29/4/15: China's Debt Pile is Frightening & Getting Worse

Just catching up on some interesting data on China, courtesy of @AmbroseEP, showing debt to GDP ratios for China's real economy:

Now, note that the comparatives are all advanced economies that can carry, normally, higher debt levels. Which makes China's 282% estimated total debt pile rather large.

The chart references as a source data presented in this (see scone chart) http://trueeconomics.blogspot.ie/2015/03/5315-troika-tale-of-irish-debt.html but adjusted to reflect RBS estimates. which pushes McKinsey point for China horizontally to the levels close to Greece.

As someone else pointed out, nominal GDP growth in China is apparently now lower than interest on debt.

Meanwhile number of stock market accounts has gone exponential in recent days - using borrowed money (Chinese residents borrowed over Yuan 1 trillion or Euro150 billion worth of cash to pump into stock markets):

Economy is clearly slowing down in China, with conflicting reports and estimates of 1Q 2015 growth suggesting possible contraction in the real economy and domestic demand. (See http://www.irishtimes.com/business/economy/china-equity-markets-boom-while-economic-growth-stutters-1.2182547).

At the top of debt chain are local authorities: latest official data shows borrowings by the local authorities were up by almost 50% since the start of H2 2013 to c. 16 trillion yuan. Local authorities debt growth accounts for a quarter of changes in overall domestic debt since 2008. Recently, the IMF warned China that the country overall economic debt is expanding at a faster pace than debt in Japan, South Korea and the U.S. grew before the onset of the Global Financial Crisis.

My view: when this pile of Chinese debt blows, things will get spectacularly ugly, globally.

19/4/15: Higher Firm Leverage = Lower Firm Employment (and Output)

In a recent briefing note on the Capital Markets Union (CMU) (here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2592918), I wrote that the core problem with private investment in the EU is not the lack of integrated or harmonised investment and debt markets, but the overhang of legacy (pre-crisis) debts.

Here is an interesting CEPR paper confirming the link between higher pre-crisis leverage of the firms and their greater propensity to cut back economic activity during the crisis. This one touches upon unemployment, but unemployment here is a proxy for production, which is, of course, a proxy for investment too.

Xavier Giroud, Holger M Mueller paper "Firm Leverage and Unemployment during the Great Recession" (CEPR  DP10539, April 2015, www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10539) argues that "firms’ balance sheets were instrumental in the propagation of shocks during the Great Recession. Using establishment-level data, we show that firms that tightened their debt capacity in the run-up (“high-leverage firms”) exhibit a significantly larger decline in employment in response to household demand shocks than firms that freed up debt capacity (“low-leverage firms”). In fact, all of the job losses associated with falling house prices during the Great Recession are concentrated among establishments of high-leverage firms. At the county level, we find that counties with a larger fraction of establishments belonging to high-leverage firms exhibit a significantly larger decline in employment in response to household demand shocks."

In short, more debt/leverage was accumulated in the run up to the crisis, deeper were the supply cuts during the crisis. Again, nothing that existence of a 'genuine' capital markets union or pumping more credit supply (debt/leverage supply) into the system can correct.

31/3/15: The Most Effective QE of all QEs

In the previous post I shared my view of the QE. Here is the best, most succinct summary of the effectiveness of the 'most effective' of all recent QEs: the US example via @Convertbond:

Nails it.

13/3/15: Emerging Markets Corporate Debt Maturity Squeeze

H/T to @RobinWigg for the following chart summing up Emerging Markets exposure to the USD-denominated corporate debt redemptions calls over 2015-2025. The peak at 2017 and 2018 and relatively high levels for exemptions coming up in 2016, 2019-2020 signal sizeable pressure on the EM corporates that coincides with expected tightening in the US interest rates cycle - a twin shock that is likely to have adverse impact on EMs' capex in years to come. With rolling over 2017-on debt becoming a more expensive proposition, given the USD FX rates and interest rates outlook, the EMs-based corporate sector will come under severe pressure to use organic revenue generation to redeem maturing debt. Which means less investment, less hiring and less growth.

The impossible monetary policy trilemma that I have been warning about for some years now is starting to play out, with delay on my expectations, but just as expected - in the weaker and more vulnerable markets first.

18/2/15: IMF Package for Ukraine: Some Pesky Macros

Ukraine package of funding from the IMF and other lenders remains still largely unspecified, but it is worth recapping what we do know and what we don't.

Total package is USD40 billion. Of which, USD17.5 billion will come from the IMF and USD22.5 billion will come from the EU. The US seemed to have avoided being drawn into the financial singularity they helped (directly or not) to create.

We have no idea as to the distribution of the USD22.5 billion across the individual EU states, but it is pretty safe to assume that countries like Greece won't be too keen contributing. Cyprus probably as well. Ireland, Portugal, Spain, Italy - all struggling with debts of their own also need this new 'commitment' like a hole in the head. Belgium might cheerfully pony up (with distinctly Belgian cheer that is genuinely overwhelming to those in Belgium). But what about the countries like the Baltics and those of the Southern EU? Does Bulgaria have spare hundreds of million floating around? Hungary clearly can't expect much of good will from Kiev, given its tango with Moscow, so it is not exactly likely to cheer on the funding plans… Who will? Austria and Germany and France, though France is never too keen on parting with cash, unless it gets more cash in return through some other doors. In Poland, farmers are protesting about EUR100 million that the country lent to Ukraine. Wait till they get the bill for their share of the USD22.5 billion coming due.

Recall that in April 2014, IMF has already provided USD17 billion to Ukraine and has paid up USD4.5 billion to-date. In addition, Ukraine received USD2 billion in credit guarantees (not even funds) from the US, EUR1.8 billion in funding from the EU and another EUR1.6 billion in pre-April loans from the same source. Germany sent bilateral EUR500 million and Poland sent EUR100 million, with Japan lending USD300 million.

Here's a kicker. With all this 'help' Ukrainian debt/GDP ratio is racing beyond sustainability bounds. Under pre-February 'deal' scenario, IMF expected Ukrainian debt to peak at USD109 billion in 2017. Now, with the new 'deal' we are looking at debt (assuming no write down in a major restructuring) reaching for USD149 billion through 2018 and continuing to head North from there.

An added problem is the exchange rate which determines both the debt/GDP ratio and the debt burden.

Charts below show the absolute level of external debt (in current USD billions) and the debt/GDP ratios under the new 'deal' as opposed to previous programme. The second chart also shows the effects of further devaluation in Hryvna against the USD on debt/GDP ratios. It is worth noting that the IMF current assumption on Hryvna/USD is for 2014 rate of 11.30 and for 2015 of 12.91. Both are utterly unrealistic, given where Hryvna is trading now - at close to 26 to USD. (Note, just for comparative purposes, if Ruble were to hit the rates of decline that Hryvna has experienced between January 2014 and now, it would be trading at RUB/USD87, not RUB/USD61.20. Yet, all of us heard in the mainstream media about Ruble crisis, but there is virtually no reporting of the Hryvna crisis).

Now, keep in mind the latest macro figures from Ukraine are horrific.

Q3 2014 final GDP print came in at a y/y drop of 5.3%, accelerating final GDP decline of 5.1% in Q2 2014. Now, we know that things went even worse in Q4 2014, with some analysts (e.g. Danske) forecasting a decline in GDP of 14% y/y in Q4 2014. 2015 is expected to be a 'walk in the park' compared to that with FY projected GDP drop of around 8.5% for a third straight year!

Country Forex ratings are down at CCC- with negative outlook (S&P). These are a couple of months old. Still, no one in the rantings agencies is rushing to deal with any new data to revise these. Russia, for comparison, is rated BB+ with negative outlook and has been hammered by downgrades by the agencies seemingly racing to join that coveted 'Get Vlad!' club. Is kicking the Russian economy just a plat du jour when the agencies are trying to prove objectivity in analysis after all those ABS/MBS misfires of the last 15 years?

Also, note, the above debt figures, bad as they might be, are assuming that Ukraine's USD3 billion debt to Russia is repaid when it matures in September 2015. So far, Russia showed no indication it is willing to restructure this debt. But this debt alone is now (coupon attached) ca 50% of the entire Forex reserves held by Ukraine that amount to USD6.5 billion. Which means it will possibly have to be extended - raising the above debt profiles even higher. Or IMF dosh will have to go to pay it down. Assuming there is IMF dosh… September is a far, far away.

Meanwhile, you never hear much about Ukrainian external debt redemptions (aside from Government ones), while Russian debt redemptions (backed by ca USD370 billion worth of reserves) are at the forefront of the 'default' rumour mill. Ukrainian official forex reserves shrunk by roughly 62% in 14 months from January 2014. Russian ones are down 28.3% over the same period. But, you read of a reserves crisis in Russia, whilst you never hear much about the reserves crisis in Ukraine.

Inflation is now hitting 28.5% in January - double the Russian rate. And that is before full increases in energy prices are factored in per IMF 'reforms'. Ukraine, so far has gone through roughly 1/5 to 1/4 of these in 2014. More to come.

The point of the above comparatives between Russian and Ukrainian economies is not to argue that Russia is in an easy spot (it is not - there are structural and crisis-linked problems all over the shop), nor to argue that Ukrainian situation is somehow altering the geopolitical crisis developments in favour of Russia (it does not: Ukraine needs peace and respect for its territorial integrity and democracy, with or without economic reforms). The point is that the situation in the Ukrainian economy is so grave, that lending Kiev money cannot be an answer to the problems of stabilising the economy and getting economic recovery on a sustainable footing.

With all of this, the IMF 'plan' begs two questions:

1. Least important: Where's the European money coming from?
2. More important: Why would anyone lend funds to a country with fundamentals that make Greece look like Norway?
3. Most important: How on earth can this be a sustainable package for the country that really needs at least 50% of the total funding in the form of grants, not loans? That needs real investment, not debt? That needs serious reconstruction and such deep reforms, it should reasonably be given a decade to put them in place, not 4 years that IMF is prepared to hold off on repayment of debts owed to it under the new programme?

Note: here is the debt/GDP chart adjusting for the latest current and forward (12 months) exchange rates under the same scenarios as above, as opposed to the IMF dreamt up 2014 and 2015 estimates from back October 2014:

Do note in the above - declines in debt/GDP ratio in 2016-2018 are simply a technical carry over from the IMF assumptions on growth and exchange rates. Not a 'hard' forecast.

17/2/15: Of Debt, Equity and the Wake Up Calls for the Financial Markets

My post for Learn Signal blog on the issues of debt v equity composition of the global financial markets: http://blog.learnsignal.com/?p=157

7/2/15: Euro Area's Debt Addiction

Europe's debt addiction in one chart: the following chart plots total domestic and cross-border credit to non-banks, at constant end-Q2 2014 exchange rates, in per cent of GDP:

Source: BIS: http://www.bis.org/statistics/gli/gli_feb15.pdf

In the above:

• The solid lines are actual outcomes, 
• The vertical lines indicate the 2007 beginning of the global financial crisis and the 2008 collapse of Lehman Brothers. 
• Figures include government. 
• The dashed lines reflect long term trend, calculated as for the countercyclical capital buffer in Basel III using a one-sided HP-filter.

Two obvious conclusions emerge from the above:

1. Since the start of the Global Financial Crisis, debt addiction expanded both in the US and the Euro area, with US addiction rising faster than the Euro area's.
2. The gap between Euro area and US dependency on debt at the end of 2014 stood at a similar level as at the start of the Global Financial Crisis and above the pre-crisis level. That is despite the fact that in the US, most recent manifestation of the debt addiction has been associated with much higher economic growth and jobs recovery than in Europe.

17/1/2015: Is QE permanent and do we need a Government debt 'deletion'?

In a far-reaching comment on the QE and its true nature, published back in 2013 (see here: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/9970294/Helicopter-QE-will-never-be-reversed.html),  Ambrose Evans-Pritchard took the arguments of several economists and drew, with them, a very far reaching set of conclusions.

To summarise these:
1) QE is permanent - it cannot be undone. I agree.
2) Better than that, QE should be used to cancel legacy Government debts, providing deficit financing ex post facto. I agree only partially.
3) QE should be expanded to a stand by facility to fund aggregate demand via funding future deficits. I disagree.

Why would I disagree with the 2 latter points?

Reason 1: Government debt is not the biggest problem shared by all economies today. In some economies, such as Greece, Italy and US, for example, it is the main problem. But in other economies, such as Ireland and Spain, for example, it is secondary to household and corporate debts. This means that even if economic growth restarts on foot of the above 3-points plan, the reversion to 'normalcy' in interest rates will simply crash legacy debt-holders. No amount of fiscal stimulus will be able to undo this damage.

Reason 2: Government deficits and debts did not arise from purely automatic stabilisers (or in simple terms solely from the disruptions caused by the Global Financial Crisis) in all economies. In some countries they did, as, for example in Italy and France. In others, they came about as the result of imbalances in the economy that drove large asset bubbles, e.g. Ireland and Spain. In yet other countries they were systemic, e.g. Greece and Italy. The 3-points plan can help the first set of countries. Can do damage to the second set of countries (via interest rates channel and/or by generating another bubble) and will provide no incentives for change for the last set of countries.

There are other arguments as to the fallacious or partially fallacious nature of points 2 and 3. These include the arguments that public spending creates own bubbles - those in wages and salaries, employment and practices in the public sector, or those in rates of return for politically connected businesses or those in public infrastructures that will have to be maintained and serviced over decades to come, irrespective of the economic returns they might generate. They also include the arguments that public spending and investment can crowd out private spending and investment. As well as arguments that in a number of countries, especially within the euro area, public spending as already hefty enough and priming it up using monetary financing today is setting us up for creating a permanent future liability to continue funding the same out of tax revenues into perpetuity after the QE funding is completed.

The key, however, is the problem of total debt distribution, not just of Government debt volumes. A 'delete' button must be pushed, I agree. But what we will be deleting has to be much more complex than just the Government debt. In some countries it will have to also include private debts. And for that, we have not had a QE devised, yet...

10/1/2015: Where did Europe's EUR3 trillion worth of debt go?

You know the Krugmanite meme… Euro area is doing everything wrong by not running larger deficits. But here is an uncomfortable reality: since 2007, Euro area countries have managed to increase their debt in excess of 60% of GDP by a staggering EUR3 trillion.

So here's the crux of the problem: where did all this money go?

We know in terms of geographic distribution:

EUR1.6 trillion of this debt increase went to the 'peripheral' countries, and EUR39.2 billion went to the Easter European members of the Euro area. EUR517 billion went to the 'core' economies. And a whooping EUR759.9 billion to France. Now, across the 'periphery' some 20-25% of the debt increase is attributable to the banks measures directly, but the rest is a mix of automatic stabilisers (e.g. increases in unemployment benefits due to higher unemployment) and old-fashioned Keynesian policies.

It might be that Euro area is not spending enough in the right areas of fiscal policy. But to make an argument that it is not spending enough across the board is bonkers. We have allocated some EUR3 trillion in borrowed spending and we will continue to run the debt up in 2015. And still there is no sign of growth on the horizon.

So, again, where is all this money going?

1/1/2015: Shared Liability: Debtor and Lender

In a recent blogpost on geography of Euro area debt flows prior to the crisis, I noted the extent to which Irish (and other peripheral euro area economies') debt bubble pre-2008 has been inflated from abroad (see here: http://trueeconomics.blogspot.ie/2014/12/27122014-geography-of-euro-area-debt.html). The argument, of course, is that the funding source, just as the funding user, should co-share in the liability created by the bubble.

This argument, advanced by myself and many others over the years of the crisis, has commonly been refuted by the counter-point that no such liability is implied: borrowers willingly borrowed from the banks, banks willingly borrowed from the markets (aka other banks) and that is where liability ends.

Here is a cogent paper on the subject from the Bank for International Settlements (not some lefty-leaning think tank or a libertarian hothouse of dissent): Turner, Philip, Caveat Creditor (July 2013). BIS Working Paper No. 419: http://ssrn.com/abstract=2384445).

The paper asserts that "One area where international monetary cooperation has failed is in the role of surplus or creditor countries in limiting or in correcting external imbalances." In common parlance, that is the area of liability of one economic system that, having generated surpluses of savings, provides funding to another economy.

"The stock dimensions of such imbalances - net external positions, leverage in national balance sheets, currency/maturity mismatches, the structure of ownership of assets and liabilities and over-reliance on debt - can threaten financial stability in creditor as in debtor countries." In other words, net lender (e.g. Germany) co-creates the imbalance with the net borrower (e.g. Ireland).

And thus, "creditor countries ...have a responsibility both for avoiding "overlending" and for devising cooperative solutions to excessive or prolonged imbalances."

Unless responsibility does not imply liability (in which case me being responsible for driving safely should not translate into me being liable for any damages done to other parties from failing to do so), we have confirmation of my logic: net lending countries (I refer you to the chart in the blogpost linked above) bear shared liability with the borrowers. By extension, lending banks share liability with the borrowers. Per BIS. Not just per the unreasonable myself.

26/12/2014: "Iceland: How Could this Happen?"

Always interesting and never ending debate about Iceland v Ireland can only be aided by the following recent paper by Gylfason, Thorvaldur, titled "Iceland: How Could this Happen? (see CESifo Working Paper Series No. 4605: http://ssrn.com/abstract=2398265).

The author "reviews economic developments in Iceland following its financial collapse in 2008, focusing on causes and consequences of the crash. The review is presented in the context of the Nordic region, with broad comparisons also with developments elsewhere on the periphery of Europe, in Greece, Ireland, and Portugal. In some ways, however, Iceland resembles Italy, Japan, and Russia more than it resembles its Nordic neighbors or even Ireland. The paper also considers the uncertain prospects for reforms and restoration as well as the possible effects of the crash on social, human, and real capital and on long-run economic growth."

To add, two charts of my own, really self-explanatory:

16/9/2014: If China Growth Fall-off is Structural... Who's Going to Drive Global Growth?..

BOFIT published their revised forecasts for Chinese economic growth 2014-2016 and the numbers are just not pretty... not quite ugly, but not pretty. 2014-2015 forecast is for 7% growth - which is a 'psychological' bond for growth in China as it entails a 10-year doubling horizon and is alleged to be supportive of demographic changes. 2016 growth forecast is for 6% - or sub-7% magic number.

All in, 2014-2016 are expected to show slowest growth since the start of the millenium and these come on foot of two previous years of growth below 8%. So far, H1 2014 posted growth of 7.5%, down from 7.7% growth in 2013.

Interestingly, BOFIT note: "If the indicative data showing a relatively good employment picture are credible, even growth lower than forecast here may be suffi-cient to satisfy the needs of the Chinese society. China’s traditional official growth targets, crystallised in a single number, have outlived their purpose. They fail to guide market ex-pectations and policies in a way that reflect economic fundamentals."

The drivers of Chinese economy slowdown appear to be very similar to those impacting Russian economy: exhaustion of the investment boom. "The current slowdown in growth is quite natural given the size of China’s economy, its resource demands and increased level of development, but there are also other factors con-tributing to the slowdown. In the wake of a decade-long investment boom, new investment no longer delivers the same “bang for the buck” it did earlier. A corollary to China’s aging population is the decline in the number of work-age people. Vast environmental degradation comes with hefty costs that are already eroding growth. Finally, short-term growth will be subdued by high indebtedness that limits the government’s room to manoeuvre in the fiscal and monetary policy spheres."

The Big Hope has always been that falling investment will be offset by rising consumption. Which is what provides upside support to BOFIT forecasts. But one must ask a simple question: if debt is already a problem, who will be paying for this increasing consumption?

In case you wondered, that 'soft landing' meme is still around, but it is now being increasingly questioned: "A controlled “soft landing” for economic growth is by no means a given at this point. Remaining on the appropriate glide path will require strong economic and reform policies. The rising indebtedness of firms and local governments remains a top challenge for China’s multi-tiered economic policy matrix. Worryingly, the credit boom in China this decade tracks several earlier credit booms in other countries that ended in crisis. Darkening the mood further is an impending correction in the real estate sector. While Chinese financial markets have been relatively calm in recent months compared to a year ago, the shadow-banking sector continues to grace the headlines with stories of defaults and other problems. "

Key point is that China is not expected to support significant upside to global growth through 2016. And this leaves global growth dependent on G7...

Full forecast is available here: http://www.suomenpankki.fi/bofit_en/seuranta/kiina_ennuste/Documents/bcf214.pdf

5/9/2014: ECB, Zero Rates, Negative Yields and Debt... The Glorious Debt...

As I noted yesterday on twitter, the ECB policy rate change might be accommodative of the upcoming September TLTROs (by lowering the gross cost of using TLTROs to raise funds), but in reality all it is doing is continuing to push more debt accommodation for the already heavily-accommodated sovereigns. I also noted yesterday that this accommodation of banks and sovereigns has done preciously little to improve lending conditions for the real economy (http://trueeconomics.blogspot.ie/2014/09/492014-ecb-little-done-loads-more-to-be.html).

So here is a neat summary table showing the extent and spread of negative rates on 3 year government bonds - the table is courtesy of @Schuldensuehner (click on the image to enlarge):

In simple terms, if you want to lend money to Austrian, German, Belgian, French, Finnish, Dutch and Slovak Governments, you now have to pay for the privilege. It is as if there is a panic dumping of cash going on out there, under some grave threat of eminent expropriation or a meltdown of the entire financial system.

You betcha the Euro needs a traditional QE at this stage, because Belgium borrowing at negative rates is just not good enough, more debt is needed to fund more debt needs so the governments can spend more to stimulate tax revenues to sustain higher demand for debt yet... This, in a nutshell, the modern monetary policy, then.

And meanwhile, having crossed into the negative territory, bond yields opened up a new horizon for price appreciation for Government paper: higher debt supply, must equal higher price, inverting everything - from fundamentals to bounds on price appreciation. If you ever needed a sight of a bubble wobbling in the sun from the internal perturbations of hot air, give it another look... before it pops one day...

23/8/2014: That Pesky Problem of Real Debt...

Again, revisiting IMF's Article 4 consultation paper for Euro Area, published in July 2014, here is a summary of the Euro area 'peripheral' countries debt overhang.

First real economic debt (debt of non-financial companies, households and public sector):

 Points of note:

1. Ireland's debt overhang is severe. More severe than of any other 'peripheral' country. Bet you forgot that little bit with all the 'best-in-class' growth performance droning in the media. Ah, and worse, remember, not the level alone, but the rate of debt increases over time, also matters. And by this metric, we too are the worst in the group, both for debt increases on 2003 levels and debt increases on 2008 levels.
2. Ireland's households' debt has declined over 2008-2013, more so than in Portugal and Spain. But it remains second highest after the Netherlands' and this decline masks true extent of debt problem because 2013 figure no longer counts household debts issued by banks that left Ireland and books of loans sold to investment funds. This also excludes some securitised debt.
3. Ireland's corporate debt problem is potentially overstating true extent of real debt in the economy, as it includes a small share of MNCs debt - debt issued by Irish institutions. This is likely to be relatively minor, in my view, as MNCs largely do not do debt intermediation via Irish domestic institutions. 

Now on to our household debt deleveraging in more detail:

Good news is, when it comes to our households, we are aggressively deleveraging compared to pre-crisis debt peak. As aggressively (in rate terms) as the U.S. Caveats mentioned above apply.

But there is a problem with all the debt legacy:

In the above 'PS' stands for private sector, not public sector. So private sector debt legacy is associated with negative subsequent economic growth, in general. But as above shows, for the peripheral countries, including the basket case outside Troika capture, Slovenia, and the rarely mentioned case of Finland (see chart below) it is also compounding structurally weak fundamentals other than debt alone.

So a timely reminder: that debt problem - it has not gone away. Not by any measure and most certainly not for Ireland.

Note: to see the problem in Finland consider the following chart:

13/7/2014: Deflating That Corporate Debt Deflation Myth

This week, the IMF sketched out priorities for getting Spanish economy back onto some sort of a growth path. These, as in previous documents addressed to Irish and Portuguese policymakers, included dealing with restructuring of the corporate debts. IMF, to their credit, have been at the forefront of recognising that the Government debt is not the only crisis we are facing and that household debt and corporate debt also matter. As a reminder, Irish Government did diddly-nothing on both of these until IMF waltzed into Dublin.

But just how severe is the crisis we face (alongside with Spanish and Portuguese economies) when it comes to the size of the pre-crisis non-financial corporate debt pile, and how much of this debt pile has been deflated since the bottom of the crisis?

A handy chart from the IMF:

The right hand side of the chart compares current crisis to previous historical crises: Japan 1989-97; UK 1990-96; Austria 1988-96; Finland 1993-96; Norway 1999-05; Sweden 1991-1994.

So:

• Irish corporate debt crisis is off-the-scale compared to other 'peripherals' in the current crisis and compared to all recent historical debt crises;
• Irish deflation of debt through Q3 2013 is far from remarkable (although more dramatic than in Spain and Portugal) despite Nama taking a lion's share of the development & property investment debts off the banks.

Now, remember the popular tosh about 'debt doesn't matter for growth' that floated around the media last year in the wake of the Reinhart-Rogoff errors controversy? Sure, it does not... yes... except... IMF shows growth experience in two of the above historical episodes:

First the 'bad' case of Japan:

 So no, Japan has not recovered...

And then the 'good' case of Sweden:

Err... ok, neither did Sweden fully recover... for a while... for over a decade.

2/6/2014: Europe in the 'Happi-Ending' Data Parlour

The EU has discovered, at last, a new source of economic growth. Just about enough to deliver that magic 1%+ expansion for 2014 that the economical zombified currency block has been predicting to happen for years now. The new growth will come not from any new economic activity or value-added, but from including into the official accounts activities that constitute grey or black markets - transactions that are often illegal - drugs, prostitution, sales of stolen goods, and so on.

The basis for this miracle is the 2010 European System of Accounts which requires (comes September this year) of all EU states to include in official GDP (and GNP) accounts all "illegal economic actions [that] shall be considered as transactions when all units involved enter the actions by mutual agreement. Thus, purchases, sales or barters of illegal drugs or stolen property are transactions, while theft is not."

Wait a sec. Here's a funny one: stealing property is not a GDP-worthy activity, but selling stolen property is… It is sort of "breaking the leg is not adding to our income, but fixing a broken leg is" logic.

The rational behind harmonised treatment of grey and black markets data is that some states, where things like prostitution are legal, already include these services in GDP calculation, while others do not. Thing are, per EU, not comparable for, Netherlands and Luxembourg because of the Red Lights districts operating in one openly, and in another under the cover. From Autumn this year, all countries will do the same. And they will also add illegally-sold tobacco and alcohol

Prostitution is legal in Germany, the Netherlands, Hungary, Austria and Greece; some drugs are decriminalized in the Netherlands. Italy started to add some illegal activities into its GDP ages ago - back in 1987, the country added to its accounts estimates of the shadow economy: off-the-books business transactions which make up ca 20% of Italian GDP. This boosted Italian GDP by 18% overnight - an event that is called il sorpasso because it drove Italian GDP up to exceed that of the UK.

Poland did same earlier this year, with its GDP about to start covering proceeds from prostitution, drugs trafficking, alcohol and tobacco smuggling. Based on GUS (the CSO of Poland) estimates, in 2010 these accounted for some 1.17% of GDP.

Outside the EU, other countries are also factoring in illicit trade and transactions into their GDP. South Africa has been at this game since 2009, with GDP revised up by a modest 0.2% to take account of unobserved economy.

With 'new activities' added, Italy's GDP is expected to rise 2% in 2014, while French GDP will boll in by 3.2%, UK boost will be 'modest' 0.7%. And so on… Spain's shadow economy runs in excess of 20% of GDP. If bribes (some are voluntary, others can be extorted) are included, Europe's GDP will take a massive positive charge.

Here is the UK note on 'methodologies' to be used in estimating the new 'additions'. It is worth noting that the UK already includes illegally smuggled tobacco and alcohol estimates into its GDP, and these add some £300mln to the economy. Here is the Danish government report on the same, showing smuggling accounting for 2% of GDP adjustment. This is from 2005 when the Government adopted inclusion of some of the illegal activities into its GDP calculations. And dating even further back, the OECD guidebook on inclusion of illegal activities into accounts: here. Here is a fascinating paper from 2007 on Croatia's accession to the EU, meeting Maastricht Criteria targets and inclusion of illegal transactions into GDP.

The net result: deficits and debt levels will officially fall compared to GDP. Even private debts, still rising for now, will see rates of growth slowing down...

Of course, Ireland's Stuffbrokers have rejoiced at the thought of CSO boosting the GDP by counting in activities that can land one in jail. Per Irish Examiner report (here): "Davy chief economist Conall MacCoille said while the inclusion of the statistics might help the Government reach its deficit target of 4.8%, the activity is contributing nothing to the exchequer. “Of course we are delighted to see the CSO capture as much economic activity in the GDP figures as possible, but the fact is that this activity is not taxed. If might help push up the GDP figure, but it will not contribute anything to the exchequer,” he said."

Read: Happy times (higher GDP) could have been even happier (tax revenues boost), but we'd settle for anything that might push up the value of Government bonds... (Who's one of the largest dealers selling said bonds?...)

Thus, do expect congratulatory statements about 'austerity working', 'reforms yielding benefits' and 'recovery taking hold' blaring out of radio and TV sets next time pass the 'Happi-Ending' Massage Parlour or a methadone clinic…

Next step: Yanukovich era corruption 'activities' added to Ukraine's GDP. That should lower country CDS from sky-high 960s to Norwegian 13s… Happy times finally arriving to world's economic basket cases, riding on a dodgy stats bandwagon.

17/5/2014: Debt, Equity & Global Financial Assets Stocks

An amazing chart via McKinsey and BIS showing the distribution of financial assets by class and overall stocks of financial assets. These are covering the period through Q3 2013.

What we can learn from this?

1. Stock of financial assets might seem absurdly high compared to overall economic activity, but it is not that much out of line with longer term growth trends. Between 2000 and 2014 the world GDP is expected to grow from USD32,731.439 billion to USD76,776.008 billion, a rise of 135%. Over 2000-2013, stock of financial assets rose at least 124%.
2. However, in composition terms, the assets are geared toward debt and especially sovereign debt. Public Debt securities are up in volumes 243% - almost double the rate of economic growth. Financial institutions bonds are up 144% - faster than economic growth. Private non-financial sectors debt is up from USD43 trillion to USD 91 trillion - a rise of 112%. Total debt is up from USD73 trillion to USD178 trillion or 144% so within debt group of assets, public debt is off the charts in growth terms.

There is much deleveraging that took place in the global economy over the recent years. All of it was painful. But there is no way current levels of debt, globally, can be sustained. 

10/3/2014: One Day There Will Be Real Growth... Until Then...

There is no growth... like credit-growth-fuelled growth...

Via Pictet, two charts plotting US economy:

Note: credit impulse is, loosely, growth in credit supply.

So one day, some day, things will turn out to be anchored in real growth - productivity, new tech, shift to higher quality, new demand, new demographics... until then, there is always a credit boom-and-bust. Don't believe me? Last chart shows that underlying growth drivers are currently close to those in 2004-2008. 

10/3/2014: NYSE Margin Accounts Busting Record Levels...

Two quick twitter posts on leverage accumulation in the markets.

First one via Holger Zschaepitz @Schuldensuehner:

Shows NYSE members debit balances in margin accounts - at historic highs (since 1960).

Second, via Ioan Smith @moved_average:

Shows the above as % of nominal GDP as third highest in history. As noted by @moved_average, currently margin accounts balances are at ca 26% of all commercial and household loans outstanding in the US banking system.

This is just NYSE... Do we need to add timing lines for QEs here?.. (Hint: see peaks...)

Monthly data on the above: http://www.nyxdata.com/nysedata/asp/factbook/viewer_edition.asp?mode=tables&key=50&category=8

Here's a good post on monthly series analysis: http://www.advisorperspectives.com/dshort/updates/NYSE-Margin-Debt-and-the-SPX.php

And a telling chart from the above on growth rates in margin accounts:

Oh, and a comment from above post: margins accounts are at historic highs in real (inflation-adjusted) terms too...

Don't get too worked up if things get jittery next... cause this time (unlike in Q2 2000 and Q3 2007) things are going to be different...

Update:  via John Tracey @traceyjc84 the above expressed relative to Dow Industrials:

23/1/2014: A Troubled Recovery: Sunday Times, January 12

This is an unedited version of my Sunday Times column from January 12, 2014.


To some extent, the forward-looking data on the Irish economy coming out in recent months resemble the brilliant compositions of Richard Mosse – Ireland's leading artist at the venerable La Biennale di Venezia, 2013 (http://www.richardmosse.com/works/the-enclave/). Mosse show in Venice comprised sweeping photographic landscapes of war-affected Eastern Kongo rendered in crimson and pink hues of hope.

In our case, the rose-tinted hues of improving recent data are colouring in hope over the adversity of the Great Recession, now 6 years in the running. Beneath it all, however, the debt crisis is still running unabated.


This week, Purchasing Manager Indices (PMIs), published by Markit and Investec, signaled a booming Q4 2013 economy. Services PMIs averaged 59.7 over the last quarter of 2013, well above the zero-growth mark of 50. Alas, the Services PMI readings have been showing expansion in every quarter since Q1 2010, just as economy was going through a recession. The latest Manufacturing PMIs averaged 53.6 over the Q4 2013, implying two consecutive quarters of growth in the sector. Sadly, manufacturing activity, as reported by CSO was down substantially year on year through October. Things might have improved since then, but we will have to wait to see the actual evidence of this. Past history, however, suggests this is unlikely: PMIs posted nine months of growth in the sector over the twelve months through October 2013, CSO's indicator of actual activity in the sector printed seven monthly declines. Rosy forward outlook of PMIs is overlaying a rather bleak reality.

But the story of fabled economic growth is not limited to the PMIs alone. Property markets were up in 2013, boosted, allegedly, by the over-exuberance of international and domestic investors, and by the penned up demand from the cash-rich, jobs-holding homebuyers. No one is quite capable of explaining where these cash riches are coming from. Based on deposits figures, Irish property buyers are not taking much of cash out of the banks to fund purchases of South Dublin homes. They might be digging money out of the fields or chasing the proverbial leprechauns’ riches or doing something else in order to pump billions into the property markets. Still, residential property prices are up year on year. Alas, all of these gains are due to Dublin alone: in the capital, residential real estate prices rose 14.5 percent over the last 12 months. In the rest of the country they fell 0.5 percent.

Fuelled by rising rents (up 7.6 percent year on year) and property prices, the construction sector also swelled with the stories of a rebound. Not a week goes by without a report about some investment fund 'taking a bet on Ireland's recovery' by betting long on real estate loans or buildings, or buying into development land banks. Thus, Building and Construction sector activity in Q3 2013 has reached the levels of output comparable with those last seen in Q4 2010. Not that it was a year marked by robust activity either, but growth is growth, right? Not exactly. Stripping out Civil Engineering, building and construction activity in Ireland is currently lingering at the levels compatible with those seen in H2 2011. Worse, Residential Building activity was down year-on-year in Q3 2013. Meanwhile, in line with other PMI indicators, Construction PMI, published by Markit and Ulster Bank, suggests that the sector has been booming from September 2013 on. Again, more data is required to confirm this, but CSO's records for planning permissions show declines in activity across the sector.

The truth is that no matter how desperately we seek a confirmation of growth, the recovery to-date is removed from the real economy we inhabit. As the Q3 2013 national accounts amply illustrated, the domestic economy is still slipping. In the nine months of 2013, personal consumption of goods and services fell EUR734 million in real (inflation-adjusted) terms, while gross domestic capital formation (a proxy for investment) declined EUR381 million. Thus, final domestic demand - the amount spent in the domestic economy on purchases of current and capital goods and services - fell EUR1.3 billion or 1.4 percent. In Q2 2013 Irish Final Domestic Demand figure dipped below EUR30 billion mark for the first time since the comparable records began back in Q1 2008, while Q3 2013 reading was the third lowest Q3 on record.

Beyond Q3, the latest retail sales data for November 2013, released this week, was also poor. Even stripping out the motor trades, core retail sales were basically flat on 2012 levels in both volume and value.


With domestic economy de facto stagnant and under a constant risk of renewed decline, Ireland remains in the grip of the classic debt deflation crisis or a balancesheet recession.

The usual canary in the mine of such a crisis is credit supply. Per latest data from the Central Bank, volumes of loans outstanding in the private economy continued to fall through November 2013. Average levels of credit extended to households fell almost 4 percent in Q4 2013 compared to 2012 levels. Loans to non-financial corporations fell some 5 percent over the same period.

Total private sector deposits are up marginally y/y for Q4 2013, but household deposits are down. Thus, recent improvements in the health of Irish banks are down to retained profits and tax buffers being retained by the corporates. Put differently, the canary is still down, motionless at the bottom of the cage.

In this environment, last thing Ireland needs is re-acceleration in business and household costs inflation. Yet this acceleration is now an ongoing threat. Courtesy of the 'hidden' Budget 2014 measures Irish taxpayers and consumers are facing an increases in taxes and state charges of some EUR2,000 per household. Health insurance, water supplies, transport, energy, and a host of other price increases will hit the economy hard.

And after the Minister for Finance takes his share, the banks will be coming for more. The cost of credit in Ireland has been rising even prior to the banks levies passed in Budget 2014. In 3 months through October 2013, interest rates for new and existing loans to households and non-financial corporations were up on average some 19-23 basis points. Deposits rates were down 71 bps. Based on ECB latest statistics, the rate of credit cost inflation in Ireland is now running at up to ten times the euro area average.

In other words, we are bailing in savers and investors, while squeezing consumers and taxpayers.


These trends largely confirm the main argument advanced in the IMF research paper, authored by Karmen Reinhart and Kenneth Rogoff and published last December. The paper argues that in response to the global debt crisis, the massive wave of financial repression is now rising across advanced economies. The authors warn that economic growth alone may not be enough to deflate the debt pile accumulated by the Governments in the advanced economies prior to and during the current crisis. Instead, a number of economies, including are facing higher long-term inflation in the future, and lower savings and investment. The menu of traditional measures associated with dealing with the debt crises in the past, covering both advanced and developing economies experiences, includes also less benign policies, such as capital controls, direct deposits bail-ins, as well as higher taxes and charges.

Ireland is a good example of the above responses. Since 2011 we have witnessed pension funds levies and increases in savings and investment taxes. We also have witnessed state-controlled and taxed sectors pushing prices ever higher to increase the rate of Government revenue extraction. Budget 2014 banks levy is another example. Given the current state of banking services in Ireland, the entire burden of the levy is going to fall onto the shoulders of ordinary borrowers and depositors. Insurance sector was bailed-in, primarily via massive increases in the cost of health cover and reduced tax deductibility of health-related spending.

As Reinhart and Rogoff note, historically, debt crises tend to be associated with a significantly lower growth and are marked by long-run painful adjustments. The average debt crisis in the advanced economies since the WWII lasted 23 years – much longer than the fabled ‘lost decade’ on reads about in the Irish media.

All of which goes to the heart of the today’s growth dilemma in Ireland: while macroeconomic performance is improving, tangible growth anchored in domestic economy is still lacking. The good news i: foreign investors rarely look at the realities on the ground, beyond the macroeconomic headlines. The bad news is: majority us live in these realities.

Box-out: 

This column's mailbox greeted the arrival of 2014 with a litany of sales pitches from various funds managers. All were weighing heavily on ‘hard’ performance metrics, with boastful claims about 1- and 5-year returns. While appearing to be ‘hard’, these quotes present a misleading picture of the actual funds’ performance. The reason for this is simple: end of 2008 – beginning of 2009 represented a bottom of the markets collapse.

Over the last 10 years, annual returns to the S&P500 index averaged roughly 5 percent. This is less than one third of the 15.5 percent annualised returns for the index over the last 5 years. In Irish case, the comparatives are even more striking. Five-year annualised rise in ISEQ runs at around 12 percent. Meanwhile 10-year returns are negative at 1.2 percent.

Since no one likes quoting losses, the industry is only happy to see the dark days of the early 2009 falling into-line with the 5 year metric benchmark: the lower the depth of the depression past, the better the numbers look today.

The problem is that even the ten-year returns figures are often bogus. The quotes, based on index performance, usually ignore the fact that the very composition of the markets has changed significantly during the crisis. This is especially pronounced in the case of ISEQ. In recent years, ISE witnessed massive exits of larger companies from its listings. Destruction of banking and construction sector in Ireland compounded this trend. Put simply, investors should be we weary of the industry penchant for putting forward five-year returns quotes: too often, there's more wishful marketing in these numbers than reality.