18/7/20: Europe, the Land of the Unliving Leadership

If the U.S. of A. is the land of the brain-dead leadership, Europe (the EU) is the land of the unliving ones. The difference is the ratio of effort to failure. The Trump Administration is almost effortlessly creates daily flow of disasters. Meanwhile the EU27 is endlessly engages in strenuous attempts to not achieve something trivial.

Latest instalment is the European leadership summit this weekend: https://www.reuters.com/article/us-eu-summit/eu-nations-deadlocked-at-tense-coronavirus-recovery-summit-idUSKBN24J0A2.

One thing of note from Ireland's (and other net contributing states') perspective is that, as I predicted two months ago (https://www.thecurrency.news/articles/17392/france-and-germany-have-proposed-a-e500m-fund-to-shield-european-economy-what-does-it-mean-for-ireland), the proposed EU fund for addressing COVID19-induced recession will be a net cost to the more advanced European states.

What's worse is that this cost will be a function of Ireland's famously grotesquely inflated GDP. The tax avoidance shenanigans of the multinational corporations will cost us more in the COVID19 Fund case. And since all measures of our economic activity, from GDP to GNP to GNI to GNI* already include taxes paid by the multinationals to the Irish Exchequer, this added cost is not going to be recovered through tax revenues.

Here are some facts. The latest data for the official "Modified gross national income at current market prices" or GNI* - a measure of economic activity that is published by the Irish authorities, that partially (note: partially) strips out these tax shenanigans - is 2018. So we can use data through that year as a yardstick by which we can measure the official and only partial gap between the real economic activity in the State and the imaginary pretend-to-matter GDP of the Republic.

In 2018, actual GNI*-measured activity was EUR 197,460 million, while official GDP was EUR 324,038 million. The real economy of Ireland was, therefore, at least 39 percent less than the officially-measured economy of Ireland. Put differently, we claim we had a national income of 324 billion, but in reality, we only made 197.5 billion. If Ireland was filling a mortgage application, it would be lying on its income line.

This gap is growing over time (chart next, with estimates for 2019 based on actual GDP reported and estimated GNI* gap from the gross value added statistics, and 2020 forecast):

Yes, you see it right:

• Officially, actual productive capacity of the Irish economy, was 39.06% lower than implied by GDP measure in 2018.
• Estimated, based on officially released, but not yet fully aggregated, data 2019 gap was around 39.8 percent. Worse than in 2018.
• Based on official growth and inflation forecasts for 2020, and gross value added data for multinationals-led sectors vs domestic sectors for 1Q 2020 already reported by the CSO, real economy gap to imaginary GDP is likely to be in the region of 43.5% in 2020, or, possibly even higher. This higher figure is suggested by the booming exports of the Ireland-based multinationals during the first 3 months of the pandemic.

Since EU contributions are, in part, based on GNI (not GNI*), which is closely linked to GDP, and thus to gross accounting effects from the multinationals, Irish contributions to the EU27 budget are excessively inflated, roughly, by the gap factor. We know as much, as even ESRI - the mouthpiece of the 'official Ireland' - said so before.

Now, back to the EU27 'COVID Fund'. 

Irish authorities finally recognised the fact that Ireland will be a net payer into the fund, as opposed to a net beneficiary: https://twitter.com/tconnellyRTE/status/1284433835581726725?s=20. Which is what I warned about two months ago, when many Irish commentators were busy dividing the imaginary COVID Fund largesse into spending and investment priorities 'made available' to Ireland from Europe. 

Based on the GDP/GNI* gap, Ireland's repayments on the EU27 'COVID Fund' are likely to be 40% higher than the actual Irish economy's productive capacity would entail. 

The Fund is also likely to alter, long-term, the structure and the distribution of the Member States' contributions. Most likely, it will increase a GDP or GNI-linked share being paid in by Ireland. But even without accounting for this, the fact that we will be net payers into the Fund means that our investment priorities to be financed from the Fund will have to change dramatically. In fact, for every EUR1 borrowed from the fund, we will have to generate EUR 1.43 or more in added activity / return only to account for the GDP/GNI* gap. 

Take a simple example: suppose we borrow from the Fund EUR 1 billion to build a hospital. Nice idea. An expected return from the hospital that justifies such a project should be around cost of administration of investment + cost of funds + return and risk premia. Hard to pin these down, but, say we want to invest in a hospital in the first place because it will have socio-economic returns equivalent to 5 percent net of the cost of raising funds, if we were to issue bonds at 0 percent interest rate. With GDP/GNI* gap we have 5%*(1+43% Gap) = 7.15% required return to make that investment compatible to the Fund. And that is assuming we are just repaying our own share to the Fund. If the Fund also lends money to, say, Poland - a net recipient of transfers from the normal EU budgets, we will have to pay, roughly a GDP-weighted share of Poland's borrowings into the fund, too. Say that amounts to our normal net EU taxes contribution of ca 0.15 percent of GDP (historical average for 2016-2018 is actually 0.153%). This means we are actually going to be repaying 0.2145% of our GNI*-based economic capacity for Poland's financing. And so on. 

What could have been economically feasible or efficient to invest in under GDP base consideration may not be feasible or efficient under the repayment cost linked to our real economic activity measures, e.g. GNI*. That hospital we would like to have, and that makes sense as a combination of a fiscal stimulus and socio-economic investment, will no longer make sense to invest in, solely because we have spent decades fooling ourselves and the world around us that we are richer than we really are... whooping 38-40 percent richer. Playing a role of a rich uncle is has a cost, folks... 

Worse, the need for the repayment of the funds in the future, and more egregiously, the need to pay for the funds not borrowed by Ireland, will mean that in the longer run, Ireland will have to run higher debt or higher budget surpluses or both. If, say, Malta or Slovakia, or Hungary or Poland were to draw down funds from the COVID Fund, Ireland will need to contribute to repaying the money they borrowed. Such a repayment will either require Ireland issuing new debt or Ireland paying in from budget surpluses in years to come. 

In other words, the COVID19 Fund is a prescription for more austerity in Ireland in the future years. Not for less. 

Irish PM / Taoiseach says it is a good thing: rescuing Europe is also favourable to Ireland. I agree. The problem is that every little bit counts and Ireland will be going into 'rescuing Europe' with a pretend-to-matter GDP base, not with the real economy-measuring GNI*. And that is wrong. It is a right thing to contribute to other countries' recovery. It is a stupid thing to do so while playing a 'rich uncle' role we hoisted out of vanity and some strategic venality (yes, truth hurts, and truth about MNCs in Ireland hurts our pretence at not beggaring our neighbours though our tax rules).

Ireland's kommentariate will really enjoy investing in public infrastructure, the EU-style... the unliving leadership of Europe is setting us up for another 2012 'Game-changing Deal' (https://www.telegraph.co.uk/finance/financialcrisis/9365504/Debt-crisis-Ireland-hails-euro-game-changer.html). Then, again, the hope is that by the time the EU27 actually agree to the terms and conditions of the 2020 COVID19 Fund, we will be dealing with the recession of 2025 or 2032 or 2087.

17/4/20: COVID19 Updated Charts and Outliers

Updating two charts for #COVID19 pandemic today:

First: US vs EU chart:

Second: Russia chart:

Since I included no commentary on Russian data in the chart itself, it is worth noting that data so far indicates no data suppression or mis-reporting. This is confirmed by analysis of 'outliers' in the data. I have looked at all countries with > 1,000 cases reported and considered observations on cases reported that fall out of trend line from the time when the country cumulated cases counts reached > 50 cases. For example, if a country reported 127 cases in day T, followed by 139 cases in day T+1, and suddenly showed 0 cases in T+2, followed by 99 cases in T+3, the date of T+2 was marked as an 'outlier'. I ignored all cases where 'outlier' suspect dates were above 20 cases, even if the number was still outside the range of the trend-defined 'norm'.

Note: these outliers can be a function of tests arrivals dates, availability of tests, hospitals reporting dates and other differences that have nothing to do with 'Government manipulation'. All in, 43 countries out of 77 with more than 1,000 cases have reported at least one outlier.

Russia had 3.45% of days reporting appearing as extreme outliers. 30 out of the total 77 countries on the list had higher percentage of outliers days than Russia. Median for 77 countries was 2.9%, mean was 5.9% and STDEV was 8.6%.

Only two of these countries, namely Russia (3.45% of observations countable as outliers) and China (13.3% of observations being outliers), has been accused in the Western media of releasing politically manipulated data. China, of course, has a very high percentage of observations that can be identified as outliers, while Russia is, basically, middle-of-the-road.

8/4/20: Ifo Institute Germany Forecast for 2020

A surprisingly 'positive' forecast for Germany from ifo Institute this morning:

While GDP contraction for 2020 looks sharp at -4.2 percent y/y, unemployment figures appear rather robust and employment levels seem to be only weakly impacted. Forecast for current account implies subdued global demand shocks. The swing in the fiscal position is roughly 6.5 percent of GDP, reflecting emergency supports measures. This is significant, and underpins shallower expected effects on employment and unemployment, as well as no deflationary dynamics in labour costs.

My view: Germany entered the pandemic crisis with already weak economy. 2019 growth at 0.6 percent was shockingly weak, with the economy skirting recession. Massive strength in the current account was reflective of weak domestic demand and the economy dependent on growth momentum globally. This momentum is now severely disrupted, and I do not expect robust global recovery outside domestic demand. In other words, my view is that worldwide exports are unlikely to rebound robustly in H2 2020, putting severe pressure on net exporting economies, like Germany and Italy.

So, whilst 4+ percent drop in full year GDP might be fine, I would expect closer to 5-5.5 percent decline (reflective of weaker prices), and much more pronounced impact on unemployment and employment levels.

15/1/20: What Trade Deal Phase 1/N Says About the Four Horsemen of Apocalypse

Phase 1 of N of the "Greatest Trade Deal" that is "easiest to achieve' by the 'stablest Genius' is hitting the newsflows today. Which brings us to two posts worth reading on the subject:

Post 1 via Global Macro Monitor: https://global-macro-monitor.com/2020/01/15/phase-1-of-potemkin-trade-deal-signed-sealed-and-yet-to-deliver/ is as always (from that source) excellent. Key takeaways are:

• "We never believed for one moment that China would cave on any of the big issues, such as restructuring its economy and any deal would be just some token political salad dressing for the 2020 election."
• "Moreover, much of the deal depends on whether the Chinese will abide by Soviet-style import quotas," or in more common parlance: limits on imports of goods into the country, which is is 'command and control' economics of central planning.
• "We are thankful, however,  the economic hostilities have momentarily ratcheted down but the game is hardly over," with tariffs and trade restrictions/suppression being the "new paranormal".
• "Seriously, after more than two years of negotiations, they couldn’t even agree on dog and cat food imports?"

Post 2 via Market Watch: https://www.marketwatch.com/story/phase-one-trade-deal-wont-end-the-uncertainty-in-markets-hsbc-strategist-says-2020-01-15. Key takeaways:

• "The [trade] environment remains very much in flux and a source of concern and challenge for investors".

My takeaways from Phase 1/N thingy: we are in a VUCA world. The current U.S. Presidential Administration is an automated plant for production of uncertainty and ambiguity, while the world economy is mired in unresolvable (see WTO's Appellate Body trials & tribulations) complexity. Beyond the White House, political cycle in the U.S. is driving even more uncertainty and more ambiguity into the system. The Four Horse(wo)men of the Apocalypse in charge today are, in order of their power to shift the geopolitical and macroeconomic risk balance, Xi, DNC leadership, Putin and Trump. None of them are, by definition, benign. 

The trade deal so far shows that Xi holds momentum over Trump. Putin's shake up of the Russian Cabinet today shows that he is positioning for some change in internal power balances into 2020, and this is likely to have some serious (unknown to-date) implications geopolitically. Putin's meeting with Angela Merkel earlier this week is a harbinger of a policy pivot to come for the EU and Russia and Lavrov's yesterday's statement about weaponization of the U.S. dollar and the need for de-dollarization of the global economy seems to be in line with the Russo-German New Alignment (both countries are interested in shifting more and more trade and investment outside the net of the U.S. sanctions raised against a number of countries, including Iran and Russia).

DNC leadership will hold the cards to 2020 Presidential Election in the U.S. My belief is that it currently has a 75:25 split on Biden vs Warren, with selection of the former yielding a 50:50 chance of a Trump 2.0 Administration, and selection of the latter yielding a 35:65 chance in favour of Warren. The electoral campaigning climate is so toxic right now, we have this take on the latest Presidential debate: https://twitter.com/TheDailyShow/status/1217431488439967744?s=20. Meanwhile, debate is being stifled already by the security agencies 'warnings' about Russian 'interference' via critical analysis of the candidates.

Mr. Trump has his Twitter Machine to rely upon in wrecking havoc, that, plus the pliant Pentagon Hawks, always ready to bomb something anywhere around the world. While that power is awesome in its destructiveness vis-a-vis smaller nations, it is tertiary to the political, geopolitical and economic powers of the other three Horse(wo)men, unless Mr. Trump gets VUCAed into a new war.

BoJo's UK as well as Japan, Canada, Australia et al, can just sit back and watch how the world will roll with the Four punchers. The only player that has a chance to dance closely with at least some of the geopolitical VUCA leaders is the EU (read: France and Germany, really). 

23/4/19: Income per Capita and Middle Class

New research reported by the Deutsche Bank Research shows that, on average, there is a positive (albeit non-linear) relationship between the per capita income and the share of middle class in total population:

Source: https://pbs.twimg.com/media/D42GiWNXkAMpID2.png:large

There is an exception, however, although DB's data does not test formally for it being an outlier, and that exception is the U.S. Note, ignore daft comparative reported in chart, referencing 'levels' in the U.S. compared to Russia, Turkey and China: all three countries are much closer to the regression line than the U.S., which makes them 'normal', once the levels of income per capita are controlled for. In other words, it is the distance to the regression line that matters.

Another interesting aspect of the chart is the cluster of countries that appear to be statistically indistinguishable from Russia, aka Latvia, Estonia and Lithuania. All three are commonly presented as more viable success stories for economic development, contrasting, in popular media coverage, the 'underperforming' Russia. And yet, only Latvia (completely counter-intuitively to its relative standing to Estonia and Lithuania in popular perceptions) appears to be somewhat (weakly) better off than Russia in income per capita terms. None of the Baltic states compare favourably to Russia in size of the middle class (Latvia - statistically indifferent, Lithuania and Estonia - somewhat less favourably than Russia).

12/7/18: Romania's Uneven convergence Path: 2007-2018

A new World Bank report, led by Donato De Rosa, covers Romania's reforms and economic development experience. Worth a read! |
"From Uneven Growth to Inclusive Development : Romania's Path to Shared Prosperity" https://openknowledge.worldbank.org/handle/10986/29864.

Quick summary:

• "Romania’s transformation has been a tale of two Romanias: one urban, dynamic, and integrated with the EU; the other rural, poor, and isolated."
• "Reforms spurred by EU accession boosted productivity ...GDP per capita rose from 30 percent of the EU average in 1995 to 59 percent in 2016."
• "Today, more than 70 percent of the country’s exports go to the EU, and their technological complexity is increasing rapidly... the gross value added of the information and communications technology (ICT) sector in GDP, at 5.9 percent in 2016, is among the highest in the EU."
• "Yet Romania remains the country in the Union with by far the largest share of poor people, when measured by the $5.50 per day poverty line (2011 purchasing power parity)".  More than 26% of country population lives below that poverty line, "more than double the rate of Bulgaria (12%)."

• "While Bucharest has already exceeded the EU average income per capita and many secondary cities are becoming hubs of prosperity and innovation, Romania remains one of the least urbanized countries in the EU, with only 55 percent of people living in cities."
• "Overall, access to public services remains constrained for many citizens, particularly in rural areas, and there is a large infrastructure gap, which is a drag on the international competitiveness of the more dynamic Romania and limits economic opportunities for the other Romania in lagging and rural areas."

The positive effects of Accession were frontloaded, when it comes to structural reforms:

• "Romania was invited to open negotiations with the EU in December 1999.  Until Romania joined in January 2007, EU accession remained an anchor for reforms, providing momentum for the privatization and restructuring of SOEs and for regulatory and judiciary reforms."
• "Output gradually recovered, and until 2008 the country enjoyed high but volatile growth... Unemployment was on a declining trend, but youth and long-term unemployment remained elevated. Skills and labor shortages became increasingly widespread. High inactivity persisted stubbornly, particularly among women. Gains in labor force participation were modest overall. ...Inequality increased further, as large categories of people—the Roma in particular—continued to be excluded from the benefits of growth."
• "Although output has recovered since 2008, institutional shortcomings have compounded the effects of the crisis, contributing to significant setbacks in poverty reduction, and are again leading to macroeconomic imbalances."
• "Fiscal consolidation during 2009–2015 has helped place economic growth on a strong footing. However, lack of commitment and underfunding for the delivery of public services and poor targeting of social programs have contributed to the negative income growth of the bottom 40 percent of the income distribution (the so-called bottom 40) in 2009–2015, with poverty remaining above pre-crisis levels, and inequality still among the highest in the EU."

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

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

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

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

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

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

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

20/2/17: CESIfo on Potential Gains from EU-EEC Trade Agreement

An interesting study from German's CESIfo on the potential impact of a Free Trade Agreement between the EU and the Eurasian Economic Community: http://www.cesifo-group.de/de/ifoHome/publications/docbase/details.html?docId=19267749.

Top of the line conclusions:

• EU side: "According to Ifo’s research results, a comprehensive agreement between the EU and the Eurasian Economic Community could lead to a 0.2 percent increase in real per capita income in the EU, corresponding to an annual EUR 91 upturn in per capita income." Of these, 31 billion euros in benefits are expected to accrue to Germany (net impact for Germany will be 22 billion euros due to increased Russian exports to Germany.
• Russian side: "For Russia this increase could be as high as three percent or EUR 235 per year. “These income gains stem from the fact that the economic structures on all sides are highly complementary.” Of these some EUR 71 billion is expected to come from increased exports from Russia to the EU states. Additional EUR 6 billion in exports increases will come from rising efficiencies in Russian trade outside the EU.
• Key obstacles: “A free trade agreement is barely conceivable as long as the Ukraine conflict remains unsettled. Such a pact could nevertheless form an integral part of a new strategic partnership between the EU and Russia” 

4/9/16: Some Points on Russian & European Policy Uncertainty Trends

With some positive (albeit very weak still) changes in the Russian macroeconomic news in recent months, it is worth looking at the evolution of trends in Russian policy uncertainty, as measured by the http://www.policyuncertainty.com/ data.

Here is an updated (through August 2016) chart comparing news-based indices of policy uncertainty in Russia and the EU

Note, series above are rebased to the same starting point for the EU and Russia (to 1994 annual average) to make them compatible.

Things of note:

• Russian policy uncertainty continues to trend below that of the EU
• The above conclusion is also confirmed in raw data 3mo averages and 3mo exponential moving averages
• This is nothing new, as general policy uncertainty has been systemically lower in Russia than in Europe since the peak of the Russian Default crisis of the late 1990s, with exception for two episodes: brief period in 2006-2007 - the starting point of Russian-Georgian trade and migration pressures; and 2014-2015 period - marked by first economic slowdown in the early 2014, followed by the Russian-Ukrainian conflict and the Ruble crisis
• Generally, the EU continues to show growing trend divergence with Russia when it comes to policy uncertainty, despite the more moderation in the underlying series since the end of the latest spike caused by the Greek crisis earlier this year (IMF participation and Tranche 2 disbursement)

It is worth noting that, despite a rise in the U.S. uncertainty index due to the ongoing election cycle, the U.S. comparatives are similar to those of Russia, as opposed to the EU. 

21/7/16: Article 50: Facts

There is a lot of poorly informed nonsense being pushed around the media (especially 'new media') about Article 50 process relating to the Brexit. The best, most cogent and brief summary of what actually is involved in this process was provided back in February by the Open Europe think-tank here: http://openeurope.org.uk/today/blog/the-mechanics-of-leaving-the-eu-explaining-article-50/.

18/7/16: Euromoney on Brexit

My comment for Euromoney on the topic of Brexit impact on UK sovereign credit risks: http://www.euromoney.com/Article/3563119/Country-risk-Experts-say-UK-economy-will-quickly-recover-from-Brexit-shock.html.

17/6/16: Forget Brexit. Think EUrisis

Swedish research institute, Timbro, published their report covering the rise of political populism in Europe. And it makes for a sobering reading.

Quoting from the report:

“Never before have populist parties had as strong support throughout Europe as they do today. On average a fifth of all European voters now vote for a left-wing or right-wing populist party. The voter demand for populism has increased steadily since the millennium shift all across Europe.”

Personally, I don’t think this is reflective of the voter demand for populism, but rather lack of supply of pragmatic voter-representing leadership anywhere near the statist political Centre. After decades of devolution of ethics and decision-making to narrow groups or sub-strata of technocrats - a process embodied by the EU systems, but also present at the national levels - European voters no longer see a tangible connection between themselves (the governed) and those who lead them (the governors). The Global Financial Crisis and subsequent Great Recession, accompanied by the Sovereign Debt Crisis and culminating (to-date) in the Refugees Crisis, all have exposed the cartel-like nature of the corporatist systems in Europe (and increasingly also outside Europe, including the U.S.). Modern media spread the information like forest fire spreads ambers, resulting in amplified rend toward discontent.

Again, per Timbro:
“No single country is clearly going against the stream. 2015 was the most successful year so far for populist parties and consistent polls show that right-wing populist parties have grown significantly as a result of the 2015 refugee crisis. So far this year left-wing or right-wing populist parties have been successful in parliamentary elections in Slovakia, Ireland, Serbia, and Cyprus, in a presidential election in Austria and in regional elections in Germany. A growing number of populist parties are also succeeding in translating voter demand into political influence. Today, populist parties are represented in the governments of nine European countries and act as parliamentary support in another two.”

Net: “…one third of the governments of Europe are constituted by or dependent on populist parties.”

And the direction of this trend toward greater populism in European politics is quite astonishing. Per Timbro, “discussions on populism too often focus only on rightwing populism. Practically everything written on populism, at least outside Southern Europe, is almost entirely concerned with right-wing populism. Within the political sciences the study of right-wing populist parties has even become its own field of study, while studies on leftwing populism are rare.”

This skew in reporting and analysis, however, is false: while “…it is the right-wing populism that has grown most notably, particularly in Scandinavia and Northern Europe. However, in Southern Europe the situation is the opposite. If the goal is to safeguard the core values and institutions of liberal democracy we need a parallel focus on those who challenge it, regardless of whether they come from the right or the left. It is seriously worrying that seven per cent of the population in Greece vote for
a Nazi party, but it is also worrying that five per cent vote for a Stalinist one. The second aim of this report is therefore to present an overview of the threat of populism, both right-wing and left-wing, against liberal democracy.”

Here are some trends:

The chart above shows that authoritarian left politics are showing a strong trend up from 2010 through 2014, with some moderation in 2015, which might be driven more by the electoral cycle, rather than by a potential change in the trend. The moderation in 2015, however, is not present in data for right wing authoritarianism:

So total support for authoritarian parties is up, a trend present since 2000 and reflective of the timing that is more consistent with the introduction of the euro and subsequent EU enlargements. An entirely new stage of increase in authoritarianism tendencies was recorded in 2015 compared to 2014.

Save for the correction downward in 2007-2009 period, authoritarian parties have been on an increasing power trend since roughly 1990, with renewed upward momentum from 1999.

You can read the full study and reference the study definitions and methodologies here: http://timbro.se/sites/timbro.se/files/files/reports/4_rapport_populismindex_eng_0.pdf.


What we are witnessing in the above trends is continuation of a long-running theme: the backlash by the voters, increasingly of younger demographics, against the status quo regime of narrow elites. Yes, this reality does coincide with economic inequality debates and with economic disruptions that made life of tens of millions of Europeans less palatable than before. But no, this is not a reaction to the economic crisis. Rather, it is a reaction to the social, ideological and ethical vacuum that is fully consistent with the technocratic system of governance, where values are being displaced by legal and regulatory rules, and where engineered socio-economic system become more stressed and more fragile as risks mount due to the technocratic obsession with… well… technocracy as a solution for every ill.

While the EU has been navel gazing about the need for addressing the democratic deficit, the disease of corporatism has spread so extensively that simply re-jigging existent institutions (giving more power to the EU Parliament and/or increasing member states’ voice in decision making and/or imposing robust checks and balances on the Commission, the Eurogroup and the Council) at this stage will amount to nothing more than applying plasters to the through-the-abdomen gunshot wound. Brexit or not, the EU is rapidly heading for the point of no return, where any reforms, no matter how structurally sound they might be, will not be enough to reverse the electoral momentum.

For those of us, who do think united Europe can be, at least in theory, a good thing, time is to wake up. Now. And not to oppose Brexit and similar movements, but to design a mechanism to prevent them by re-enfranchising real people into political decision making institutions.

11/7/15: Harder Default for Greece, Less Democracy for All

My article on the Greek crisis for Irish Independent: impossible mathematics of debt and the political trilemma of sacrificed democracies: http://www.independent.ie/opinion/comment/expect-a-harder-default-for-greeks-and-less-democracy-for-the-rest-of-us-31368677.html

17/5/15: Two Asias and the U.S. European Incentives

If you want to see the context to the ongoing geopolitical re-distribution of power that is threatening the world order, do not look at the margins of the European realm, like Ukraine. Look at Asia.

Here is an excellent discourse that supports the thesis of the emergence of two Asia:

• Asia dominated (already) economically by China; and
• Asia dominated (for now) military-wise and geopolitically by the U.S.

Read the full text here: http://belfercenter.ksg.harvard.edu/files/Summary%20Report%20US-China%2021.pdf and a summary here: http://www.businessinsider.com/major-change-in-world-order-china-us-economy-2015-5.

Europe has already decoupled with the U.S. on the issue of Chinese-led Asian Infrastructure Investment Bank, while BRICS have decoupled from the U.S. on a vast range of initiatives. But European signals of willingness to engage with the new Asia are going to continue being half-hearted, principally because of the second bullet point above - economic cooperation will not resolve the growing tension on geopolitical stage. Sooner or later, the U.S. dominance in Asia Pacific will be weakened to the point of the Western block playing a second (albeit not insignificant, by any means) role.

There are two levers for retaining direct and active links to the Asia Pacific centre of power that are currently available to Europe: India and Russia. Alas, both are lost to Europeans for now, one for the reason of perpetual neglect and the other for the reason of perpetual antagonisation.

Oh, and one last piece of 'food for thought' breakfast: as the U.S. is being squeezed in Asia Pacific, is it more or less likely that the U.S. will need to amplify cohesion of its allies around the Atlantic? And if you think the answer to this question is 'more likely' (as I do), what other means can the U.S. find to doing so other than by playing centuries old angsts across EU's Eastern borders? 

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.

9/2/15: Sanctions: "poisoning the public water supply in the hope of killing some enemies"

An excellent article on the effectiveness of economic sanctions as a tool in geopolitical conflicts: http://www.capx.co/sanctions-against-russia-are-dangerously-defeating-in-a-globalised-economy/

Quick quotes:

"Research by the Peterson Institute for International Economics in 1997 showed that, in instances where the United States imposed economic sanctions in partnership with other nations, between 1945 and 1970 they were successful in 16 cases and failed in 14 – a success rate of 53 per cent. Between 1970 and 1990, when sanctions were applied more prolifically, they succeeded in 10 instances and failed in 38, reducing the success rate to 21 per cent. ...Unilateral US sanctions had a high success rate of 69 per cent between 1945 and 1970, tumbling to 13 per cent in the period 1970-90."

Meanwhile, "in economic terms they carry a cost. …the reality is that Russia is the European Union’s third largest commercial partner and the EU, reciprocally, is Russia’s chief trade partner. Who thought it was a good idea to subvert this arrangement?"

"Economic sanctions have the same credibility as poisoning the public water supply in the hope of killing some enemies. Sanctions are not a weapon that can responsibly be used in a globalised economy."

Yep. On the money. Though I am not so sure that "killing some enemies" is even an attainable goal here: so far, sanctions have been hitting predominantly smaller enterprises (via cut off of credit supply) and ordinary people (via supporting currency devaluations). As per oligarchs and Government-connected elites, for every instance where their property abroad has suffered, there are tens of thousands of instances where devalued ruble has made their forex holdings and forex-denominated portfolios of investments increase in purchasing power. So be prepared to see more concentration of economic power in Russia in their hands over the next 12 months.

28/7/2014: Double Down or Stay Course in Ukraine: the Only Rational Alternatives for Moscow?

The latest reports from the U.S. strongly suggest that Russia is perceived as an un-yielding adversary in Ukraine and that Moscow is about to 'double-down' on its gambit in Ukraine (see here).

The point is that if so, then why and then what?

Why? Russia has currently no exit strategy from the conflict in Ukraine. Forcing complete and total closure of the separatists operations is

1. Infeasible for Moscow (the separatists are not directly controlled troops that can be withdrawn on orders and indications are, they are not all too well coordinated and organised to be following any orders);
2. Were it even theoretically feasible, will be immediately visible to the external observers. Note that, for Moscow, (1) means political benefits of such an action will not be immediately apparent, while (2) means political costs of such an action will materialise overnight.
3. As sanctions escalate, the marginal returns of domestic political support become more important, since external economic benefits from cooperation vanish, but marginal costs remain (see below).

On marginal external benefits: it is absolutely uncertain what exact conditions Russia must fulfil to completely reverse the sanctions: is it

• (a) compel the rebels to surrender unconditionally to Kiev troops? 
• (b) compel them to surrender to either official troops or pro-Kiev militias, unconditionally? 
• (c) compel them to surrender conditionally - without any conditions set and without any mechanism to enforce these in place? 
• (d) compel them to declare a ceasefire - without any conditions set and without any guarantees of enforcement by the opposite side? 
• (e) compel the separatists to engage in peace talks - not on offer by Kiev? 
• (f) compel the separatists to stand down - in some fashion - and enter into negotiations with Kiev on Crimea? 
• (g) Is Crimea at all on the table? and so on...

On marginal costs: the costs of sanctions are tied to Russia delivering some sort of compliance with Western demands. Can someone, please, point to me a website where these demands are listed in full and the states that imposed sanctions have signed off on a pledge that once these conditions are satisfied, sanctions will be lifted?

Thus, in simple terms, current Western position leaves little room for Moscow not to double down in Ukraine. The only other viable alternative for Moscow currently is not to escalate. De-escalation, as much as I would like to see it take place, is not within rational choice alternatives. The core reason for this is that when one constantly increasing pressure in forcing their opponent into the corner without providing a feasible exit route for de-escalation, the opponent's rationally preferred response, at certain point in time, becomes to strike back and double down.

Update: interestingly, Reuters editorial today (29/7/2014: http://www.reuters.com/article/2014/07/29/us-ukraine-crisis-putin-analysis-idUSKBN0FY1AC20140729?feedType=RSS&feedName=topNews&utm_source=twitter) provides very similar lines of argument on costs and incentives for Moscow to de-escalate the situation in Eastern Ukraine.

29/6/2014: Mid-Summer CDS Dreams: Ukraine v Russia

One of these countries has a brand new Association Agreement with the EU... and a fresh probability of sovereign default of 41%... another one (with probability of default at 11.9%) does not...

In two years from June 2012 through June 2014, Ukraine's probability of default declined 1.47% as the country received massive injections of funds from the IMF, US and EU. Russia's probability of default fell 3.89% over the same time. For comparatives: Ukraine's June probability of default is running at around 41%, Serbia's at 17.6%. Ukraine is currently the worst rated sovereign (by CDS-based probability of default) of any state with an Association Agreement with EU.

28/6/2014: Ukraine's Costly European Dream: BloombergView

In light of the celebrations in Ukraine and Brussels over the signing of the EU-Ukraine Association Agreement, here is an excellent op-ed from BloombergView on the topic: http://www.bloombergview.com/articles/2014-06-27/ukraine-s-costly-european-dream

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.