Thursday, November 30, 2017

30/11/17: Efficiency of Enforcement vs Volume of Regulation

Yesterday, in our class on Economics, we talked about the distinction between regulation (volume of rules) and efficient enforcement (monitoring, investigatory, enforcement and pre-emptive functions of regulatory authorities). As an example, we referenced the repeated chain of customer-level scandals at the Wells Fargo Bank.

Here is the latest scandal, unveiled earlier this week that I mentioned:

From our stand point, this case is really pushing the gap between regulation and enforcement out into new widths. Previous scandals, e.g. false accounts being created by bank employees, were harder to detect, pre-emptively, from regulatory point of view. The latest one was out in plain view for any supervisor/regulator to spot.

The bank signed a contract with its customers (standard terms of contract applying to all specified groups of customers) for ca 0.15% commission on foreign currency exchanges. The bank charged its customers (in 88% of all cases analyzed) higher fees, ranging to as much as 4%.

As ZeroHedge notes, this is absurd level of charges. And this charge comes on already absurd banks' spreads on buying and selling currency (so it is not the only charge customers pay). And yes, as ZeroHedge also notes, there are multiple service providers who do the same for much much lower fees. I use a service that charges me a flat rate fee of $1 for transaction, including transfers of money from one bank to another, plus exchange from one currency into another and trades currency at quoted market rates (average over 2 hours prior to transaction timing). So, in effect, I pay zero spread margin and my total cost of exchanging anything between $10 and $1 million is $1.00.  Were I to have used Wells Fargo services to do my last transaction, I would have paid somewhere around $29 more for the honor of wiring money into my Wells Fargo account than I did, judging by rates quoted to me for the date by Wells Fargo, as opposed to the rate I obtained from my service provider.

The only way the banks sustain the business model that provides them with such an opportunity to earn a huge profit off simple transactions is the model of monopolistic competition with price discrimination: the banks price their services at the high end of transaction cost in full knowledge that those of us who need the service often enough (like myself) will use other service providers, while those who use this service only infrequently will opt to pay higher price to avoid the cost of searching for better alternative.

But that absurd inefficiency of the services provided by the banks is a secondary point from our point of view. The primary one is the regulation in relation to consumer protection.

Let's face the music: the financial regulators receive data from the banks regarding their volumes of transactions carried out for customers in foreign exchange on a regular basis. They also receive the breakdown of costs and margins these transactions generated. It is a matter of excel-level algorithm to detect the discrepancy between the contractual 0.15% charge and the effective charge that - on the aggregate for Wells Fargo - would have been well in excess of 0.15%.

A red flag would have gone up at that stage. The timing to that would have been within one month (per reporting lags).

A sample of actual transactions could have been requested as soon as the flag was up and the actual fees charged could have been identified against the contractual fees. Assume that would have taken a lag of, say, another month.

Within two months from the start of the scam, Wells Fargo would have been under investigation. Damages to customers would have been limited, costs to the bank of complying with the regulations and consumer protection laws would have been limited, the enforcement system would have worked.

Is any of this feasible in the current regulatory and monitoring environment? You bet. Why was it not done? Because there is no pro-active analytics of reported data when it comes to smaller scale transactions. And because the culture of regulation is based on the assumption that too-big-to-fail banks are too-big-to-mistrust.

Either way, Wells Fargo governance and strategy misfires continue to deliver new lessons for us all. The lesson this week is that when the regulators talk the fine talk about protecting the small folks, it is actually whistleblowers or the media or competitors who most often do the heavy lifting on this front - they do the enforcement bit of job that the regulators are de facto walking away from. Efficiency of enforcement, when neglected, undermines the promise of regulation, even when the latter is backed by volumes of rules.

29/11/17: Four Omens of an Incoming Markets Blowout

Forget Bitcoin (for a second) and look at the real markets.

Per Goldman Sachs research, current markets valuation for bonds and stocks are out of touch with historical bubbles reality: As it says on the tin,

“A portfolio of 60 percent S&P 500 Index stocks and 40 percent 10-year U.S. Treasuries generated a 7.1 percent inflation-adjusted return since 1985, Goldman calculated -- compared with 4.8 percent over the last century. The tech-bubble implosion and global financial crisis were the two taints to the record.”

Check point 1.

Now, Check point 2: The markets are already in a complacency stage: “The exceptionally low volatility found in the stock market -- with the VIX index near the record low it reached in September -- could continue. History has featured periods when low volatility lasted more than three years. The current one began in mid-2016.”

Next, Check point 3: Valuations are not everything. In other words, levels are not the sole driver of blowouts. In fact, per Goldman, valuations explain “less than half the [markets] variation since 1900.” But, when blowouts do happen, involving 60/40 portfolios “over the past century [these] amounted to 26 percent in real terms on average, lasting 19 months. It took two years to get back to previous peaks, on average.” And the problem with this is that there might be no firepower to fight the next blowout. “Central banks “might not be able or willing to buffer growth or inflation shocks.” They also face fewer options to ease monetary policy given low rates and big balance sheets.”

So to sum the above up: levels of market valuations are screaming bubbles in both bonds and stocks; investors are fully bought into the hype of rising valuations; and there might be a shortage of dry powder in store at the Central Banks.

Goldman’s team, predictably, thinks the likeliest unwinding scenario from the above will involve, you’ve guessed it… a soft landing.

Now to Check point 4:

Source: ZeroHedge

Observe the following simple fact: the rate of the ‘balanced’ portfolio appreciation in the current cycle is sharper than in the 2002-2007 cycle. And it is sharper, in cumulative terms (both nominal and real), than any other cycle in modern (post 1970s - end of Bretton Woods and stagflationary environments) period.

So the Check point 5 adds strong bubble dynamics to bubble signals of levels of out-of-touch valuations, investors complacency and risks to the Central Banks’ commitment.

This is, put frankly, ugly. Because all four components of a major market blowout are now in place. So while the froth might still run for some weeks, months, quarters, … and may be even a year or two, the longer it runs, the worse the fallout will be. And the fallout is coming.

29/11/17: China vs U.S. - the WTO Fight

Per latest reports, there is a renewed spat between the U.S. and China in the WTO. As reported in the FT (

"The Trump administration has lambasted China’s bid for recognition as a market economy in the World Trade Organization, citing decades of legal precedent and what it sees as signs that China is moving in the opposite direction under Xi Jinping. The US move to oppose China’s longstanding efforts to be recognised as a market economy in the WTO came in a legal submission filed last week and due to be released publicly on Thursday in a case brought by Beijing against the EU."

Here are background slides to the dispute from my recent lecture @MIIS :

First, what's behind the WTO dispute: the fight between the U.S. and the EU against China and other emerging economies in core Bretton Woods institutions - the IMF and the World Bank

 Plus the geopolitics of trade:
 All of which informs the current fight in the nearly-comatose WTO:

So the case is not new, but the case is highly important. Not because China is or is not a market economy. But because China is directly challenging U.S. (and European) dominance over the post-WW2 international institutions. 

Make no mistake here: trade status is just the current, momentary, battle field in what is a long, and quite outright nasty, geopolitical war.

Tuesday, November 28, 2017

28/11/17: Price vs value: economics of art

From time to time, I have been posting on the blog links to articles on economics of art. Here is the latest one that caught my eye: The economics of ridiculously expensive art by Bronwyn Coate for CapX:

Without any comment from myself, other than: interesting read.

28/11/17: Hacking the market: Systemic contagion from cybersecurity breaches

Our article for LSE Business Review is now live on the site:

You can read (free) our paper, on which this article is based, in full here: Corbet, Shaen and Gurdgiev, Constantin, What the Hack: Systematic Risk Contagion from Cyber Events (September 7, 2017). Available at SSRN:


Sunday, November 26, 2017

26/11/17: FAANGS+ Brewing up another markets storm

One of the key signals of a systemic mispricing of financial assets is concentration risk. I wrote about this in a number of posts on the blog, so no need repeating the obvious. Here is the latest fragment of evidence suggesting that we - the global financial markets and their investors - are at or near the top of froth when it comes to 'irrational exuberance':

So what should investors do? Some lessons from the GFC that can help are summarized here: And some additional warning signs of the bubble are summarized here:

Quote: "...our new Delirious Dozen consists of the FAANGs (Facebook, Apple, Amazon, Netflix and Google) plus seven additional high flyers (Tesla, NVIDIA, Salesforce, Alibaba, UnitedHealth, Home Depot and Broadcom)."

What the above valuations imply?

  •  "Amazon is now valued at $550 billion and thereby trades at 293X its $1.9 billion of LTM net income" - EV/EBITDA ratio of x46.5
  • "Broadcom trades at 246X net income"
  • "Netflix is valued at 194X" or x107.8 EV/EBITDA ratio
  • "Salesforce (CRM) ... is currently valued at $77 billion, and Tesla, which sports a market cap of $54 billion. Yet both had large net losses during the latest 12 months. In fact, during the last five years, CRM has posted cumulative net losses of $650 million and Tesla has lost $3.3 billion." Enterprise Value/EBITDA for CRM is now x154; for Tesla: x80.7 after  the recent price drops.
  • NVIDIA sports EV/EBITDA ratio of x44.9 and Alibaba of x43.5
  • UnitedHealth is absolutely cheap at x13.3 EV/EBITDA as is Home Depot at x13.9 although the latter does sport a P/BV ratio of x57.3 and that is before it takes a full writedown on the 'value' of its stores, in lines with forward expectations of the changes in the retail environment in the near future
  • Facebook EV/EBITDA is x26.6 with expectations forward on earnings bringing trailing P/E ratio from x41 to x27.6 which is really equivalent to saying that there is no business cycle that can impact adversely Facebook's business any time soon.
  • Apple's EV/EBITDA is x13.3 - cheap by all 'FAANGS' measures, but forward relative to trailing P/Es imply earnings growth of at least 35-40 percent in 24 months horizon. Which is, again, suggesting no one should ever expect any clouds on Apple's horizon.
  • Google's EV/EBITDA is x19, while forward vs trailing P/E ratios imply earnings growth of at least 33-40 percent, similar to Apple's.
There is, quite clearly and transparently, an eyes wide shut moment for the markets. Greenspan might have called this the 'irrational exuberance', while your friendly sell-side broker will undoubtedly call it 'time to buy into the market' moment. But you have to have guts of steel and brain the size of a pea to not spot the trouble ahead with the current markets valuations.

Friday, November 24, 2017

24/11/17: Learning from the GFC: Lessons for Investors

My article, summing up the key lessons from the Global Financial Crisis that investors should review before the next crisis hits is now available via Manning Financial newsletter:

Tuesday, November 21, 2017

21/11/17: ECB loads up on pre-Christmas sales of junk

Holger Zschaepitz @Schuldensuehner posted earlier today the latest data on ECB’s balance sheet. Despite focusing its attention on unwinding the QE in the medium term future, Frankfurt continues to ramp up its purchases of euro area debt. Amidst booming euro area economic growth, total assets held by the ECB rose by another €24.1 billion in October, hitting a fresh life-time high of €4.4119 trillion.

Thus, currently, ECB balance sheet amounts to 40.9% of Eurozone GDP. The ‘market economy’ of neoliberal euro area is now increasingly looking more and more like some sort of a corporatist paradise. On top of ECB holdings, euro area government expenditures this year are running at around 47.47% of GDP, accord to the IMF, while Government debt levels are at 87.37% of GDP. General government net borrowing stands at 1.276% of GDP, while, thanks to the ECB buying up government debt, primary net balance is in surplus of 0.589% of GDP.

Meanwhile, based on UBS analysis, the ECB is increasingly resorting to buying up ‘bad’ corporate debt. So far, the ECB has swallowed some 255 issues of BB-rated and non-rated corporate bonds, with Frankfurt’s largest corporate debt exposures rated at BBB+. AA to A-rated bonds count 339 issues, with mode at A- (148 issues).

It would be interesting to see the breakdown by volume and issuer names, as ECB’s corporate debt purchasing programme is hardly a very transparent undertaking.

All in, there is absolutely no doubt that Frankfurt is heavily subsidising both sovereign and corporate debt markets in Europe, largely irrespective of risks and adverse incentives such subsidies may carry.

20/11/17: Tallying the Costs: U.S. Wars in Iraq, Afghanistan & Pakistan

The folks at Brown University have carried out the most detailed assessment of the disastrous costs of the U.S. wars fought since 9/11. The details can be found here: These are a must read!  While Russia stands accused by the U.S. of triggering the humanitarian crisis through its intervention in Syria (the civil war that started with the U.S. support and blessing), here is Brown University's conclusion about the real refugees crisis:

Not to say that one wrong (U.S.) makes another wrong right (Russia), but 10.1 million estimated refugees caused by the U.S. wars? This got to stand out, folks.

The U.S. has spent estimated USD5.6 trillion from 9/11 through fiscal year 2018 according to the study.

Enough to buy healthcare for every American, or to pay all outstanding student debt. Hell, in fact, it would have allowed for both.

And the above costs and impacts do not account for Libya, Egypt, Yemen and other direct and indirect 'minor' conflicts the U.S. has been involved in. The statistics do not include Syria.

In a recent post, I mused about the asymmetric warfare and the fact that, seemingly, outspending the entire world in terms of defense expenditures, the U.S. appears incapable of achieving its core objectives (see the post here:

There appears to be no learning curve from the past 16 years - neither in the public minds (who support increasing expenditure on military industrial complex) and in the mind of the Washington politicians (see

And there is neither an increase in transparency in the American policies post-9/11, nor an increase in scrutiny of choices made (see

As folks from Brown University project conclude: "The wars have been accompanied by violations of human rights and civil liberties, in the US and abroad. The wars did not result in inclusive, transparent, and democratic governments in Iraq or Afghanistan... The human and economic costs of these wars will continue for decades with some costs, such as the financial costs of US veterans’ care, not peaking until mid-century. US government funding of reconstruction efforts in Iraq and Afghanistan has totaled over $170 billion. Most of those funds have gone towards arming security forces in both countries. Much of the money allocated to humanitarian relief and rebuilding civil society has been lost to fraud, waste, and abuse."

This is genuinely frightening!

20/11/17: Your Family Doc, Called AI...

In a recent post, I wrote about the AI breaching the key dimension of 'intelligence' - the ability to self-acquire information and self-replicate knowledge (see  And now, Chinese AI developers have created a robot that is capable of excelling at (not just passing) a medical certification exams:

Years ago, working for IBM's think tank, IBV, I recall discussions about the future potential applications for Watson. Aside from the obvious analytics involved in finance (my area), we considered the most feasible application for AI and language-based software in... err... that's right: medicine. More precisely, as family doctors replacement. For now, Watson is toiling primarily in the family doctors' support function, but truth is, there is absolutely no reason why AI cannot currently replace 90% of the family doctors' practices.

And, while we are on the subject of AI, here is an interesting article on how China is beating the U.S. (and by extension the rest of the world) in the AI R&D game: and

Still scratching your heads, Stanford folks?.. 

20/11/17: Bitcoin: an Unknowable Bubble?

There is a much-discussed in the crypto-sphere chart making rounds these days, plotting Bitcoin price dynamics against the historical bubbles of the past:

The chart is striking. Albeit simplistic. See Note 1 below for a technical argument on the chart timing.

On price dynamics alone, Bitcoin looks like a sure bubble - a disaster waiting to happen. But Bitcoin dynamics are basically not suited for any empirical analysis of any significant accuracy.

As noted by some commentators, Bitcoin had numerous 80-90% and larger drawdowns in the past (given its immense volatility). It keeps coming back from these. Some claim this to be the evidence that Bitcoin it not a bubble. Which is neither here nor there: bubbles are generated by exuberant expectations of investors, not by actual parameters of price processes. Causality does not flow from dynamics to bubbles, but the other way around. So to identify a bubble, one needs to identify exuberance. See Note 2 below for more on 80% drawdowns.

In the case of Bitcoin fans, there is clearly such.

No investor or serious analyst has been able to provide a fundamentals-based valuation model for Bitcoin.

A disclosure in order here: myself and a graduate student of mine have looked at the fundamental modelling for Bitcoin over the summer. We found no tangible relationship between any economic or financial parameters tested and Bitcoin price dynamics. In another piece of research, myself and two co-authors are currently looking at empirical dynamic and fractal properties of Bitcoin. Again, we finding nothing consistent with a behaviour of an asset with fundamentals-derived valuations.

Absence of evidence is not the same as evidence of absence. But, taken together with the general lack of credible fundamentals-linked modelling of the crypto-currency, this means that, at this point in time, Bitcoin price can be potentially driven solely by… err… expectations held by its enthusiasts, plus the incentives by the predominantly China-based investors to avoid extreme risks of capital controls and expropriations. If so, both drivers would make it a speculative bubble.

The only quasi-fundamentals-linked argument for Bitcoin has been the blockchain one - the promise of Bitcoin serving as a key tool for data aggregation, recording and transmission. This argument, however, no longer holds. Blockchain technology has migrated from public blockchains, like Bitcoin, to either open blockchains, like Ethereum or, increasingly more frequently, private blockchains. It is the latter that currently hold the promise to serve as viable platforms for data economy.

As a libertarian, I should like a private currency system that supports anonymity of transactions. As an economist, I should like the innovative nature of Bitcoin. And, put simply, I do. Both.

But as an investor, I do not have the stomach for Bitcoin’s valuations and volatility, as well as for its higher moments behaviour (in particular worrying are kurtosis, co-skews and co-kurtosis, which severely complicate empirical dynamics analysis, see Note 3 below). And I have even less enthusiasm for the crypto market that is sustained increasingly by undertakings, like BitMEX - a purely speculative platform trading some $35 billion in Bitcoin derivatives with leverage up to x100 to the amateur speculators who, put frankly, have zero idea what they are buying and at what price. The vast majority of Bitcoin investors have no clue what a butterfly option looks like and how it can be valued. And the vast majority of financial markets analysts and professionals won’t be able to price a butterfly strategy for Bitcoin, given its painfully twisted moments. Yet, within a month of starting trading, BitMEX reached 1/3 of the market capitalisation of Bitcoin. This is not just a shoe-shine-boy moment, folks. It is white-powder-under-the-nose-and--empty-bottles-of-vodka-on-the-floor hour for high school dropouts with cash to burn.

Another worrying issue with Bitcoin is the argumentation of its main supporters.

This ranges from the cognitively biased “you don’t know anything about the Bitcoin” to “Bitcoin is scarce & limited in supply” to “Bitcoin is a promise of liberating the masses from the oppression of the Central Bankers”.

The first sort of argument exhibits not just Jurassic ignorance of logic, but also a gargantuan dose of arrogance. Repeated sufficiently enough, it signifies the absurd degree of exuberance of investors’ expectations.

The second argument is patently false. Bitcoin has undergone splits, and engendered dozens of other cryptos, with unlimited supply of such into the future. Bitcoin itself is divisible ad infinitum and, with forks, its supply is potentially unlimited. Worse, Bitcoin rests on man-made mathematical foundations. Which means it has no physical bound or constraint. Anything man-made (and even more so, anything mathematically derived) is, by definition, fungible and axiomatic. Just because to-date no one cracked the code to alter Bitcoin mid-stream or drain blockchain-held information does not mean that in the future such a code cannot be written. So hold your horses: gold is physically limited in quantity (even though in the Universe, it is not as scarce as it is on Earth, which makes long term supply constraint on gold potentially non-binding). Bitcoin is limited by our capacity to alter the underlying code defining it. Anyone thinking of an algorithm as a 'law' needs to go back to Godel's mathematics.

Finally, there is an argument of ‘liberation’. Bitcoin value is only sustained as long as it remains convertible into goods, services and other currencies. This means that Bitcoin cannot remain a government- regulation-free asset, as long as its popularity as a medium of exchange and a vehicle for store of value grows. Which means that in the medium terms (3 years or so?), Bitcoin will either cease to be, or cease to be anonymous. All protection from the dictate of the Central Bankers will be gone.  Benign tolerance of Bitcoin by some regulators can quickly turn into outright prohibition on trading - as current and past examples of China, Vietnam, Nigeria, Colombia, Taiwan, Ecuador, Bangladesh, Kyrgyzstan and Bolivia, Russia, and Thailand suggest. Evolution of cybersecurity measures and regulatory and supervisory tools, including their spread into cryptocurrencies domain will only increase effectiveness of such measures into the future. So, unless you are planning to live in a libertarian paradise, where legal norms of other states do not apply, good luck committing much of your wealth to Bitcoin as a safe haven for oppressive or coercive actions of the nation states.

Worse, anyone claiming that Bitcoin is a hedge against inflation fails to understand how modern markets work. Again, to increase in value, Bitcoin requires higher rates of adoption. Higher rates of adoption bring about higher rates of asset instrumentation (see above for BitMIX). Higher rates of instrumentation and adoption, taken together, imply higher holdings of Bitcoin by institutional and diversified portfolio investors. So far so good? Right, now the kicker: these holdings imply greater, not lower, positive correlations between Bitcoin and other asset classes in shock-experiencing markets. That's right, dodos: Goldman holdings of Bitcoin are correlated to liquidity supply in general markets, because if such liquidity starts evaporating, Goldman will sell Bitcoin to plug holes in other instruments. Sell-off in the markets can trigger sell-off in Bitcoin. Now, another kicker: Bitcoin is currently less liquid than any major asset class (see extreme volatility of pricing across various Bitcoin exchanges). Which means that smart folks at Goldman will be dumping Bitcoin before they dump gold and other assets. Hipsters hugging their laptops will be the last to wake up to this momentum (behavioural evidence suggests, they might actually buy into falling Bitcoin in hope of speculatively gaining on a bounce, which, incidentally, can explain why large drawdowns in Bitcoin can turn so fast into upward trends).

The tricky bit about Bitcoin is that its enthusiasts need to learn to live in the real world first. Until they do, Bitcoin will continue its upward path, and this process can go one for quite a while, depending on the supply of cash in the markets for Bitcoin. Once they are taught a sufficient lesson, however, the rest of us will be learning the long term fundamentals valuations of Bitcoin. I, for now, have no idea what these valuations might be.

So Bitcoin, then. A bubble or not? If you ignore the arguments that attempt to justify its valuations, it looks like one, albeit with dynamics that are very hard to interpret. If you listen to them, it looks that way even more, with more confidence in the arguments bogus nature. Draw your own final conclusions.

Note 1: In defence of the chart above, without validating its implied conclusions: the chart plots Bitcoin evolution from 3 years ago through today. This starting point makes sense. Until mid-2014, Bitcoin was extremely obscure, hype-only investor vehicle, with volatility so off the charts, any analysis of its dynamics was futile (I know, I did such analysis and presented the results in my talk at Bloomberg two years ago). Those us who do research in finance generally and routinely disregard the first 3-4 years of existence of Bitcoin for exactly that reason.

Note 2:  A note due here: Bitcoin's returns from 80-90% drawdowns is not a solid evidence of the crypto-currency not being a bubble, because they are in line with Bitcoins' overall massive volatility. In other words, a valid comparative for these drawdowns relative to other asset classes is not "an 80% drawdown in  Bitcoin ~ an 80% drawdown in stocks", but "an 80% drawdown in Bitcoin ~ an 8% drawdown in stocks". Apples to apples. Dust to dust.

Note 3:  Interesting Elliott Wave analysis of Bitcoin dynamics here: and here, although I am not convinced Bitcoin price trends are established enough for this technique to work.

Monday, November 20, 2017

20/11/17: Russian economic growth slides. Structural issues loom large

An interesting view of the Russian economy (as usual) from Leonid Bershidsky:

Credit, is not a sustainable source for growth in Russia, especially as the Russian households’ leverage capacity (underpinned by expected future wages) is not exactly in rude health. A recent study from the Russian government's own Analytical Center found that roughly 17% of the working population, or about 12.1 million Russians, can be classified as the working poor - those earning less than enough to cover the minimum purchases required to sustain a family. The study also found that majority of the working poor in Russia rely on microcredit, short term payday loans and/or traditional bank or credit card borrowing to meet daily necessary expenditure.

Low wages, rising credit

Rosstat data confirms the findings. Roughly 7% of all wage-earners are paid wages below the monthly subsistence minimum. Over 17% of people working in the education sector or various municipal services earn below-subsistence wages.

Moscow has set a target of 2019 for raising wages to the legally required subsistence minimum level, with minimum wages hiked in 2016 and mid-2017. Current minimum wage is set at Rub 7,000 per month (roughly EUR115) which is only about 60% of the average subsistence minimum levels and close to 20% of the average monthly wage, according to BOFIT report. This is about half the level (of 40%) ratio of the minimum wage to the average wage across the OECD countries.

Accumulation of household debt, therefore, is hardly the good news for the economy in the long run, as debt affordability is only sustained today by the falling interest rates (cost of carry), and is not consistent with the wages dynamics, and wages levels, especially at the lower end of earnings.

Meanwhile, the latest data on economic growth came in at a disappointing print. Russian GDP growth fell from 2.5% y/y in 2Q 2017 to 1.8% in 3Q 2016, driven down by slower expansion in both exports and domestic investment. Over the period from January through September, Russian economy grew by roughly 1.6% y/y - well below the official forecasts and analysts consensus expectations. Oil output fell, despite the rise in global oil prices, as Russia continued to implement OPEC-agreed production cuts.

On external trade, exports of oil and related products were up in 3Q 2017 in line with oil prices, rising 26% y/y. Exports of metals and other primary materials were down sharply. In January-September, exports of goods were also up 26% y/y with the share of oil and gas in total goods exports up sharply to 60%.

Notably, the value of exports of goods and services (at USD250 billion) over the first nine months of 2017 has robustly exceeded the value of imports (at USD 170 billion).

Structural Problems

Russian growth slowdown is structural, as I wrote on numerous occasions before. The structural nature of the slowdown is reflected in subdued private investment growth and lack of dynamism in all private enterprise-led sectors, with exception, perhaps of the cyclical agriculture. Even food production sector - which should have benefited from record crops (over 2014-2017) and trade sanctions (import substitution) is lagging. Capital deepening and technological innovation are far behind where these should have been after roughly 19 years of post-default recovery in the economy.

The structural decline in the private sectors activities is contrasted by expansion of the state sector.

According to the Rosstat figures, over recent years some 11-12% of total earnings in the Russian economy was generated by the larger state-owned or part-state-owned enterprises. This figure excludes direct Government spending. In other words, state spending and state-owned companies revenues now account for close to 40% of the Russian GDP. As reported by BOFIT, state-owned enterprises “revenues are highly concentrated. Surveys by the Russian Presidential Academy of National Economy and Public Administration (RANEPA) show that just 54 large state-owned enterprises (SOEs) account for 8% of revenues [half of that accrues to only two companies: Gazprom and Rosneft]. When 20 indirectly state-owned firms are added the share rises to 12%.” This is in line with the figure of 11% reported by based on their list of 400 biggest companies in Russia.

Outright direct Government (local, regional and federal) expenditure amounts to slightly above 13% of GDP, based on Rosstat figures. This means that, raising the larger enterprises share to account for smaller and medium sized state-owned companies, the total state-owned enterprises and Government share of the economy can be around 38% mark, slightly above the 2010 estimate of 35%, provided by the ENRD. Interestingly, the above imbalances in the structure of the Russian economy do not seem to reflect too poorly on the country rankings in the World Bank Doing Business report. Out last week, the rankings put Russia in 35th place globally, our of 190 countries, placing it just below Japan and well ahead of China (78th).

In summary, Russian economy will not be able to get onto a higher growth path (from the current 1-1.5 percent range) until there is a significant shift in growth drivers toward capital deepening (necessary both to offset adverse demographics and the chronic under-investment in new capital over the recent years), and technological deepening (required to modernise industrial and services sectors). To effectively trigger these processes, Russia needs to hit, simultaneously. three policy targets:

  1. Improve overall relationship with Europe, while continuing to build on positive trade and investment momentum with Asia-Pacific region;
  2. Increase the share of private enterprise activity in the economy, by reducing the state share of the economy to below 35% of GDP; and
  3. Focus on reforming institutional frameworks that currently hold Russian investors from investing in the domestic production, including closing gaps on product/services certification between Russia and Europe, and effectively (not pro-forma) reforming legal frameworks.

20/11/17: Wait till rates normalization hits the property markets

In the context of the ongoing Chinese debt bubble crisis (yet to explode into a full crisis, but the timer is ticking ominously), the ZeroHedge presented the following chart:

The dire state of the global economy post-QE waves of 2008-2017 is reflected in the vast asset bubbles building up across the main markets, with Canada, China, Australia leading the surge, while the U.S. residential property prices are now also at historical peak (previous peak reading was at 184.62 against current at 195.05):


New Zealand is not far off from its neighbour, Australia:


In short, things are getting beyond the pre-2007 bubble levels and the risks of a blowout in global property markets are rising. All we need is a catalyst for breach, which is likely to be either a ramp up in credit costs in the advanced economies or a tightening of credit in China, or both.

19/11/17: S&P on Irish Banks & Tracker Mortgages

S&P Global article on the fate of tracker mortgages scandals in Irish banks (with comments of mine):

Sunday, November 19, 2017

19/11/17: Mainstream Media & Fake News: Twin Forces Behind Voter Behavior Biases

Behavioral biases come in all shapes and forms. Many of these, however, relate to the issue of imperfect information (e.g. asymmetric information, instances of costly information gathering and processing that can distort decision-making, incomplete information, etc).

A recent Quartz article on the balance of threats/risks arising from the 'fake news' phenomenon (the distortion of facts presented, sometimes, by alternative and mainstream media alike) and another informational asymmetry, namely selectivity biases (which apply to our propensity to select information either due to its proximity to us - e.g. referencing bias, or due to its ideological value to us - e.g. confirmation bias, etc). Note: Quartz article is available here:

According to the article: "News sources aim to cover—in the words of the editor in chief of Reuters—the “facts [we] need to make good decisions.”" But, "As readers, we also suffer from what’s called confirmation bias: We tend to seek out news organizations and social media posts that confirm our views. Selective facts occur precisely for this reason." In other words, confirmation bias is a part of our use and understanding of information. The author concludes that "Selective facts are worse than outright fake news because they’re pervasive and harder to question than clearly false statements."

So far so good. except for one thing. The article does not go in detail into why selective facts are, all of a sudden, prevalent in today's world. Why does confirmation bias (and, unmentioned by the author, proximity heuristic) matter today more than they mattered yesterday?

The answer to this, at least in part, has to be the continued polarization of the mainstream media (and, following it, non-traditional media).

Here is a PewResearch study from 2014 on ideological polarization in the mainstream media and social media:  Two charts from this:

Not enough to drive home the point? Ok, here is from Forbes article covering the topic (source:
"The Reuters Institute recently released its 2017 Digital News Report, analyzing surveys from 70,000 people across 36 countries and providing a comprehensive comparative analysis of modern news consumption. The report reveals several important media trends, including rising polarization in the United States. While 51% of left-leaning Americans trust the news, only 20% of conservatives say the same. Right-leaning Americans are far more likely to say they avoid the news because “I can’t rely on news to be true.""

The trend is not new. In the 1990s, plenty of research have shown that print and cable media have started drifting (polarizing) away from the 'centre-focused' news reporting as local monopolies of newspapers and TV stations started to experience challenges from competitors. You can read about this here:

  • Tuning Out or Tuning Elsewhere? Partisanship, Polarization, and Media Migration from 1998 to 2006 by Barry A. Hollander (2008), Journalism & Mass Communication Quarterly, Volume 85, Issue 1, which posits a view that polarization of the mass media has been driving moderate voters away from news and toward entertainment. Which, of course, effectively hollows out the 'centre' of media ideological spectrum. 
  • "This article examines if the emergence of more partisan media has contributed to political polarization and led Americans to support more partisan policies and candidates," according to "Media and Political Polarization" published in Annual Review of Political Science Vol. 16:101-127 (May 2013) by Markus Prior.
  • And economics of media polarization in "Political polarization and the electoral effects of media bias" by Dan Bernhardt, Stefan Krasa, and Mattias Polborn, published in Journal of Public Economics, Volume 92, Issues 5–6, June 2008, Pages 1092-1104
These are just three examples, but there are plenty more (hundreds, in fact) of research papers looking into twin, causally interlinked, effects of media polarization and the rise of the polarized voter preferences.

Which brings us to the Quartz's observation: "While social media and partisan news has allowed more voices to be heard, it also means we are now surrounded by more people manipulating what facts make it to our newsfeeds. We’d draw a different conclusion—or even just a more nuanced picture—if we were given all the information on an issue, not just the parts that best benefit a particular viewpoint."

It may be true, indeed, that current markets for supply of alt-news are enabling greater confirmation bias prevalence in voter attitudes. But it is at best just a fraction of the complete diagnosis. In fact, the polarized, or put differently - biased, nature of the mainstream news is at least as responsible for the evolution of these biases, as it is responsible for the growth in alt-news. That is correct: fake information is finding are more accepting audiences today, in part, because the CNN and FoxNews have decided to cultivate ideologically polarized market differentiation for their platforms in the past.

18/11/17: The Road Ahead: EchoChamber Podcast

It was my pleasure, recently, to record a podcast with excellent Tony Groves @Trickstersworld . The link to the podcast is here: Enjoy!

19/11/17: The Next Global Financial Crisis

My column for Cayman Financial Review on how the stage has been now set for the next Global Financial Crisis is available at

18/11/17: Say thanks BEPS, as Sweden Cuts Corporate Tax Rates Again...

Sweden, the tough-fighting 'socialist' haven of capitalism is cutting its corporate tax rates. Again.

Yes, that is right. Sweden used to have a decisively 'socialist' rate of corporate income tax (irony implied) of 28% until 2008. In 2009 this rate dropped to a relatively convincing 'socialist' rate of 26.3%, before falling to a sort-of-'socialist' softy 22%. It now plans a cut to 20%.
 h/t for the chart to @mattyglesias 

The announcement is made here: h/t to @tylercowen for the link. 

Note, extensive compliance changes proposed for Swedish tax code to bring it in line with the OECD's BEPS scheme. The scheme was designed, as defined by its objectives, to make it harder for the corporations to avoid taxes in the future. Which means, of course, that to maintain effective tax rates closer to where they were before the BEPS, Sweden, as other states, will need to offset BEPS-induced accounting changes with lower headline rates. 

Tax optimization, folks, just went mainstream in Europe and the U.S. Which is a good thing for transparency (reducing the disparity between the effective rates and the headline rates). But a bad news for personal income taxes. To offset the declines in corporate tax revenues that BEPS changes will inevitably engender, Governments from Sweden to Italy, from Canada to the U.S. will have to either cut spending or increase personal income tax rates. No medals for guessing what they will opt for.

Saturday, November 18, 2017

18/11/17: North Korean Uncertainty and Market Impacts

S&P new post about the risks poised by North Korea is a neat summary of key actions and players involved (see the full note:

And it is very interesting to those of us, who study the links between geopolitical risks and financial markets.

Two pieces of evidence are presented in the S&P note worth pondering: first, the rising frequency of the North Korea threat signals:

The above shows that starting with 2016, acceleration in the North Korea threat signals has been posing a departure from the previous trend. Structurally, this suggests that we are entering a new regime in terms of potential market spillovers from North Korean risks to global financial markets.

Next, some evidence on changes in specific shares valuations timed close to the North Korean threat signals:

The evidence above suggests that, in line with our research findings in other instances, the uncertainty about North Korean threat evolution is feeding into the valuations of defence stocks. And that this effect is still ambiguous. Which is in line with our findings on the links between actual conflicts and defence stocks valuations revealed in my paper with Mulhair, Andrew, "Performance Analysis of U.S. Defense Stocks in Relation to Federal Budgets and Military Conflicts in the Post-Cold War Era" (April 2017). Available at SSRN: Furthermore, the nature of North Korean policy-induced uncertainty is consistent with our findings relating to terrorism spillovers to financial markets as revealed in my paper with Corbet, Shaen and Meegan, Andrew, "Long-Term Stock Market Volatility and the Influence of Terrorist Attacks in Europe" (August 2017). Available at SSRN: Note, the latter paper is now forthcoming in the Quarterly Review of Economics and Finance.

While explicit testing of spillovers from North Korean uncertainty to global financial markets is yet to be firmly established in empirical literature, it is worth noting that the indirect evidence (based on data similar to S&P blog post) suggests that North Korean threat is likely to have a significant VUCA-consistent effect on the markets.

18/11/17: ECB Induces Double Error in the EU Policy Markets

In economics, two key market asymmetries/biases lead to the severe reduction in markets efficiency often marking the departure from theoretical levels of efficiency (speed, with which markets incorporate new relevant information into pricing decisions of markets agents) and the practical outcomes. These asymmetries or biases are: information asymmetry and agency problem.

For those, uninitiated into econospeak, information asymmetry (sometimes referred to as information failure), is a situation, in which one party to an economic transaction possesses greater knowledge of facts, material or relevant to the decision, than the other party. For example, a seller may know hidden information about a car on offer that is not revealed to the buyer. In more extreme example, a seller might actively conceal such information from a buyer. This can happen when a seller 'prepares' the car for sale by cleaning the engine, thus removing leaks and accumulations of oil and / or coolant that can indicate the areas where the problems might be.

The agency problem, also referred to as principal-agent problem, arises when an agent, acting on behalf of the principal, has distinct set of incentives from the principal. The resulting risk is that the agent will act in self-interest to undermine the goals and objectives of the principal. An example here would be a real estate agent contracted by the seller, while taking a commission kickback from the buyer. Or vice versa.

Occasionally, both problems combine to produce an even more powerful distortionary result, pushing the markets further away from finding a 'true' (or fundamentals-justified) price point.

Today, we have an example of such interaction. As reported in Euractiv, the ECB has denied the EU Court of Auditors access to data on Greek bailout. (Full story here: The claimed justification: banking secrecy. The result:

  1. There is now clearly an asymmetry in information between the EU, the Court of Auditors, and the ECB when it comes to assessing the ECB actions in the Greek bailout(s). The 'car salesman' (the ECB) has scrubbed out information about the 'vehicle' (the bailout(s)) when presenting it to the 'buyer' and is refusing to show any evidence on pre-scrubbed 'car'.
  2. And there is an agency problem. The ECB is an agent for the EU (and thus an agent relative to the principal - the EU Court of Auditors, which represents the interest of the EU). As an agent, the ECB has a contractual obligation to act in the interest of the EU. But as a part of the Troika in the case of the Greek bailout(s), the ECB is also contracted into a set of incentives to act in concert with other players: the sub-set of the EU, namely the EU Commission and the EFSF/ESM funds, and the IMF. At least one of these agents, the IMF, has a strong incentives to avoid transparent discovery of information about the Greek bailout(s) because these bailout(s) have, potentially, violated the IMF by-laws in lending to distressed countries. Another agent, the EU Commission, has an incentive to conceal the truth about the same bailout(s) in order to sustain a claim that the Greek bailout(s) are(were) a success. The third set of the agents (various EU funds that backed the bailout(s)) has incentives to sustain the pretence that the Greek bailout(s) were within the funds' bylaws and did not constitute state aid to the insolvent government.
In simple terms, the ECB refusal to release information on Greek bailout(s) to the EU Court of Auditors is a fundamental violation of the entire concept of the common market principle that overrides any other consideration, including the consideration of monetary policy independence. This so because the action of the ECB induces two most basic, most fundamental failures into the market: the agency problem and the asymmetric information problem, which are (even when taken independently from each other) the core drivers for market failures.

Tuesday, November 7, 2017

7/11/17: 800 years of bond markets cycles

An interesting new working Paper from the BofE, titled “Eight centuries of the risk-free rate: bond market reversals from the Venetians to the ‘VaR shock’” (Bank of England, Staff Working Paper No. 686, October 2017) by Paul Schmelzing looks at new data for “the annual risk-free rate in both nominal  nd real terms going back to the 13th century.”

Such a long horizon allows the author to establish and define the existence of the long term “bond bull market”

Specifically, the author shows “that the global risk-free rate in July 2016 reached its lowest nominal level ever recorded. The current bond bull market in US Treasuries which originated in 1981 is currently the third longest on record, and the second most intense.”

And plotting real debt bull markets (shaded):

Finally, the extent of the current bond bull market (since 1981) relative to previous historical bull markets is reflected also in the extent of yield compression (annualized) that has been achieved during each bull market cycle:

While the rest of the paper goes through three specific case studies of bull markets corrections, it is the first section - the one based on historical long-term data series - that poses the starkest evidence of just how exceptional (and thus risk-loaded) the current markets environment is. Looking at historic averages, and potential for historical mean reversion for yields, the current yield on U.S. 10 year paper will have to double, effectively increasing long-term risk exposure to widening fiscal deficits by the tune of 2.5-2.75 percent of GDP. The cost of carrying this level of indebtedness, when yields run 1.5-1.7 times the upper envelope of the potential rate of economic growth is a function of simple arithmetic. Currently, this arithmetic suggests that the U.S. will either have to figure out how to live with above 5% annual deficits and ballooning debt, or how to live within its own means.

7/11/17: To Fine Gael or not: Employment Stats and Labour Force

Recently, Fine Gael party PR machine promoted as a core economic policy achievement since 2011 election the dramatic reduction in Ireland’s unemployment rate. And in fact, they are correct to both, highlight the strong performance of the Irish economy in this area and take (some) credit for it. The FG-led governments of the recent years have been quite positive in terms of their policies supporting (or at least not hampering) jobs creation by the MNCs. Of course, they deserve no accolades for jobs creation by the SMEs (which were effectively turned into cash cows for local and central governments in the absence of any government power over taxing MNCs), nor do they deserve any credit for the significant help in creating MNCs’ jobs that Ireland got from abroad.

Now, to briefly explain what I mean by it: several key external factors helped stimulate MNCs-led new jobs creation in Ireland. Let me name a few.

  1. ECB. By unleashing a massive QE campaign, Mario Draghi effectively underwritten solvency of the Irish State overnight. Which means that Dublin could continue avoiding collecting taxes due from the MNCs. And better, Mr Draghi’s policies also created a massive carry trade pipeline for MNCs converting earnings into corporate debt in Euro area markets. The combined effect of the QE has been a boom in ‘investment’ into Ireland, and with it, a boom of jobs.
  2. OECD. That’s right, by initiating the BEPS corporation tax reform process, the arch-nemesis of Irish tax optimisers turned out to be their arch blesser. OECD devised a system of taxation that at least partially, and at least in theory, assesses tax burdens due on individual corporations in relation physical tangible activities these corporations carry out in each OECD country. Tangible physical activity can involve physical capital investment (hence U.S. MNCs rapidly swallowing up new and old buildings in Ireland, that’s right - a new tax offset), an intangible Intellectual Property ‘capital’ (yep, all hail the Glorious Knowledge Development Box), and… err… employment (that is why Facebook et al are rushing to shift more young Spaniards and Portuguese, French and Dutch, Ukrainians and Italians, Poles and Swedes… into Dublin, despite the fact they have no where to live in the city).
  3. EU. Not to be outdone by the aforementioned ‘academics’ from Parisian La Defence, the EU Commission helped. It waved in the utterly ridiculous, non-transparent, skin deep in fundamentals, Irish tax optimisation scheme that replaced the notorious Double-Irish Sandwich  - the scheme is the already mentioned above Knowledge Development Box. The EU Commission also aggressively pursued a handful of top MNCs trading from Ireland - Apple, Google, etc. This put more pressure on both the Irish Government and the MNCs to cough up some at least half-credible scheme that would show some sort of tangible business expansion and growth in Ireland.

So the result of all of the above has been a jobs boom in the MNCs-dominated sectors, a boom that soaked up quite a bit of the younger graduates from Irish Universities as well, but also helped to grow indigenous ICT sector in Ireland. The latter soaked up some more graduates. Unemployment fell. employment rose.

If this sounds like Nirvana, it ain’t. Because above the silver lining of the good and strong employment/unemployment numbers there is also a cloud of rather darker hues. That club is the Labour Force Participation Rate.

As Chart above shows, seasonally-adjusted LFP for Ireland stood at 59.8% in 2Q 2017 - matching the lowest recorded levels for the entire 16 years since the end of !Q 2001. And the lowest level in 13 consecutive quarters. Worse, as the chart above clearly shows, the dismal performance of the economy in terms of LFP has been in place since the Great Recession. In other words, all the recovery to-date has not been able to shift Irish participation rate.

Which brings us to the real point of the crisis: the current levels of LFP are much much worse than the comparable headline rates attained in 1999-2000. How? Simple.

  • Unlike in 2000-2001, we have years of net outward emigration (and continued net outward emigration for Irish nationals). This should increase LFP, and yet it clearly does not.
  • Unlike in 2000-2001, we have widening retirement age, not shrinking as was the case in 2000-2001. This too should have supported LFP to the upside. And again, it clearly is not happening.
  • In contrast with the 2000-2001, we also have more students in the third level and above education today. Which, again, should have supported current LFP to the upside relative to the early 2000s. 

And so on… in simple terms, our starting conditions (post-crisis environment) and our demographics all suggest that current LFP is reflective of deeper structural problem than the same LFP reading back in 2000-2001 was.

So, yes, Fine Gael can claim some strong record of improvements in the economy that took place on its watch. But, no, this is not the time to enjoy the laurels. Until such time when more Irish people go back to search for jobs, train for jobs and the LFP rises to 63.2% range (2005-2008 average), it is way too early for us to declare a victory over the Great Recession.

Now, what does 3.4% increase in LFP mean? To keep current rate of unemployment fixed at 6%, that means adding 70,450 new jobs and adding roughly 4,500 new unemployed to the Live Register. What that would take in terms of time? Given the current rate of 17,150 new employment added per quarter over the last 4 quarters, this implies about roughly 13 months of jobs creation.

Of course, attracting the disillusioned folks back into labour force is not as easy. So the more important bit is not whether we can achieve it, but rather, what would it mean in terms of economic policies necessary to achieve it? I expect answers from the various FG departments and may be even some Ministers…