22/10/17: Italian North: another chip off Europe's Nirvana

Having just written about the Czech electoral pivot toward populism last night, today brings yet another  news headline from the politically-hit Europe.

In a non-binding referendums in two wealthiest Italian regions, Veneto and Lombardia, the voters have given local governments strong mandates to push for greater autonomy from Rome and the Federal Government. Both regions are dominated by the politics of Lega Nord, a conservative, autonomy-minded party with legacy of euro scepticism, strong anti-immigration sentiment and the past promotion of outright independence for the Northern Italy.

In both referendums, turnout was relatively strong by Italian standards (58% projected for Veneto and over 40% for Lombardia). And in both, exit polls suggest that some 95% of voters have opted for stronger regional autonomy.

The referendums were not about outright independence, but about wrestling more controls over fiscal and financial resources from Rome. Both regions are net contributors to the Italian State and are full of long run resentment over the alleged waste of these resources. Both regions want more money to stay local.

In reality, however, the vote is about a combination of factors, namely the EU policies toward Italy, the monetary conditions in the euro area, the long-term stagnation of the Italian economy and the centuries-old failure of Italian Federal State to reform the economy and the society of the Southern Italian regions. Italy today is saddled with stagnation, huge youth unemployment, lack of business dynamism, weak entrepreneurship, dysfunctional financial institutions, high taxes, failing and extremely heterogenous public services, collapsed demographics and centuries-old divisions. Some of these problems are european in nature. But majority are Italian.

Greater autonomy for wealthier regions, in my view, is a part of the solution to the long running problems, because it will create a set of new, stronger incentives for the Southern regions to reform. But in the end, it is hard to imagine the state like Italy sustaining its membership in the euro area without an outright federalization of the EU.

In the nutshell, within a span of few weeks, the dormant political volcano of the Europe has gone from stone cold to erupting. Spain, Austria, Czech, & Italy are in flames. Late-stage lava flows have been pouring across Poland, Hungary and the UK, Slovakia and parts of the Baltics for months and years. Tremors in Belgium, the Netherlands, Germany, (especially Eastern Germany) and Finland, as well as occasional flares of populist/extremist activity in other parts of the Paradise are ongoing. And, it is only a matter of time before populism resurges in France.

All of this with a background of stronger economic growth and booming markets. So wait till the next crisis/recession/market correction hits...

7/6/17: European Policy Uncertainty: Still Above Pre-Crisis Averages

As noted in the previous post, covering the topic of continued mis-pricing by equity markets of policy uncertainties, much of the decline in the Global Economic Policy Uncertainty Index has been accounted for by a drop in European countries’ EPUIs. Here are some details:

In May 2017, EPU indices for France, Germany, Spain and the UK have dropped significantly, primarily on the news relating to French elections and the moderation in Brexit discussions (displaced, temporarily, by the domestic election). Further moderation was probably due to elevated level of news traffic relating to President Trump’s NATO visit. Italy’s index rose marginally.

Overall, European Index was down at 161.6 at the end of May, showing a significant drop from April 252.9 reading and down on cycle high of 393.0 recorded in November 2016. The index is now well below longer-term cycle trend line (chart below). 

However, latest drop is confirming overall extreme degree of uncertainty volatility over the last 18 months, and thus remains insufficient to reverse the upward trend in the ‘fourth’ regime period (chart below).

Despite post-election moderation, France continues to lead EPUI to the upside, while Germany and Italy remain two drivers of policy uncertainty moderation. This is confirmed by the period averages chart below:

Overall, levels of European policy uncertainty remain well-above pre-2009 averages, even following the latest index moderation.

28/4/17: Euromoney on Italian Risks

Euromoney article on the continued evolution of the Italian crisis: http://www.euromoney.com/Article/3712913/Country-risk-Italy-is-the-volcano-waiting-to-erupt.html, quoting - amongst others - myself.

12/4/17: European Economic Uncertainty Moderated in 1Q 2017

European Policy Uncertainty Index, an indicator of economic policy risks perception based on media references, has posted a significant moderation in the risk environment in the first quarter of 2017, falling from the 4Q 2016 average of 307.75 to 1Q 2017 average of 265.42, with the decline driven primarily by moderating uncertainty in the UK and Italy, against rising uncertainty in France and Spain. Germany's economic policy risks remained largely in line with 4Q 2016 readings. Despite the moderation, overall European policy uncertainty index in 1Q 2017 was still ahead of the levels recorded in 1Q 2016 (221.76).

• German economic policy uncertainty index averaged 247.19 in 1Q 2017, up on 239.57 in 4Q 2016, but down on the 12-months peak of 331.78 in 3Q 2016. However, German economic uncertainty remained above 1Q 2016 level of 192.15.
• Italian economic policy uncertainty index was running at 108.52 in 1Q 2017, down significantly from 157.31 reading in 4Q 2016 which also marked the peak for 12 months trailing period. Italian uncertainty index finished 1Q 2017 at virtually identical levels as in 1Q 2016 (106.92).
• UK economic policy uncertainty index was down sharply at 411.04 in 1Q 2017 from 609.78 in 4Q 2016, with 3Q 2016 marking the local (12 months trailing) peak at 800.14. Nonetheless, in 1Q 2017, the UK index remained well above 1Q 2016 reading of 347.11.
• French economic policy uncertainty rose sharply in 1Q 2017 to 454.65 from 371.16 in 4Q 2016. Latest quarterly average is the highest in the 12 months trailing period and is well above 273.05 reading for 1Q 2016.
• Spain's economic policy uncertainty index moderated from 179.80 in 4Q 2016 to 137.78 in 1Q 2017, with the latest reading being the lowest over the five recent quarters. A year ago, the index stood at 209.12.

Despite some encouraging changes and some moderation, economic policy uncertainty remains highly elevated across the European economy as shown in the chart and highlighted in the chart below:

Of the Big 4 European economies, only Italy shows more recent trends consistent with decline in uncertainty relative to 2012-2015 period and this moderation is rather fragile. In every other big European economy, economic uncertainty is higher during 2016-present period than in any other period on record. 

20/2/17: The Effect of GFC on Italian Non-Performing Loans Overhang

In yesterday’s post I covered some interesting current numbers relating to NPLs in the European banking sector. And sitting, subsequently, in the tin can of an airplane on my way back to California, I remembered about this pretty decent paper from Banca d’Italia, published in September 2016.

Titled “The evolution of bad debt in Italy during the global financial crisis and the sovereign debt crisis: a counterfactual analysis” and authored by Alessandro Notarpietro and Lisa Rodano (Banca d’Italia Occasional Paper Number 350 – September 2016), the paper looked at the evolution (dynamics) of Italian banks’ NPLs since the start of the Global Financial Crisis and the twin recessions that hit Italy since 2008. Actual data is compared against “the counterfactual simulations". "A ‘no-crises scenario’ is built for the period 2008-2015. The counterfactual dynamics” generate a comparative new bad debt rate, which “depends on macroeconomic conditions and borrowing costs.”

Per authors, “the analysis suggests that, in the absence of the two recessions – and of the economic policy decisions that were taken to combat their effects – non-financial corporations’ bad debts at the end of 2015 would have reached €52 billion, instead of €143 billion."

Chart above plots the evolution of two time series of debt: actual and ex-crisis counterfactual, for non-financial corporates, showing the crisis-related debt overhang of around EUR 90 billion. More precisely: “In the absence of the two crises – and of the economic policy decisions that were taken to contrast their effects – the stock of non-financial corporations’ bad debts at the end of 2015 would have reached €52 billion, instead of €143billion. In the counterfactual scenario, the level at the end of 2015 is only 1.7 times larger than the one observed at the end of 2007; in actual data, the observed level was almost 5 times as large. As a share of total outstanding loans to non-financial corporations, bad debts rose at about 17.9 per cent at the end of 2015; had the two crises never occurred, it would have been around 5 per cent, roughly in line with the pre-crisis level.”

While the numbers may appear to be relatively small, given the size of the Italian real economic debt pile, provisioning on this bad debt overhang would amount to a serious dosh. Per the authors’ and previous estimates, roughly 13 percentage points was lost in Italian GDP (once public debt is accounted for). In other words,  through 2015, Italian economy has lost some 13.5 percent of GDP in potential output due to debt overhang. Of this, near 7 percentage points were lost due to sovereign debt-related losses and 6.5 percentage points due to corporate bad debt overhang.

28/10/16: Rising Risk Profile for Italy

Euromoney Country Risk on Italian referendum and rising risks relating to Euro area's third largest economy:

10/6/16: Italian Manufacturing Capacity post-crisis

A third paper on manufacturing capacity, also from Italy is by Libero Monteforte and Giordano Zevi, titled “An Inquiry into Manufacturing Capacity in Italy after the Double-Dip Recession” (January 21, 2016, Bank of Italy Occasional Paper No. 302: http://ssrn.com/abstract=2759786).

Here, the authors “…investigate the effects of the prolonged double-dip recession on the productive capacity of the Italian manufacturing sector”. The authors “…estimate that between 2007 and 2013 capacity contracted by 11–17%, depending on the method.”

In addition, the authors “…conduct an exercise to quantify the loss with respect to a counterfactual evolution of capacity in a ‘no-crisis’ scenario in which pre-2008 trends are extrapolated: in this case the loss is close to 20% for all methods.”

Summary of the results:

And here is decomposition of the potential output drop by factor of production:

Per authors: “In terms of factor determinants, about 60% of the cumulated drop of potential output in 2007-13 came from labour, while around 25% was attributable to the TFP (Chart above). The reason why the contribution of capital is comparatively small is twofold: first, the industrial
sector is characterized by a large wage share (close to 70%), therefore the contribution of K in the production function is limited; second, capital is a highly persistent variable and the fall in investments recorded during the two recessions, even if remarkably large, has not (so far)
resulted in a dramatic drop of the capital stock.”

The key lessons from all of this are: potential output in Italy fell precipitously across the manufacturing economy in the wake of the Global Financial Crisis. Meanwhile, counterfactual extension of pre-crisis trends was strongly signalling to the upside in manufacturing.

Majority of metrics used suggest that productive capacity in Italy declined by 15-18 percent through 2013, while counterfactual estimates for pre-crisis trend would have implied an average rise of ca 5 percent.

Last, but not least, “Firms producing basic metals, fabricated metal products and machinery and equipment are found to be the ones that were most penalized by the crisis of the last six years; by contrast, sectors that were already shrinking before 2008, such as the manufacture of textiles, appear not to have performed significantly worse during the double-dip recessions than they had in the early 2000s.”

10/6/16: Italian Industrial Production: 2007-2013

Staying with the earlier theme of industrial / manufacturing sector trends, here is a paper from the Banca d’Italia, authored by Andrea Locatelli, Libero Monteforte, and Giordano Zevi, titled “Heterogeneous Fall in Productive Capacity in Italian Industry During the 2008-13 Double-Dip Recession” (January 21, 2016, Bank of Italy Occasional Paper No. 303: http://ssrn.com/abstract=2759788) looks at the two periods of shocks, separated by one period of brief recovery.

Per authors, “between 2008 and 2013 productive capacity was considerably downsized in the Italian manufacturing sector” based on micro data from the Bank of Italy surveys across “the whole 2008-13 period and in four sub-periods (pre-crisis 2001-07, first phase of the crisis 2008-09, recovery 2010-11, and second crisis 2012-13).”

The study main findings are:
i) “losses of productive capacity varied widely across manufacturing sub-sectors with differences in pre-crisis trends tending to persist in a few sub-sectors during the double-dip recession”;
ii) “large firms were more successful in avoiding major capacity losses, especially in the first phase of the crisis”;
iii) “the share of sales on foreign markets was negatively correlated with performance in 2008-09, but the correlation turned positive in 2012-13”;
iv) “among the Italian macro-regions, the Centre weathered the long recession better” (see charts below);
v) “subsidiaries underperformed firms not belonging to any group”; and
vi) “the negative effects on productive capacity of credit constraints, which discouraged investments, were felt by Italian firms particularly in 2012-13”.

Very interesting outrun by region, presented here in two charts:

Some beef on that point: “The decline in [productive capacity] was not evenly distributed across the Italian macro-regions. The macro-regions more exposed to foreign demand were severely hit by the global financial crisis, with [productive capacity] declining by 8.6% in the North West and 7.0% in the North East.” Now, here’s the irony: Italy was (barely) able to sustain long-term Government borrowing on foot of its extremely strong exporters. During the recent twin crises, this very strength of the Italian economy turned against it. Which sort of raises few eyebrows: strong exporting capacity of Italy led the country to experience sharper shock than in many other states. Yet, the core prescription for growth from across the EU members states is - export!; and core prescription for recovery from the status quo main stream economists is - beef up current ace t surpluses (aka, raise exports relative to imports). Italian evidence does not really sound that supportive of these two ‘solutions’…

“During the temporary recovery, the South under-performed the rest of the country, losing 4.0% of its [productive capacity], while [productive capacity] stagnated in the other macro-regions.”

“The sovereign debt crisis affected the entire country more evenly. As a result, between 2010 and 2013 the loss of [productive capacity] in the South (-8.0%) was roughly twice as large as that recorded in the rest of the country (-4.7%)… The gap reflects the within-country heterogeneity in firms’ characteristics : …South Italy has mainly small firms, with an average of 100 employees (roughly constant during the double-dip crisis). Average firm size is larger in the Centre, just below 150, and in the North East, around 180, and even more so in the North West (consistently above 200). …southern regions have smaller export shares (about 20%), which are higher everywhere else (around 35% at the beginning of the sample); the export share shows a positive trend in all macro-regions.” You can see these reflected in the charts above.

In summary, thus, “the degree of foreign exposure helps to explain why the North suffered more during the global financial crisis. Also, the continuing decline of [productive capacity] in the South since 2007 is consistent with the smaller firm size in that macro-area (discussed above) and the larger decline of domestic demand there”.


So the key lesson here is: in the current environment characterised by rising regionalisation of trade flows and weak global demand, the exports-led recovery is more likely to trigger a negative shock to the economy than support economic growth.

Unless you are talking about a country like Ireland, where exports are booming despite global demand slowdown. Which, of course, cannot be explained by anything other than beggar-thy-neighbour tax optimisation policies.

4/5/16: Canaries of Growth are Off to Disneyland of Debt

Kids and kiddies, the train has arrived. Next stop: that Disneyland of Financialized Growth Model where debt is free and debt is never too high…

Courtesy of Fitch:

Source: @soberlook

The above in the week when ECB’s balancehseet reached EUR3 trillion marker and the buying is still going on. And in the month when estimates for Japan’s debt/GDP ratio will hit 249.3% of GDP by year end

Source: IMF

And now we have big investors panicking about debt: http://www.businessinsider.com/druckenmiller-thinks-fed-is-setting-world-up-for-disaster-2016-5. So Stanley Druckenmiller, head of Duquesne Capital, thinks that “leverage is far too high, saying that central banks and China have allowed for these excesses to continue and it's setting us up for danger.”

What all of the above really is missing is one simple catalyst to tie it all together. That catalysts is the realisation that not only the Central Banks are to be blamed for ‘allowing the excesses of leverage’ to run amok, but that the entire economic policy space in the advanced economies - from the central banks to fiscal policy to financial regulation - has been one-track pony hell-bent on actively increasing leverage, not just allowing it.

Take Europe. In the EU, predominant source of funding for companies and entrepreneurs is debt - especially banks debt. And predominant source of funding for Government deficits is the banking and investment system. And in the EU everyone pays lip service to the need for less debt-fuelled growth. But, in the end, it is not the words, but the deeds that matter. So take EU’s Capital Markets Union - an idea that is centred on… debt. Here we have it: a policy directive that says ‘capital markets’ in the title and literally predominantly occupies itself with how the system of banks and bond markets can issue more debt and securitise more debt to issue yet more debt.

That Europe and the U.S. are not Japan is a legacy of past policies and institutions and a matter of the proverbial ‘yet’, given the path we are taking today.

So it’s Disneyland of Debt next, folks, where in a classic junkie-style we can get more loans and more assets and more loans backed by assets to buy more assets. Public, private, financial, financialised, instrumented, digitalised, intellectual, physical, dumb, smart, new economy, old economy, new normal, old normal etc etc etc. And in this world, stashing more cash into safes (as Japanese ‘investors’ are doing increasingly) or into banks vaults (as Munich Re and other insurers and pension funds have been doing increasingly) is now the latest form of insurance against the coming debt markets Disneyland-styled ‘investments’.

18/10/15: Is Ireland a Euro Periphery Outlier? Some Historical Data

How unique is Ireland within the club of euro peripheral countries? Well, historically, rather unique. Alas, sometimes for the reasons not entirely in our favour.

The following are excerpts from the recent ECB paper titled “Fiscal policy adjustments in the
euro area stressed countries: new evidence from non-linear models with state-varying thresholds”.

Quote: “Fiscal policy authorities of Greece, Ireland, Portugal and Spain are shown to have, on average, historically followed a "spend-and-tax" model of fiscal adjustment, where government spending is decided by the political process, and the burden of correcting fiscal disequilibria is entirely left to the tax instrument.”

Of course, ‘historically’ here means over the period 1960-2013 for all countries, with exception of Spain (1970-2013).

But before then, what were the pre-conditions (thresholds) for taking action? “During the 1960-2013 period for Greece, Ireland and Portugal and during the 1970-2013 period for Spain, we find that the threshold estimate for the budget deficit-to-GDP ratio, which led to different fiscal correction regimes, was on average 4.90% for Greece, 5.10% for Ireland, 3.22% for Portugal and 3.12% for Spain.”

In other words, Ireland had the greatest tolerance - over the entire period - for deficits, opting to wait until average deficit as % of GDP would hit above 5.1%, well above Greece (4.9%) and the rest of the peripheral states.

So now, let’s tackle the more recent period, from the start of the Euro: “When considering the period after 1999, this overall picture worsens for Greece and Portugal and improves for Ireland. Moreover, the results for Ireland and Spain are driven by the financial crisis period. In particular for Ireland, the decoupling dynamics of the government spending reflects the support to the financial sector. In fact, when considering the pre-crisis EMU period between 1999 and 2007, the threshold for fiscal adjustment in Ireland and Spain are estimated to be positive; namely, the regime change took place when the budget balance was in surplus. Conversely, the fiscal deficit-to-GDP thresholds estimated at 5.32% for Greece and 4.08% for Portugal remained rather high.”

The above basically boils down to the following: since 1999, growing economies of Ireland and Spain allowed two countries to substantially reverse pro-cyclicality of deficits and significantly reduce thresholds for budgetary actions. This did not happen in Greece and Portugal. While Ireland gets a pat on the back for pre 2007 period, it is hardly unique in this achievement.

But despite the gains of the 1999-2007, things did not change all that much within the structure of deficits and adjustments. So per ECB paper “Looking at the effects of the economic cycle, we find that fiscal deficit-to-GDP ratio was not reduced in Greece, Ireland and Portugal with the improvement in economic activity. Consequently, during the contractionary times, fiscal corrections became more costly, as tax adjustments became a priority in an attempt to restore fiscal discipline.”

In other words, we were not unique in the way we handled the underlying structure of public spending imbalances, despite having substantially reduced the fiscal action thresholds.

But may be during the peak of the crisis we widened up? Indeed, ECB offers some positive evidence in this direction, but it also argues that the same took place in Spain and Portugal. “The results also suggest that during a financial crisis the fiscal deficit-to-GDP threshold was relaxed in Ireland and Spain, while it was reduced in Portugal. By relaxing the fiscal deficit-to-GDP threshold (in an attempt to stave off deep recessionary pressures) Ireland and Spain relied on business cycle improvements to raise tax revenues. Given the tendency by Portuguese authorities to improve the fiscal imbalances during a financial crisis, these figures make sustainability concerns for Ireland, Portugal and Spain less of an issue compared to Greece, in an historical perspective.”

Which, once more, does not really identify Ireland as a ‘unique’ case amidst the imprudent (but learning) peripherals.

“The results …suggest that during a financial crisis the fiscal deficit-to-GDP threshold was relaxed from 5.10% to 6.99% in Ireland and from 3.12% to 4.00% in Spain, while it was reduced from 3.22% to 1.92% in Portugal.” In other words, Irish Government thresholds actually worsened in the financial crisis, albeit most of that worsening is attributable to the Government decision to rescue Irish banks.

Overall, as table below illustrates, Ireland has managed to perform best during 1999-2007 period in fiscal adjustment thresholds terms, while Spain was the overall best performer in 1999-2013 period and over the entire sample.

My handy addition to the chart are red boxes (highlighting worst performers) and green boxes (best performers) when it comes to budgetary adjustment thresholds.

This completes the arguments about Ireland’s alleged uniqueness as an outlier to the group of peripheral states: with exception of the period during which our property and financial sectors bubbles were inflating to unprecedented proportions, Ireland was pretty much a ‘normal’ peripheral state when it comes to fiscal management. Celtic Tiger et al…

So let's hope the latest Budget 2016 does not return us back to the historical record track...

22/7/15: Paging from the Planet Debt...

Ah, good old Europe... Austerity, Reforms, Structural Changes, Improved Competitiveness, Return to Growth... and rising, rising, rising debt.

Per latest Eurostat release (see here), euro area Government debt/GDP levels have hit 92.9% of GDP in 1Q 2015, up on 92.0% in 4Q 2014 and up on 91.9% of GDP in 1Q 2014. Year on year, Government debt rose from EUR9.179 trillion to EUR9.433 trillion.

Of the five most indebted (fiscally_ economies (excluding Ireland, which did not report 1Q 2015 GDP figures):

• Debt fell in the case of Greece by 8.3 percentage points between 4Q 2014 and 1Q 2015 to 168.8% of GDP; 
• Debt rose in the case of Italy by 3 percentage points to 135.1% of GDP;
• Debt fell 0.6 percentage points in Portugal to 129.6% of GDP;
• Debt rose 4.5 percentage points in Belgium to 111.0% of GDP;
• Debt fell 0.7 percentage points in Cyprus to 106.8% of GDP.

Italian debt is now at the highest level since the peak of Inter-war period in the 1920s:

Source: @Schuldensuehner 

Congratulations to the inhabitants of the Planet Debt...

7/6/15: Greece: How Much Pain Compared to Ireland & Italy

Today, I took part in a panel discussion about Greek situation on NewstalkFM radio (here is the podcast link http://www.newstalk.com/podcasts/Talking_Point_with_Sarah_Carey/Talking_Point_Panel_Discussion/92249/Greece.#.VXPx-AJaDJQ.twitter) during which I mentioned that Greece has taken unique amount of pain in the euro area in terms of economic costs of the crisis, but also fiscal adjustments undertaken. I also suggested that we, in Ireland, should be a little more humble as to citing our achievements in terms of our own adjustment to the crisis. This, of course, would simply be a matter of good tone. But it is also a matter of some hard numbers.

Here are the details of comparatives between Ireland, Italy and Greece in macroeconomic and fiscal performance over the course of the crises.

Macroeconomic performance:

Fiscal performance:

All data above is based on IMF WEO database parameters and forecasts from April 2015 update.

The above is not to play down our own performance, but to highlight a simple fact that to accuse Greece of not doing the hard lifting on the crisis response is simply false. You can make an argument that the above adjustments are not enough. But you cannot make an argument that the Greeks did not take immense amounts of pain.

Here are the comparatives in various GDP metrics terms:

4/6/15: Trend-spotting Out in 3 Key Charts

If you want to understand the German (and the Euro area) economy key trend, here are three charts:

Source for all: http://www.pewsocialtrends.org/2015/05/21/family-support-in-graying-societies/#

Combined, these imply one thing and one thing only: Domestic Demand (Investment + Consumption + Government Spending) can be sustained [in theory] over the next decades by just one thing: "Government Spending". In practice, the bad news is: such spending is neither hugely productive, nor feasible in current levels of indebtedness worldwide. Worse [from economic perspective] news: much of this spending will be swallowed by health & end-of-life services that will not be increasing the productive capacity of our societies.

In the mean time, logic of the above two charts implies:

1. Increased build up of external imbalances (current account surpluses in more extremely ageing countries);
2. Increased savings not suitable (due to risk profiles) for private investment (hence higher retail & long-term demand for highly rated bonds and equity, as opposed to higher growth bonds and equity); 
3. Reduced domestic consumption;
4. Heating up tax competition on the side of capturing revenues (as opposed to incentivising higher growth);
5. Growing reliance on 'hidden' taxes (e.g. currency devaluations and indirect taxation) to amplify (1) and (4);
6. Current 'peak productivity' generation (chart 3 above) is screwed on the double, and productivity growth curve going forward is downward-sloping, most likely even if we control for technological innovation.

All six points currently are at play. Draw your own conclusions.

20/5/15: Effects of commuting times on couples’ labour supply

"You’ve come a long way, baby. Effects of commuting times on couples’ labour supply" by Francesca Carta and Marta De Philippis, (Banca d'Italia, number 1003 - March 2015: http://ssrn.com/abstract=2600874) [comments within quotes are mine]"…explores the effects of husbands' commuting time on their wives' labour market participation and on family time allocation. We develop a unitary family model of labour supply, which includes commuting times and household production. In a pure leisure model [model where there is a binary choice: work or leisure; as opposed to work, leisure or work at home] longer commuting time for husbands increases their wives' labour market participation and reduces their own working hours. However, a model that includes household production might determine the exact opposite result."

So far so good for the theory: the paper shows that when the non-principal earner is faced with a choice of either enjoying leisure only or working only, absent household production, the second earner will opt, on average, for work and the principal earner will take less effort in their own work. However, once household production is an option or a requirement (as in the case of, say, a family with children or other dependents), then the secondary earner will more likely opt for staying out of the workforce and devoting their effort to increased household production, while the primary earner will apply more effort in their own work.

That's in theory. But empirical application is a bit less straight forward:  "We then examine the sign of these effects by using data from the German Socio-Economic Panel from 1997 to 2010. Employer-induced changes in home to work distances allow us to deal with endogeneity of commuting times. We find that a 1% increase in a husband's commuting distance reduces his wife's probability of participating in the labour force by 1.7 percentage points, 2% over the mean. Moreover, it increases his working hours by 0.2 hours per week. The average effect masks substantial heterogeneity: lower participation rates are concentrated in couples with children and where the husband has higher levels of education."

17/5/2015: BlackRock Institute Survey: N. America & W. Europe, April

BlackRock Investment Institute released the latest Economic Cycle Survey results for North America and Western Europe:

"This month’s North America and Western Europe Economic Cycle Survey presented a positive outlook on global growth, with a net of 48% of 56 economists expecting the world economy will get stronger over the next year, compared to 52% from previous report. The consensus of economists project mid-cycle expansion over the next 6 months for the global economy. At the 12 month horizon, the positive theme continued with the consensus expecting all economies spanned by the survey to strengthen or stay the same except Canada and Denmark."

Country results 6 months forward compared to current conditions assessment:

Note: (0,0) Corner point denotes Austria, Denmark, Norway, Spain, Sweden and the Netherlands

Country results 12 months forward:

"Eurozone is described to be in an expansionary phase of the cycle and expected to remain so over the next 2 quarters. Within the bloc, most respondents described Finland, Greece and Italy to be in a recessionary state, with the even split between contraction or recession for Portugal. Over the next 6 months, the consensus shifts toward expansion for Italy. Over the Atlantic, the consensus view is firmly that North America as a whole is in mid-cycle expansion and is to remain so over the next 6 months except Canada where the consensus is split between mid-cycle or late-cycle states."

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

1/4/15: H-W Sinn "Europe’s Easy-Money Endgame"

A very interesting op-ed by Professor Hans-Werner Sinn of German Ifo Institute for Project Syndicate: http://www.project-syndicate.org/commentary/euro-demise-quantitative-easing-by-hans-werner-sinn-2015-03

The problem outlined by Professor Sinn is non-trivial.

"...for countries like Greece, Portugal, or Spain, regaining competitiveness would require them to lower the prices of their own products relative to the rest of the eurozone by about 30%, compared to the beginning of the crisis. Italy probably needs to reduce its relative prices by 10-15%. But Portugal and Italy have so far failed to deliver any such “real depreciation,” while relative prices in Greece and Spain have fallen by only 8% and 6%, respectively".

As Professor Sinn notes, there are four possible solutions:

1. "Europe could become a transfer union, with the north giving more and more credit to the south and later waiving it." 
2. "The south can deflate." 
3. "The north can inflate." 
4. "Countries that are no longer competitive can exit Europe’s monetary union and depreciate their new currency."

So here's the problem, correctly identified by Professor Sinn: "Each path is associated with serious complications. The first creates a permanent dependence on transfers, which, by sustaining relative prices, prevents the economy from regaining competitiveness. The second path drives many debtors in crisis countries into bankruptcy. The third expropriates the creditor countries of the north. And the fourth may cause contagion effects via capital markets, possibly forcing policymakers to introduce capital controls".

Now, note: Ireland has opted for the second path. Any surprise we are driving people into bankruptcy in tens of thousands (once current legal queue is taken into account), along with multiple businesses?

But back to Prof Sinn's analysis. Remember the ECB QE? Ok, says Prof Sinn, suppose it delivers on target inflation of just under 2%. What does it mean for internal devaluations in the 'peripheral' Europe?

"If, say, southern Europe kept its inflation rate at 0% and France inflated at a rate of 1%, Germany would have to inflate by a good 4%, and the rest of the eurozone at 2% annually, to reach a eurozone average of slightly less than 2%. This pattern would have to continue for about ten years to bring the eurozone back into balance. At that point, Germany’s price level would be about 50% higher than it is today."

The problem, thus, is an unresolvable dilemma, since with that sort of arithmetic, we are in a tough bind:

• Either Germany runs mild inflation, while the 'periphery' runs outright deflation, allowing - over a painfully long period of time (decade or more) to devalue the imbalances, or
• Eurozone pursues Mr Draghi's objective of 'just under' 2% inflation across the entire Euro area at the expense of Germany (and the rest of the already shrunken 'core').

Do note, I have argued before that deflation in the 'periphery' is not a bad thing, as it allows for the interest rates to remain low (servicing cost of household and corporate debts is lower) and deleveraging of the households and companies to be less painful, while sustaining some domestic demand through increased purchasing power of incomes. So I agree with Professor Sinn's criticism of the ECB QE programme. 

The problem is that this means, as Professor Sinn rightly suggests, continued suppression of demand (the 'austerity' bit).

The choice faced by Europe are ugly. All of them. And there are no guarantees for any of them to actually work. And the cause of this problem is singular: creation of a political currency union. For anyone who says that Greece, Italy, Portugal, Cyprus, Ireland and Spain have caused their own problems, the replies are both simple and complex: 

• The simple one: absent the euro, their problems would have been by now solved by a combination of the old-fashioned defaults and devaluations. 
• The complex one: absent monetary transfers (lower interest rates and ample bank liquidity flowing cross-borders) with the EMU from the late 1990s through 2007, the imbalances generated in the 'peripheral' economies would never have been this large. Which means that the simple reply above would have been even more easy to apply.

27/12/2014: Geography of the Euro Area Debt Flows

The debate about who was rescued in the euro area 'peripheral' economies banking crisis will be raging on for years to come. One interesting paper by Hale, Galina and Obstfeld, Maurice, titled "The Euro and the Geography of International Debt Flows" (NBER Working Paper No. w20033, see http://www.nber.org/papers/w20033.pdf) puts some facts behind the arguments.

Per authors, "greater financial integration between core and peripheral EMU members had an effect on both sets of countries. Lower interest rates allowed peripheral countries to run bigger deficits, which inflated their economies by allowing credit booms. Core EMU countries took on extra foreign leverage to expose themselves to the peripherals. The result has been asset-price bubbles and collapses in some of the peripheral countries, area-wide banking crisis, and sovereign debt problems."

The causes explained, the paper maps out "the geography of international debt flows using multiple data sources and provide evidence that after the euro’s introduction, Core EMU countries increased their borrowing from outside of EMU and their lending to the EMU periphery."

So braodly-speaking, core euro area economies funded excesses. Hence, in any post-crisis rescue, they were the beneficiaries of transfers from the 'peripheral' economies and taxpayers.

Some details.

According to Hale and Obstfeld, "one mechanism generating the big current account deficits of the European periphery could be summarized as follows: after EMU (and even in the immediately preceding years), compression of bond spreads in the euro area periphery encouraged excessive borrowing by these countries, domestic lending booms, and asset price inflation. We further argue that a substantial portion of the financial capital flowing into the European periphery was intermediated by the countries in the center (core) of the euro area, inflating both sides of the balance sheet of the large financial institutions in the euro area core."

So, intuitively, lenders/funders of the asset bubbles should be bearing some liability. And it would have been the case were the funds transmitted via equity or direct asset purchases (investment from the Core to the 'periphery' in form of buying shares or actual real estate assets). Alas they were not. "These gross positions largely took the form of debt instruments, often issued and held by banks. Thus, EMU contributed not only to the big net deficits of the peripheral countries, but to inflated gross foreign debt liability and asset positions for nonperipheral countries such as Belgium, France, Germany, and the Netherlands – countries that all experienced systemic banking crises after 2007."

Debt, as we know it now, has precedence over equity when it comes to taking a hit in a crisis, and debt is treated on par with deposits. Hence, "the tendency for systemically important banks to increase leverage in line with balance sheet size …implied a substantial increase in financial fragility for these countries’ financial sectors."

In the short run, prior to the crisis, leveraging up from the Core into the 'periphery' had a stimulative effect on asset bubbles. "Four main factors contributed to the suppression of bond yields in the European periphery after the introduction of the euro.
- First, the risk of investing in the European periphery declined with the advent of the euro due to investor assumptions (perhaps erroneous) about future political risks, including the possibility of official bailouts.
- Second, transaction costs declined and currency risk disappeared for euro area investors investing in the periphery countries.
- Third, the ECB’s policy of applying an identical collateral haircut to all euro area sovereigns, notwithstanding their varied credit ratings, encouraged additional demand for periphery sovereign debt by euro area financial institutions, which, moreover, were able to apply zero risk weights to
these assets for computing regulatory capital. The EU’s recent fourth Capital Requirements
Directive continues to allow zero risk weights for euro area sovereign debts, even though the borrowing countries cannot print currency to pay their debts.
- Fourth, financial regulations in the EU were harmonized and the euro infrastructure implied a more efficient payment system though its TARGET settlement mechanism."

Crucially, all four factors combined to reinforce each other giving "…core euro area financial institutions a perceived comparative advantage in terms of lending to the periphery, and this would also likely have affected financial flows from outside to both regions of the euro area.

In line with the above, the authors find:
- "...strong evidence of the increase in the financial flows, both through debt markets and
through bank lending, from core EMU countries to the EMU periphery."
- "… that financial flows from financial centers to core EMU countries increased, but predominantly due to increased bank lending and not portfolio debt flows.
- "In addition, …evidence from the syndicated loan market that is broadly consistent with the core EMU lenders having a comparative advantage in lending to the GIIPS."

Net conclusion: "The concentration of peripheral risks on core EMU lenders’ balance sheets helped to set the stage for the diabolical loop between banks and sovereigns that has been at the heart of the euro crisis."

Authors quote other sources on similar: “German banks could get money at the lower rates in the euro zone and invest it for a decade in higher yielding assets: for much of the 2000s, those were not only American toxic assets but the sovereign bonds of Greece, Ireland, Portugal, Spain, and Italy. For ten years this German version of the carry trade brought substantial profits to the German banks — on the order of hundreds of billions of euros ... The German advantage, relative to all other countries in terms of cost of funding, has developed into an exorbitant privilege. French banks exploited a similar advantage, given their major role as financial intermediaries between AAA-rated countries and higher yielding debtors in the euro area.” (From Carlo Bastasin, Saving Europe: How National Politics Nearly Destroyed the Euro, Washington, D.C.: Brookings, 2012, page 10.)

Charts below summarise flows from Core markets to 'peripheral' markets

CPIS is stock of portfolio debt claims from CPIS data in real USD:

BISC is stock of total international bank claims from consolidated BIS data in real USD:

BISL Flow is valuation-adjusted flows of total cross-border bank claims from locational BIS data in real USD:

And conclusions: "Not only did peripheral countries borrow more after EMU; in addition, financial institutions in the core of the euro area expanded their balance sheets to facilitate peripheral deficits, thereby increasing their own fragility. This pattern set the stage for the diabolical feedback loop between banks and sovereigns that has been such a powerful driver of the euro area's recent crisis."

So next time someone says that 'periphery' is to be blamed for the causes of the crisis, send them here. for in finance, like in dating, it takes two to tango…

26/12/2014: Advanced Economies: Public Debt Explosion 2008-2014

Some interesting insight into the legacy of the Great Recession that we are carrying over into 2015. From the start of 2008 through 2014:

• Average increase in gross debt of all advanced economies was 27.2 percentage points of GDP, with a range from a decrease of 21 percentage points for Norway and an increase of 88.5 percentage points for Ireland. Thus, the average annualised rate of increase in government debt over the period was around 3.47 percentage points of GDP with a range of -2.76 percentage points annualised decline for Norway and a 9.48 percentage points annualised increase in Ireland.
• Average change in the gross government debt of the group of countries where debt declined over the crisis was -12.0 percentage points of GDP. There were only 3 countries in this group.
• Average increase in gross government debt of the group of countries with benign levels of increase (levels of increase consistent roughly with offsetting GDP contraction over the crisis period) was 4.8 percentage points of GDP. There were only 5 countries in this group and only two of these were in Europe, with none (at the time of the crisis onset) being members of the euro area.
• Average increase in gross government debt within the group of countries where debt rises were moderately in excess of contraction in the economy was 16.4 percentage points of GDP.
• Average increase in gross government debt within the group of countries with debt increases significantly in excess of economic contraction was 26.6 percent of GDP.
• Average increase in the government debt within the group of countries with severe debt overhang was 60.4 percentage points of GDP, with a range of increases in this group between 41.6% for the U.S. at the lower end and 88.5% of GDP for Ireland at a higher end.

Chart above summarises these facts and also highlights the extent to which Ireland's government debt increases were out of line with experience in all other countries, including Greece and all other 'peripheral' economies.

The average rise in gross government debt across all peripheral economies 2008-2014 was 56.5 percentage points of GDP (excluding Ireland), which is more than 1/3 lower than that for Ireland. Our closest competitor to the dubious title of worst performing sovereign in terms of debt accumulation is Greece, which experienced a debt/GDP ratio increase almost 1/4 lower than Ireland.

And in case you wonder, our Government's net debt position is not much better:

15/12/2014: BlackRock Institute Survey: North America & Western Europe, December 2014

BlackRock Investment Institute released the latest Economic Cycle Survey results for North America and Western Europe:

"This month’s North America and Western Europe Economic Cycle Survey presented a positive outlook on global growth, with a net of 52% of 84 economists expecting the world economy will get stronger over the next year, compared to net 47% figure in last month’s report." Back in October, the proportion was 43% and in September it was 55%. The consensus of economists project mid-cycle expansion over the next 6 months for the global economy - same as in October and November.

"At the 12 month horizon, the positive theme continued with the consensus expecting all economies spanned by the survey to strengthen or stay the same except Finland, Sweden and Norway." Norway featured as an exception in October report and November. Back in October and November reports, expected deviation from stronger trend was also reported for Belgium.

"Eurozone is described to be in an expansionary phase of the cycle and expected to remain so over the next 2 quarters. Within the bloc, most respondents described Finland and Italy to be in a recessionary state, with the even split between contraction or recession for Greece, France and Portugal. Over the next 6 months, the consensus shifts toward expansion for both Finland and Italy." These results were broadly consistent with october and November reports.

"Over the Atlantic, the consensus view is firmly that North America as a whole is in mid-cycle expansion and is to remain so over the next 6 months." Again, this was in line with October and November reports.

 Note: Red dot denotes Austria, Canada, Denmark, Ireland, Spain and Switzerland.

For comparative purpose: October survey mapping 6 months out:

Previous report was covered here: http://trueeconomics.blogspot.ie/2014/10/6102014-blackrock-institute-survey-n.html

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

6/10/2014: BlackRock Institute Survey: N. America & W. Europe, September 2014

BlackRock Investment Institute released the latest Economic Cycle Survey results for North America and Western Europe. Here are the main points (emphasis and comments are mine):

"This month’s North America and Western Europe Economic Cycle Survey presented a positive outlook on global growth, with a net of 55% of 98 economists expecting the world economy will get stronger over the next year, compared to net 59% figure in last month’s report [and 81% in July survey]."

Global outlook: "The consensus of economists project mid-cycle expansion over the next 6 months for the global economy. At the 12 month horizon, the positive theme continued with the consensus expecting all economies spanned  by the survey to strengthen or stay the same except France, Finland and Belgium.

Regional outlook: Euro Area: "Eurozone is described to be in an expansionary phase of the cycle and expected to remain so over the next 2 quarters. Within the bloc, most respondents described Greece, Italy and France to be in a recessionary state [same outcome was recorded back in August survey], with the even split between contraction or recession for Belgium and Finland [in August survey, this applied to Portugal and Finland]. Over the next 6 months, the consensus shifts toward expansion for Greece and Italy [with Italy being a new addition to this list compared to August survey]."

US and North America: "Over the Atlantic, the consensus view is firmly that North America as a whole is in mid-cycle expansion and is to remain so over the next 6 months." [Same result as in August survey].


Two charts to illustrate:

Previous month results are here: http://trueeconomics.blogspot.ie/2014/08/2382014-blackrock-institute-survey-n.html

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.