Economics 16/05/2010: EU on the brink

Before I begin the post on Euro, let me bring you a piece of really good news I've learned about last night. Although it has been publicly released few weeks ago, I learned about this just last night. Ireland is ranked third in the world as a centre for research in immunology (details here). Interestingly, I was informed by an anonymous source close working in scientific R&D field that the DofF is putting loads of pressure on science funding organizations to provide 'commercial return'-linked 'Irish drugs' products backed by the above-mentioned research. In immunology, like in any other field linked to phrama or biopharma, it takes around 15 years on average and scores of millions of euros in funding before a drug can brought to the market. We are just at the beginning of what is now internationally recognized to be successful undertaking in immunology research. Sometimes, DofF needs to wait patiently for a payoff! Let's hope they do.


Ambrose Evans-Pritchard, in today's piece (link here) has a superb analysis as to why Euro is in the end game, with pat not an option for its fierce opponents. And, incidentally, why it's the markets that are getting things right in nailing Euro zone. Let me quote few passages (as usual, comments are mine):

"Geneva professor Charles Wyplosz said EU leaders made the error of overselling up their shock and awe package [€750 billion rescue package issued two weeks ago] before establishing any political mechanism to mobilise such sums. The fund is an empty shell, he wrote at Vox EU. Worse still, crucial principles have been sacrificed for the sake of unconvincing announcements."

Bingo: Wyplosz is 100% correct, as I wrote here, the package is a bizarre amalgamation of impossible, improbable and outright reckless:

• It contains guarantees that cannot be backed by resources
• It shoves more debt onto the shoulders of already insolvent sovereigns
• It turns Germany - a solvent nation - into an implicitly (as long as guarantees remain implicit) insolvent nation
• It contains no real mechanism for imposing any sort of discipline on Eurozone sovereigns who might continue engaging into reckless deficit financing
• It demolishes any credibility built up by the ECB over the last decade and with it tears the fabric of the Euro
• It represents a massive cost imposition on Eurozone's economies

"Brussels was unwise to talk of smashing the wolf pack speculators and defeat the worldwide organised attack on the Eurozone. As Napoleon said, if you set out to take Vienna, take Vienna. Besides, the language of the EU priesthood ex-ECB board member Tomasso Padoa-Schioppa talks of the advancing battalions of the anti-euro army frightens Chinese and Mid-East investors needed to soak up EU debt. These metaphors are a mental flight from the issue at hand, which is that vast imbalances masked by EMU, indeed made possible only by EMU have been decorked by the Greek crisis and now pose a danger to the entire world."

Bingo again! Since the foundation of the EU in its modern incarnation - in other words since the mid 1990s, Brussels did nothing in terms of economic policies other than issue lofty plans and guidance documents - which promptly went nowhere real, and blame 'others' for its own troubles. At times, this reminded me of the good old Sovietskies whose entire edifice of the state was supported - from the early 1970s through the late 1980s - solely by the threat of 'others' coming to take over the Motherland.

"One can only guess what Mr Trichet meant when he said we are living through the most difficult situation since the Second World War, and perhaps the First. ...was Mr Trichet alluding to something else after witnessing the Brussels tantrum by President Nicolas Sarkozy? According to El Pais, Mr Sarkozy threatened to pull France out of the euro and break the Franco-German axis at the heart of the EU project unless Germany capitulated. To utter such threats is to bring them about. You cannot treat Germany in that fashion."

And herein is where the trouble's brewing. One thing for people to say Germany should exit the troubled Euro to save itself. Another thing for the country like France, which never really bothered to comply with the budgetary restrictions of the Maastricht Criteria or SGP to threaten to pull out, leaving Germany to pick up the pieces...

"The German nation is moving on. I was struck by a piece in the Frankfurter Allgemeine proposing a new hard currency made up of Germany, Austria, Benelux, Finland, the Czech Republic, and Poland, but without France. The piece entitled The Alternative says deflation policies may push Greece to the brink of civil war and concludes that Europe would better off if it abandoned the attempt to hold together two incompatible halves. It can be done, the piece says."

So the rationale for a German exit is there. As it has been since the first day of the Euro creation and the massive pan-European euphoria (or call it chauvinism) that engendered the idea (no matter how absurd) that EU can absorb the entire Continent into its folds and stretch into Asia via 'acquisition' of Turkey, plus the grand delusion of the Euro becoming the reserve currency of the world. Only now, this rationale has real feet - the markets gave them these by exposing the weakness behind Europe's great experiment. The markets did exactly that with the USSR in the 1980s, with Asia in the second half of the 1990s, Russia in 1998, New York in the 1970s, Orange County in the 1990s, Latina America in the 1980s and then in 2002-2003. They will, once the European day-dreams are fully dealt with, do the same to China's economy on state steroids. After all, this is what the markets are designed to do - expose lies and support the true value.

But, says Evans-Pritchard, "What makes this crisis so dangerous is not just that Europe's banks are still reeling, with wafer-thin capital ratios. The new twist is that markets are no longer sure whether sovereign states are strong enough to shoulder rescue costs. The IMF warned in last weeks Fiscal Monitor that the tail risk of a widespread loss of confidence in fiscal solvency could no longer be ignored. By 2015 public debt will be 250pc in Japan, 125pc in Italy, 110pc in the US, 95pc in France, and 91pc in the UK."

Do I need to remind you what it will be like in Ireland? Check out here. And that's with only direct cost of Nama factored in. 122% of the national income by 2015! And our Minister for Finance dares to call us turning the corner.

Evans-Pritchard is right in his analysis of 'solutions' to the Euro crisis: "There is a way out of this crisis, but it is not the policy of wage deflation imposed on Ireland, Greece, Portugal, and Spain, with Italy now also mulling an austerity package. This can only lead to a debt-deflation spiral. ...The only viable policies short of breaking up EMU or imposing capital controls is to offset fiscal cuts with monetary stimulus for as long it takes. Will it happen, given the conflicting ideologies of Germany and Club Med? Probably not. The ECB denies that it is engaged in Fed-style quantitative easing, vowing to sterilise its bond purchases euro for euro. If they mean it, they must doom southern Europe to depression. No democracy will immolate itself on the altar of monetary union for long."

Note to all folks eagerly rubbing their hands in hope of getting their hands on Government 'stimulus' to offset deflationary effects of austerity in Ireland: Evans-Pritchard is talking about Euroarea-wide massive emission of liquidity. I called for that months ago in the Indo and in Mail articles. And on this blog as well. Back then, before the current sovereign bonds crisis hit, I thought an issuance of €1 trillion directly to citizens of Europe would do the trick. Now, we are more in the need of issuing €3 trillion. This should be split as follows:

• €2 trillion issued directly to each adult and child inhabiting Europe (EU27) and
• €1 trillion issued to the EU16 sovereigns on the basis of each sovereign share of the total Euroarea population.

Wait another month, and we'll need €4 trillion...

Of course, there's always an option of Germany leaving the Euro and setting up a separate, credible currency. It's the lower cost solution, for it requires no replay of the same crisis 10 years from now - which is, of course, an inevitability given the nature of the Euro area. No matter whether fiscally integrated or not.

Economics 27/10/2009: What credit flows data tells us...

There is a superb blog post by Ronan Lyons exposing the economic nonsense spun by Nama supporting 'economists' - read HERE. In case you still wonder who that 'mysterious' uber-adviser from Indecon was - well, might it have been Time Magazine-famous (see here) Pat 'Never-Heard-of-Before' McCloughan?..


An interesting data from the ECB: The annual rate of growth of M3 money supply has decreased to 1.8% in September 2009, from 2.6% in August 2009. This marks new deterioration in money growth. The 3mo average of the annual growth rates of M3 over the period July 2009 - September 2009 decreased to 2.5%, from 3.1% in the period of June 2009 - August 2009. Table below summarises:
The annual rate of change of short-term deposits other than overnight deposits decreased to -5.3% in September, from -4.1% in the previous month. This implies that banks are bleeding cash at an increasing rate. In the mean time, the annual rate of change of marketable instruments increased to -8.8% in September, from -9.3% in August. Hmmm - has this anything to do with more aggressive repo operations? Or with more aggressive re-labeling of what constitutes 'marketable' instruments? Or both?

On the asset side of the MFI sector, "the annual growth rate of total credit granted to euro area residents increased to 3.1% in September 2009, from 2.8% in August. The annual rate of growth of credit extended to general government increased to 13.6% in September, from 11.5% in August, while the annual growth rate of credit extended to the private sector was 1.1% in September, unchanged from August." So here we have it - the credit pyramid in full swing. Banks borrow against bonds issued by the state (increasing supply of 'marketable' paper to the ECB). The states promptly issue more bonds that are then bought up by the banks, increasing supply of credit to the governments.

In the mean time the real economy is taking more water: "...the annual rate of change of loans to the private sector decreased to -0.3% in September, from 0.1% in the previous month (adjusted for loan sales and securitisation the annual growth rate of loans to the private sector decreased to 0.9%, from 1.3% in the previous month)." [The latter number means that barring accounting shenanigans with re-classifying and restructuring loans, credit to private sector was falling even faster].

"The annual rate of change of loans to non-financial corporations decreased to -0.1% in September, from 0.7% in August. The annual rate of change of loans to households stood at -0.3% in September, after -0.2% in the previous month. The annual rate of change of lending for house purchase was -0.6% in September, after -0.4% in August. The annual rate of change of consumer credit stood at -1.1% in September, after -1.0% in August, while the annual growth rate of other lending to households was 1.5% in September, after 1.3% in the previous month." Again, the last sentence reflects increases in credit due to arrears (short-term lending to households).

So to summarise, economy is still tanking, while the governments are still monetizing new debt through the banks. Expect a bumper crop of profits from Eurozone financial institutions in months to come as they reap the gains of the government-financing pyramid.

Let me show you some illustrations based on ECB data:

First we have Government borrowing:
followed by non-MFIs
...and non-financial corporations
and finally by the households:

As commented in the charts, this data shows conclusively that the private sectors (non-financial corporations and households) have been:

• accumulating liabilities in the years before crisis in a transfer of the debt off the public sector shoulders onto private economy shoulders; and
• were unable to deleverage in the last 24 months since the onset of the financial crisis.
  

This implies that in years to come, weakened consumers and corporates will be exerting downward pressure on European growth, with interest rates hikes potentially inducing a destabilizing pressure on already over-stretched households and corporates. In this environment:

• any talk about ECB and Governments' 'exit strategies' is premature, unless one is to completely disregard the credit bubble still weighing on non-financial private economy; and
• continued public sector spending stimuli and ECB discount window-reliant monetary policy cannot be a workable solution to the crisis. Instead, there is an acute need for orderly deleveraging in the private economy.