the trend line is flatter than over the entire sample, which means exports performance remains relatively strong. However, this does not mean things are great. April 2010 exports are down 9.9% on April 2009 and up only 2.22% on April 2008. They are down 6.6% on April 2007. Exports were down 7.7% in March 2010 in year on year terms. So despite flashing above the long run trend line, exports are still under pressure.
Imports have posted significant rise. Imports increased by 8% between March and April 2010.
In Q1 overall, exports fell from €21,911m to €20,789m down -5%. This was driven by:
- Organic chemicals falling by 17%, Computer equipment by 42% and Other transport equipment (including aircraft) by 85%, offset by
- Exports of Medical and pharmaceutical products increase of 8% and Metalliferous ores increase of 75%.
- Computer equipment decreased by 54%, Other transport equipment (including aircraft) by 42% and Electrical machinery by 11%.
- Imports of Petroleum increased by 25%, Medical and pharmaceutical products by 19% and Road vehicles by 30%.
Trade balance is now below long-term trend line. Between April 2009 and April 2010 trade balance fell a whooping 25.7%, much larger drop than the decrease between March 2009 and March 2010 -9.5%. However, trade balance is extremely healthy compared to 2008 - up 38.4% on April 2008.
Terms of trade stats are not updated from December 2009:
But, due to our exports reliance on imported inputs (see my earlier post on IMF statement today), there is basically no relationship between Ireland's terms of trade and our exports activity:
Geographic snapshots for top 30 countries by volume of exports in Q1 2010:
US down, UK down. Total EU exports down. Euro zone down in double digits. All double-digit gains are in the smaller trading partners (less than 1% of total trade volumes).
1. Through assertive steps to deal with the most potent sources of vulnerability,
Irish policymakers have gained significant credibility.
2. Along the complex and long-haul path to normalcy, retaining policy credibility will require active risk management. The appropriately ambitious fiscal consolidation plan demands years of tight budgetary control. Likewise, the weaning of the banking sector from public support and its eventual return to good health will proceed at only a measured pace. In the interim, unforeseen fiscal demands may occur. …With limited fiscal resources for dealing with contingencies, maintaining a steady policy course will require mechanisms for oversight and transparency, and high quality communication to minimize risks and sustain the political consensus and market confidence.
[The really significant bit here is the IMF voicing their position that “maintaining a steady policy course will require mechanisms for oversight and transparency, and high quality communication”. In a diplomatic world of IMF’s statements, neutered by the ‘consultative’ bargaining with the Government, this is likely to mean the following: “Ireland has no mechanism for transparency and oversight (enter Nama). Ireland has no quality communications mechanism, with the preference given to ‘hit-and-run’ announcements of successive cash injections into the banks preceded by no policy debates, and followed by meek Dail talking shops in which discordant voices of fiscally and financially unqualified opposition and backbenchers bicker over minutiae, missing the big picture.”]
3. Ireland is likely to emerge from its output contraction into a period of relatively modest growth potential and high unemployment. Current Irish and global conditions make forecasts subject to much uncertainty. Various indicators point to a return to economic growth during this year, but following its earlier steep fall, GDP in 2010 is projected to be about 1/2 percent lower than in 2009. As the post-crisis dislocations are undone, annual growth rates should rise gradually to about 3.5 percent by 2015. After peaking around 13.5 percent this year and, absent additional policy measures, a sizeable structural component will likely keep unemployment at around 9 percent in 2015.
[Now, these numbers fly in the face of our budgetary projections – see table from the Budget 2010 estimates submitted to the EU Commission. And they imply much more significant challenge on fiscal consolidation side than what the Government has been aiming for.]
4. The improved global outlook will help, but to a limited extent. With some reversal in the earlier loss of competitiveness and improvements in the global economy, exports will lead the recovery. But spillovers to the domestic economy will be limited because of exports’ heavy reliance on imports, their tendency to employ capital-intensive processes, and the sizeable repatriation of profits generated by multinational exporters.
[I’ve been saying this for some time now. Exports will not get us out of this corner. More importantly, since our exports rely on inputs imports so heavily, we are staring at the situation where positive effects from the weaker euro on exports will be offset by the negative effects of rising cost of imported inputs. Also notice – this statement clearly puts IMF at odds with the Government, in so far as the IMF is explicitly stating here that for fiscal balance, it is Irish GNP, not GDP that matters most. Again, good to see another one of my long term concerns validated.]
5. Moreover, home-grown imbalances from the boom years will act as a drag on growth. The unwinding of these imbalances—arising from rapid credit growth, inflated property prices, and high wage and price levels—will limit the upside potential.
Financial sector weakness, fall in real estate prices, and high unemployment could continue to reinforce each other.
[In other words, as I have recently pointed out in the press and on the blog – the twin credit and asset markets crisis is likely to last long time. Years in fact. And this really blows apart the entire Nama strategy of getting the transferred loans back to the par with 10% (or was it not 5% before that?) appreciation in property values.]
But deleveraging to reduce the loan-to-deposit ratio and banks’ risk aversion will constrain lending and the pace of economic recovery, at least in 2010–11. Higher than expected losses, uncertainties in global regulatory trends, and renewed financial market tensions—that may restrict access to funding—create downside risks. In this environment, the targets for SME lending need to be combined with strong prudential safeguards as the non-performing loans of this sector have grown rapidly.
[So unlike the Irish Government, IMF sees banks deleveraging impacting adversely the real economy, higher margins pushing homeowners deeper into insolvency, higher banks charges and banking costs destroying operating capital capacity in the economy, etc. All the things we’ve been warning the Government about – Karl Whelan, Peter Mathews, Brian Lucey, myself – but to which our policymakers paid no attention whatsoever.]
7. Three restructuring priorities deserve attention:
NAMA should schedule an orderly disposal of the property assets acquired aimed to reduce the large overhang of property in state hands, restart market transactions and, thus, help normalize the property market. Oversight of NAMA operations, which is provided for in the legislation, is desirable.
[Thank you, IMF, for supporting exactly the criticism that myself and others have been levying against Nama. Nama needs transparency, oversight, clear business plan. Unfortunately, the legislation does not provide for proper oversight. Nama is an insider-run institution with no meaningful oversight capacity given to anyone, save for the Minister for Finance. Of course, the IMF is saying this indirectly. If the legislation did provide oversight systems sufficient enough, why is the IMF concerned about the need for oversight of Nama operations?]
Mindful of the moral hazard risks, narrowly-targeted support measures for vulnerable homeowners would limit the economic and social fallout of the crisis. …This process will be aided by an overdue shift to a more efficient and balanced personal insolvency regime.
[Again, everything here is a repeat of what we, the critics of the Government approach to the crisis, have been saying for months now. Including the need for reforming our atavistic bankruptcy laws (the calls that have been falling on Government’s deaf ears for some months now) and the need for a support package for homeowners in negative equity and distress (the calls that the Government is responding to by preparing to introduce new taxes on the same homeowners already stretched financially).]
10. Looking ahead, substantial challenges remain. Following the already sizeable consolidation in 2009 and 2010, further consolidation measures, although not as large as that already achieved, of at least 4.5 percent of GDP are required to reach the 2014 target. If GDP growth outcomes are weaker than those currently foreseen by the authorities—a clear possibility within the current range of scenarios—the additional effort needed may even be greater. Staying on target is critical to retain the hard-earned credibility. But the risk of “consolidation fatigue” and, hence, a fraying of the necessary social cohesion cannot be ruled out. For this reason, greater specificity on further proposed measures is necessary. Sustainable expenditure savings will be central, including through efficiencies in public services. Broadening the tax base for revenue enhancement will also be necessary.
[This is clearly the heaviest-edited section of the statement from the point of view of ‘consultative’ additions added by the Government. The language clearly states that the IMF does not believe Government current plans for reducing the deficit to 3% target by 2014. Just month and a half ago, IMF showed its estimates of Government deficit and they are clearly above 5% mark in 2015. Yet, a month ago the Government already had in place plans to further reduce the deficit by 4.5% before 2014. So either the IMF is saying that the Government will require a fiscal adjustment of 4.5% on top of previously announced 4.5% - to the total of 8.8% of GDP or roughly speaking €14.5 billion in total between now and 2014, or their numbers do not add up – per link above.
The really important stuff in this statement is just what risks concern the IMF. The risk of ‘consolidation fatigue’ – referring most likely to the Croke Park deal that effectively shut down any new savings in the public sector wage bill through 2014 would be one. The risk of the Government falling off the target – the risk reinforced by the continued delusionary rhetoric emanating from the ‘turnaround is upon us’ crowd. The risk of weaker growth than forecasted in the Budgetary estimates (table above).
Note that the IMF insists on central role in the adjustment to be played by ‘sustainable expenditure savings’. This is certainly divergent from the approach adopted so far, with tax measures and capital spending cuts (one-offs) being responsible for the lion’s share of fiscal adjustments.]
[On the net, the IMF is clearly seriously concerned about the ability of the Government to achieve meaningful consolidation of the budgets. On the day when Irish Government 10-year bond yields hit 5.38%, this concern means that means that IMF polite wording is just catching up with the bond markets’ clear and loud vote of low confidence in Ireland’s ability to match its tough rhetoric with equally resolute actions.]
Wednesday, June 23, 2010
Speaking at St Petersburg Economic Forum - annual leadership summit held in the Northern Russian city every year in June - Russian President Dmitri Medvedev said that his Government will abolish the capital gains tax on all long-term investments (including foreign direct investment). The measure is seen as a stimulus for non-oil and gas related investment in new technologies, manufacturing and services - areas that Russian Government established as priority for development over the next 10 years.
Russia already sports a flat-rate 13% income tax and a corporate tax of 20% (reduced by 4 percentage points in 2008 from 24%). Regional governments can cut the corporation tax to 16% on their own authority. There is zero tax on royalties from patents, know how and other forms of IP for domestic receipts and a 20% tax on payments from abroad - except where specified otherwise by bilateral treaties. Companies also enjoy an unlimited carry forward on losses.
The Government will also reduce its enterprise holdings by 80% to allow private (domestic and foreign) ownership of many 'strategic' national enterprises currently numbering around 200. "I am cutting the number of strategic companies five times...I have signed a decree to this effect today," Medvedev said.
Russian economy grew by 4% in 5 months between January and end of May 2010 and Medvedev also opened the door for future tax cuts on businesses, but this will be subject to continued economic growth and, presumably, continued displacement of extraction industries at the top of growth pyramid by other sectors.
"We shall return to the issue of a tax burden easening for businesses in the next few years if the global and Russian economies recover in favorable conditions. If everything goes to a favorable scheme," Medvedev said. Before then, there is a need to strengthen country fiscal position which means that some privatizations of the companies previously off the private investors' radar due to state restrictions will be forthcoming.
Medvedev also proposed the government will set up a joint investment fund with state and private investors to develop strategic projects. "...where state money will be augmented with private capital - say, we expect one ruble of state investment to attract three rubles of private investment. I think the idea should be implemented within a year," Medvedev said.
Behind the headlines about the ongoing eurozone fiscal crisis, three significant events have taken place on both sides of the Atlantic in recent weeks.
First, in April, assets under management in hedge funds domiciled in North America reached above $1 trillion mark for the first time in 18 months. Currently, North American funds account for two thirds of the total global assets under management.
Second, both the US and Canadian governments, preparing for the upcoming G20 summit have signalled their unwillingness to join European leaders in their crusade against financial markets. In fact the US has taken a distinctly different approach to dealing with the aftermath of the financial crisis, focusing on banks stability and addressing balance sheet risks in the recent finance reform packages that cleared US Congress.
Third, bloodied and bruised by the bonds markets and the voters, European politicians, led by Angela Merkel, have been gearing up for an all-out fight with so-called financial speculators.
As unconnected as these events might appear today, make no mistake, should the EU continue down the path consistent with its recent rhetoric, Toronto, New York, Chicago and Boston, alongside other major financial services centres around the world will be boom towns courtesy of the investors fleeing populist and politicized EU.
German plans for an EU-wide revision of fiscal and financial architecture range from suspending voting rights of the member states to national bankruptcy proceedings, from regulating hedge funds to introducing a tax on financial transactions.
A global or at the very least an EU-wide financial services transaction tax has been an on-and-off topic of discussion amongst the member states and Brussels for some years. Back in 2006 I was asked to review one of such proposals for a senior European decision maker from one of the continental member states. Having systematically overtaxed and overspend their economies, European sovereigns have been seeking new means of getting their hands on taxpayers cash since at least 2002-2003. Like a junkie in a desperate search of the next hit, the EU states are now searching for a convenient and politically, if not economically, easy target to mug. A Tobin-styled transaction levy on financial instruments is just that.
Transactions tax has been proposed back in 1972 as a theoretical construct to reduce the volumes of high frequency trading in foreign exchange markets. The rationale for it was a naïve belief that currencies should only be traded internationally for the purpose of physical commerce – exporting and importing. Any other trading, such as using foreign exchange as either a hedge or a flight to safety instrument against inflation, low economic growth, excessive state graft on personal income, sovereign insolvency and other fundamentals was viewed as speculative. In reality, modern currency is cash and cash is more than a facilitator of physical transactions. It is an asset.
Fallacious in application to Forex markets, Tobin tax would be even more erroneous were it to be applied to a broader set of financial instruments.
Take Ireland: a gravely sick financial system with plenty of financial services taxes, including a stamp duty on transactions. Has the presence of the Tobin tax here helped to prevent or even moderate the crisis? No. Worse than that, over the last 5 years, Irish markets have shown remarkably high volatility, despite having one of the highest stamp duty rates in the developed world. If anything, our stamp duty can be blamed for artificially reducing liquidity in the Irish stock market and, as a result, for adversely (albeit extremely modestly) contributing to the collapse of Irish shares.
Sweden toyed with transactions tax on financial markets back in 1984, imposing moderate levels of a stamp duty on stocks and derivatives. Within one week of the new law coming into effect, Swedish bond market saw an 85% collapse in volumes traded, futures trades fell 98% and options trading ceased all together. Swedes finally abandoned this self-destructive tax in 1991. Finland faced exactly the same experience. Japan was forced to abandon Tobin-style tax in 1999. Switzerland – a global financial services hub – does charge, in theory, a transaction tax, set at a fraction of the one Germany is rumoured to favour. However, in a typical example of Swiss flexibility, authorities there have power to grant exemption from this tax for specific investors.
OECD has issued the following official position on Tobin-style taxes back in 2002: “A “Tobin tax” penalises high frequency trading without discriminating between trades which may be de-stabilising and those which help to anchor markets by providing liquidity and information. Indirect evidence from other financial markets where a securities transaction tax has been in place suggests a substantial effect on trading volume but either no effect, or a small one of uncertain direction, on price volatility.”
Tobin tax will not work for Europe:
The tax is avoidable by conducting trades and structuring portfolia outside the EU. The end game will be higher cost of capital raising for European companies, selection bias in favour of larger companies in access to the capital market, selection bias in favour of larger financial assets trading platforms, to the detriment of smaller exchanges, and lower after-tax returns to investors. Which part of this equation makes any economic sense?
The tax will not fund sufficient insurance cover for future crises. Given the magnitude of bailouts witnessed in the last two years, the levels of taxation would have to be so high – well in excess of benign rate of 0.1-0.2% currently levied in some countries – that there will be no European financial markets left.
This tax on financial transactions will retard economic development in Europe for decades to come.
One of the reasons why European banks are so sick right now is European companies’ disproportionate, by international standards, over-reliance on debt financing. This contrasts the US corporates, which use more equity financing to raise capital. When the debt financing meets an asset bubble, banks balance sheets swell with bad loans. There is no equity cushion on European corporate balancesheets to underwrite the resulting losses. Instead, taxpayers get thrown to the wolves to rescue banks. Mrs Merkel & Co latest plans for ‘reforms’ will, therefore, mean even greater risks of bailouts in the future, and less growth and fewer jobs.
Next, of course, in Berlin’s line of fire were the hedge funds. Per populist rhetoric in European capitals, they had to be reined in because… well, no one actually knows, why. Hedge funds did not cause the current fiscal crisis (they had no control over the EU governments’ borrowing and spending excesses), nor did they cause the crash of our financial systems (hedgies did not pollute banks balance sheets and account for no more than 5% of the global financial assets). The hedge funds are not responsible for the property bubble or for exuberant stock markets overvaluations achieved in 2007-2008 worldwide.
The sole reason for this ‘reform’ is that for European leadership, ‘Doing right’ means ‘Doing politically easy’. Hedgies have no strong political lobby backing them, unlike banks, property developers, sovereign bondholders and issuers, or civil servants. So the EU prefers to attack a bystander in order to pretend that we are tackling the criminal. While taxpayers are being skinned alive to rescue reckless governments and banks, hedge funds are being presented as villain supremo. Farce? No – it’s politics.
After hedgies, came in even more sci-fi villains. Following Mrs Merkel’s ‘reforms’ talk, Germany banned naked short-selling and the trading of naked credit default swaps in euro zone debt. It turns out that European crisis was, after all, not about absurdly high levels of public debt carried by the PIIGS, nor by fraudulent (yes, fraudulent) deception by some countries of European authorities and investors about the true extent of national deficits. It was not exacerbated by the decade-long recessions turning into bubbles of exuberant lending and borrowing by companies and households, nor by a resultant severe depression that afflicted Euro area since 2008. The cause of these were the investors who were betting on all of these factors adding up to an unsustainable fiscal and economic situation in Europe. Farcical, really!
Worse than that, on top of the ridiculous financial services policies decisions Chancellor Merkel has also been working hard “on far-reaching changes to the treaty underpinning Europe's common currency”. German government would like to increase monitoring of member states' annual budgets, the introduction of stiff sanctions for those in violation of euro-zone debt rules and the suspension of voting rights in the European Council. Furthermore, Germany wants to establish “bankruptcy proceedings for insolvent euro-zone countries.”
The problem with the first part of Mrs Merkel’s fiscal policy proposal is that there are no independent organizations in Europe left that could oversee member states’ budgets. The ECB is a full hostage to Europe’s whims on monetary policy, engaging in the most reckless forms of monetary interventionism known to mankind – direct purchases of risky states’ debt. Outside the ECB ‘Yes, Minister’-styled ‘independent’ states-sponsored institutes populate the realm of European economic policymaking. By-and-large, they have no capability of delivering any independent analysis. Even the likes of the OECD – a very capable organization with some degree of independence – is subject to direct political and bureaucratic interference from its own members.
As far as German proposals for euro zone rules enforcement go, member states that do not conform to deficit reduction rules will be temporarily cut off from receiving structural funds. The galling dis-proportionality and lack of realism in this proposition does not even occur to the EU leaders supporting the idea.
Greece today is recipient of €110 billion bailout. Will suspending a few billion worth of discretionary structural funds commitment be a significant deterrent to a state like that?
This idea is potentially quite dangerous economically. Structural funds go to finance long term infrastructure investment programmes which often rely on co-funding from the Member States and/or private partners. All have private sub-contractors. Withholding EU funds will either destabilise these investments (if the measures to have any punitive powers), thus preventing economic growth necessary for fiscal stabilization or will do nothing. In short, Mrs Merkel’s proposal is a cure that threatens to make the disease incurable.
Earlier in May, German officials also mentioned the possibility of suspending member states' votes should they find themselves in violation of European debt rules. Of course, should this come to pass, Italy, Greece… no wait virtually the entire Eurozone, including Germany will have to be suspended from voting.
In short, in contrast to the US Congressional blueprints for financial sector reforms, European proposals to date can be described as a bizarre amalgamation of the impossible, the improbable, and the outright reckless. Their likeliest outcomes would be a large scale capital flight out of Europe and perpetuation of the status quo of continued sovereign and banks bailouts across the continent. Already struggling under the unsustainable burden of European taxation, the real economy – exportable and non-traded services and manufacturing – will be left holding the bag for these politically driven ‘reforms’. In addition to having an acute solvency problem, the EU will be saddled with a crippling lack of liquidity that only financial markets can provide.
Monday, June 21, 2010
One must commend the Sindo team for putting forward series of articles this weekend on negative equity. One linked here refers my statement, contained in a series of posts on the subject I published here, here and here.
Now, in a farcical move, the Irish banks are apparently working on a scheme to allow negative equity homeowners to roll their mortgage in excess of the value of the house into a new mortgage (details are here, alongside some good analysis). Now, suppose you have a LTV 80% (at origination) mortgage for €400K on a property bought in 2006 and in 4 years since your family has grown in size. You weren't reckless then - borrowing only 80% of the value of the house, and you are not greedy now - requiring just an extra bedroom for those additions to the family. Below are summary estimates of the deal the banks are working out for you as we speak:
In other words, were you to fall for the trap being set up by the banks under the guise of 'We are doing our bit to help people in trouble', you will be either pushed into a 162% LTV ratio 30 year mortgage (good luck getting out of this level of debt with an asset in surplus value) or you'd have to pony up €197,400 for the privilege of seeing your mortgage shrink by €36,000 (the difference between what remains on your mortgage today and the mortgage you'll be taking out under the deal.
This deal is, in short, a pure hogwash for the majority of people in negative equity. The farce will be when, following the deal release into the market, our Government and its paid-for 'analysts' start cooing over the great rescue package for the hardest hit families... Watch their lips.
Of course another amazing thing here is that after all the talk about barring 100% mortgages, the new product will push more vulnerable households into mortgages multiples of the 100% leveraging. Happy times are just around the corner folks.
At 4% annual growth in house prices, the new mortgage will yield a break-even between the debt and the asset value by the end of 2023, not factoring in the costs of repayment. The old deal, were the household to continue with the existent mortgage, would have recovered by the end 2020. Hmmm... looks like our real estate brokers are just a month or so away from a rush of purchasers into the market with this kind of 'new products engineering' courtesy of the Irish banks.
But pardon me for asking. The same homeowners who are about to be offered this 'new deal' by the banks are also providing cost-free rescue to the banks themselves, their management and bond holders, while subsidizing shareholders and developers. 'Mortgage holders' from the development end of business have non-recourse loans worth tens and hundreds of millions. They are being offered a full write-off with virtually no consequences. Households in negative equity are being asked to pay for that, plus to engage in reckless financial engineering projects. Am I getting something wrong here, folks?
Sunday, June 20, 2010
“The Second Law of Thermodynamics, that every engineer knows well, says that the entropy of complex systems will inevitably increase over time. In other words, the system's capability will deteriorate. However, a more recent law, from evolutionary biology, says that the capability of complex systems evolves and improves over time. Engineering concepts guide not only machine designers, but also organization designers. Thus organizations are "engineered" and "reengineered," and "levers" are put in place for their masters to make the machine work and the organization to perform. …And in this concept, a boss on top with authority over the rest is necessary to put discipline into them.
In contrast, consider a rich tropical forest, humming with myriad forms of life supporting each other. Who is in charge? There is a mystery of organization in these forests. Complex self-adaptive systems, like the tropical forest, are organized according to the laws of evolutionary biology, and not the laws of machines.
[Ok, let’s pause and do take time to consider a rich tropical forest system. It is humming. Indeed, it is singing with individuals of various species consuming each other – not exactly a model for the ‘humanism’ of the contribution Number 3 to the list, is it? Over long run, entire species disappear. Not a real model for sustainable humanity. The balance of the forest eco-system is maintained by the precise order of life forms in the hierarchy of who kills whom. Not exactly a model for equality or for social mobility, or indeed for any sort of human rights. So if this stuff about ‘systems’ and ‘learning from the forests’ was to be really useful, it will have to apply only to hierarchical, non-horizontal or rights-based systems. A bit limiting, I’d say. By the way – in the tropical forest and indeed across the entire natural world, the one who’s on top of the food chain is “a boss on top with authority over the rest”… too bad Forbes’ visionary writing about this stuff didn’t bother to check it out himself by taking a camping trip to, say, Grizzly Bear territory armed with nothing more than a flashlight. He’d learn very quickly who’s the boss there and just how much ‘on top with authority’ this boss will get with our visionary]
“The first Enlightenment made man believe that he and his machines could master nature. [Well, we did master large chunks of the nature.] The second Enlightenment will come about with man learning from nature, and realizing that he is a part of it, not the master of it. [Fair play] …Within it lies an ability to produce innovations and to adapt and evolve. In the architecture of complex self-adaptive systems lie clues to the design of organizations in which the constituents work together to create a whole from which they all benefit...
An idea that will change the world for the better for everyone is a new architecture of organization learned from nature and other complex self-adaptive systems. With this architecture, we will get better governance and more co-operation across boundaries. Working together, many organizations may improve the condition of India's children. And, working together, humanity may accelerate its progress towards the Millennium Development Goals, and even mitigate climate change.”
[I’ve had enough. Two things –
- Yes, self-adapting systems are cool. Not futuristic, really, but cool. And have room to be deployed more.
- But the idea that cooperation is superior form of organization is pure ideological hogwash.
“The tragedy of modern atheism is to have ignored just how many aspects of religion continue to be interesting even when the central tenets of the great faiths are discovered to be entirely implausible. …In the light of this, it seems evident that what we now need is not a choice between atheism and religion--but a new secular religion: A religion for atheists.”
[Irony has it, but the good philosopher who wrote this doesn’t quite get the point that from the logic point of view, atheism is a form of religion – it is faith-based as any religion is, and is dogmatic in its acceptance of the first principle that God does not exist]
“What would such a peculiar idea involve? For a start, lots of new buildings akin to churches, temples and cathedrals. We're the only society in history to have nothing transcendent at our centre, nothing which is greater than ourselves. In so far as we feel awe, we do so in relation to supercomputers, rockets and particle accelerators. The pre-scientific age, whatever its deficiencies, at least offered its denizens the peace of mind that follows from knowing all man-made achievements to be inconsequent next to the spectacle of the universe.”
[Spot the contradiction here – if we are the first culture that has nothing transcendent at our core, then we are the culture that does not treat anything as being eternal. Which, of course, means that we cannot de fact believe that any of our achievements can transcend ‘the spectacle of universe’. By the same argument, past cultures, by believing that they left something behind – buildings, temples etc, but always man made – that transcended time had to believe that the ‘spectacle of universe’ was at the very least equaled by their own legacy left for posterity. In other words, the author is clearly logically wrapped up in contradictions here once again.]
“A secular religion would hence begin by putting man into context and would do so through works of art, landscape gardening and architecture. Imagine a network of secular churches, vast high spaces in which to escape from the hubbub of modern society and in which to focus on all that is beyond us.”
[Museums and art galleries as cathedrals? Unquestioned, accepted on faith? Not tested by either time or repetition? Artists as ‘creators’ of a divine license? This is really something closer to the heart of communists and fascists – both have attempted to use art as a vehicle for propagation of the ‘ultimate truth’ – although both have had some artificial (and disastrous in quality) systems of controls over the messengers.]
“In addition, a secular religion would use all the tools of art in order to create an effective kind of propaganda in the name of kindness and virtue. Rather than seeing art as a tool that can shock and surprise us (the two great emotions promoted by most contemporary works), a secular religion would return to an earlier view that art should improve us. It should be a form of propaganda for a better, nobler life.”
[Goebels would approve… as would Stalin. But would modern artists, operating on the basis of personal freedom of expression – which includes freedom to shock, to surprise, to… well, to ‘not be a part of any propaganda’ – approve? I doubt it.]
[At this point, I must say the idea of a secular religion – as espoused by the author here – just doesn’t appeal to me. It is a prescription for totalitarian control, with the ideology of a master race being replaced in its ‘posters’ by the ideology of ‘better and nobler life’… One wonders if there ever was a totalitarian regime, internecine and all that ever postulated its objectives of not achieving a ‘better and nobler life’? The road to Hell is always paved with good intentions... and, may I add, often well-decorated with art...]
Saturday, June 19, 2010
I’ll be blogging about it over the next few days.
"In coming years, increasingly larger amounts of capital will come into the financial system. ...India, China and a few other developing economies will attract a much larger portion of foreign savings. …This increased flow of capital presents us with a unique opportunity to transform [Indian] society. …the financing, investment and risk management needs of companies and governments are growing in size and complexity, and financial institutions should have the ability to support this growth.”
[So far, nothing new – investment into Brics has been growing steadily and the trend is likely to continue for some time assuming:
- Massive Government-fuelled credit and spending expansion in China continues
- Massive Government spending-fuelled expansion in Brazil continues (for the record – Brazil’s fiscal deficit is reaching beyond 13% per annum at the time of rapid economic growth – if one ever had a more pro-cyclical fiscal policy than that and didn’t end up in ditch afterward, do let me know)
- India can supply significant translation of internal growth into external and expatriable revenue for companies without either running a massive inflation or grinding to a halt on the back of collapsed exports demand
- Russia returns to robust growth – though in the case of Russia, there is little chance the country does not really attract massive external funding outside extraction industries.
“Technology will play an important part in this transformation, because it has the ability to break access barriers and bring down transaction costs to a fraction of what they are today. …One such transformational change will come from mobile payment systems.” [An interesting, but not very ‘futuristic’ view – the view that few would disagree with]
“Technology will enable Mutual Funds to sell and service much smaller investment units and insurance companies to sell much smaller policies than they are able to do now. [Alas, mutual funds industry is hardly a cutting edge stuff. Especially since ETFs offer much more at much lower costs. And they do not need any new technology to offer their services to smaller investors] …Similarly, processing small loans and small insurance claims will become faster and easier... Databases with credit histories, and Unique Identification systems will allow financial institutions to reduce risk when they make loans or provide other financial services.” [I am not sure that risk management is a matter of technology bottlenecks. While computational and data processing power can help, it can’t alleviate the problems of modelling and pricing risk, or the problems relating to catastrophic risks, or the much more salient – from Bric’s perspective – problem of basic individual risks inherent in the client base. Machines might change the modes of analysis, but they can’t change the default probabilities of people.]
“The impact of technology is not limited to retail financial services alone. At the core of the financial system where equity, credit, currency and other risks are traded, we need deep, liquid and resilient markets. Technology is helping these markets enormously, and playing an important role in improving efficiency of capital allocation and risk management.” [Yes, but… the speed of order systems in world’s leading exchanges is now so much faster than the speed at which information is delivered to the public and even recorded, that we have clearing and disclosure systems operating at slower speeds than booking systems. It is a serious concern]
[I am not really convinced the idea of India’s and emerging markets financial revolution is… well… all together so revolutionary. Looks like a simple linear projection of a trend.]
Number 2: the emergence of non-English language based cultures on the web.
“…culture does get transmitted; the early adopters, eagerly working on the [African languages] Internet, say, will also be speaking English or French, and they will transmit best practices. It won't take as long as it did the first time. …You already have the 3G mobile network so basically you just need a device to connect. The questions are what devices they will use to connect and when those devices will become affordable. Like with telephony, where people who have never had a landline leap straight to mobile phones, we will see people who have never had an Internet connection leap straight to broadband.”
[An interesting point, but again, hardly revolutionary. In fact, most of hardware referred to above is clearly already in place or being put into action. Its price is collapsing rapidly, including in emerging economies. African consumers of mobile data are pretty much identical in their patterns of consumption to those in the West or Asia. The question is about ‘software’ of culture, of language. A person, say in Africa, can opt for the use of a local language and local culture, drawing on few thousands in terms of potential market for their ideas and content. Or the same person can opt for English or French or Spanish or Chinese. Foreign language merging with foreign culture will not only open the culture up to a larger scale market, but it will also lead to more interesting interaction between language and culture, potentially leading to a development of (at first) non-convergent sub-cultures that will inhabit the web alone and will have only loose (or even superficial) connections to the original culture itself and to the language-based system they utilise on the web. Now, that’s a revolutionary idea – not a transformation of existent cultures, but their mutation into new cultures. The next question is – following convergence of communications, will there be a convergence of atomistic new web-based cultures? Will the web lead to the emergence of a truly global, non-localized culture? And here is another ‘futuristic’ idea for you that comes off the same core – once convergence of technologies and communications takes place, the next step will be to merge these with biological systems. Then, new cultures – until then existent solely in the virtual world – will become physical – or biological. What happens next? Imagine your children’s computer games acted out in real physical universe? May be not by 2030… but what about by 2050?]
“There is a strange paradox at the heart of human nature. We humans are the most sociable creatures on earth, with a remarkable ability to cooperate with one another. … Human beings are also creatures of unparalleled ferocity. No other animal is capable of the horrors--the wars, genocides, torture and oppression--that we have regularly visited upon our fellow human beings. This is all the more perplexing because killing does not come easily to us. …What goes on in the human mind to make… brutality possible? We dehumanize our fellow human beings when we convince ourselves …that they are less than human... The immense destructive power of dehumanization lies in the fact that it excludes its victims from the universe of moral obligation, so killing them is of no greater consequence swatting a mosquito, or poisoning a rat. If dehumanization is a key factor in war and genocide, we ought to be working very hard to prevent it.”
[This is more like a real 21st century challenge, although the humanitarian dream has been with us for a very, very long time. One interesting aspect of the entire idea of finding a ‘cure’ for cruelty and inhumanity is that all, even theoretical, ones seem to lead to a mind control and totalitarian suppression of thought in general. And the article on the topic linked above leaves absolutely no clues as to how we can resolve the truly horrific problem of dehumanization without actually dehumanizing ourselves in the process.]