Monday, September 28, 2015

28/9/15: Blow Outs in the Markets: Beware of Debt Financing

 This is an unedited version of my article in the Village Magazine from June 2015.

Three recent events, distinct as they may appear, point to a singular shared risk faced by the Irish economy, a risk that is only being addressed in our policy papers and in the mainstream media.

Firstly, over the course of May, European financial markets have posted surprising rises in Government and corporate bond yields amidst falling liquidity, widening spreads and increased volatility.

Secondly, both the IMF and the Irish Government have recognised a simple fact: once interest rates revert back to their 'normal' path, things will get testing for the Irish economy.

And thirdly, the Irish Government has quietly admitted that the fabled arrears solutions to our household debt crisis are not working.

Deep below the lazy gaze of Irish analysts, these risks are connected to the very same source: the massive debt overhang that sits on the back of our struggling economy.

Stability? Not So Fast.

Take the first set of news. The problem of spiking yields and blowing up trading platforms in the European bond markets was so pronounced in May, that the ECB had to rush in with a bold promise to accelerate its quantitative easing purchases of Government paper to avoid an even bigger squeeze during the summer. All in, between January and the end of May, euro area government bond yields rose by some 6 basis points, cost of non-financial corporate borrowings rose by around 9 basis points, and banks' bond yields were up 1 basis point. All in the environment of declining interbank rates (3-month Euribor is down 10 basis points) and massive buying up of bonds by the ECB.

In one recent survey completed by the Euromoney before May bond markets meltdown almost 9 out of 10 institutional investors expressed deep concerns over evaporating market liquidity (higher costs of trading and longer duration of trades execution) in the sovereign bond markets. In another survey, completed in late 1Q 2015 by Bank of America-Merill Lynch, 61% of large fund managers said that European and U.S. stocks and bonds are currently overvalued - the largest proportion since the survey began back in 2003.

In the U.S., current consensus expectation is for the Federal Reserve to start hiking rates in 3Q 2015. In Europe, the same is expected around Q3 2016. And recently, both estimates have been moving closer and close to today, despite mixed macroeconomic data coming from the economies on the ground. If the process of policy rates normalisation coincides with continued liquidity problems in the bonds markets, we can witness both evaporation of demand for new government debt issues and a simultaneous increase in the cost of funding for banks, companies and the Governments alike.

Cost of Credit

Which brings us to the second point - the role of interest rates in this economy.

In recent Stability Programme Update (SPU) filled with the EU Commission, the Department of Finance provided a handy exercise, estimating the impact of 1% rise in the ECB key rate. The estimates - done by the ESRI - show that in 2017, a rise in ECB rate to 1 percentage point from current 0.05% will likely cost this economy 2.1% of our GDP in 2017, rising to 2.4% in 2018 and 2019. By 2020, the effect can amount to the losses of around 2.5% of GDP.

This increase would bring ECB rates to just over 1/3rd of the historical pre-crisis period average - hardly a major 'normalisation' of the rates. Which means that such a hike will be just a start in a rather protracted road that is likely to see rates rising closer to 3-3.5 percentage points.

But here is a kicker, the ESRI exercise does not account fully for the realities on the ground.

In addition to the ECB rate itself, several other factors matter when we consider the impact of the interest rates normalisation on the real economy. Take for example cost of funds in the interbank markets. Average 12 months Euribor - prime rate at which highest-rated euro area banks borrow from each other - averaged 3.29% for the period of 2003-2007. Today the rate sits at 0.18%. Which means rates normalisation will squeeze banks profits line. If euro area, on average, were to hike their loans in line with ECB increases, while maintaining current 12 months average lending margins, the rate charged on corporate year and over loans in excess of EUR1 million will jump from the current 2.17% to 3.37%.

It turns out that due to our dysfunctional banking system, Irish retail rates carry a heftier premium than the euro area average rates, as illustrated in Chart 1 below. Which, of course, simply amplifies the impact of any change in the ECB base rate on Ireland’s economy.

The reason for this is the pesky issue of Irish banks profitability - a matter that is distinct from the euro area average banking sector performance due to massive non-performing loans burden and legacy of losses carried by our banking institutions. Per latest IMF assessment published in late April, Irish banking system is the second worst performing in the euro area after the Greek when it comes to existent levels of non-performing loans. In today's terms, this means that the average lending margin charged by the banks in excess of ECB policy rate is 3.4% for house purchase loans, 5.63% for loans to Irish companies under EUR1 million with a fix of one year and over, and 4.0% for loans to same companies in excess of EUR1 million. Which means that a hike in the ECB rate to 1% will imply a rise in interest rates charged by the banks ranging from 0.84% for households loans, to 0.92% for smaller corporate loans and to 1.22% for corporate loans in excess of EUR1 million.

Chart 2 below highlights what we can expect in terms of rates movements in response to the ECB hiking its base rate from the current 0.05% to 1%.

No one - not the ESRI, nor the Central Bank, nor any other state body - knows what effect such increases can have on mortgages arrears, but is pretty safe to say that households and companies currently experiencing difficulties repaying their loans will see these problems magnified. Ditto for households and companies that are servicing their debts, but are on the margin of slipping into arrears.

While the ESRI-led analysis does enlighten us about the effects of higher rates on tax revenues and state deficits, it does little in providing any certainty as to what happens with consumer demand (linked to credit), property investment and development (both critically dependent on the cost of funding), as well as the impact of higher rates on enterprise formation and survivorship rates.

In addition, higher rates across the euro area are likely to imply higher value of the euro relative to our major trading partners' currencies. Which is not going to help our exporters. Multinational companies trading through Ireland are relatively immune to this effect, as most of their trade is priced internally and stronger euro can be offset by accounting and other means. But for SMEs exporting overseas, every percentage point increase in the value of the euro spells lower sales and lower profits.

Debt Overhang: It Matters

Across the euro area states, there are multiple pathways through which higher rates can drain growth momentum in the economy.

But in Ireland's case, these pathways are almost all invariably adversely impacted by the debt overhang carried by the households and the corporate sectors. Current total debt, registered in Irish financial institutions as being extended to Irish households and resident enterprises stands at just over EUR263.7 billion. And that is before we take into the account our Government debt, as illustrated in Chart 3.

A 1 percentage point increase in retail rates can see some EUR2.64 billion worth of corporate and household incomes going to finance existent loans - an amount that is well in excess of EUR2.28 billion increase in personal consumption recorded in 2014 compared to 2013, or 24% of the total increase in Ireland's GNP over the same period. Add to that added Government debt costs which will rise, over the years, to some EUR1.5 billion annually.

What is not considered in the analysis is that at the same time, rising cost of credit is likely to depress the value of the household's collateral, as property prices are linked to credit markets conditions. Which means that during the rising interest rates cycle, banks may be facing an added risk of lower recovery from home sales.

The effect of this would be negligible, if things were relatively normal in Irish mortgages markets. But they hardly are.

At the end of Q4 2014, total number of mortgages in arrears stood at 145,949 accounts, amounting to the total debt of EUR29.8 billion or 18% of total lending for house purchases. 94,929 accounts amounting to EUR14.94 billion of additional debt were restructured and are not in arrears. Roughly three quarters of the restructured mortgages involve 'solutions' that are likely resulting in higher debt over the life time of the restructured mortgage than before the restructuring was applied. We cannot tell with any degree of accuracy as to how sensitive these restructured mortgages are to interest rates changes, but arrears cases will be much harder to resolve in the period of rising rates than the cases so far worked out through the system.

When, Not If…

You'd guess that the ESRI and Department of Finance would do some homework on all of the above factors. But you would be wrong. There is no case-specific risks analysis relating to interest rates changes performed. Perhaps one of the reasons why majority of analysts have been dismissing the specific risks of interest rates increases is down to the lack of data and models for such detailed stress-testing.

Another reason is the false sense of security.

Take the U.S. case. The U.S. economy is now in an advanced stages of mature recovery, based on the most recent survey of economic forecasters by the BlackRock Investment Institute. But the underlying weaknesses in growth remain, prompting repeated revisions of analysts' expectations as to the timing of the Federal Reserve rates hikes. Still, the Fed is now clearly signaling upcoming rate hike.

The Fed is pursuing a much broader mandate than the ECB - a mandate that includes the target of full employment. The twin mandate is harder to meet than the ECB's singular objective of inflation targeting.

While the European inflation is low, it is not as low as one imagines. Stripping energy - helped by the low oil prices - inflation in the Euro area was estimated to be at 0.7% in April 2015. Combined, prices of gas, heating oil and fuels for transport shaved 0.66 percentage points off headline inflation figure. Although 0.7% is still a far cry from 'close to but below 2%' target, for every 10% increase in energy prices, HICP metric watched by the ECB will rise approximately 1.06 percentage points. So far, in April 2015, energy prices are down 5.8% y/y - the shallowest rate of decline in 5 months. Month on month prices rose 0.1 percentage points.

Sooner or later, interest rates will have to rise.  In the U.S., explicit Fed policy is that such increases will take place after the real economy recovers sufficiently to withstand such a shock. In the euro area, there is no such policy in place, in the aggregate, across the entire common currency area, and in the case of specific weak economies, such as Ireland, in particular.

Thursday, September 24, 2015

24/9/15: Ireland's Remittances and Foreign Workforce

In a recent post, titled  "Ireland: a land of un-remarkable savers",  I covered EU Commission research on savings rates across different countries.

One interesting finding in the report relates to the issue net remittances or transfers from the country to foreign destinations net of inflows of funds from abroad into the country. These figures cover household remittances, so no direct effect of FDI and other investment flows in them.

Take a look at the following chart:

In absolute terms, Ireland leads the EU in terms of net remittances outflows abroad as percentage of the Gross National Income. Keep in mind - Cyprus was in an emergency funding situation from January 2012 on (when the country first received Russian emergency loans) and requested assistance from the EU in mid-2012, with actual bailout package agreed a year later. In other words, much of 2012 net outflows of household funds from Cyprus was probably down to relatively panicked situation in the country financial sector.

Ireland's net remittances outflows were running, in contrast, against more stabilised situation and inflows of funds from a number of emigrants who left during the crisis. Demographically, these can be divided into three categories:

  • Returning migrants (who have little connection to Ireland and, thus, were more likely to take funds out of Ireland on their exit);
  • Younger Irish workers (who would have left older family behind and whose earnings abroad would not have allowed for them to become net sender of funds into Ireland) and
  • Middle-aged families, who often left properties behind with outstanding mortgages that required regular remittances into Ireland to fund.

The key for Ireland's position at the bottom of the European remittances table is, most likely, foreign workers in Ireland sending their surplus earnings/savings abroad for the lack of interest in investing in Irish assets (property and financial assets). If so, we have a problem: Ireland attracts large numbers of highly skilled younger workers who come here to work in MNCs-led sectors, such as ICT and ICT services, as well as Financial services. These workers, judging by remittances outflows, have little anchoring in the Irish economy.

As the result of remittances (counting only unrecorded remittances, and omitting the deeply negative official remittances), Irish savings rate falls from 14th in the EU to 17th in the EU:

24/9/15: The Ugly Faces of Trade Protectionism

Neat chart from Credit Suisse summarising the extent (and distribution) of new protectionist policies across several key economies:
Several points worth making:

  • The obvious one: the U.S. leads in terms of protectionism. Which is ironic, given the U.S. championship of open trade agreements (TTIP and TPP being the most current ones) and the U.S. tendency to de-alienate the world into 'Free Trade' and 'Protectionist' groups of countries.
  • BRIC come second and Europe comes third. Which is again highly ironic as BRIC rely heavily on trade-driven model for growth and Europe can't get over how (allegedly) free trade it is.
  • Everywhere, save Russia and the U.S., state aid & bailouts is minor segment of trade protectionism policies.
  • Export subsidies are meaningful in China and India.
  • Trade defence and finance measures dominate in the U.S., India, Brazil and Europe, and are weaker in Japan and China, while virtually non-existent in Russia.
All-in - a pretty ugly picture of reality post-crisis.

Wednesday, September 23, 2015

23/9/15: China Flash PMI for Manufacturing: September

China flash Manufacturing PMI is at 47.0 for September - lowest level since March 2009 and 7th consecutive reading below 50. Over the last 12 months, the index has been below 50 in 9 months, at 50 for one month and has not been statistically above 50 since July 2014.

Index is now on a solid downward trend since January 2010 and looks set to be the second worst performing PMI in BRIC group (after Brazil) for the third month in a row.

Tuesday, September 22, 2015

22/9/15: Ireland: a land of un-remarkable savers

Remember the persistent whinging about 'high savings rates' in Ireland. And recall all the talk about how these savings are allegedly killing of domestic demand (because, of course, the 'recovery' has been supporting that demand, so if only the bad households stopped squirrelling away stashes of cash... then).

Ok, it always smelled like a rat, primarily because the alleged savings were not translating into household deposits. But, hey, the story rolled on for years...

So here is a neat EU Commission report on savings across the EU. And here is the top-line chart:

The chart above tells us two things about Irish savings:

  1. Our savings rate was pretty darn low - fourteenth from the top in the EU - back in 2012.
  2. Our savings rate was pretty darn low over 1995-2012 horizon - fourteenth from the top in the EU.
In fact, as the chart above illustrates, instead of jumping up in 2012 compared to 1995-2012 average, our rate stayed on average. Bang on it (we are on a red line).

Worse, adjusting for pensions, our savings rate is also remarkably poor - ranked 12th highest in the EU per following chart:
And our social services (pretty wide-ranging for some key demographics of dis-savers and very narrow for the demographic of savers) have little effect on our savings rate - net of social services, our saving rate ranks 15th (as opposed to 14th) from the top:

Of course, savings rates can be calculated differently across economies, so EU report distinguishes two sources of financial savings (savings used to purchase financial assets) and non-financial savings (savings used to purchase homes, gold etc). So may be, just may be the 'high rate of savings' was down to the latter (remember, Irish households were trying to repay their home mortgages as fast as possible)?
Nope, not that either. Per chart above, we rank 11th in the EU in terms of our financial savings rate and 19th in terms of non-financial savings.

So what on earth was that 'high savings' story about? A business lobby-invented scheme to get the state to 'nudge' savings out of the banks and into spending? A state-concocted dream to justify potential (and in some cases actual, e.g. pensions levy and property tax) introduction of taxes on assets? A glitch in data caused by mortgages close-offs due to sales to unregulated foreign entities and to writedowns on banks balancesheets? Precuationary savings that went to fund relocation of younger adults abroad? Or a compensation in the accounts by increased financial (cash) savings offsetting somewhat decline in the values of non-financial savings (house prices tanking)? Or all of the above?

One way or the other, Ireland is clearly not a nation of savers nor are we a nation of spenders. We are, remarkably unremarkably mid-of-the-road type...

22/9/15: Germany's IFO: "Refugees to Cost Ten Billion Euros"

Here is the full release from the Ifo Institute (emphasis in bold and comments in italics are mine):

"Ifo Institute Expects Refugees to Cost Ten Billion Euros

Munich, 22 September – If a total of 800,000 asylum-seekers do indeed come to Germany this year, as forecast by the German Federal Ministry of the Interior, it would cost the state around ten billion euros. This figure does not take into consideration family members joining the refugees or any educational measures; and is therefore a conservative estimate.  [here is a useful, albeit dated, link on family reunification framework in Germany showing significant potential impact. More current data is covered here. In addition, while educational expenditures can be significant, part of the costs will be carried through apprenticeships and training schemes that are covered by employers and that involve productive work, contributing to value added in the German economy.]

The qualification structure of immigrants from the crisis-afflicted states of Syria, Iraq, Nigeria and Afghanistan is probably poor. According to data from the World Bank, the illiteracy rate even among the 14-24 year old age group is 4 percent, 18 percent, 34 percent and 53 percent in these countries respectively. Even in the most developed of these countries (Syria) only 6 percent of the population has a university degree, which is not equivalent to a German diploma in many cases. Although refugees tend to be male and younger than the demographic average age, one thing is still clear: they are poorly prepared for the German labour market. In addition to language courses, Germany will also need to invest in training, which will generate extra costs. [We do not know exact quality of education and skills attained by the refugees, but applying average population parameters in this case can be fraught with some problems. For example, refugees coming through trafficking channels are required to pay up-front fees that are substantial in size, relative to average incomes. This means that there can be a strong selection bias in terms of refugees who reach Europe, compared to the average population in the country of origin - biases that tend to select more educated / better skilled and more financially enabled migrants. If so, their literacy rates and educational attainment status can be well above averages. In addition, undergoing a refugee journey implies very significant hardship, that is most likely known (at least partially) prior to the journey start. This can imply that refugees arriving into Europe may have stronger aptitude to succeed in integrating into new host society than those who remain behind. These biases are relatively well known in the literature on migrants flows in large scale migrations in the past.]
Many refugees will remain in Germany in the long-term and bring their relatives into the country. Migratory pressure from North Africa and the Middle East will remain high purely due to the demographical situation in these countries.  [This is correct, and the pressures are rising, not abating. The problem here is signalling: by openly accepting 800,000 refugees, German leaders have sent a very loud signal to the potential future refugees. Reality, however, is that such a signal will probably have only a marginal effect on refugees flows over time, since the main drivers (first order factors) pushing larger quantities of refugees into Europe - demographics, political and geopolitical instability, institutional deterioration, regional wars and conflicts, as well as issues such as climate change - remain acute.]

To avoid the refugee crisis becoming a long-term financial burden for German taxpayers, refugees have to get paid employment as fast as possible, so that they can meet their own living costs. There are fears, however, that many of them will not be able to find a job with a minimum wage of 8.50 euros in place because their productivity is just too low. It would be therefore be a good idea to lower the minimum wage across the board to prevent unemployment from rising.  [This is a matter for a separate analysis. While refugees initial productivity is likely to be lower, training and apprenticeship schemes should provide fast uplift in productivity for those who are well-enabled for such training. The key to limiting the cost of integrating refugees hinges crucially on several dimensions of German policy, namely: access to training, incentives to undertake training, quality of matching individuals to training opportunities, etc. Other considerations (for example pre-acceptance assessment of attitudes and aptitudes to integration) can help, but at this stage are not feasible except on a margin (for example prioritising processing of refugees who pass pre-acceptance assessments). Minimum wage coverage should not apply to apprenticeships and training schemes in general, in my view, and instead these activities should be covered by a separate minimum wage set below the normal employment-related minimum wage.]

Raising Hartz IV standard rates in the present situation is a very bad idea, as this would reduce incentives for refugees to look for work and generate an additional fiscal burden.
Model simulations by the Ifo Institute show that even in the case of a suspension of minimum wage legislation and Hartz IV rates remaining stable, the supposed immediate integration of immigrants into the German labour market does not stand to benefit the German economy. Although there are some labour market advantages, they are outweighed by higher unemployment rates and net transfers to immigrants.
Article: “Immigration: What Does the Domestic Population Stand to Gain?”  in: ifo Schnelldienst 18/ 2015; p. 3-12; a preview of the article is available at: "

Overall, a bold and interesting statement from Ifo (who are known for being bold), and a topic worth discussing.

22/9/15: Why Reform Irish Cider Excise System?

My paper for the Cider Ireland submission to Budget 2016 is available as text here.

Sunday, September 20, 2015

20/9/15: Euromoney: "Cyprus almost as safe as Portugal"

"The Cyprus risk score has steadily improved this year in Euromoney’s crowdsourcing survey, rebounding in Q2, and is seemingly on course for further improvement in Q3 as economists and other risk experts make their latest quarterly assessments. Chalking up almost 53.1 points from a maximum 100 allotted, Cyprus has managed to climb one place in the rankings to 56th out of 186 countries surveyed, leapfrogging India and closing in on Portugal into a more comfortable tier-three position:"

Read more here.

Here are my notes on the topic (to accompany the quote in the article):

In my view, Cypriot economy recovery after 3 years of deep recession and banking sector devastation is still vulnerable to growth reversals and deeply unbalanced in terms of sources for growth. Firstly, the rate of growth is hardly consistent with the momentum required to deliver a meaningful recovery. Cypriot GDP rose 0.2% y/y in 1Q 2015 and 1.2% y/y in 2Q 2015. This comes on foot of 14 consecutive quarters of GDP decline. Quarterly growth rate in 2Q came below flash estimate and expectations.

Positive growth was broadly based, but key investment-focused sector of construction posted negative growth. Deflationary pressures remained in the Cypriot economy with HICP posting -1.9% in August y/y on top of -2.4% in July. Over January-August 2015, HICP stood at -1.6% y/y.

Despite some fragile optimism, the Cypriot Government has been slow to introduce meaningful structural reforms outside the financial sector. The economy remains one of the least competitive (institutionally-speaking) in the euro area, ranked 64th in the World Bank Doing Business 2015 report - a worsening of its position of 62nd in 2014 survey. This compares poorly to the already severely under-performing Greece ranked in 61st place.

Thus, in my view, any significant improvements in the country scores relate to the policy-level post-crisis normalisation, rather than to a measurable improvement in macroeconomic fundamentals.

Saturday, September 19, 2015

19/9/15: IBM's Global Location Trends Report

Recently released "Global Location Trends: 2015 Annual Report" by IBM should be a pleasant read for Irish policymakers. The report "outlines the latest trends in corporate location selection — where companies are locating and expanding their businesses and creating jobs around the world."

And Ireland features positively and prominently, albeit with a caveat (below).

Take, for example, jobs creation by FDI-backed firms: per report, "Ireland and Singapore remain the strongest per-capita performers among the more mature (and, therefore, higher-cost) economies"

Notice that Ireland's rank has slipped slightly in 2014 compared to 2013.

Another category where we perform really strongly is average job value:

Per report: "For the fourth year in a row, Ireland is the top ranking country in the world on this measure. It continues to attract investment projects in industries characterized by high knowledge intensity and economic value added, such as life sciences and information and communication technology (ICT). The global top 10 ranking consists primarily of mature economies with a mix of investments similar to Ireland’s".

These are pretty impressive numbers, except for one major caveat: none of the report data was adjusted for corporate inversions. So when a U.S. company moves offshore to, say, Ireland (as many did and continue to do), via a tax-optimising inversion, the results appear to be an addition to Ireland's stock of FDI and Ireland's jobs creation, whilst in reality, both are superficial at best, and beggar-thy-neighbour at worst.

Perhaps surprisingly, despite being the main focal point of FDI inflows in the Republic, Dublin did not fare too well in the urban rankings, coming in at joint 12th position in 2014 ranking, down 5 places from the 7th rank in 2013.

Overall, the positive tone of the report is more than warranted in Ireland's case.

Nonetheless, the problem of aggressive tax optimisation and sharp practices by a number of MNCs invested in Ireland should be reflected and discussed in the global rankings.

This is especially important, given the report claims to reflect quality of FDI and jobs created. Ireland attracts massive inflows of tax optimising FDI in the areas of ICT services, pharma, biotech and medical devices, with aggressive on-shoring of Intellectual Property, and dire lack of actual research jobs being created. Instead of actual research, jobs in sales and back office activities, as well as residual (lower value) research are being registered as being registered as 'Professional' or 'Scientific' and the value added by these jobs creation is often, de facto, fully reflective of tax optimisation schemes.

The report authors might want to consult some facts listed here.

19/9/15: Irish Construction PMIs: August 2015

Irish Construction Sector PMIs for August showed moderate de-acceleration in sector growth.

Per Markit:

On a 3mo average basis:
  • Overall Construction Sector PMI stood at 60.4 in 3mo through August 2015, up on 57.8 for the 3mo average through May 2015, but down on same period a year ago (61.3).
  • Housing Activity sub-index posted deterioration m/m. However, on a 3mo basis the index through August 2015 (58.7) was up on the 3mo average through May 2015 (56.5), but down on 3mo average through August 2014 (63.5).
  • Commercial Activity sub-index posted deterioration m/m. On a 3mo basis the index through August 2015 (61.3) was up on the 3mo average through May 2015 (59.4), but down on 3mo average through August 2014 (62.4).
  • Civil Engineering activity sub-index posted deterioration m/m and a reading sub-50.0 for the second consecutive month. On a 3mo average basis, 3mo average through August 2015 was at 50.1, identical to the 3mo average through May 2015 and up on 47.6 average through August 2014.

Thus, all sub-indices have deteriorated on a m/m basis, and all, with exception of Civil Engineering, posted deterioration y/y on 3mo average basis.

As shown in the chart below, two key sub-indices of construction sector activity remain above 50 mark, but a sharp deterioration in overall growth momentum for the second month in a row. Both sub-series are signalling potential reversal in the positive momentum trend from September-November 2014 on.

In Civil Engineering, a brief recovery momentum signalled in Q4 2014 has now been erased:

Friday, September 18, 2015

18/9/15: "Russia is not the enemy": Boston Globe Op-ed

Superb op-ed in the Boston Globe dissecting the U.S. strategic errors in viewing Russia as an intrinsic enemy of the West:

"Emotion argues that Russia is a troublemaker because it refuses to play by our rules, and must be confronted and punished. Reason should reply that Russia is a legitimate power, cannot be expected to take orders from the West, and will not stand quietly while the United States promotes anti-Russia movements on its borders."

Read the full article here.

Thursday, September 17, 2015

17/9/15: That 'Lost Decade' Meme... U.S. Median Incomes

The common memes in the media today are:

  1. U.S. economic recovery from the crisis is complete and is well ahead of that of the euro area; and
  2. The most recent economic crisis is a standalone event (a recession, rather than a continuation of a period of longer-term stagnation) and, thus, we can talk about the so-called 'lost decade' when it comes to the crisis-induced disruption.

Three really powerful articles on the topic of median incomes in the U.S. over the last 30 years that clearly dispute these points.

  • First, piece, using US Census Bureau data, showing that inflation-adjusted median household income in 2014 stood at USD53,657 down 6.5% on 2007 levels and back to the levels compatible with 1989. Link to full article here.
  • Second, Mike Shedlock's piece covering same data from more involved angles, with more scar figures: "Real median household income for all races is where it was in 1996. Real median household income for white non-Hispanics is where it was in 1997. Real median household income for blacks is where it first was in 1995. Real median household income for Hispanics is where it first was in 1998. Real median household income for Asians is where it first was in 1995." Full article here. The key point in both is that the so-called 'lost decade' looks more like 'lost two decades' and counting.
  • Third, Yves Smith's piece on the same topic, taking adjustments to historical data into account, showing (chart below) that "Median household income for non-elderly households in 2014 ($60,462) was 9.2 percent, or $6,113, below its level in 2007. The disappointing trends of the Great Recession and its aftermath come on the heels of the weak labor market from 2000–2007, during which the median income of non-elderly households fell significantly from $68,941 to $66,575, the first time in the post-war period that incomes failed to grow over a business cycle. Altogether, from 2000–2014, the median income for non-elderly households fell from $68,941 to $60,462, a decline of $8,479, or 12.3 percent…" Full article here.

Do remember, we are talking here about the engine of global recovery, the home of hope for the real workers, the jobs creation machine, the U.S. economy that is, allegedly, in a ruder health than the rest of the advanced economies world... just don't forget to add that crucial 's' at the end of its 'lost decade' descriptor...

17/9/15: Greek Crisis: Structural & Institutional Drivers

A lot has been written about Greek economy, with basically two divergent views (ignoring comical extreme perspectives usually harboured by the media) of the core problem:

  • The first perspective is that Greek economy has been driven by wrong-footed European policies (austerity, failed restructuring of Private Sector-held debt), as well as by deceptive practices of some private sector players (that somehow facilitated Greek Governments' false declarations of deficits, questionable restructuring of pre-Euro era debts etc).
  • The second perspective is that Greece suffers from chronic, long term institutional failures that have left economy deeply non-competitive.
In my view, both narratives coexist in reality, even though the first one became the dominant preferred narrative of the 'Left' while the second one became the dominant one on the 'Right' of political spectrum within Greece and outside.

Ideology aside, here is an interesting and wide-ranging view from the second perspective, courtesy of Edmund S. Phelps. Worth a read... 

As a note to this, one part of the first perspective that is glaringly false is the perception of Greece as being a victim state of the 'international bankers'' manipulation of the national debt accounting (the so-called Goldman Sachs Swap deal). Greek Government, at the time, wilfully and freely contracted Goldman Sachs to execute the deal. Informational disclosures available to the Greek Government at the time were sufficient for the Government to know exactly what it was doing and why. Eurostat was notified of the deal and did not object. There appears to have been no deception nor any coercion involved, except for the deception by the Greek Government at the time, knowing neglect of the issue by the Eurostat and soft coercion of the EU in dealing with Greek Accession to the Euro.  

Far from being a victim, Greek authorities have actively, willingly and knowingly participated, over decades, in shaping numerous institutional failures that strongly contributed to the economic destruction of the country. These authorities acted on the basis of electoral mandates. Their failures are briefly listed in Endmund S. Phelps' article linked above.

This does not, of course, diminish the pain from the crisis and does not eliminate the need for cooperative assistance and support to be extended to Greece, including direct debt relief. But it does call for a better balancing of analysis of the Greek economic situation overall. And it does call for the Greek people to engage in some serious soul-searching as to the nature and quality of the political leadership they elect. Especially, given the fact that they are about to go to the polls on September 20th.

17/9/15: Predict Conference: Data Analytics in the Age of Higher Complexity

This week I spoke at the Predict Conference on the future of data analytics and predictive models. Here are my slides from the presentation:

Key takeaways:

  • Analytics are being shaped by dramatic changes in demand (consumer side of data supply), changing environment of macroeconomic and microeconomic uncertainty (risks complexity and dynamics); and technological innovation (on supply side - via enablement that new technology delivers to the field of analytics, especially in qualitative and small data areas, on demand side - via increased speed and uncertainty that new technologies generate)
  • On the demand side: consumer behaviour is complex and understanding even the 'simpler truths' requires more than simple data insight; consumer demand is now being shaped by the growing gap between consumer typologies and the behavioural environment;
  • On micro uncertainty side, consumers and other economic agents are operating in and environment of exponentially increasing volatility, including income uncertainty, timing variability (lumpiness) of income streams and decisions, highly uncertain environment concerning life cycle incomes and wealth, etc. This implies growing importance of non-Gaussian distributions in statistical analysis of consumer behaviour, and, simultaneously, increasing need for qualitative and small data analytics.
  • On macro uncertainty side, interactions between domestic financial, fiscal, economic and monetary systems are growing more complex and systems interdependencies imply growing fragility. Beyond this, international systems are now tightly connected to domestic systems and generation and propagation of systemic shocks is no longer contained within national / regional or even super-regional borders. Macro uncertainty is now directly influencing micro uncertainty and is shaping consumer behaviour in the long run.
  • Technology, that is traditionally viewed as the enabler of robust systems responses to risks and uncertainty is now acting to generate greater uncertainty and increase shocks propagation through economic systems (speed and complexity).
  • Majority of mechanisms for crisis resolution deployed in recent years have contributed to increasing systems fragility by enhancing over-confidence bias through excessive reliance on systems consolidation, centralisation and technocratic responses that decrease systems distribution necessary to address the 'unknown unknowns' nature of systemic uncertainty. excessive reliance, within business analytics (and policy formation) on Big Data is reducing our visibility of smaller risks and creates a false perception of safety in centralised regulatory and supervisory regimes.
  • Instead, fragility-reducing solutions require greater reliance on highly distributed and dispersed systems of regulation, linked to strong supervision, to simultaneously allow greater rate of risk / response discovery and control the downside of such discovery processes. Big Data has to be complemented by more robust and extensive deployment of the 'craft' of small data analytics and interpretation. Small events and low amplitude signals cannot be ignored in the world of highly interconnected systems.
  • Overall, predictive data analytics will have to evolve toward enabling a shift in our behavioural systems from simple nudging toward behavioural enablement (via automation of routine decisions: e.g. compliance with medical procedures) and behavioural activation (actively responsive behavioural systems that help modify human responses).

Monday, September 14, 2015

14/9/15: Swiss Model... it does shine

An interesting view from Dan Mitchell on Swiss model:

Honoured to see TrueEconomics chart cited in the piece too.

14/9/15: Europe's Gen Jinx: At Home and Stagnating

One fascinating map:


And here is the same data set for 2013:


Plotting percentage of people aged 25-34 living with their parents across the continent (plus the U.S.), the map tells a very interesting story. Consider the following issues relating to these numbers. Higher % of prime working age adults living with their parents 
  • Implies lower mobility of prime working age cohort across jobs and career opportunities (poorer labour market matching);
  • Lower exposures to key skills, such as cultural diversity and languages, etc for this cohort;
  • Is likely associated, in part, with longer duration in education (good thing) and higher life-time cost of such education compared to labour markets returns on education (bad thing);
  • Is reflective of lower employment rates and higher unemployment rates of this cohort across a number of European countries;
  • Implies lower propensity toward family formation (a demographic time bomb of sorts);
  • Suggests greater dependency costs for older generations of parents who (within ages of over 45) are simultaneously facing pressures to save for their own retirement;
  • Implies lower investment and tax bases in the economies where this trend is more pronounced; 
  • Likely correlates with higher cost (relative to income) of renting quality accommodation - a signal of reduced capacity of these economies to attract high quality human capital from abroad, thus reducing social and economic mobility not only for the country natives, but also across Europe as a whole, and so on…

All of which makes this map extremely significant in terms of identifying future potential for long-term economic development and growth in a number of European countries. And, frankly speaking, for any country with said percentage in excess of 20%, these prospects are not too great… 

Welcome to Europe's Generation Jinx...

Sunday, September 13, 2015

13/9/15: Some Insightful Links on European Refugees Crisis

There has been a lot written about the migration crisis or refugees crisis or whatever one might choose to call the crisis on European borders. I am not about to add to the continuously expanding literature on the subject (at least not yet).

But here are a couple of links / summary data tables worth checking out.

First, an excellent essay in the Foreign Policy showing the extent of discontinuity between the Central European self-interest-driven humanitarian values of the 1990s and the region's current attitude toward migration.

But then again, Eastern and Central Europe has been re-writing its own history at will, on one occasion after another, to suit one master or the other, one nationalist leader or the next... here's a good reminder from earlier this month from one side, and the same view from another, both valid (by the way).

So here's a table of facts on European attitudes toward refugees, so hard to re-shape to suit a particular political narrative:

There is a neat summary of key issues behind the current crisis in the Vox but for all the facts and all the good discussions, the Vox article just can't get itself around to one topic - the role of the U.S. in all of this (and the role of the U.S. allies), so for the sake of not re-writing history, here's an alternative angle on that too.

And for all the headlines about the current crisis being the worst in European history since WW2... there's this handy chart from Globe & Mail:

Nor is the problem tied into Syrian crisis alone as the following chart from the same Globe & Mail article shows:

Which leads to the conclusion. And an unpleasant one. Either the Schengen is going to go bust... or we are going to hear - pretty soon - a call for yet another *Genuine* Union, this time around a Genuine Migration Union or a Genuine Borders Union, for any solution to all European crises must always involve greater harmonisation of something.

13/9/15: Irenomics101: No One's an Island...

Remember all the jubilation over the EU milk quotas abolition? Ah, what a difference a few months and basic Economics 101 make...

And that Economics 101 lesson is: remove restrictions - supply goes up. Unless demand goes up as much, prices will fall. And demand... oh, that demand...
But, of course, Irish dairy farmers are 'cautious' and 'wise' and 'will gradually increase supply in response to demand'... And then there's another lesson to be learned: there is no such thing as 'collective caution' when it comes to commodities producers... so in July 2015, milk for human consumption supply in Ireland rose 8.4% y/y and butter production rose 20.8%. And in January-May 2015 (latest data available for EU-wide comparatives), milk intake by pasteurisers and creameries fell across the EU 0.1% and rose 6.3% in Ireland (second largest increase after Hungary, which has an intake of 638,000 tonnes of milk over that period against Ireland's 2,516,000 tonnes). In reality, things were even more 'cautious' on the side of Irish farmers - domestic (as opposed to imported) milk production rose 8.6% y/y in January-July 2015.

Just as domestic milk output prices fell 24.5% y/y in July 2015...

Which neatly brings us back to that original argument from the Irish industrial farming lobby - the one about 'cautious' increases being a buffer against price collapse... it is about as good as late Brian Lenihan's unfortunate argument that bank runs can't happen here, "Ireland being an island"...

Saturday, September 12, 2015

11/9/15: 2Q 2015 National Accounts: Recovery on pre-crisis peak

In the first post of the series covering 2Q national Accounts data, I dealt with sectoral composition of growth. The second post considered the headline GDP and GNP growth data. The third post in the series looked at Domestic Demand that normally more closely reflects true underlying economic performance, and the fourth post covered external trade.

In this post, let us briefly consider per capita GDP, GNP and Domestic Demand.

Chart below shows cumulative four quarters per capita GDP, GNP and Domestic Demand based on the latest data for population estimates and the National Accounts through 2Q 2015.

As shown above, Final Domestic Demand on per capita basis was at EUR33,782, up 5.95% y/y in 2Q   2015, closing some of the crisis period gap. Still, compared to peak, per capita Final Domestic Demand is still 13.3% below pre-crisis peak levels in real (inflation-adjusted terms). In part, this is driven by the Personal Consumption Expenditure which, on a per-capita basis was EUR19,163, up 2.1% y/y in 2Q 2015, but down 8% on pre-crisis peak.

GDP per capita rose 5.3% y/y in 2Q 2015 to EUR42,106, down only 0.82% on pre-crisis peak. GNP per capita rose to EUR36,189 up 5.9% y/y and 1.49% ahead of pre-crisis peak.

CONCLUSIONS: With GNP per capita attaining pre-crisis levels back in 1Q 2015, the recovery from the crisis has been effectively completed in real terms in terms of GNP after 28 quarters. In GDP terms, we are now close to regaining the pre-crisis peak levels, with 30 quarters to-date at below the peak. However, recovery is still some distance away in terms of Final Domestic Demand per capita and in terms of Personal Consumption Expenditure. 

12/9/15: Russian Exports & Trade Balance for July

Central Bank of Russia released latest figures (for July 2015) covering external trade in goods. Here are some details.

Russian exports of goods (in US dollar terms) fell 40.15% y/y in July following a 25.6% drop in June. These are not seasonally-adjusted figures, so we can only do y/y comparatives. The drop was sharper for Russian trade with countries outside the CIS (down 42.35% in July) than with CIS countries (down 'only' 22.71%). This implies a reversal in June changes when exports to CIS countries fell more substantially than exports to non-CIS countries (-30.46% and -24.76% respectively).

Taking out some monthly volatility, 3mo average for Russian exports of goods were down 32.15% y/y in May-July, with distribution of declines pretty much even across both CIS and non-CIS states (-32.19% and -32.15%, respectively).

Russian imports of goods fell even more than exports in percentage terms. Russian imports of goods fell 41.87% in July in y/y terms, having previously posted a decline of 38.3% in June. 3mo average through July 2015 was down 40.19% y/y.

However, in level terms, declines in exports were sharper than declines in imports: 3mo average through July 2015 for exports was down USD14.04 billion against decline in imports of USD10.99 billion.

As the result, Russian trade balance (goods only) deteriorated sharply in July 2015, declining 37.21% y/y in July, having previously posted a relatively small decline of 1.24% in June. On a 3mo average basis through July 2015, trade balance in goods was down USD3.041 billion compared to the same period in 2014 (-18.66%). On 3mo average basis, trade balance with CIS was down marginally USD802 million in value terms, but sharply in percentage terms (-29.3%), while trade balance with non-CIS states was down sharply in both levels (USD2.24 billion) and in percentage terms (-16.5%).

As chart above shows, the contraction in July Trade Balance was very sharp. To see this, consider historical series for Russian Trade Balance in goods since January 2000:

July 2015 y/y decline in overall Trade Balance for goods ranks as the sharpest since July 2009 and 13th sharpest decline since January 2000.

CONCLUSIONS: Overall July drop in Russian Trade Balance (goods only) was driven primarily by lower energy (oil and gas) prices and deterioration in Ruble valuations (Ruble is down some 15% since July 1).

As a related note, as reported by Bloomberg earlier this month, despite another strong harvest, Russian exporters of wheat are being held out of the global markets by the Government measures aimed at curbing food inflation at home.

Thursday, September 10, 2015

10/9/15: 2Q 2015 National Accounts: External Trade

In the first post of the series covering 2Q national Accounts data, I dealt with sectoral composition of growth, using GDP at Factor Cost figures.

The second post considered the headline GDP and GNP growth data.

The third post in the series looked at the Expenditure side of the National Accounts, and Domestic Demand that normally more closely reflects true underlying economic performance,

Now, consider extern trade.

  • Exports of Goods and Services were up 13.56% y/y in 2Q 2015 previously having risen 14.17% y/y in 1Q 2015. Over the last 4 quarters, growth in exports of goods and services averaged 14.2% y/y.
  • Most of growth in exports of Goods and Services is accounted for by growth in Goods exports alone. These rose 16.36% y/y in 2Q 2015 after rising 16.86% y/y in 1Q 2015. Average y/y growth rate in the last 4 quarters was 18.38%. In other words, apparently Irish exports of goods are doubling in size every 4 years. Which, of course, is simply unbelievable. Instead, what we have here is a combination of tax optimisation by the MNCs and effects of currency valuations on the same.
  • Exports of Services also grew strongly in 2Q 2015, rising 10.34% y/y, having previously grown 10.94% in 1Q 2015 and averaging growth of 9.94% over the last 4 quarters. Again, these numbers are beyond any reasonable believable uptick in real activity and reflect MNCs activities and forex valuations.
  • Imports of Goods and Services rose 16.9% y/y in 2Q 2015, an increase on already fast rate of growth of 15.46% in 1Q 2015. Unlike exports side, imports side of goods and services trade was primarily driven by imports of services which rose 21.8% y/y in 2Q 2015 (+20.7% y/y on average over the last 4 quarters) as compared to 9.0% growth y/y in imports of goods (+13.5% y/y on average over last 4 quarters).

As the result of the above changes,

  • Trade Balance in Goods and Services fell in 2Q 2015 by 1.8% y/y, having previously recorded an increase of 7.4% y/y in 1Q 2015. Combined 1H 2015 trade balance is now up only EUR399 million on same period 2014 (+2.26%).
  • Trade Balance in Goods registered 26.9% higher surplus in 2Q 2015, and was up EUR6.206 billion in 1H 2015 compared to 1H 2014 (+28.4%). Trade Balance in Services, however, posted worsening deficit of EUR5.584 billion in 2Q 2015 against a deficit of EUR2.174 billion back in 2Q 2014. Over the 1H 2015, trade deficit in services worsened by EUR5.806 billion compared to 1H 2014 (a deterioration of 136% y/y).


  1. Irish external trade continued to show strong influences from currency valuations and MNCs activities ramp up, making the overall external trade growth figures look pretty much meaningless. 
  2. Overall Trade Balance, however, deteriorated in 2Q 2015, which means that external trade made a negate contribution to GDP growth. 
  3. Over the course of 1H 2015, the increase in overall Irish trade balance was relatively modest at 2.26% with growth in goods exports net of goods imports largely offset by growth in services imports net of services exports.

Stay tuned for more analysis of the National Accounts.

10/9/15: 2Q 2015 National Accounts: Domestic Demand

In the first post of the series covering 2Q national Accounts data, I dealt with sectoral composition of growth, using GDP at Factor Cost figures.

The second post considered the headline GDP and GNP growth data.

Here, let's consider the Expenditure side of the National Accounts, and most importantly, Domestic Demand that more likely reflects true underlying economic performance, removing some (but by far not all) tax activity by the MNCs.

As before, I will be dealing with y/y growth figures throughout the post.

Remember: Final Domestic Demand is a sum of Personal Expenditure, Government Expenditure, and Gross Fixed Capital Formation. Adding to that change in stocks gives us Total Domestic Demand, while adding net exports to Total Domestic Demand and subtracting outflows of factor payments to the rest of the world gives us GDP.

  • In 2Q 2015, Personal Expenditure on Goods and Services rose 2.83% y/y, having previously risen 3.71% in 1Q 2015. The rate of growth in 2Q 2015 was, therefore, slower than in 1Q, but faster than in 2Q 2014 (2.28%). Overall, Personal Expenditure added EUR599 million to the economy in 2Q 2015 compared to the same period in 2014, a drop in positive contribution from EUR784 million added in 1Q 2015. Nonetheless, the figures for Personal Expenditure are healthy.
  • Net Expenditure by Government on current goods & services rose 1.73% y/y in 2Q 2015, which marks a slowdown on 5.45% rate of growth recorded in 1Q 2015. Rate of growth recorded in 2Q 2015 was also lower compared to 2Q 2014 when Government expenditure rose 3.92% y/y in real terms. This marks 2Q 2015 as the first quarter since 1Q 2013 in which Government expenditure rose slower than Personal expenditure.
  • Gross Domestic Fixed Capital Formation posted a massive 34.2% rise y/y in 2Q 2015, compared to already rapid growth of 9.2% recorded in 1Q 2015. It is worth noting that these figures include investments by MNCs tax-registered in Ireland (e.g. tax inversions et al) and vulture funds and other foreign investors' purchases of domestic assets. Over the last 4 quarters, Gross Domestic Fixed Capital Formation growth averaged 18.44%. This line of expenditure contributed EUR2.977 billion to GDP growth in 2Q 2015 and in H1 2015 total contribution was EUR3.781 billion.
  • As the result of the above, Final Domestic Demand rose 10.07% y/y in 2Q 2015 - a massive rate of increase, especially compared to 5.34% growth recorded in 1Q 2015 and 6.4% growth recorded in 2Q 2014.

However, despite all the Nama sales and vultures investments, tax inversions and organic growth, Irish Final Domestic demand remains below the levels attained prior to the crisis, albeit the gap is now at only 5.62%:

Chart below shows the extraordinary uplift in Gross Fixed Capital Formation:

We have no idea what drove this uptick, but were Gross Fixed Capital Formation growth running at 1Q 2015 pace in 2Q 2015, this line of expenditure contribution to GDP would have been EUR2.175 billion lower, and overall GDP growth would have been less than 2.1% y/y instead of 6.7%. This just shows how volatile Irish figures are and how dependent they can be to a single line change of unknown nature.


  1. Overall, Irish economy posted moderate growth in Personal Expenditure and Government Expenditure in 2Q 2015. Slightly negative news is that growth in 2Q 2015 was slower in these two categories than in 1Q 2015.
  2. Gross Fixed Capital Formation posted an unprecedented rate of increase y/y rising 34.2% in 2Q 2015. There is absolutely no clarity as to the sources or nature of this growth, especially considering that traditional investment areas of Building & Construction have been growing at just 1.5% y/y in 2Q 2015. Stripping out growth in this area in excess of 1Q 2015 already rapid expansion would have generated much lower, more realistic growth figure for GDP and for Domestic demand.
  3. Final Domestic Demand expanded strongly on foot of Fixed Capital Formation, rising 10.1% y/y in 2Q 2015 almost double the 5.3% rate of growth recorded in 1Q 2015.
  4. One area of potential concern is the impact on Domestic Demand (via Gross Fixed Capital Formation) from the MNCs activities via MNCs inverted into Ireland. There are multiple examples of such inversions across various sectors all having potential implications on how we treat investment by such firms in National Accounts. Another area of concern is treatment of capital investments by some financial firms, such as aircraft leasing firms and, increasingly, vulture funds and REITS.

Analysis of external trade flows is to follow, so stay tuned.