3/2/2015: Japanification of Europe?

One of the main narratives for understanding European economy's longer term growth outlook has been the risk of Japanification: a long-term stagnation punctuated by recessionary periods and accompanied by low inflation and or deflationary episodes and pressures. I posted on the topic before (see for example here: http://trueeconomics.blogspot.ie/2014/10/19102014-chart-of-week-japanising-europe.html) and generally think we are witnessing some worrying similarities with Japan, driven primarily by longer-term trends: debt overhangs across real economy, nature of debt allocations (concentrated in less productive legacy assets, such as property in some countries, physical capital in others) and, crucially, demographics-impacted political and institutional paralysis.

One recent paper, titled "The Macroeconomic Policy Challenges of Balance Sheet Recession: Lessons from Japan for the European Crisis" by Gunther Schnabl (CESIFO WORKING PAPER NO. 4249 CATEGORY 7:MONETARY POLICY AND INTERNATIONAL FINANCE, MAY 2013) sets out the stage for looking into the direct comparatives between Japan's experience and that of the EU.

Per Schnabl, "Japan has not only moved through a boom-and-bust cycle …almost 20 years earlier than Europe but has also made important experiences with a crisis management in form of monetary expansion, unconventional monetary policy making, fiscal expansion and recapitalization of banks. Although Japan has reached the (close to) zero interest rate environment more than a decade earlier than Europe and gross general government debt (in terms of GDP) has gone far beyond the levels, which are today prevalent in Europe, growth continues to stagger."

In other words, as we know all too well, Japan presents a 'curious' case of an economy where neither monetary, nor fiscal policies appear to work, even when applied on truly epic scale.

What Schnabl finds is very intriguing. "The comparison between the boom-and-bust cycles in Japan and Europe with respect to the origins of exuberant booms, the crisis patterns, the crisis therapies, and the (possible) effects of the crisis therapies shows that despite significant differences important similarities exist. With the growing socialisation of risk Europe follows the Japanese economic policy decision making pattern, with – possibly – a similar outcome for European growth and welfare perspectives. The gradual decline in real income in Japan should be incentive enough for a turnaround in economic policy making in both Europe and Japan."

The key to the above is in the phrase "With the growing socialisation of risk Europe follows the Japanese economic policy decision making pattern" which of course has several implications:

• Mutualisation / Socialisation of risk is actually mutualisation and, thus, socialisation of debt - clearly suggesting that the path toward debt deleveraging is not the one we should be taking. The alternative path to debt deleveraging via mutualisation / socialisation is debt restructuring.
• To date, no European leader or organisation has come up with a viable alternative to the non-viable idea of 'internal devaluation'. In other words, to-date we face with a false dichotomous choice: either mutualise debt or deflate debt. Neither is promising when one looks at the Japanese experience. And neither is promising when it comes to European experience either. See more on this here: http://trueeconomics.blogspot.ie/2014/08/1082014-can-eu-rely-on-large-primary.html and http://trueeconomics.blogspot.it/2014/08/1082014-inflating-away-public-debt-not.html.
• ECB policies activism - the alphabet soup of various programmes launched by Frankfurt - is still treating the symptom (liquidity or credit supply to the real economy) instead of the disease (debt overhang). And the outcome of this activism is likely to be no different from Japan: debt overhang growing, economy stagnating, asset prices and valuations actively concealing the problem, data detaching from reality.

Here are some slides from Schnabl's November 2014 presentation on the topic:

So here's the infamous monetary bubble / illusion:

And the associated public sector balloon (do ignore some of the peaks that were down to banks rescue measures and you still have an upward trend):

And an interesting perspective on the Japanification scenario for Europe:

Happy demanding more Government involvement in the economy, folks... for this time, all the monetary, fiscal, regulatory, institutional, propagandistic etc 'easing' will be, surely, different... very different... radically different...

26/1/15: Markets v Greece: Too Cool for School... for now

There is much talk about the impact (or rather lack thereof) of Greek elections on the markets.

In fact, the euro continued to price in the effects of a much larger factor - the QE announcement by the ECB, the stock markets did the same. Only bonds and CDS markets reacted to the Greek elections, and even here the re-pricing of Greek risks was moderate so far (see chart below and the day summary for CDS - both courtesy of CMA).

The reason for this reaction is two-fold.

Firstly, Greece is a small blip on the overall radar map of Euro area's problems. Even in terms of Government debt. Here is the summary of the Government debt overhang levels (over and above 60% of debt/GDP benchmark) across the Euro area:

In simple terms, real problems for the euro, in terms of risk pricing, are in Italy, France and Spain.

Secondly, Greece is a political risk, not a financial risk to the Euro area. And it is a risk in so far, only, as yesterday's election increases the probability of a Grexit. But increasing probability of a Grexit does not mean that this increase is worth re-pricing. It is only worth worrying about if (1) increase in probability is significant enough, and (2) if elections changed the timing of the possible event, bringing it closer to today compared to previous markets expectations.

Now, here is the problem: neither (1) nor (2) have been materially changed by the Syriza victory last night. My comments to two publications yesterday and today, summarised below, explain.


Greek elections came as a watershed for both the markets analysts and the European elites, both of which expected a much weaker majority for the Syriza-led so-called 'extreme left' coalition. The final outcome of yesterday's vote, however, is far from certain, and this has been now fully realised by the markets participants.

The confrontation with the EU, ECB and the IMF, promised by Zyriza, is but one part of the dimension of the policy course that Greece will take from here on. Another part, less talked about today in the wake of the vote is accommodation.

Let me explain first why accommodation is a necessary condition for both sides in the conflict to proceed.

Greece is systemically important to the euro area, despite all claims by various European politicians to the contrary. Greece is carrying a huge burden of debt, accumulated, in part due to its own profligacy, in part due to the botched crisis resolution measures developed and deployed by the EU. It's debt is no longer held by the German, French and Italian banks, so much is true. German and French banks held some EUR27 billion worth of Greek Government debt at the end of 2010. This has now been reduced to less than EUR100 million. There is no direct contagion route from Greek official default to the euro area banking sector worth talking about. But Greek private sector debts still amount to roughly EUR10 billion in German and French banking systems (with more than EUR8 billion of this in German banks alone). Greek default will trigger defaults on these debts too, blowing pretty sizeable hole in the euro area banks.

However, lion's share of Greek public debt is now held in various European institutions. As the result, German taxpayers are on the hook for countless tens of billions in Greek liabilities via the likes of the EFSF and Eurosystem.

And then there is the reputational costs: letting Greece slip out into a default and out of the euro area will mark the beginning of an end for the euro, especially if, post-Grexit, Greece proves to be a success.

In short, one side of the equation - the Troika - has all the incentives to deal with Syriza.

One the other side, we can expect the fighting rhetoric of Syriza to be moderated as well. The reason for this is also simple: the EU-IMF-ECB Troika contains the Lender of Desperate Resort (the ECB) and the Lender of Last Resort (the IMF). Beyond these two, there is no funding available to Greece and Syriza elections promises make it painfully clear that it cannot entertain the possibility of a sharp exit from the euro, because such an exit would require the Government to run a full-blown budgetary surplus, not just a primary surplus. For anyone offering an end to austerity, this is a no-go territory.

So we can expect Syriza to present, in its first round of talks with the Troika, some proposals on dealing with the Greek debt overhang (currently this stands at around EUR 210 billion in excess debt over the 60% debt/GDP limit), backed by a list of reforms that the Syriza government can put forward in return for EU concessions on debt.

These reforms are the critical point to any future negotiations with the EU and the IMF. If Syriza can offer the EU deep institutional reforms, especially in the areas so far failed by the previous Government: improving the efficiency and accountability of the Greek public services, robust weeding out of political and financial corruption, and developing a functional system of tax collections, we are likely to see EU counter-offers on debt, including debt restructuring.

So far, Syriza has promised to respect the IMF loans and conditions. But its rhetoric about the end of Troika surveillance is not helping this cause of keeping the IMF calm - IMF too, like the ECB and the EU Commission, requires monitoring and surveillance of its programme countries. Syriza also promised to balance the budget, while simultaneously alleviating the negative effects of austerity. In simple, brutally financial terms, these sets of objectives are mutually exclusive.

With contradictory objectives in place, perhaps the only certainty coming on foot of the latest Greek elections is that political risks in Greece and the euro area have amplified once again and are unlikely to abate any time soon. Expect the Greek Crisis 4.0 to be rolling in any time in the next 6 months.

So in the nutshell, don't expect much of fireworks now - we all know two deadlines faced by Greece over the next month:

• The IMF review, to start as soon as the new Government is in place;
• February Euro Group meeting (tomorrow one will not be of much substance) with Greek bailout expiring February 28th, although the EU is already signaling, less than 24 hours after Greek election, willingness to extend maturity of the programme (http://uk.reuters.com/article/2015/01/26/uk-greece-election-eu-idUKKBN0KZ0ZB20150126)

These are the markers for the markets to worry about and these are the timings that will start revealing to us more information about Syriza policy stance too. Until then, ride the wave of QE and sip that kool-aid lads... too cool to worry about that history lesson, for now...

26/1/15: If not Liquidity, then Debt: ECB's QE competitive limping

I have written before, in the context of QE announcement by the ECB last week (see here: http://trueeconomics.blogspot.ie/2015/01/2312015-liquidity-fix-for-euro-what-for.html) that the real problem with the euro area monetary and economic aggregates has nothing to do with liquidity supply (the favourite excuse for doing all sorts of things that the ECB keeps throwing around), but rather with the debt overhang.

In plain, simple terms, there is too much debt on the books. Too much Government debt, too much private debt. The ECB cannot even begin directly addressing the unspoken crisis of the private debt. But it is certainly trying to 'extend-and-pretend' public and private debt away. This is what the fabled EUR1.14 trillion (or so) QE announcement is about: take debt surplus off the markets so more debt can be issued. More debt to add to already too much debt, therefore, is the only solution the ECB can devise.

While EUR1.14 trillion might sound impressive, in reality, once we abstract away from the fake problem of liquidity, is nothing to brag about. Take a look at the following chart:

Forget the question in red, for the moment, and take in the numbers. Remember that 60% debt/GDP ratio is the long-term 'sustainability' target set by the Fiscal Compact - in other words, the long-term debt overhang, in EU-own terminology, is the bit of debt above that bound. By latest IMF stats, there is, roughly EUR3.5 trillion of debt overhang across the euro area 18, just for Government debt alone. You can safely raise that figure by a factor of 3 to take into the account private sector debts.

Which puts the ECB QE into perspective: at the very best, when fully deployed, it will cover just 1/3rd of the public debt overhang alone (actually it won't do anything of the sorts, as it includes private and public debt purchases). Across the entire euro area economy (public and private debt combined) we are talking about the 'big bazooka' that aims to repackage and extend-and-pretend about 10-11% of the total debt overhang. Not write this off, not cancel, not burn... but shove into different holding cell and pretend it's gone, eased, resolved.

This realisation should thus bring us around to that red triangle and the existential question: What for? Between end of 2007 and start of 2015, the euro area has managed to hike its debt pile by some EUR3 trillion, after we control for GDP effects. Given that this debt expansion did not produce any real growth anywhere, one might ask a simple question: why would ECB QE produce the effect that is any different?

The answer, on a post card, to the EU Commission, please.

20/1/2015: IMF Global Growth Outlook 2015-2016: Europe Slips, U.S. Powers Away

My analysis of the IMF update to the World Economic Outlook is now available on Learn Signal blog: http://blog.learnsignal.com/?p=148

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.

27/12/2014: Geography of the Euro Area Debt Flows

The debate about who was rescued in the euro area 'peripheral' economies banking crisis will be raging on for years to come. One interesting paper by Hale, Galina and Obstfeld, Maurice, titled "The Euro and the Geography of International Debt Flows" (NBER Working Paper No. w20033, see http://www.nber.org/papers/w20033.pdf) puts some facts behind the arguments.

Per authors, "greater financial integration between core and peripheral EMU members had an effect on both sets of countries. Lower interest rates allowed peripheral countries to run bigger deficits, which inflated their economies by allowing credit booms. Core EMU countries took on extra foreign leverage to expose themselves to the peripherals. The result has been asset-price bubbles and collapses in some of the peripheral countries, area-wide banking crisis, and sovereign debt problems."

The causes explained, the paper maps out "the geography of international debt flows using multiple data sources and provide evidence that after the euro’s introduction, Core EMU countries increased their borrowing from outside of EMU and their lending to the EMU periphery."

So braodly-speaking, core euro area economies funded excesses. Hence, in any post-crisis rescue, they were the beneficiaries of transfers from the 'peripheral' economies and taxpayers.

Some details.

According to Hale and Obstfeld, "one mechanism generating the big current account deficits of the European periphery could be summarized as follows: after EMU (and even in the immediately preceding years), compression of bond spreads in the euro area periphery encouraged excessive borrowing by these countries, domestic lending booms, and asset price inflation. We further argue that a substantial portion of the financial capital flowing into the European periphery was intermediated by the countries in the center (core) of the euro area, inflating both sides of the balance sheet of the large financial institutions in the euro area core."

So, intuitively, lenders/funders of the asset bubbles should be bearing some liability. And it would have been the case were the funds transmitted via equity or direct asset purchases (investment from the Core to the 'periphery' in form of buying shares or actual real estate assets). Alas they were not. "These gross positions largely took the form of debt instruments, often issued and held by banks. Thus, EMU contributed not only to the big net deficits of the peripheral countries, but to inflated gross foreign debt liability and asset positions for nonperipheral countries such as Belgium, France, Germany, and the Netherlands – countries that all experienced systemic banking crises after 2007."

Debt, as we know it now, has precedence over equity when it comes to taking a hit in a crisis, and debt is treated on par with deposits. Hence, "the tendency for systemically important banks to increase leverage in line with balance sheet size …implied a substantial increase in financial fragility for these countries’ financial sectors."

In the short run, prior to the crisis, leveraging up from the Core into the 'periphery' had a stimulative effect on asset bubbles. "Four main factors contributed to the suppression of bond yields in the European periphery after the introduction of the euro.
- First, the risk of investing in the European periphery declined with the advent of the euro due to investor assumptions (perhaps erroneous) about future political risks, including the possibility of official bailouts.
- Second, transaction costs declined and currency risk disappeared for euro area investors investing in the periphery countries.
- Third, the ECB’s policy of applying an identical collateral haircut to all euro area sovereigns, notwithstanding their varied credit ratings, encouraged additional demand for periphery sovereign debt by euro area financial institutions, which, moreover, were able to apply zero risk weights to
these assets for computing regulatory capital. The EU’s recent fourth Capital Requirements
Directive continues to allow zero risk weights for euro area sovereign debts, even though the borrowing countries cannot print currency to pay their debts.
- Fourth, financial regulations in the EU were harmonized and the euro infrastructure implied a more efficient payment system though its TARGET settlement mechanism."

Crucially, all four factors combined to reinforce each other giving "…core euro area financial institutions a perceived comparative advantage in terms of lending to the periphery, and this would also likely have affected financial flows from outside to both regions of the euro area.

In line with the above, the authors find:
- "...strong evidence of the increase in the financial flows, both through debt markets and
through bank lending, from core EMU countries to the EMU periphery."
- "… that financial flows from financial centers to core EMU countries increased, but predominantly due to increased bank lending and not portfolio debt flows.
- "In addition, …evidence from the syndicated loan market that is broadly consistent with the core EMU lenders having a comparative advantage in lending to the GIIPS."

Net conclusion: "The concentration of peripheral risks on core EMU lenders’ balance sheets helped to set the stage for the diabolical loop between banks and sovereigns that has been at the heart of the euro crisis."

Authors quote other sources on similar: “German banks could get money at the lower rates in the euro zone and invest it for a decade in higher yielding assets: for much of the 2000s, those were not only American toxic assets but the sovereign bonds of Greece, Ireland, Portugal, Spain, and Italy. For ten years this German version of the carry trade brought substantial profits to the German banks — on the order of hundreds of billions of euros ... The German advantage, relative to all other countries in terms of cost of funding, has developed into an exorbitant privilege. French banks exploited a similar advantage, given their major role as financial intermediaries between AAA-rated countries and higher yielding debtors in the euro area.” (From Carlo Bastasin, Saving Europe: How National Politics Nearly Destroyed the Euro, Washington, D.C.: Brookings, 2012, page 10.)

Charts below summarise flows from Core markets to 'peripheral' markets

CPIS is stock of portfolio debt claims from CPIS data in real USD:

BISC is stock of total international bank claims from consolidated BIS data in real USD:

BISL Flow is valuation-adjusted flows of total cross-border bank claims from locational BIS data in real USD:

And conclusions: "Not only did peripheral countries borrow more after EMU; in addition, financial institutions in the core of the euro area expanded their balance sheets to facilitate peripheral deficits, thereby increasing their own fragility. This pattern set the stage for the diabolical feedback loop between banks and sovereigns that has been such a powerful driver of the euro area's recent crisis."

So next time someone says that 'periphery' is to be blamed for the causes of the crisis, send them here. for in finance, like in dating, it takes two to tango…

19/10/2014: Chart of the Week: Japanising Europe

A chart of the week, courtesy of @Schuldensuehner

10 year benchmark bonds: Japan for 1987-2004 period of decline and stagnation and Germany for 2004-present period of decline and ... oh, well... Japanisation of Europe is still ongoing, but it goes without saying: lower yields are not conducive to economic recovery. Or as @Schuldensuehner  noted:

Everything is going according to script...

Now, check out why Germany's lower borrowing costs mean preciously nothing when it comes to the hopes of Keynesianistas around the world for more German borrowing: http://trueeconomics.blogspot.ie/2014/10/13102014-germany-too-old-to-read-paul.html

16/10/2014: Stating the Obvious, yet the Un-mentionable

With all the talk about 'inflation is too low' in Europe, let me put it to you succinctly: It is not the inflation, stupid! It is income, aka consumers capacity to sustain demand...

In real terms, and with illicit drugs and prostitution factored in, whilst counting in addition bogus R&D reclassifications and other 'bells and whistles' of national accounts, only TWO of the Euro Area 12 'rich' economies have managed to regain their pre-crisis real GDP per capita peak: Germany and Austria. One of them - Germany - has no demographic driver for increased demand. So go figure: price inflation is low because incomes are low! Not because monetary authorities are not doing something. Nor because Germany is dragging Europe down. May be, because, in part, fiscal authorities have taxed the daylights out of people. And may be because banks have shoved so much credit into households prior to the crisis than few can borrow much more to sustain unsustainable (judging by income growth) consumption growth.

So again: It is not the inflation that is too low, stupid! It is income, aka consumers capacity to sustain demand, that is too low...

13/10/2014: Germany: Too Old to Read Paul Krugman or Rescue Europe

You want to know WHY Germany ain't 'saving Europe' in a fashion favoured by Paul Krugman? Read this:

Key point, of course, is demographics. Germany already experiencing shrinking working age population pool. And this process is only going to accelerate.

Here are 2009 projections for worker/retired ratios in economies:

Source: http://www.ncpa.org/pdfs/st319.pdf

This shows Germany as second worst-off economy to Italy. And here (from the above source) estimates of pensions and health liabilities:

In 2012, Germany already had second lowest income replacement ratio for new entrants into workforce, meaning its capacity to fund future cost increases without hitting directly the retirees is now pretty much exhausted:

Source: http://www.oecd-ilibrary.org/finance-and-investment/oecd-pensions-at-a-glance_19991363

And here's a table of projections for public spending on pensions, showing Germany accelerating spending as share of GDP earlier than other comparable economies:

All of which means that Germany is not in a position to ramp up leveraged fiscal expenditure or investment. It has no fuel to move itself, let alone the Euro area. So stop calling on Germany 'to do the right thing'. It is too old to read Paul Krugman.

9/10/2014: IMF Lagarde: We Are Out of Ideas, You Are Out of Convictions

In several recent posts, I have highlighted the fact that the IMF - that stalwart of global 'structural' reforms - has now effectively exhausted its toolkit of ideas as to how we can get global growth back on track. And the governments around the advanced economies world are now equally out of conviction to deploy the IMF's old toolkit.

This is evident across the board: from the Fund latest World Economic Outlook update which keeps endlessly banging on about the need for

• Accommodative monetary policies and, simultaneously, de-risking of the financial economy (the two tasks that actually contradict each other, as IMF own GFSR report admits);
• Structural markets reforms (which in the IMFspeak means preciously little more than more reforms of the labour markets, or in distilled terms: more 'activation' efforts to bring the unemployed to still inexistent jobs and push welfare recipients off the dole into still inexistent jobs);
• Credit supply restoration in the economy amidst continued banks deleveraging (which basically means that the banks need to get rid of old - presumably bad risk - loans while increasing their stock of new - presumably better risk - loans);
• Creation of better, more robust risk management frameworks in banking while increasing banking sector concentration (the outcome of the deleveraging process) and increasing risks concentrations by creating more centralised controls and supervision (e.g. the European Banking Union); and so on.

All of the above 'reforms' are clearly self-contradictory in so far as achieving one side of the objective implies undermining the other side.

And with today's release, we have a veritable Map to the Middle-Earth from the Fund's own Christine Lagarde. In today's "The Managing Director's Global Policy Agenda" Ms. Lagarde is navel gazing over 14 pages of text, charts and slides under the sub-heading of "Aiming Higher, Trying Harder". You get the sense of frustration of the Fund stuff with the intransigent Governments unwilling to deploy all of the medicines prescribed to them by the Fund, but you also get a feeling for the out-of-touch banality of the IMF's approach to the crisis.

Take the preamble. "Bold and resolutely executed policies are needed to prevent growth from settling into a “new mediocre,” with unacceptably low job creation and inclusion. Measures should emphasize":

• "Lifting growth. Decisive structural reforms are needed to bolster confidence and lift today’s actual and tomorrow’s potential growth and break the pattern of persistent underperformance and insufficient job-creation. Accommodative monetary policies should continue to support demand and provide breathing space as these reforms are implemented. But it is essential that they are accompanied by macro-critical reforms that remove deep-seated distortions in labor and product markets; improve credit flows to productive sectors; strengthen growth-friendly fiscal frameworks; and eliminate infrastructure gaps." You get a sense that this has been said before, argued many times over and offers nothing new. In effect, the IMF is saying: spend more, cut spending more, re-spend more; and fund it all by printing presses, while making sure the rag-tag of the real economy (SMEs and households) don't get their hands on the printed cash.
• "Building resilience. Easy money continues to increase market and liquidity risks, especially in the shadow banking sector, potentially compromising financial stability. Appropriate regulation and vigilant financial sector supervision, including developing and deploying macro-prudential tools, can help limit excessive financial risk-taking. Preparations for less benign financial conditions also need to be stepped-up. As monetary policy normalization approaches in some major economies, stronger policy frameworks, institutions, and economic fundamentals can mitigate potentially adverse spillovers." But, dear IMF, who creates this 'easy money'? And for who the money is 'easy'? The answer is in the first point above: printing presses do create 'easy money' and Governments and larger banks get 'easy money'. So de facto, IMF advice 1 and 2, taken together mean that creating growth + building resilience to risk = growing the share of Government and big banks in the economy. That should really keep troubles at bay, especially since the current crisis is caused by… yep, you've guessed it, rising role of Governments and big banks in the economy. Apparently, what can't kill you makes you stronger.
• And then there is IMF advice that IMF should learn to follow itself: "Achieving coherence. International cooperation is needed to amplify the benefits from these bold policies and to avoid exacerbating existing distortions, particularly regarding financial stability and global imbalances. Dialogue and policy cooperation can help smoothly rebalance global demand; minimize adverse spillovers and spillbacks from asynchronous monetary unwinding; ensure consistent financial regulation; and maintain an adequate global financial safety net. Fresh momentum must be injected into the global trade dialogue." Where did we hear that? Ah, yes, right - we've heard in Greece (when the IMF quietly stood by as the EU rained chaos onto Greek and Cypriot financial systems and Exchequers by refusing to get Public Sector Participation - or restructuring - going); and we heard it in Ireland (where the IMF stood idly by as the Irish Governments and European partners loaded some EUR70 billion-plus worth of banks debts onto the real economy and then destroyed entire sectors of the economy in the name of Nama-lution); and in Italy (where IMF is still refusing to acknowledge the need for sovereign debt restructuring).

Do not forget that the IMF team has run out of Athens this week in a hissy - the most heavily 'repaired' economy in the world seems to be going off-the-rails again.

Here is the road map for advanced economies as traced by the IMF:

As we have it: in Euro Area the achievements were: 1) 'good progress' on monetary easing (the printing press) but more to be done; 2) 'some progress' on consolidating the banking system eggs in one regulatory basket (and more to be done); 3) basically no fiscal reforms; and 4) no reforms on taxation, no improvement in competition across both labour and product markets (not to mention decline in competition in financial economy).

Are we still talking, Ms Lagarde? Oh yes…

Let's take a look at the first pillar of IMF 'wisdom': the printing press. Here's Fund own assessments of the outcomes: "Despite massive and welcome monetary support in major advanced economies and slowing fiscal consolidation, the recovery remains uneven and sluggish. Growth, and hence policy advice, are increasingly divergent across countries. Inflation is still below target in many advanced economies and is a growing concern in the euro area, while unemployment has stayed high. … The envisaged acceleration in economic activity has again failed to materialize."

So just as with Krugmanomics, the IMFology calls for more printing, cause previous rounds weren't enough: "Growth prospects in advanced economies are expected to remain uneven across regions. The strongest growth rebound is expected in the United States, while growth in Japan will remain modest. The crisis legacy brakes (including high private and public debt) are expected to only gradually ease in the euro area, while inflation expectations continue to drift down and deflationary risks are rising. Growth elsewhere, including other Asian advanced economies, Canada, and the United Kingdom, is projected to be solid."

And with all of those 'structural reforms' - do we have an uplift in at least potential (if not actual) output? Nope: "Growth potential may be lower than earlier assumed… Increasing evidence suggests that potential growth started to decline in advanced economies even before the onset of the crisis—which may be affecting the current pace of recovery. The recent slowdown in EMEs also has a large structural component, raising questions about the sustainability of growth rates achieved prior to the crisis and during the 2010–11 rebound."

So here are two road maps side by side: one for Spring 2014 and another for Fall 2014… and, save for gentle re-phrasing of the same, the two are largely identical when it comes to the advanced economies.

So spend more on infrastructure as opposed to reduce debt overhang... and that will be funded by what? Pears and apples?

Out of new ideas. QED.

3/10/2014: East Asian Crisis, European Disaster: Tale of Two Recoveries

My post for Learning Signal blog on IMF report covering East Asian Crisis of the 1990s comparatives to the Euro area crisis 2007-present is available here: http://blog.learnsignal.com/?p=55 

26/9/2014: Eurocoin Signals Accelerating Fall in Economic Activity

Eurocoin, euro area leading growth indicator compiled by Banca d'Italia and CEPR has fallen again in September, indicating further slowdown in growth conditions:

• In August 2014 Eurocoin indicator stood at 0.19. In September, the indicator fell to 0.13 - its lowest reading in 12 months.
• Growth forecast consistent with current readings for Q3 2014 are in line with y/y euro area GDP growth of 0% (range between +0.1% and -0.1%).

As usual, updating my ECB Monetary Policy Dilemma chart:

The above shows the proverbial 'growth corner' for ECB: historically low interest rates and virtually zero growth signalled by the leading indicator.

Annualised growth rates are abysmal:

Per release: the latest decline reflects continued losses in consumer and business confidence, slowdown in exports and weakening of industrial production conditions. Those tracking my analysis for previous months would note that in the past Eurocoin was supported to the upside primarily by equity markets valuations. As predicted, these effects are now becoming exhausted and as the result we are witnessing rapid declines in the leading indicator.

29/8/2014: Eurocoin Signals Further Slowdown in Growth in August

August the €-coin - a lead growth indicator for euro area GDP - fell to 0.19 from 0.27 in July, continuing the trend that began last spring.

Last month Eurocoin coverage is here: http://trueeconomics.blogspot.ie/2014/08/1482014-yugo-area-economy.html

Per CEPR and Banca d'Italia release, "The decline of the indicator reflects the weakening of economic activity in the second quarter and the recent worsening of consumer and business confidence, although the flattening of the interest rate curve made a slightly positive contribution."

This comes as further bad news for the euro area that has been posting some pretty awful macro data for some months now.

Eurocoin latest decline is marks the fourth consecutive month of no growth in the indicator. The stock market performance component of the indicator is holding it above the zero line, but August reading is no longer statistically distinguishable from zero growth. Once stock markets effects fizzle out, there will be little left to support indicator.

In Q1 2014, the eurocoin indicator averaged 0.35 against actual GDP growth coming at 0.2%, in Q2 2014, the indicator averaged 0.34 and actual growth came in at 0.0%. So far in Q3 2014 we have two months-average of 0.23, suggesting that factoring out stock and bonds markets / interest rates performance from the indicator we have negative growth closer to -0.05-0.1%.

Bond markets are currently out of touch with reality. Take Italian auction this week. EUR2.5 billion of 2019 BTPs sold at a yield of 1.1% - down from 1.2% in July 30 auction, EUR4 billion worth of 2024 BTPs sold at 2.39%. This has nothing to do with the country fundamentals that are all flashing red. Italian unemployment is now up 0.3% m/m to 12.6% in July with youth unemployment down 0.8% on June at a massive 42.9%. Retail sales fell 0.1% in June, compared to May, for non-food items and Q2 average was down 0.2% on Q1 average. Business confidence is tanking, having fallen from 90.8 in July to 88.2 in August. Inflation is (flash estimate for August) at -0.2% m/m and y/y, worse than -0.1% consensus expectations. And so on...

Inflationary signals are also weak: August data we have so far shows German inflation at 0.8%, Spanish at -0.5%, Belgian at 0% and Slovenian at 0%. Update: Euro area flash estimate for inflation is now down to 0.3% from 0.4% in August weighted down by energy costs and food.

Some charts to illustrate the Eurocoin performance:

You can see the weakening growth trend in the above, incorporating the latest growth forecast for Q3 2014. This puts even more pressure on the eCB which has already used up all conventional (rates policy) tools without much of a positive effect on growth:

And to remind you all - euro area growth record is abysmal to begin with, even with 'good years' factored in:

23/8/2014: Labour Costs and Euro area's myth of 'productivity' gains

Looking back at July 2014 IMF Article 4 paper on Euro area (most of which I covered back when it was published), here is an interesting chart mapping changes in the euro area countries' unit labour costs.

The chart is complex, so let me point out few things in it:

Firstly: improvements in the unit labour costs (ULCs) is reflected in the vertical distance between the black dot (accumulated change in ULCs over 2000-2007 period: higher level of the dot reflects lower competitiveness or higher ULCs compared to EA17 levels) and the black bar (accumulated change in ULCs over 2008-Q3 2013 period).

1. This shows that Ireland has delivered (a) the highest ULCs deterioration of the sample of countries reported over 2000-2007 period, and (b) since 2008, Ireland has delivered the largest improvement in competitiveness (ULCs drop) of the sample. 
2. Second largest improvement in ULCs was recorded in Greece and it is comparable to, but modestly shallower than in Ireland; third and virtually indistinguishable from the second - in Spain and fourth in Portugal.
3. The above two facts suggest that improvements in the ULCs are indeed related to the rates of increases in  unemployment: all countries with significant improvements have seen dramatic rises in unemployment. Jobs destruction 'helps' competitiveness.

Secondly, coloured bars show composition of gains over two periods. Here, the following points arise:

1. Labour costs declines have been responsible for the lion's share of ULCs gains in Greece, followed by Ireland, Italy, Portugal and Spain.
2. Labour costs declines are dramatic in the case of only two countries: Greece and Ireland.
3. The above two facts suggests that jobs destruction impacted dramatically in the sectors that were employment/labour-intensive, allowing for substantial moderation of labour costs across the remaining economy on average. So 'concentrated' jobs destruction 'helps' improve competitiveness a lot.
4. Meanwhile, productivity gains in economy were significant contributors to improved competitiveness in Spain, followed - by some margin of difference - by Ireland, and Portugal.
5. Points 1-2 and 4 together strongly suggest that in Ireland and Spain (and to a lesser extent Portugal) gains in competitiveness came about not because the remaining working population suddenly became more productive, but because the new jobless were working in sectors that were less productive, plus because remaining workers got paid less on average.

One more point: of course, our (and other euro area 'peripherals') gains here are measured not in absolute terms, but against EA17 aggregate levels of competitiveness, so to a large extent, our gains in the chart above are also down to their (other euro area countries') losses in competitiveness. This is exactly what the above figure shows for Austria, Germany, Belgium and the Netherlands.

That's happy times of productivity growth in the euro area 'periphery', then... down to throwing people off the employment bus and bragging about fabled improved productivity for the remaining passengers...

16/8/2014: Three Charts of Euro Area's Abysmal Growth Performance

Few charts to summarise the continued problems with growth in euro area and the 'peripheral' states:

First, consider changes in real GDP on pre-crisis peak:

Next, the weakest link in the euro area: Italy. This is really woeful - since hitting absolute lows, Italian economy continued to decline, steadily and with little sign of improvement.

The above also shows the miserable state of the euro area as a whole.

Another chart, to show changes on crisis-period absolute lows:

Note: the first 2 charts reference index to 2005=100, the last one references index to Q4 2006=100.

14/8/2014: The Yugo Area Economy

Much has been already said about the disastrous GDP data for Q2 2014 posted today by the Eurostat.

Here is to add to the pile... Starting with the Eurostat grotesque or pathetic - or as I put it EUrwellian - language headlining zero growth as 'stable' performance:

Link here: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-14082014-AP/EN/2-14082014-AP-EN.PDF

I covered slowdown in the industrial production in the EU here: http://trueeconomics.blogspot.it/2014/08/1482014-euro-area-industrial-production.html

And as far as leading economic indicators go, today's miss on expectations is largely driven by the fact that said expectations for positive growth were based on superficially-optimistic data: PMIs, investors' surveys and asset markets performance (see here: http://trueeconomics.blogspot.it/2014/07/3172014-deflationary-trap-eurocoin.html).

But here's a much more worrying bit: there is preciously little in the data to be surprised about. Euro area has been sick - when it comes to growth - not for a quarter, nor for a year, not even for a decade. Here is a chart showing average annualised rates of growth over longer periods of time:

In no period (and I computed the above series for every 12 month period average from 1 year through 15 years) did the euro area average longer-term growth reached above 1% per annum.

The main point of this can be best seen by removing the extreme underperformance during the peak of the crisis and taking a trend, as shown in the chart below:

 As the red line clearly shows:

• Over the last 12 months, as dismal as its performance has been, growth in the euro area has outperformed its long term trend.
• Long-term trend growth in the euro area should be where it is: near/below zero.

There is a structural or a very-long-run recession/stagnation in the euro area and it coincides with two other factors:

1. Low cost of credit over the last 15 years, and
2. Low inflation over the lats 15 years

We are all sick and tired of hearing the words 'structural reforms', but it is painfully clear at this stage that the entire history of the euro area to-date is that of sustained weakness. The ECB has now firmly run out of any conventional tools for dealing with it. And this brings us back to where Jean Claude Trichet left us some years ago, before the crisis hit in 2008: the simple truth about Europe is that it has no real drivers for growth. Forget q/q starts-and-fails of the engine, this diesel can't take you to a grocery store, with kids on board or without...

Time to call it what it is: the Yugo Area Economy...

14/8/2014: Euro Area Industrial Production H2 2014

With stagnant GDP and falling inflation, Euro area is set back into the rot of economic crisis, not that you'd notice as much from the Eurostat headline lauding 'stable' GDP print.

Here is the chart showing the miserable performance of the euro area's industrial production from end-June 2011 through 2014:

A message to Brussels: keep digging, folks...

And here's the same story in terms of average year-on-year growth rates for the last 3 years:

And the last 12 months:

19/7/2014: Trueconomics Cited in FT

Delighted and proud that FT is quoting the blog on European banks woes: http://www.ft.com/intl/cms/s/0/de39b744-0e61-11e4-a1ae-00144feabdc0.html#axzz37pQsLLmF

July 18, 2014 1:03 pm

Reality check for European banks

By Christopher Thompson and Andrew Bolger

Constantin Gurdgiev at True Economics says while current monetary and investment climates remain supportive of lower yields, markets are starting to show an increasing propensity to react strongly to negative newsflows. Investors’ view of the peripheral states as being strongly correlated in their performance remains in place, especially for Spanish, Portuguese and Greek sovereigns and corporate issuers.

“The markets are jittery and are getting trigger-happy on sell signals as strong rises in bond prices in recent months have resulted in sovereign and corporate debt being overbought by investors,” says Mr Gurdgiev.

Nice birthday present for myself. Thanks, FT!

11/7/2014: My comment on Greek and Portuguese bonds pressures

Portugal's Expresso on Greek and Portuguese bond yields with my comment: here.

My full comment in English:

In my view, we are seeing a strong reaction by the markets to adverse news relating to some peripheral euro area countries. 

In the Greek case, much of the rise in bond yields can be attributed first to the persistent uncertainty over the deficit adjustments and the progression of the reforms. The most recent suggestions by some analysts that Greece may require additional EUR2-3 billion over 2015-2016 relating to the news that the country pension fund is now facing an annual EUR2 billion funding gap have triggered some pressure on the country sovereign debt. This was compounded by thin and nervous markets for today's issuance of EUR1.5 billion bond which originally attracted just over 2.0x cover, but saw final demand slump somewhat on generally negative sentiment in the markets. Today's bond was priced at a yield of 3.5% with guidance between 3.5% and 3.625% issued two days ago on Tuesday. This is below the April 2014 5-year bond issue - the issue that attracted EUR20 billion worth of bids and was priced at 4.95%. However, shortly after the issue, secondary markets yields on April bond shot up to 5.10%.

In Portugal's case, the core risk trigger so far has been building up of pressures in the banking sector, and in particular in relation to Espirito Santo International announcement on Tuesday. This pushed Portuguese yields above 4% for 10 year bonds in today's trading. 

Portuguese risks have also put a stop to Banco Popular Espanol contingent convertible bond issue, as well as Spanish construction company ACS plans for an issue.

All in, Greek 10 year bonds closed at 502.0 spread to 10 year German bund up 20.4 bps on yesterday, Portugal's at 276.2 up 22.3 bps, Spanish at 161.8 up 9.2 bps, Italian at 174.1 up 9.3 bps, and Irish at 112.7, up 4.4 bps.

Spreads on 10 year German Bund:

The markets instability is a reminder that while current monetary and investment climates remain supportive of lower yields, markets are starting to show increasing propensity to react strongly to negative newsflows. Investors' view of the 'peripheral' states as being strongly correlated in their performance remains in place, especially for Spanish, Portuguese and Greek sovereigns and corporate issuers. 

The markets are jittery and are getting trigger-happy on sell signals as strong rises in bond prices in recent months have resulted in sovereign and corporate debt being over-bought by the investors. These investors are now staring into the prospect of gradual uplift in US and UK interest rates, weakening of the euro and thus rising cost of carry trades into the European sovereign bonds. At some point in time, these pressures are likely to translate into earlier investors in 'peripheral' bonds starting to exit their positions. 

We are not there yet, but market nervousness suggests that we are getting close to that inflection point.

7/7/2014: About those Global Growth Uplift Forecasts...

Last week, IMF updated its World Economic Outlook with a fresh upgrade to global growth forecast for 2015. Lot's of media miles have been travelled over this upgrade (here's one example). And, in fairness, the IMF might be right: there has been some firming up in global growth in recent months.

More significantly, the firming up is coming on foot of stronger performance of the advanced economies, where the cycle is now clearly indicating early stages recovery.

The same positive momentum has been confirmed in a number of expert surveys, e.g. BlackRock Investment Institute and McKinsey Global Institute and so on.

Still, just to be on the safer side, it is worth taking IMF forecasts in perspective. The Fund has been systematically wrong in its outlooks for Global and Advanced economies growth in recent years. Here is some evidence.

First: take the same period estimates (April-published estimates for the same year growth). These should be pretty easy to predict, as by the date of their release, the Fund has contemporaneous data flows on the economies (e.g. PMIs) and previous year dynamics pretty much sorted. Table below shows that, despite some data already being available, the Fund has rather varied experience with its estimates. And when it comes to the World Economy estimates, things have goo ten worse over the last three years, compared to the 5 years range.

Second, let's look at one year-ahead forecasts. Here, things are better in most recent three years, but they are not brilliant, especially when it comes to the Fund forecasts for the Euro Area. 3-5 year average over-estimate of growth is to the tune of 0.76-1.05% per annum. When it comes to World growth forecasts, these too turn out to be too optimistic, in the range of 0.56-0.60% annually.

Third: over two years forecasts, Fund's performance is worse: for the World economy forecasts tend to be on average more optimistic than the outrun by between 0.68% and 1.04% per annum. The same range for Euro Area is 1.19% to 1.53%.

Two charts illustrate the above. First: One-year ahead forecasts compared to outrun:

Next: 2008-2012 forecasts and 2013 (April) estimate for growth in 2013 compared to actual outrun:

Someone criticised my choice of the period covered, but the entire point of my argument here is not that the IMF is bad at forecasting (it is no worse than many other sources), but that forecasts at the times we live in are by their nature highly restrictive. That is, of course, not the notion one gets from reading business media reports of every IMF (or other major source) forecasts update.

So the net conclusion must be that there are indicators of global growth firming up… but I would't be rushing to buy on foot of IMF statements about 2015… At least not until there is a clear and established trend along which the forecasters can glide smoothly. When we need forecasts most, they are least useful… such is reality.