18/07/2011: Some thoughts on Irish stocks bubble

There is a classic defined relationship between the various stages of bubble formation and markets responses, as illustrated in the chart from (source here) below.

Of course, there is an argument to be made that ‘normal’ bubbles are driven by either information asymmetries or behavioural ‘exuberance’ or both, and are, therefore, significant but temporary departures from the steady state ‘mean’ growth trend. The return to the mean, thus implies the end of the correction phase, as also shown in the chart below.


Of course, one can make an argument that what we have experienced in the case of Ireland is more than a simple bubble, but a structural break underwritten by underlying fundamentals, such as lower permanent rate of growth.

Irish GDP grew 8.82% cumulative in the period 2003-2010 in terms of constant prices or annualized rate of growth of 1.215%. In per capita terms current prices it grew by 14.85% cumulatively and at an annualized rate of 1.998%. Taken from these rates, from 2003 on through today, the average expected value of IFIN should be around 8,898 (mid-point between 8,659 and 9,139 implied by above rates from the ‘Smart Money’ period mid-point valuation). Note that, crucially, the new mean post-bubble bursting should be at least at or above the ‘Smart Money’ end-of-period valuations.

This is certainly not the case with Irish financials as shown in figure below:
Note that three forecasts (my own calculations, so treat as indicative, rather than absolute) provided assume that the average annual growth rate of 1.998% (upper forecast from the starting point at 2003-2004 average), mean forecast (based on 1.215% annualized average growth, starting from 2003-2004 average) and lower forecast (based on 1.215% annualized growth, starting from 2000-2003 average). All three are well above the post-Despair peak.

What about other signs of a classic bubble?
In the run up to the Public Money phase, it is clear that IFIN shows a number of sell-offs and shallow bear traps, but these can be linked to higher overall volatility of the index.

For any period we can take, IFIN exhibits more volatility than either S&P or FTSE bank shares sub-indices. Historically, across indices (to assure comparable scale), IFIN standard deviation stands at 65.40 against S&P’s BIX at 36.84 and FTSE A350 Banks at 32.70. January 2003 through June 2006, IFIN standard deviation was 25.16 against that for BIX of 10.29 and FTSE A350B at 12.07. For the run up to the crisis period between June 2006 and June 2007, IFIN standard deviation was 15.66 against S&P’s BIX of 4.64 and FTSE A350B of 5.22. Lastly, during the crisis – from July 2007 through today, IFIN standard deviation was 56.40 against 28.07 for S&P BIX and 27.83 for FTSE A350B.

To see the relationship, or the lack there of between the volatilities, consider the following chart.
Even from the simple consideration of the rates of change, week on week, IFIN has the lowest correlation with the S&P Banking BIX index – with relatively low explanatory power. Things are even worse if we are to look at the downside risks. Chart below plots downside weekly movements for the three indices that correspond to market declines of 2% or more week-on-week. Again, you can see that both before and during the crisis, there is little relationship between downside risk to Irish financials and to S&P measure.
And the same story is formally confirmed by the Chart below which plots the pair-wise relationships between S&P BIX and FTSE A350 and IFIN.
So overall, IFIN data strongly suggests that we are not in a “normal” financial bubble scenario.

But what about that claim that Lehman's Bros collapse had influence on our banks shares? Recall, Lehman was in trouble since Spring 2008 and went to the wall on September 15, 2008. Also recall that the issues started with Bear Sterns troubles in March 2008 and JPMorgan Chase completed its acquisition of Bear Stearns on May 30, 2008. So let's take the data subset on extreme downward volatility for the period from May 2008 through September 2009. If Lehmans and/or Bear had much of an effect on Irish financials we should expect either one of the following two or both to hold:

1. Correlation between IFIN and S&P BIX to be large and significant
2. Correlation between IFIN and BIX to be larger in the period considered than over the history from 2003 through today.

Overall, evidence suggests that actually the opposite of both (1) and (2) above holds. In fact, based on data for weekly market declines greater than 2% (relatively significant events, but not really too dramatic by far), the period between Bear & Lehman collapse and the next 12 months, Irish financials were less impacted by the US financial shares movements than in the period of 2003-present overall. The impact of Lehmans & Bear on UK financials was stronger, although not dramatically strong, however.

18/07/2011: Two charts on electricity prices

Another look at the residential and industrial prices for electricity across EU27 + 3 (Norway, Turkey and Bosnia candidate states). All information within the charts.

15/07/2011: Irish electricity prices and subsidies

Some interesting data on electricity prices within the EU - the latest is now available from the Eurostat, covering H2 2010. Keep in mind, between 2008 and 2010 we have experienced the largest deflation of overall consumer prices in the Euro area.

In terms of household prices for electricity, 2010 H2 price in Ireland was €0.1875/kWh up on €0.1855/kWh in H2 2009 and down from €0.2033/kWh in H2 2008. Back in H2 2008, Ireland ranked as the 6th most expensive electricity market for households in EU27, plus Norway, Turkey, and Bosnia & Herzegovina (let's call these EU27+3 for brevity hereinafter). The ranking improved to 7th most expensive in H2 2009 and to 9th in H2 2010. Chart below (arranged in order of increasing cost for H2 2010) illustrates.
Small, but progress: over 2 years overall decline was 7.8% in average prices.

Next, the cost of electricity for industrial users: In H2 2010 Irish electricity prices for industrial users averaged €0.1131/kWh down from €0.1419/kWh in H2 2008 and down on €0.1175/kWh in H2 2009. So the decline in the industrial electricity prices over the same period of time was almost 3times larger than for households - 20.3%.
Why? One reason - taxes. Our Government, incapable of creating a level playing field for investment and entrepreneurship has made a conscious choice to shift tax burden from the shoulders of producers/employers onto the shoulders of employees/households. Hence, as with income tax and other taxes, business taxes are kept lower for electricity than for households.

Before taxes are added, Irish household electricity cost was 0.1629 in H2 2010, which was 44.9% above the comparable pre-tax price for industrial users. Now, suppose this premium was justified by higher transmission costs to the households. And do note that Ireland and France are the only two countries that do not report break down of final prices by generation and transmission. For all other countries, network transmission costs account for about 42.15% on average of the total pre-tax price of household electricity in H2 2010. But here comes a tricky thing. After taxes are factored in, final price premium for electricity paid by households over and above industrial users rises to 65.8%.

What's the 20.85% tax wedge on the premium about? Most likely - a subsidy from the households to industrial users, cause, you know, to be competitive we have to charge someone to subsidise someone else... Although the subsidy is a sort of Pyrrhic victory, you see, since even with this transfer, Irish industrial users face the 6th highest electricity tariff in the EU27+3 in H2 2010, same as in H2 2009, but an improvement on the 4th highest in H2 2008.

Let us say thank you to the Social Partners and CER who work this hard protecting our consumers' interests.

12/07/2011: Irish Tax Rates in International Perspective - Part 2

More tax comparatives, courtesy of OECD dataset. Note, these refer to 2009 tax returns.

In the previous post (here), I provided some assessments of the overall taxation burden in Ireland compared to EU27, plus Norway, Israel and Switzerland. Now, let's look at components of the total taxes.

First - taxes on production:
What this chart above tells us is that we are not distinct from the sample average in terms of our taxes on production expressed as a function of GNP, while we are below average when expressed in terms of GDP:

• Total production and imports tax revenues in Ireland stood at 14.0% of GNP and 11.5% GDP in 2009. Sample average stood at 13.1% (median 13.0%) and +/- 0.5 STDEV band is (11.0, 14.4). So Irish taxes on production and imports as a share of GNP were above sample average. Again, for comparison : Switzerland was at 6.8% of GDP, while Sweden at 19.0%.
• Total production and imports tax revenues are broken down into Taxes on Products, and Other Taxes on Production. Taxes on Products in Ireland yielded 12.4% of GNP and 10.2% of GDP against sample average of 11.6% (median 11.3%), with +/- 0.5 STDEV band around the mean of (10.6,12.7). Again, Irish tax yields here were within the band when expressed in terms of GNP and below the mean when expressed against GDP. Other Taxes on Products (other than Vat, Import Duties and direct taxes on products) accounted for 1.3% of GDP and 1.6% of GNP - against the mean of 1.5% and the +/- 0.5 STDEV band of (0.9,2.1). Neither GDP nor GNP comparative here was out of line with the mean.
• Taxes on Products mentioned above can be further broken down into Vat, Taxes & Duties on Imports (ex-Vat), Taxes on products ex-Vat & Import taxes. VAT in Ireland in 2009 accounted for 6.4% of GDP and 7.8% of GNP. Sample average here was 7.3% with +/- 0.5 STDEV band around the mean of (6.6,8.0), median of 7.4, which means that Irish Vat receipts were in line with the sample average in terms of GNP, but below the mean in terms of GDP. In terms of Taxes on products ex-Vat & Import taxes, the same picture holds. In terms of taxes and Duties on Imports ex-Vat, Irish receipts were above the mean (statistically significantly) for both GDP and GNP measures.
  

Next, Irish Times / ESRI / Trade Unions' favorite taxes on Income and Wealth:
Remember, we allegedly have very low taxes on these and more needs to be extracted out of the 'Irish rich' :

• Total current taxes on income and wealth in Ireland stood at 10.7% of GDP and 13% of GNP. This compares against the sample average of 11.9% of GDP (median of 10.8%) with +/- 0.5 STDEV band around the mean of(9.3, 14.5). In other words, our taxes were slightly (but statistically insignificantly) above average in terms of GNP and also slightly (and again statistically insignificantly) below average in terms of GDP.
• The above can be broken down into Taxes on Income, and Other Current Taxes. Taxes on income yielded 12.5% of GNP and 10.3% of GDP. Both are within sample average range: sample average was 11.3%, +/- 0.5 STDEV band around the mean was (8.8,13.8) and median was 10.4%. Other current taxes were small at 0.4% of GDP and 0.5% of GNP, but also within the range of the mean of 0.6% of GDP.
• Capital taxes came in within the mean range in terms of both GDP and GNP comparatives.
• Total income tax related receipts and capital taxes accounted for 22.4% of GDP and 27.2% of GNP in Ireland in 2009. The sample average was 25.2% and the median was 24.4%. +/- 0.5 STDEV band around the mean was (22.0, 28.5), which means that our income and wealth taxes were solidly within the range of the mean for both GDP and GNP measures. An interesting coincidence - Swiss and Netherlands' taxes in this heading were bang on identical as a function of GDP to ours.
  

Social Contributions taxes:
Now, keep in mind that social contributions are meant to pay for social protection services. For which we, in Ireland, should have lower demand than in other states of EU due to younger population, but the demand on social welfare side does offset this due to a spike in unemployment. Social protection taxes in Ireland have also been dramatically increased in Budget 2011 - not reflected in the data above.

• Social Contributions is the largest component of the tax receipts here, with Irish contributions accounting for 7.0% of GNP and 5.8% of GDP. The mean was 10.6 and the median 11.2, while +/- 0.5 STDEV band around the mean was (8.7,12.5). This means Irish Social Contributions overall were below the mean in terms of GDP and GNP.
• Let's take a look as to why. Our Employers' contributions (at 3.3% of GDP and 4.0% of GNP against the mean of 6.3% and band of (4.9, 7.7)) fell short of the mean in terms of GDP and GNP. The same was true for our Contributions by self- and non-employed (o.2% of GDP and GNP against the average of 1.1% with the median of 0.7% and the band of (0.6, 1.6)).
• The above 'below average" performance was offset slightly by the Employees Contributions which came in at 2.3% of GDP and 2.8% of GNP against the mean of 3.2% with the median of 3.1% and +/- 0.5 STDEV band around the mean of (2.4, 4.1). In other words, our Employees Contribution is within the average for GNP metric, but below the average for GDP metric.

So now on to the overall tax burden in this economy. As highlighted in the previous post, our total tax revenue stood at 35.9% of GNP and 29.6% of GDP. The average for the sample was 36.5% against the median of 35.9%. The +/- 0.5 STDEV band around the mean was (33.5, 39.6) which means that our overall tax burden

• expressed as a function of GNP was bang on with the median, and statistically indistinguishable from the mean;
• ex pressed as a function of GDP was statistically significantly below the mean.
  

Again, folks, the data above shows that by virtually all comparisons, we are a country with average tax burdens - not a low tax economy.

11/07/2011: Real value of the Euro and Irish trade

A new paper from IMF looks at the effects of Euro currency valuations and the effect on competitiveness-trade links for trade within the Euro area and for trade outside the Euro area. The study, authored by Tamim Bayoumi, Richard Harmsen and Jarkko Turunen and titled Euro Area Export Performance and Competitiveness is available from the IMF as a working paper from June 2011, IMF WP/11/140.

The main issue assessed is: "Concerns about export growth within the euro area peripheral countries due to a lack of competitiveness within the euro area are a key policy issue."

The main results are:

1. Long-term price elasticities for exports within the euro area are at least double those for exports outside euro area. In other words, exports outside the euro area are much less responsive, in the long term, to price changes than exports within the euro area. Which, of course, is good news for countries with diversified direction of exports. Ireland is a relatively good performer here, as we re-exports to the US, UK and as our exports to the rest of the world are also growing.
2. (1) above means that traditional real effective exchange rate indexes may overstate the effectiveness of euro depreciation in restoring exports growth in the euro area periphery. Specifically, the study shows that Real Effective Exchange Rate metrics of competitiveness yield highly volatile effects on countries exports. Wholesale Price Indices-based measures provide a better metric for competitiveness within the Euro area and poorer metrics for competitveness for exports outside the euro area. Unit Labour Cost-based competitveness metrics too perform best for trade within the euro area, but are signifcant performance metrics for outside the euro area exports as well. (Note - in my own analysis on this blog, I use consistently only ULC-based metrics). Finally, CPI-based metrics are yeilding totally counter-intuitive results and represent the poorest metric.
3. So, per (2), the pace of deterioration in exports due to appreciation of the euro, depends on the measure of relative prices used.

In particular, the four REER indicators for the peripheral countries "give only partial support to the much-discussed view that external competitiveness deteriorated significantly since the adoption of the euro became likely enough that interest rates started to narrow":

• In Ireland, the CPI-based REER has appreciated by about 20 percent since 1995, while the WPI- and ULC-based REERs have depreciated by about 20-30 percent over this time period.
• Portugal shows similar divergences.
• While Italy’s competitiveness does appear to have eroded, the size of this effect is, frankly, anyone’s guess—while the CPI- and WPI-based measures show only modest appreciation since 1995, the ULC- and XUV-based indicators have appreciated by about 50 and 110 percent, respectively.
• The data for Greece and Spain show a more consistent story, involving steady appreciation of some 10-40 percent on all four measures.

You can read the charts below just as you read my charts on Harmonized Competitiveness Indicators: higher values mean bad things. Higher REERs in the second figure reflect export-related REERs for wthin and outside the Euro area trade.

Figure 1. Real Effective Exchange Rates in Euro Area Countries, 1995 to 2009 , Index 1995 = 100

Figure 2. Real Effective Exchange Rates in Euro Area Countries: Intra/Extra-Euro Area, 1995 to 2009, Index 1995 = 100

"There is surprisingly large variation across our four measures of extra- and (in particular) intra-euro area relative prices—based on wholesale prices, consumer prices, unit labor costs, and export unit values. For some countries, such as France and Ireland, the picture becomes clearer if one ignores the CPI price series that generate unconventional results".


All together, a very interesting study which suggests that in particular for Ireland, intra-Euro area trade has been consistent with continuously depreciating Euro, while extra-Euro trade is consistent with consistently appreciating Euro. Since exports within Euro area are more price-sensitive than exports outside Euro area, this clearly explains, at least to some extent, why nominally appreciating Euro (in Forex markets) had so far little adverse effect on Irish trade outcomes: we benefit from effective real devaluation within the Euro zone and are not signficantly hurt by effective euro appreciation outside the Euro area.

11/07/2011: A simple guide to an EU bailout

How EU countries go bust - a Simple 13-steps Guide for Asking for Bailouts:

Stage 1: Deny the problem (debt/deficit/banks - or all three) exists
Stage 2: Blame the Markets (ban short selling 'speculation' and condemn irresponsible profiteering)
Stage 3: Announce first round of cuts to purely "increase markets confidence" (no need to actually want to implement them)
Stage 4: Deny again that problem exists ("Our resolute measures - stage 3 - have resolved the problem")
Stage 5: Claim your country is not like Portugal/Greece/Ireland/Iceland
Stage 6: Announce a turnaround in the economy's prospects (or the imminent arrival of one)
Stage 7: Blame domestic 'doomsayers' for 'turnaround' being delayed
Stage 8: Announce more fake/ineffective/unimplemented austerity
Stage 9: Claim solvency for the next 6-9mo ("We are pre-funded for... months")
Stage 10: Ask Ohli "Imagineerer" Rhen / Grabosso / Lag(behind reality)arde / Frumpy von Rompuy to confirm Stages 4, 5, 6, and 9 announcements during a trip to your country
Stage 11: Send a motorcade to the airport to meet ECB/IMF team and Ask for a Bailout.

Post Bailout:
Stage 12: Blame ECB/IMF/EU/Markets/Rating Agencies for collapse of your economy
Stage 13: Repeat from Stage 4 through 10 to arrive at Bailout-2...