Monday, July 16, 2012

16/7/2012: IMF Fiscal Monitor Update - Ireland

IMF just published its Fiscal Monitor Update for July 2012 with some interesting data. I will focus here on forecast changes and updates to Advanced Economies, including Ireland.

 Chart above shows changes in the cyclically adjusted fiscal balances (structural deficits) which clearly highlight Ireland as a relative laggard in the fiscal adjustment process. Despite this, IMF concludes in the case of Ireland that:

Not exactly time to grab champagne yet... In its Table 1 IMF supplies Fiscal Indicators for the countries for 2008-2013 period, inclusive of revisions from April 2012 report to July 2012 report. And I plotted these in the charts below:

First chart covers Overall Fiscal Deficits for 2011, 2012 and 2013 per latest (July 2012 forecasts):


Clearly, Ireland had the worst fiscal deficit in 2011 of all EA17 states covered by the IMF update.  But we are also expected to post the worst deficit in 2012 and 2013.

Adding insult to injury, chart below shows that IMF downgraded our deficit cutting prospect for 2013 by 0.2 ppt, which is the worst case (on par with Spain) of a downgrade for an EA17 state covered. Note: we did get an upgrade from April to July forecasts for 2012 results.


Let's take a look at Cyclically-Adjusted Deficits measured as % of potential GDP (aka structural deficits):


Again, per chart above, Ireland had the worst EA (covered states) cyclically-adjusted deficit in 2011, followed by the expected worst deficits in 2012 and 2013. We posted the second worst downgrade for 2013 forecast (Spain was first). As before, we got an upgrade on cyclically-adjusted deficit forecast for 2012 - which is good news.


Now, what about that fabled Irish leadership in austerity? Chart below shows the depth of structural deficits reductions from 2009 through 2012 (forecast consistent with July update):


It turns out, per chart above, that our championship in austerity is really behind that of Greece (-14%),  Portugal (-6.7%) and Spain (-4.7%).

And the really worrisome update is reserved for Government debt levels. Back two years ago I predicted that Irish debt/GDP ratio will top over 120% marker. Back then, I was criticized for this because an army of our 'green jersey' economists and commentators decided that 120% is a magic number we will never reach. The reason for their ardent defense of this imaginary line in the sand is that they bought into the ECB and EU line that 120% is 'sustainability bound' for public debt. Of course, I never aligned with the idea that 120% debt/GDP ratio is a magic 'sustainability bound'. But, now, take a look at chart below:


Per IMF latest forecast, Ireland's 2012 Government debt will reach 117.6% of GDP (up on 113.2% forecast for 2012 back in April) and in 2013 it will peak at 121.1% of GDP (up on 117.7% forecast for 2013 back in April).


Note that for all our efforts, our Government debt/GDP ratio will be relatively close in 2013 to that of Italy (126.4% of GDP) and above Portugal (118.6% of GDP).

Pretty ugly.

Friday, July 13, 2012

13/7/2012: CERN and Other 'Alternatives'

There is an interesting debate going on right now in Ireland about our membership in CERN project.

The debate is exemplified by some claiming that Ireland funds 'other' programmes of similar expenditure magnitude and therefore, we can fund CERN membership as well. Here is one example, just for illustrative purposes (not to pick on the specifics, but to illustrate):


This type of an argument is doubtful at lest on 3 fronts: 

  1. It assumes that €20mln on methadone support (other programme) yields lower value 4 money than CERN membership. Which is unproven. I am yet to see a feasibility study for:
    • CERN membership 
    • Methadone support withdrawal
    • Comparative between two actions
  2. It assumes that CERN membership will return 'jobs & science' for Ireland. Which is unproven & not supported by any assessment, as far as I know. I place tremendous value on science, especially on primary science. Primary science is supported by CERN with some promises (note - promises) of applications. However, Ireland has many other, and arguably potentially more pressing needs for financing in science. Perhaps, to support physics and other primary fields relating to CERN, an alternative to CERN membership can be developed via collaborative research or 'partial' (per-project) membership? If we have brilliant ideas to be tested at CERN, surely German or French or UK etc researchers would love to co-author with our physicists on these? If no, something is deeply amiss in the field.
  3. It assumes that we have a choice between supporting methadone dispensing (other spending lines) and supporting CERN. This is only true if the two spending alternatives presented are comparable ones in terms of social and public safety goods and economic returns. I doubt there is any evidence to support this either.
In short, yes, there is plenty of spending waste in Government programmes, including in sciences and public health. No, this does not mean we should simply swap one programme for another because they 'spend similar' amounts. But, yes, we need serious assessments of potential membership in CERN.

Thursday, July 12, 2012

12/7/2012: Wealth taxes - coming up next to Europe near you...

And so wealth taxes (on those who are not all that wealthy, in fact) is a matter of EU-wide policy now, thanks to Schauble: link here and here. Note, the idea is to tax property assets in excess of €250,000 - with an additional one-off levy of 10% on top of other taxes and presumably, as per talk in one of the links about 'capital taxes' other assets can be included. And the original source for the grand idea is here.

Thus, the logic goes, you've saved for the retirement (which requires at least as much in provisions as the tax bound) and you are not a drag on social pensions system. Off you go, pay up...

One question - what happens if two years from now property values drop and your property 'wealth' declines to below €250K... do you get a refund?.. Question two - what happens when tax is levied and as the result, property markets go into further contractions, forcing question one above to the forefront?.. Question three - what happens in the long run when taxes have depleted not only disposable (investable) incomes, but also investable (and largely illiquid) wealth - do pensions provisions go up?.. do Governments step in to provide cheap capital for investment?.. does Schauble and his friends drop their own pensions demands to compensate economy for €230 billion they've sucked out of investment pool?..

Idiots squad has never been so much enforced in Europe as today.

Saturday, July 7, 2012

7/7/2012: Banking union - a bit of a folly

Daniel Gros makes a cogent argument on banking union at vox.eu : http://bit.ly/L0tmUR

However... his argument is partially self-defeating.

Unified banking operations for an Italian bank with german subsidiary he uses as an example, by allowing transfer of liquidity (funds / deposits) from German subsidiary to cover Italian parent's liquidity demand that arises from Italian bank's overall elevated riskiness would be, in effect, a case of mis-pricing risk for German customers of the Italian bank. Should these customers re-price risk post-banking union, the customers will walk out of the subsidiary and the Italian parent bank will still be short of liquidity.

Thus, unless Italian bank is made a German bank (or until), the problem will remain. The only way for the supervisory authority to avoid the problem arising in the short run is by deceiving German customers of the Italian bank.

In addition, in order to make an Italian bank into a German bank, common supervision will require full convergence of all banking models to a common denominator. Whether such a convergence yields a better Italian bank (by the standards of the day) and / or a less safe German bank is a matter of more than supervision, but of a full regulatory convergence.

Tuesday, July 3, 2012

3/7/2012: Curb your enthusiasms?

So, the NTMA have issued a (welcome) note that Ireland is to resume auctions of T-bills. The note states that "on Thursday 5 July 2012. The NTMA will offer €500 million of Treasury Bills with a three-month maturity in its first such auction since September 2010." 



The details of the auction on 5 July are as follows: 
• Auction size: €500 million. 
• Maturity: 15 October 2012. 
• Auction opens: 9:30 a.m. 
• Auction closes: 10:30 a.m. 
• Settlement date: 9 July 2012. 

This is potentially (pending results of sale, namely yield, volume and percentage allocation to non-captive banks and funds) a minor positive for Ireland. Minor, because:
  1. Bills are NOT bonds - bills are short-term instruments, traditionally under 12 months maturity (bonds are over 1 year maturity).
  2. Bills issued currently fall to mature within the period of existent EFSF funding programme, so in effect there will always be funds to cover these, short of a catastrophic collapse of the euro during the duration of the bills.
  3. Issuance of bills has nothing to do in terms of signaling the state of public finances health or economic conditions health of the issuer, as both Greece (see here) and Portugal (here) have issued these during their tenure in the rescue programmes.
  4. Portugal issuance (linked above) covered 18-mos bills, which would constitute a stronger positive signal than that of planned Irish sale, if there was any whatsoever informational content to these auctions.
  5. Ireland has issued T-bills back in September 2010, and then it was NOT a signal of any confidence in Ireland's financial health.
The media statements that this sale shows that 'Ireland is back to bond markets' is fully incorrect. T-bills market is not the same as bond market. And T-bill instruments are distinct from the bonds. For example, T-bills were not covered by PSI default in Greece, unlike bonds.

Funding public spending via T-Bills is a (marginally?) riskier undertaking for the Exchequer because it implies transfer of any potential maturity mismatch risk onto the Exchequer. Maturity mismatch risk arises when the Government uses short-term debt to finance longer-term spending commitments.

So what is the 'positive' then in NTMA news? For now - just a hope we do not get a complete rejection (which is highly unlikely, as NTMA has primed the market already). We need to see results of the auction to tell if things are positive or not - e.g. how high is the demand from outside Ireland? how expensive is the funding obtained compared to secondary bonds markets on shorter maturity end? etc.

H/T for some of the above to: Prof Karl Whelan, Prof Brian M Lucey, Owen Callan (Danske Markets)

Update:  There is a nagging question begs asking - why does Ireland need T-bill? Portugal and Greece might have used T-Bills to manage expenditure in the interim of disbursals of EFSF funds, which, especially for Greece this year, have been uncertain. Ireland is fully compliant with Troika requirements and is getting its money on schedule, with no uncertainty. In effect, therefore, either we are facing a shortfall on funding within the programme (unlikely in my view) or we are using T-bills (more expensive money raising) to finance that which we can finance at cheaper rates via Troika funds. The latter option is double-daft as the repayment of T-bills will be done out of the same Troika money. In this latter case, of course, the motivation can be to simply 'generate feel-good news' by the Government that 'Ireland is back to the (bond) markets'...

Monday, July 2, 2012

2/7/2012: Sunday Times 24/06/2012: Pharma Cliff is Here

This is an unedited version of my Sunday Times article from June 24th.


Since the beginning of this crisis back in 2008, Irish Governments have been quick to point to our exceptional and exemplary trade performance as the sole hope for the recovery. As we know, five years into the crisis, that recovery is still wanting. However, our exports have expanded significantly.

The latest Irish trade in goods statistics, released this week by the CSO and covering the period through April 2012 come on foot of the last week’s release of the more detailed trade statistics for Q1 2012. Both are presenting an alarming picture.

April 2011 Stability Programme Update (SPU), the official Government report card to the Troika, envisioned exports growth of 6.8% in 2011 and 5.7% in 2012. Budget 2012 revised 2011 exports growth estimate to 4.6%. By April 2012 – the latest SPU publication – actual 2011 growth outrun was 4.1%, down a massive 2.7 percentage points on a 9 months-ahead forecast from April 2011. April 2012 SPU also revised 2012 projected exports growth to 3.3%. More realistic IMF is now projecting exports growth of 3.0% this year as per its latest Article IV report on Ireland released last week.

As poor as the above prospects might be, the reality is even more alarming. For trade in goods only, January-April 2012 period total volume of imports was down 7.2% on the same period of 2011, while the volume of exports was down 0.9%, not up 3.3% as forecast in the Budget and the latest SPU. So far, average rate of growth in exports in the first four months of 2012 is -0.6%, down from the same period 2011 average growth rate of 7.4%.

Our trade surplus in goods is up 7.7%, but that is due to the fall-off in imports, especially in Machinery and Transport Equipment and in Chemicals and Related Products categories. The decline in imports, while boosting temporarily our trade balance, can mean only two possible things: either imports will accelerate much faster than exports in months ahead as MNCs rebuild their diminishing stocks of inputs, or MNCs will cut back their exports output even further. Either way, there will be new pressure coming from the external trade side.

The latest decreases in exports are driven by the rapid shrinking of two sub-sectors.

In the first four months of 2012, Medical and Pharmaceutical Products exports have fallen to €7.93 billion from €9.01 billion a year ago – a decline of almost 12%. And this trend is accelerating with 21% drop in April 2012 compare to 12 months ago. The patent cliff, or in common terms, production cuts as drugs go off patent, is now biting hard with blockbuster drugs, such as Lipitor and Viagra either going or scheduled to go soon into competition with generics.

Organic Chemicals have also shrunk in April compare to a year ago, although the first four months of the year exports are still up on 2011.

These two sectors are the giants of Irish exports. In 2010, exports of Medical and Pharmaceutical Products and Organic Chemicals accounted for 49% of our total shipments of goods abroad. By 2011 this number rose to 50%. At the same time, in 2010 and 2011 the two sectors trade surplus (the difference between the value of exports and imports) was close to 88% of our total trade surplus in goods. So far, in the first 4 months of 2012, the same holds, with two sectors contribution to trade surplus now reaching above 95%.

Given the on-going contraction in the sectors activity revealed in April data, and given steady, even rising, share of their contribution to our overall trade in goods, one has to ask a question as to why other sectors of exporting activity are not taking up the slack created by declining pharma sales?

The answer is, unfortunately, as worrying as the stats above.

Since about 2007, when the effects of the upcoming patent cliff started to feed into the decision makers’ diaries, Irish trade development and FDI policy has shifted in the direction of promoting bio-pharmaceutical and biotechnology investment and trade. Much hope was placed on these two sectors stepping up to the plate to replace revenues that were expected to be lost in the pharma sector.

These are yet to bear fruit and, given the accelerating competition worldwide for biotech business and investment, our time maybe running out. The main obstacles to the bio-pharma and biotech sectors development here in Ireland are regulatory, policy and institutional.

One key focus of biotechnology sector research pipeline worldwide is on stem-cell research – the area restricted in Ireland by the lack international (rather than national) standards. The same applies to a number of other areas of R&D intensive sector. Analysis by Pfizer, published two years ago, spelled exactly why Ireland is not at the races when it comes to clinical research, an area that covers huge R&D related spends of major pharmaceutical and biotech companies. We lack competitiveness in terms of providing unified and transparent research infrastructure, absence of a systemic ‘knowledge-sourcing’ opportunities, protracted and unpredictable research approval and trial processes, high cost of sourcing patients for trials, cost and bureaucratic burden relating to regulatory inspections and compliance, and lack of PR and communications platforms that can be used outside Ireland.

Back in 2010, the Research Prioritization Steering Group was set up to review priorities for Ireland’s research funding. Published this March, the Group report marks a significant departure from the previous funding approach for bio-medical sciences, re-focusing funding toward commercialization and jobs creation, away from ‘pure’ science and early stage research. This shift in the approach is both radical and reflective of the realities in the biotechnology and other core high technology sectors to-date. During the previous decade, the state spent €7.3 billion on R&D supports under Government Budget Appropriations or Outlays on R&D, helping to employ some 340 PhDs and 171 non-PhD researchers in the state sector alone in 2010 (down from 431 and 197, respectively in 2008). Yet there is preciously little in terms of exports generation that came from these programmes, and today Ireland has no serious indigenous or FDI-supported start-ups culture in bio-pharma or modern medicine and healthcare.


As competition for the sector investment heats up, and as MNCs-led pharma exports continue to shrink, Ireland needs to move fast to create institutional and regulatory systems that can make us attractive to biotech firms. One simple step would be to reinstate a national bioethics council and integrate organizational systems relating to biotech R&D. The role of the Government’s Science Advisor should become more assertive, outputs-focused and linked directly to providing better information to the Government and policymakers on both the strategic aspects of R&D policies and actual outcomes. Alongside, we need to put in place systems for better assessment of returns on investment in R&D as well as processes that would allow us to act on such evaluations. If entrepreneurship and jobs creation were to become core objectives for R&D backing, we should consider merging commercialization functions of the Science Foundation Ireland with exports development capabilities of the Enterprise Ireland. This should leave SFI dealing solely with pure research, reducing duplication in the system of commercialization supports.

The latest trade figures, taken on their own, should sound an alarm bell in the corridors of power.





Box-out:

In an economy that is importing pretty much everything it uses for capital investment, having an investment ‘stimulus’ is equivalent to taking each euro of Government spending and sending over a half of it abroad – in aid of imports manufacturers in Germany, France, the UK and further afield. The end result of such a transaction would be a gross gain to the economy from employing lower-skilled domestic workers installing imported capital, minus the value of imports, plus the returns to the installed capital. Given the low value-added of low skilled labour, the net result would most likely be a loss to the economy due to close-to-zero returns on the above transaction and high cost of financing such a stimulus in the current funding conditions. In Ireland, the above negative return is likely to be increased further by the politicized nature of our public ‘investments’. Thus, in my view, the ESRI is correct in its assessment, published this week, of the undesirability of a fiscal stimulus in the current conditions. Minister Howlin, in his response to the ESRI arguments claimed that “…the social imperative of getting people back to work is … a far more important [priority] in the current climate.” His statement betrays disdain for evidence and economic illiteracy of frightening proportions. The Government should not and can not be in the business of wasting people’s resources, including the resources of the unemployed taxpayers, on feel-good ‘policies’. Yet Minister Howlin disagrees, even when the wastefulness of his own belief is factually evidenced by research. The Government should have economically sensible programmes for dealing with the curse of long-term unemployment. These, however, should not come at the expense of creating apparent waste.

2/7/2012: One brutal Monday

Brutal beginning to the week in terms of economics data:


(via ZeroHedge) and

(via Reuters)

2/7/2012: 16 issues with ESM 'deal'



This is the second post for this blog on the latest Euro area ‘deal’ struck early morning last Friday – the ‘deal’ that is thin on details (see statement here http://trueeconomics.blogspot.ie/2012/06/2962012-deal-preliminary-reaction.html) and even thinner on actual commitments (as in ‘new commitments’ not ‘repeated old commitments’).

(1) The core ‘commitment’ in the deal is the possibility that – once “effective single supervisory mechanism is established” (which may or may not take long – depending on whether the already existent EBA structure can be seen as ‘effective’ and whether it can be enhanced with real supervisory powers to oversee EA17 states, who are yet to agree such enhancements and such oversight) “the ESM could, following a regular decision, have the possibility to recapitalize banks directly” (so on top of establishing a common supervisory structure and endowing it with sufficient powers, the member states are yet to endow ESM with ‘regular decision’ powers to recap banks).

Assuming that such possibility is indeed delivered upon, this would allow banks recapitalizations via ESM instead of directly via sovereign funds and thus will – for accounting purposes – prevent banking debt being counted directly as Government debt. This is the positive and it is a significant positive, for Europe.

However, it has limitations, although it also delivers some potential positives. A mixed bag overall for Europe.

(2) Irish experience shows that – with Nama debt not officially counted as Exchequer debt, while Promissory Notes to IBRC and interest on them is counted as such. Both are fully backed by Government and both have economic implications, but only one (Promo Notes) has implication for sovereign finances. In other words, removing for accounting purposes debt off Government balancesheet does not remove the costs and burdens of this debt off the balancesheet of the economy as a whole. What this means is that the ‘deal’ does not share responsibility for debt across the Euro zone, as long as there remain Government guarantees. Instead it spreads debt into the economy (as banking system will still have to repay them), putting taxpayers into the second line of fire.

Incidentally, Nama – that vehicle which absorbed some of the banks bailouts – is highly unlikely to be featured in any potential/theoretical/rumoured/alleged retroactive restructuring of the banks-related sovereign debt.

This also means that the deal does not fully break the link of contagion from banks bad debts to Government balancesheet, but makes this link more opaque.

(3) There is no retrospection in the deal, although the Irish Government claims there is. We hope there can be such retrospection, but it is difficult to see how that can be delivered given that
a) Retrospection would open ESM to some €200 billion worth already committed Governments’ funds from the peripheral and other states (including Germany), effectively erasing 40% of ESM capacity before it gets to lend to any new states (e.g. Italy and Spain).
b) Retrospection in any case would not apply to non-debt funds committed by the Irish state (some €21 billion in NPRF cash paid in already).
c) Retrospection could challenge some of the requirements for conditionality (as it cannot be covered by any new conditions) and any potential requirements for collateralization (see below).

The Irish Government is so convinced that retrospective deal is possible, it has set the target of 17% of GDP for debt writedown (see: http://www.irishtimes.com/newspaper/breaking/2012/0702/breaking4.html) which will require a restructuring of €34 billion and if achieved will be a significant help to the Exchequer, although doubtful in value to the economy at large.


(4) The deal clearly states that the banks bailouts will be subject to the "appropriate conditionality, including compliance with state aid rules, which should be institution-specific, sector-specific or economy-wide and would be formalized in a Memorandum of Understanding." In other words, the conditions will not be universal for all states, but will be granular – specific to individual environments. Render onto… comes to mind, and the Caesar – Italy, Spain, any other large member state, is not the same as Ireland, Cyprus, Portugal, Greece et al.

(5) The ESM itself is, at this stage, still not set up and, more importantly, has not raised any funds. When operational it will have capacity to raise €500bn which is highly unlikely to be sufficient to cover sovereigns’ own needs, let alone underwrite any significant banks bailouts. If current EFSF participants were allowed to roll into ESM their banks’ exposures along with Spain, the ESM will have to allocate some €200 billion or so of funds to existent programmes, leaving €300 billion or so to fund other banks bailouts that might arise and fund Exchequers’ needs outside banks bailouts. Thus, ESM will be faced with a dilemma – either it acts as a somewhat credible banks bailout fund or a somewhat credible support for Government bonds. So far, under any of the existent proposals, it cannot do both. Were such proposals to be put in place in the future (e.g. leveraging via ‘banking license’ etc – explicitly excluded from the ‘deal’), the ESM will have to balloon well past €1 trillion mark.

Absent such proposals for ESM structure, the ‘deal’ says that ESM will be allowed to directly intervene in the markets to purchase Government debt. This is not new – in fact it was always supposed to do so.

(6) ESM structure remains unchanged under the deal, so the fund will go to the funding markets with a backing of collective guarantees of the member states. The internal backing of credit flows within ESM is that of the guarantees by the borrowing states to the fund – same as in the EFSF – except absent subordination. This can mean two things:
a) ESM will have to pay more for borrowing in the markets, and
b) ESM might face severe difficulties, similar to those experienced by the EFSF, in raising funds.
The things are getting so tight with the ESM (even before it is launched) that within the ESM set-up, the combined "guarantees" by the peripheral states borrowers from the EFSF/ESM plus Italy to ESM creditors are proportionately in excess of the guarantee provided by Germany.

However, on the positive side here, removal of subordination clause from ESM lending affirms to private lenders to national Governments the equal treatment of their bonds with supra-national ESM debt. In the long run, therefore, this should reduce risk premia for those member states still capable of tapping the private markets for debt. Thus, making things harder for ESM might make things easier for Germany & Co.

(7) ESM structure of guarantees is itself a troubling scheme. When Spain receives the bailout funding, its share of ESM funding and guarantees will be reallocated to other member states. Germany’s share will move from 29% to 33%, Italy’s share from 19% to 22%, France’s from 22% to 25% and so on. Two weaker Euro area states – Italy and Belgium – will become larger guarantors of ESM. And France, which wants effectively to expand ESM and to grow the overall euro area debt pile to finance own agenda. More fun? Unwilling participants to the scheme – Finland, Austria, the Netherlands – all are getting more ‘voting’ power in the ESM too. Which, of course, should make the whole ESM proposition even more risky in the eyes of external investors.

(8) ESM structure under the ‘deal’ is reinforced by the compulsion of the borrower state to comply with strict and specific conditions. To maintain credibility, therefore, ESM will require these conditions to be at least as stringent as those imposed under the EFSF (Troika) deals. The problem, alas, is that no country, save Ireland, to-date has been able to comply with the previous conditions and the entire mess we are in today was triggered (not caused) by Greece and Spain refusing to comply with these conditions.

This means that either ESM will have to offer its own funders much lesser security (higher risk of borrowers from ESM not being able to deliver internal adjustment programmes necessary for repayment of ESM funds) or it will have to avoid buying Spanish and Greek debts. Alternatively, the ESM lending will have to come with even stricter conditions to compensate for the lack of subordination, which is clearly unviable in current political environment.

(9) To secure ESM funding, the member state applying for the funds will be required to sign an agreed Memorandum of Understanding (as with Troika) which then will have to be approved by other member states. In the past, Finland, the Netherlands, Austria and Slovakia, not to mention Germany, have opposed to some conditions that would have allowed easier access to ESM funds. Specifically, some countries on the list have demanded use of collateral to secure lending even with assumed (under previous ESM plans) and actual (under EFSF) super-seniority conditions. What these and other countries might demand from the ESM funding recipient state is, thus, completely unclear and uncertain. The same applies to ESM lending to the banks, with an added caveat – conditions for banks will have to be even more strict.

We are now, therefore, facing a possibility that the collateral for loans debate can be reignited.

(10) Pretty much everyone agrees that the only lasting resolution to the crisis will have to arrive via ECB. Yet, to-date, ECB has been reluctant to engage even with the crisis spinning out of control. If the latest agreement de facto injects more funds in support of the banking and sovereign balancesheets, the current deal can actually result in even lower willingness of ECB to engage. In other words, the ECB might play a wait-and-see game, allowing the ESM to become fully engaged and only thereafter, assuming the crisis remains acute, stepping in. In other words, instead of deploying monetary policy upfront, we might see Euro area first increase its overall level of indebtedness via ESM and only after that move for the aggressive deployment of the monetary policy. As we know, this has happened in Japan and it has shown the weakness of the monetary policy at the time of elevated debt crisis.


(11) On a positive side, we must recognize that the deal explicitly recognized two things:
a) Germany no longer holds total power over the Euro area decisions,
b) A Euro area state should not be forced to accept bankruptcy level debts in order to underwrite banking system solvency (although there is yet to be a realisation on the side of same happening to the economy)


(12) Also on a positive side, it appears that likely outcome of common supervision regime will include deposits guarantee and banks insolvency resolution regime. Both are net positives and both are consistent with my long-held views on what should be done to repair Euro area banking system. Alas, the resolution regime will have to come ex post already adopted measures, so it is unlikely to make material difference to the banking system we currently have.


(13) A unified banking supervision itself might be a tight spot. Suppose it is set up. And suppose it is functional. In this case, any Euro area banking regulator will be faced with a problem – banks under his/her supervision holding massive and increasing exposures to the sovereign debt of their own governments, some of which are in ESM. There is a clear-cut case here to be made that this situation cannot be sustained. However, should the Euro area regulator move to curtail, say Italian or Spanish banks buying more of their Governments debts, there will be effectively an end to these countries participation in the funding markets and a larger call on ESM. Alternatively, should the regulator ignore the problem of accumulating risks, the regulatory system itself can be undermined.


(14) The deal – and especially the path that it took to arrive at – is the example of European policy brinkmanship, not cooperation. All accounts show that the meeting was broken by Mario Monti with support of Rajoy and that Hollande provided back up. There is absolutely no argument to make that any other member state was explicitly on their side, although most likely Ireland and Portugal were only happy to ride on the coattails of the opposition. Either way, the whole process of deriving the deal was not a cooperative solution, but a stand-off. This is not a break from the established pattern of past summits. But equally ominously, the latest success of brinkmanship is underpinned not by the change in the Euro area leaders’ positions, but by changes in the electoral landscape in Europe, with opposition to the status quo growing on the side of the ‘rebels’ in Greece (Syriza), Italy (Five Star), France (recent lections shift toward more extreme parties support), Finland (the True Finns), Germany and so on.

(15) In the end, ESM will not resolve the problem of too much debt accumulated on the shoulders of European sovereigns and dysfunctional banking system. The economies involved – Spain, Ireland, Greece, Portugal, Cyprus, and potentially Italy – are simply incapable of repaying these debts (please, do consider that even under the rosy Irish Government scenarios – the best performer in the group – Government debt reductions envisioned post 2014 are minor and mostly driven by economic growth, not repayment of actual debts). With this, the ESM can become a perpetual lender, with the requirement to continue raising funds well past the envisioned 10-15 years period. Any cyclical recession before then or after will derail repayments and the ESM debt will have to simply rise, risking a debt spiral that we are experiencing today replaying at some point in the future. Not a pretty thought and certainly a risk that the ‘game changer’ of the ‘deal’ might end up being the ‘end-game’ losing move.


(16) The deal does provide some room for ECB to claim that now there is a realistic progression toward more centralized oversight over banking sector and thus it can engage more actively in monetary easing. The signal to watch for is the ECB 1% repo rate, which can be lowered, implicitly signalling ECB willingness to long-term tolerate inflation over 2%. Thereafter, 4% inflation becomes feasible and ECB can start priming the pump. In turn, devaluation of the euro will compensate German economy by boosting exports and will put even more pressure on internal devaluations in peripheral states (imports costs up, exports largely non-existent to benefit from cheaper euro, etc).

Today’s PMI figures showing broad euro zone-wide and sharp contraction in activity in June should make the ECB move this Thursday a ‘no-brainer’.




Sunday, July 1, 2012

1/7/2012: H1 2012 US Mint data: demand for gold coins

Based on data from the US Mint we can now update H1 2012 figures for sales of the US-minted gold coins. As the background - new coins issued by the US Mint, in my opinion, represent a much more fundamentals-linked asset as the demand for these coins differs, if only subtly, from the demand for gold as an asset:

  • Coins are purchased by long-hold collectors;
  • Coins are easier to purchase and store than gold bars, attracting more demand from savers, rather than speculative investors; and
  • Coins are used frequently to store inter-generational wealth and start family savings schemes
All of this means that correlations between demand for coins and gold price should be less pronounced and that is exactly what we observe throughout the historical and current data:



So with that in mind, what should we expect from the gold coins sales. Price of gold has been trending side-ways with some correlation over the 20-day averages since April 2011 ranging between USD1505.5 low in June 2011 to the high of USD1813.5 in August 2011 and into USD1570 in June 2012. With this, we should expect some moderation in demand for gold coins coming from the reduced speculative demand. Since this speculative demand forms a smaller component of overall coins demand, we should expect moderation in demand for coins to bring us down toward historical averages for the crisis period. 

At the same time, outside the euro area, global crisis has entered a stage of stabilization (not growth, yet), which means that demand for gold as safe haven (rather than a hedge) should be moderating as well. This can be expected to have a more modest impact on coins sales than on gold sales and especially ETFs-instrumented gold sales.

In other words, fundamentals (inflation expectations, longer-term savings and investment objectives) should be driving current demand for gold coins.

And, this is exactly what we are seeing. In June 2012, the US Mint sold 54,500oz of coinage gold, up on 53,000 in May 2012. Total for H1 2012, US Mint sales of gold coins in terms of total weight sold are down 41.3% on H1 2011 and it is down 49.8% on H1 2010 and 50.3% on H1 2009. Dramatic? Sure, when one disregards consideration of drivers for 2009-2011 demand for coins being coincident with extreme risks in other markets. 

Total H1 2012 demand was at 338,000oz still well ahead of H1 average demand for 2000-2007 period when it was 165,679oz, but down on 531,750oz average for H1 2008-2011 crisis period.

Exactly the same picture - return to fundamentals - is seen in the number of coins sold. 

Consistent with still robust demand drivers, H1 2012 average coin sold contained 0.60 oz, while H1 2000-2007 period average was 0.51oz and H1 2008-2011 period average was 0.76oz.

Here's a summary of H1 changes and a chart highlighting dynamics:



All three parameters (coins sold, oz total sold and oz/coin) are showing that H1 2012 was continuing moderation in demand away from short-term safe haven considerations toward fundamentals-driven consideration and basics of long-term hold demand. All three also show that current demand dynamics for gold coins remain ahead of historical averages. There is neither a panic buying, nor a panic selling and should demand stabilize at around 10% upside to the historical average ex-1999 spike, and recall that this is NEW demand, we will be in the comfortable longer term range that can take us well into global economic growth cycle once it resumes.


PS: This continues to confirm my long-term view on gold coins as more fundamentals-driven and fundamentals-reverting instrument.


Disclaimer:
1) I am a non-executive member of the GoldCore Investment Committee
2) I am a Director and Head of Research with St.Columbanus AG, where we do not invest in any specific individual commodity
3) I am long gold in fixed amount over at least the last 5 years with my allocation being extremely moderate. I hold no assets linked to gold mining or processing companies.
4) I receive no compensation for anything that appears on this blog. Never did and not planning to start now either. Everything your read here is my own personal opinion and not the opinion of any of my employers, current, past or future.