One ugly euro chart:
Nothing new, of course, just an illustration.
Nothing new, of course, just an illustration.
Showing posts with label Euro zone. Show all posts
Showing posts with label Euro zone. Show all posts
Sunday, July 29, 2012
Thursday, July 12, 2012
12/7/2012: Wealth taxes - coming up next to Europe near you...
And so wealth taxes (on those who are not all that wealthy, in fact) is a matter of EU-wide policy now, thanks to Schauble: link here and here. Note, the idea is to tax property assets in excess of €250,000 - with an additional one-off levy of 10% on top of other taxes and presumably, as per talk in one of the links about 'capital taxes' other assets can be included. And the original source for the grand idea is here.
Thus, the logic goes, you've saved for the retirement (which requires at least as much in provisions as the tax bound) and you are not a drag on social pensions system. Off you go, pay up...
One question - what happens if two years from now property values drop and your property 'wealth' declines to below €250K... do you get a refund?.. Question two - what happens when tax is levied and as the result, property markets go into further contractions, forcing question one above to the forefront?.. Question three - what happens in the long run when taxes have depleted not only disposable (investable) incomes, but also investable (and largely illiquid) wealth - do pensions provisions go up?.. do Governments step in to provide cheap capital for investment?.. does Schauble and his friends drop their own pensions demands to compensate economy for €230 billion they've sucked out of investment pool?..
Idiots squad has never been so much enforced in Europe as today.
Thus, the logic goes, you've saved for the retirement (which requires at least as much in provisions as the tax bound) and you are not a drag on social pensions system. Off you go, pay up...
One question - what happens if two years from now property values drop and your property 'wealth' declines to below €250K... do you get a refund?.. Question two - what happens when tax is levied and as the result, property markets go into further contractions, forcing question one above to the forefront?.. Question three - what happens in the long run when taxes have depleted not only disposable (investable) incomes, but also investable (and largely illiquid) wealth - do pensions provisions go up?.. do Governments step in to provide cheap capital for investment?.. does Schauble and his friends drop their own pensions demands to compensate economy for €230 billion they've sucked out of investment pool?..
Idiots squad has never been so much enforced in Europe as today.
Monday, July 25, 2011
25/07/2011: Comprative analysis of Euro Area and Euro Big 4
There’s a lively debate going on in parts of Europe about the longer-term fall out from last week’s ‘Deal for Greece +”. Most notably – in Germany (see here). In light of this, it is worth looking into some facts about economic performance of the Euro area Big 4 economies: is Germany right about protecting its fiscal conservativism from collectivization of risks envisioned by the ‘Deal’?
Let us plough through some data and IMF forecasts for the following set of countries & country-groups: France, Germany, Italy and Spain (the Big 4) against the Euro area as a whole, plus Advanced Economies and Major Advanced Economies (G7). Please note that the IMF forecasts are not exactly in agreement with my view of where some of these economies are heading, but for the reasons of comparative simplicity and transparency, I will rely on IMF data here.
In the end, what I am after here is some (crude – so be warned) metric of risks – disaggregated across countries and groups.
Starting from the top: chart below shows annual growth rates in GDP expressed in constant prices.
Economies, 2000-2007 growth rates averaged 2.61%, while the crisis years growth fell on average 0.06% annually. The projected growth for post-crisis period 2011-2016 IMF forecasts growth of 2.46%. In all of these periods, Advanced Economies group leads the league table of our sample countries/regions.
Area managed to achieve average annual growth of 2.16% in pre-crisis period, but suffered 0.63% annual average contraction during the crisis. Post-crisis, Euro area economies are expected to grow 1.76% which is the third slowest rate of growth in our sample.
G7 economies grew 2.27% on average annually in pre-crisis period and faced a relatively mild average crisis-period contraction of output of 0.36%. These economies are expected to grow at 2.29% per annum on average in 2011-2016.
France recorded average annual growth of 2.12% in 2000-2007 and subsequently posted relatively mild contraction of 0.32% (annual average) in 2008-2010. The country is expected to grow its economy at an average annual rate of 1.94%.
German economy grew on average at an annual rate of 1.58% during the pre-crisis years – posting second slowest growth in the sample. During the crisis, the economy contracted 0.15% per annum on average (second best performance in the sample), while it is expected to grow at 1.84% average rate in 2011-2016 – not a blistering growth forecast, but above Euro area as a whole.
Italy posted slowest average annual growth in the sample during the pre-crisis period (1.46%), the deepest average annual contraction in the sample during the crisis (-1.75%) and is expected to continue slowest growth performance with 1.32% average annual growth rate in 2011-2016.
Spain recorded the fastest real growth in the sample for the pre-crisis period (3.62% average annual rate), followed by the second magnitude of contraction (-1.0% per annum on average) in the crisis period. Spanish economy is expected to grow at 1.62% on average in 2011-2016 – second slowest in the sample.
In terms of GDP per capita (chart below):
Germany was the first in our sample to reach pre-crisis peak level of GDP per capita between 2009 and 2010, followed by the Advanced Economies and the Euro area. G7 group of countries recovered from the crisis in terms of GDP per capita by the end of 2010, while France’s recovery will take it into 2011. Spain is expected to recover from the declines in GDP per capita around 2011-2012, while Italy will take the longest to reach pre-crisis peak – some time between 2012 and 2013.
In terms of investment as a share of GDP (chart below):
Advanced economies investment averaged 21.05% in the period prior to the crisis, falling to 19.08% during the crisis before recovering somewhat to 20.08% in the period 2011-2016. No data is available for the Euro area and G7 countries.
France invested 20.2% of its GDP on average during 2000-2007 period, recording a marginal decline to 20.11% in the crisis years and is expected to recover to 20.60% of GDP in 2011-2016.
Germany was the weakest country in the sample in terms of investment with investment ratio to GDP of 18.24% in the pre-crisis years, followed by 17.50% during the crisis and by expected 17.81% in the post-crisis period.
Italian economy investment as a share of GDP was 21.01% in pre-2008 period, followed by 20.11% during the crisis. IMF expects Italian investment to rise to 20.54% of GDP in the post-crisis period.
Spain’s investment to GDP ratio was 28.30% in 2000-2007 period, followed by 25.5% in 2008-2010 and 22.98% projected for 2011-2016.
So in terms of investment as a share of GDP, Germany is clearly a laggard here, which is of course explained by two core factors: (1) aging population and (2) already extensive stock of capital.
Unemployment rates are shown in the chart below:
During pre-crisis period, Spain psoted the highest rate of unemployment, averaging 10.54%, followed by Germany (8.93%) and France (same as Germany). Euro area as a whole averaged 8.45% unemployment rate during the pre-crisis period, followed by Italy at 8.11%. This poor performance by European part of out sample is contrasted by the pre-crisis unemployment of 6.11% for the group of Advanced Economies and 6.05% for G7 group.
During the crisis, Spanish unemployment rose to 16.47%, followed by France (9.02%) and Euro area (9.0%). G7 economies posted 7.35% average rate of unemployment while Advanced economies came in at 7.34%. Germany shows the best unemployment rate for the period at 7.22%.
Post-crisis, IMF forecasts for Spain to remain worst performing country in our sample with 16.91% average unemployment rate, followed by Euro area at 9.03% and France at 8.57%. In contrast, Italy’s unemployment is projected to settle at 7.87% average, with Advanced economies coming in at 6.77% and G7 economies at 6.54%.
So what about employment – in other words, jobs creation:
The chart clearly shows that Germany, G7 group and France are the weaker performers in the sample in terms of longer-term trends in jobs creation. Now, see the following chart on population changes. Of course the problem here is that while German population is shrinking (so jobs creation is not exactly high on their agenda, especially with low unemployment), for France (with expanding population) slow jobs creation is a major draw back (hence high unemployment as well).
By 2015, based on IMF projections, German population will shrink by 1.284 million relative to 2000, while Italian population will grow by 4.638 million, French by 5.352 million and Spanish population will expand by 6.304 million.
In terms of fiscal performance, consider the following two charts plotting general government revenue as % of GDP and the general government expenditure as % of GDP:
The following chart shows general government deficits:
Based on three charts above, consider the fiscal adjustments required to deliver on the deficit targets to 2016:
Of all countries in the sample, France represents the steepest required fiscal adjustment in terms of deficit reductions, totaling 4.475% of GDP between 2011 and 2016, followed by the G7 group of countries with 4.063% and Advanced economies at 3.567%. Euro area projected adjustments are 2.519%, while German projected adjustment is 2.326%. The weakest – fiscally – performing countries – Italy and Spain – have the lowest fiscal adjustments planned at 1.439% and 1.679% respectively.
Mapping these adjustments alongside the absolute measure of fiscal performance (Gross Debt) and taking into account the economies growth potential, chart below shows two groups of countries. The first group (no shading) is the group of economies facing the moderate adjustment on deficits side, against stronger targets on debt reductions. This group includes Germany, Italy and Euro area. The second group of countries represents a group facing steeper adjustments on fiscal deficits side and/or significant deterioration in debt positions. This group covers Spain, Advanced economies, G7 and France. It is worth noting that this group of countries faces stronger growth prospects, but Spain and France represent two weaker economies in this group.
Chart below provides an illustration of the debt challenges faced by the sample economies. General Government debt rose 48% in Spain form an average of 47.62% of GDP in 2000-2007 to 70.5% of GDP projected average for 2011-2016. In France, the same increase was 43.6% from 61.83% of GDP pre-crisis to 88.76% average in post-crisis period. At the same time in Germany, gross government debt to GDP ratio rose from 63.64% of GDP pre-crisis to 76.48% of GDP in post-crisis period – the second slowest rate of increase in the sample after Italy.
Overall, for the period of 2011-2016, average gross government debt levels are expected to range from 121.93% of GDP for the G7 economies, to 119.32% of GDP for Italy, 105.33% of GDP for Advanced economies, 88.76% of GDP in France, 87.55% of GDP for the Euro area, 76.48% of GDP in Germany and 70.49% of GDP in Spain.
Lastly, let’s take a look at the current account positions.
As chart above shows, cumulative 2011-2016 expected current account positions as the share of GDP are: Germany +25.9% of GDP, Euro area +0.67% of GDP, Advanced Economies -1.92% of GDP, G7 economies -7.13% of GDP, France -14.6% of GDP, Italy -17.4% and Spain -24.5% of GDP.
Now, let us pool the information contained in the above data to derive the overall riskiness of each economy/group in the sample. To do this, I assign to each country/group a score out of 1-14 based on their performance relative to the top performing economy. So top performer in each category of score below gets 14, the with the next performer getting 12 or less, with distribution of scores within each category/heading following the underlying data. The higher raw scores reflect stronger economic performance and / or lower risk. So the final risk scores are based on inverting the raw scores. Summing these up across categories/criteria produces the total risk score reported in the penultimate column of the table. These are ranked in the last column with 1=highest risk country.
The results are consistent with statistical distribution and are robust to several checks, namely:
1) Removal of the GDP per capita recovery statistics
2) Removal of the Employment index
3) Removal of the Government Expenditure metric
The core results are:
Let us plough through some data and IMF forecasts for the following set of countries & country-groups: France, Germany, Italy and Spain (the Big 4) against the Euro area as a whole, plus Advanced Economies and Major Advanced Economies (G7). Please note that the IMF forecasts are not exactly in agreement with my view of where some of these economies are heading, but for the reasons of comparative simplicity and transparency, I will rely on IMF data here.
In the end, what I am after here is some (crude – so be warned) metric of risks – disaggregated across countries and groups.
Starting from the top: chart below shows annual growth rates in GDP expressed in constant prices.
Economies, 2000-2007 growth rates averaged 2.61%, while the crisis years growth fell on average 0.06% annually. The projected growth for post-crisis period 2011-2016 IMF forecasts growth of 2.46%. In all of these periods, Advanced Economies group leads the league table of our sample countries/regions.
Area managed to achieve average annual growth of 2.16% in pre-crisis period, but suffered 0.63% annual average contraction during the crisis. Post-crisis, Euro area economies are expected to grow 1.76% which is the third slowest rate of growth in our sample.
G7 economies grew 2.27% on average annually in pre-crisis period and faced a relatively mild average crisis-period contraction of output of 0.36%. These economies are expected to grow at 2.29% per annum on average in 2011-2016.
France recorded average annual growth of 2.12% in 2000-2007 and subsequently posted relatively mild contraction of 0.32% (annual average) in 2008-2010. The country is expected to grow its economy at an average annual rate of 1.94%.
German economy grew on average at an annual rate of 1.58% during the pre-crisis years – posting second slowest growth in the sample. During the crisis, the economy contracted 0.15% per annum on average (second best performance in the sample), while it is expected to grow at 1.84% average rate in 2011-2016 – not a blistering growth forecast, but above Euro area as a whole.
Italy posted slowest average annual growth in the sample during the pre-crisis period (1.46%), the deepest average annual contraction in the sample during the crisis (-1.75%) and is expected to continue slowest growth performance with 1.32% average annual growth rate in 2011-2016.
Spain recorded the fastest real growth in the sample for the pre-crisis period (3.62% average annual rate), followed by the second magnitude of contraction (-1.0% per annum on average) in the crisis period. Spanish economy is expected to grow at 1.62% on average in 2011-2016 – second slowest in the sample.
In terms of GDP per capita (chart below):
Germany was the first in our sample to reach pre-crisis peak level of GDP per capita between 2009 and 2010, followed by the Advanced Economies and the Euro area. G7 group of countries recovered from the crisis in terms of GDP per capita by the end of 2010, while France’s recovery will take it into 2011. Spain is expected to recover from the declines in GDP per capita around 2011-2012, while Italy will take the longest to reach pre-crisis peak – some time between 2012 and 2013.
In terms of investment as a share of GDP (chart below):
Advanced economies investment averaged 21.05% in the period prior to the crisis, falling to 19.08% during the crisis before recovering somewhat to 20.08% in the period 2011-2016. No data is available for the Euro area and G7 countries.
France invested 20.2% of its GDP on average during 2000-2007 period, recording a marginal decline to 20.11% in the crisis years and is expected to recover to 20.60% of GDP in 2011-2016.
Germany was the weakest country in the sample in terms of investment with investment ratio to GDP of 18.24% in the pre-crisis years, followed by 17.50% during the crisis and by expected 17.81% in the post-crisis period.
Italian economy investment as a share of GDP was 21.01% in pre-2008 period, followed by 20.11% during the crisis. IMF expects Italian investment to rise to 20.54% of GDP in the post-crisis period.
Spain’s investment to GDP ratio was 28.30% in 2000-2007 period, followed by 25.5% in 2008-2010 and 22.98% projected for 2011-2016.
So in terms of investment as a share of GDP, Germany is clearly a laggard here, which is of course explained by two core factors: (1) aging population and (2) already extensive stock of capital.
Unemployment rates are shown in the chart below:
During pre-crisis period, Spain psoted the highest rate of unemployment, averaging 10.54%, followed by Germany (8.93%) and France (same as Germany). Euro area as a whole averaged 8.45% unemployment rate during the pre-crisis period, followed by Italy at 8.11%. This poor performance by European part of out sample is contrasted by the pre-crisis unemployment of 6.11% for the group of Advanced Economies and 6.05% for G7 group.
During the crisis, Spanish unemployment rose to 16.47%, followed by France (9.02%) and Euro area (9.0%). G7 economies posted 7.35% average rate of unemployment while Advanced economies came in at 7.34%. Germany shows the best unemployment rate for the period at 7.22%.
Post-crisis, IMF forecasts for Spain to remain worst performing country in our sample with 16.91% average unemployment rate, followed by Euro area at 9.03% and France at 8.57%. In contrast, Italy’s unemployment is projected to settle at 7.87% average, with Advanced economies coming in at 6.77% and G7 economies at 6.54%.
So what about employment – in other words, jobs creation:
The chart clearly shows that Germany, G7 group and France are the weaker performers in the sample in terms of longer-term trends in jobs creation. Now, see the following chart on population changes. Of course the problem here is that while German population is shrinking (so jobs creation is not exactly high on their agenda, especially with low unemployment), for France (with expanding population) slow jobs creation is a major draw back (hence high unemployment as well).
By 2015, based on IMF projections, German population will shrink by 1.284 million relative to 2000, while Italian population will grow by 4.638 million, French by 5.352 million and Spanish population will expand by 6.304 million.
In terms of fiscal performance, consider the following two charts plotting general government revenue as % of GDP and the general government expenditure as % of GDP:
The following chart shows general government deficits:
Based on three charts above, consider the fiscal adjustments required to deliver on the deficit targets to 2016:
Of all countries in the sample, France represents the steepest required fiscal adjustment in terms of deficit reductions, totaling 4.475% of GDP between 2011 and 2016, followed by the G7 group of countries with 4.063% and Advanced economies at 3.567%. Euro area projected adjustments are 2.519%, while German projected adjustment is 2.326%. The weakest – fiscally – performing countries – Italy and Spain – have the lowest fiscal adjustments planned at 1.439% and 1.679% respectively.
Mapping these adjustments alongside the absolute measure of fiscal performance (Gross Debt) and taking into account the economies growth potential, chart below shows two groups of countries. The first group (no shading) is the group of economies facing the moderate adjustment on deficits side, against stronger targets on debt reductions. This group includes Germany, Italy and Euro area. The second group of countries represents a group facing steeper adjustments on fiscal deficits side and/or significant deterioration in debt positions. This group covers Spain, Advanced economies, G7 and France. It is worth noting that this group of countries faces stronger growth prospects, but Spain and France represent two weaker economies in this group.
Chart below provides an illustration of the debt challenges faced by the sample economies. General Government debt rose 48% in Spain form an average of 47.62% of GDP in 2000-2007 to 70.5% of GDP projected average for 2011-2016. In France, the same increase was 43.6% from 61.83% of GDP pre-crisis to 88.76% average in post-crisis period. At the same time in Germany, gross government debt to GDP ratio rose from 63.64% of GDP pre-crisis to 76.48% of GDP in post-crisis period – the second slowest rate of increase in the sample after Italy.
Overall, for the period of 2011-2016, average gross government debt levels are expected to range from 121.93% of GDP for the G7 economies, to 119.32% of GDP for Italy, 105.33% of GDP for Advanced economies, 88.76% of GDP in France, 87.55% of GDP for the Euro area, 76.48% of GDP in Germany and 70.49% of GDP in Spain.
Lastly, let’s take a look at the current account positions.
As chart above shows, cumulative 2011-2016 expected current account positions as the share of GDP are: Germany +25.9% of GDP, Euro area +0.67% of GDP, Advanced Economies -1.92% of GDP, G7 economies -7.13% of GDP, France -14.6% of GDP, Italy -17.4% and Spain -24.5% of GDP.
Now, let us pool the information contained in the above data to derive the overall riskiness of each economy/group in the sample. To do this, I assign to each country/group a score out of 1-14 based on their performance relative to the top performing economy. So top performer in each category of score below gets 14, the with the next performer getting 12 or less, with distribution of scores within each category/heading following the underlying data. The higher raw scores reflect stronger economic performance and / or lower risk. So the final risk scores are based on inverting the raw scores. Summing these up across categories/criteria produces the total risk score reported in the penultimate column of the table. These are ranked in the last column with 1=highest risk country.
The results are consistent with statistical distribution and are robust to several checks, namely:
1) Removal of the GDP per capita recovery statistics
2) Removal of the Employment index
3) Removal of the Government Expenditure metric
The core results are:
- Germany clearly represents the most sustainable country in the sample of all Big 4. In fact, its fiscal and macroeconomic position would be significantly undermined if it were to move to Euro area harmonized position
- Spain and Italy are the two weakest economies in the sample with very high risk rating
- France is statistically closer to Spain and Italy than to Euro area harmonized economy and is clearly the least sustainable economy in the sample after Spain and Italy.
Thursday, May 7, 2009
Economics 08/05/2009: ECB - a bark, but no bite..., Obama's Frying Pen for Ireland
ECB's latest rate cut has a bark, but little real bit...
As we all know by now - the ECB has cut the rate by 25bps to a 'historic' low of 1%. The word 'historic' is suppose to impress us, yet it does not - the US rates are at zero, UK at 0.5%, Japan at 0.1%, Canada at 0.25% and these countries have seen significant devaluations vis-a-vis the Euro and quantitative easing...
Some say - this is the seventh reduction in seven months. "Geez Louise!", as Woody Allen would say. It would have been better if they were to cut the rate once - seven months ago - to 1.25% and not pretend to be 'conservative'. More medicine quickly is what gets the sick back on their feet. Drip-feeding vitamins to a dying patient is not going to do much good. And hence, I am not impressed by today's cut.
More significant was the statement that the ECB delivered alongside the decision. This is worth to be discussed on several fronts:
1) It suggests (and Trichet hinted at the same) that the forthcoming growth data for Q1 2009 is going to be poor. Does ECB know something we don't? My forecast (see April 24 post) was for 1.1% decline - monthly. So quarterly decline of ca 3.3% or more than double on Q4 2008 (-1.6%). Can it be worse? Yes, it can - Germany is forecast to fall 5.6% in 2009, with most of the falling to be done in Q1-Q2 2009. My gut feeling is that no matter what the fall off in Q1 can be (and we will know today), we are now in a 3.5-4% decline territory for Q2 as well. Hold on to your seats, because if this is the case, ECB's posturing that we are at the end of the cuts cycle is a fantasy. Expect a cut to 0.75% in June-July. Why? Because if H1 contraction were to be in a 4-5% territory, we are going to post a similarly deep contraction for the whole year. And that would warrant serious intervention.
So on the net, I must revise my forecast - yet to be quantitatively confirmed (which I will do tomorrow once the Q1 figures are in) - downward, and my feeling is that the full year 2009 figure is now shaping to look like a 4-4.5% fall in the eurozone.
2)Trichet had to mention the 'tentative signs of stabilization' in the economy. Presuming he was not talking about the US, the phrase reflects lack of agreement within the council as to what is taking place in the real economy. This is good news for us, analysts, since we now are no longer alone in not knowing what is going on, but it is bad for the markets. Uncertainty is something that usually spurs the Fed to act, and ECB to stall. Hence, I suspect we will see a month-long pause before another 25bps cut is enacted. Remember, the patient - the euro area economy - is still in ICU...
3)Whether you call it quantitative easing or not, but the plan to purchase €60bn in covered bonds (CBs) is a joke. Brian Cowen alone would burn through that amount in a year (with NAMA - in a blink of an eye). And there are Austria, Italy, Greece, Portugal, Spain still waiting in line for a handout. CBs are debts backed by cash flows from underlying loans (e.g mortgages). It is the sort-of securitization product, with all the stuff - however toxic, as long as it is paying some sort of interest - bunched in. It does appear that Ireland and Spain are the two leading contenders for the first slot at the new 'ECB pawn brokers' window, as our banks have been shifting all sorts of pesky stuff across their books into the ECB already.
The only question to ask here - what will be the associated terms and conditions? We will know these only about a month from now when ECB actually sketches these. But I suspect Brian Lenihan will be phoning Trichet's people to find out the details starting from tomorrow. After all, survival of the Irish financials and the Exchequer is now hanging by the thread, and Mr Trichet has a pair of sharp scissors at his disposal. Significantly, of course, the ECB's newest plan is to come ahead of NAMA legislation, so here is a question: Is this new CBs-purchasing plan a tailor-made device for Ireland to be tested as a guinea pig in European financial rescue experimentation?
On a bit more positive note, the ECB stretched liquidity provision terms to 12 months. It also added the European Investment Bank to the eligible counterparties list, in effect creating an additional supply of credit - ca €40bn. Now, combined the ECB €60bn, plus the EIB's €40bn are just about covering the borrowing requirements for Biffonomics and Lenihanama.
Obamanomics might, just might, spell a real disaster for Ireland Inc...
It was 100-days in the Hot Seat for Barak Obama last week and, true to his promises to change America, the President has gone for his big pledge: to crack down on the use of offshore tax havens. This time around Ireland will have to do better than sending Mary Coughlan to Washington in order to keep the US taxman at bay.
A key initiative, announced Monday, would partially close a provision that allowed US companies to defer paying taxes on the profits they make on their overseas investments. Another proposed change is to close completely the loophole that allowed companies to treat foreign subsidiaries as non-resident in the US for tax purposes.
A report by the Congressional General Accounting Office found that 83 out of the US top 100 companies have set up subsidiaries in tax havens. Some $20bn in allegedly ‘lost’ annual revenue for Uncle Sam is at stake, as in 2004 – the latest year for which data is available – US MNCs paid just $16bn in Federal tax on foreign earnings of $700bn. That’s an effective rate of tax of ca 2.3%.
Now, an interesting twist in the proposals is to allow deferring tax payments only on R&D investments, so expect Ireland suddenly jump to the top of the league of nations in per capita R&D spending, should the White House plan go through Congress.
It is worth remembering that our much-loved Bill Clinton prepared an even more ambitious plan for shutting down tax havens that would have seen US investment here dry-out like a salty pond in the middle of Sahara. Much-disliked George Bush shelved it, saving our US MNCs-led economy. Now, another Democrat - ah they are such 'friends of Ireland' those Democrats - is going to fry us up crispy...
How're those 4% growth forecasts from DofF looking now?
As we all know by now - the ECB has cut the rate by 25bps to a 'historic' low of 1%. The word 'historic' is suppose to impress us, yet it does not - the US rates are at zero, UK at 0.5%, Japan at 0.1%, Canada at 0.25% and these countries have seen significant devaluations vis-a-vis the Euro and quantitative easing...
Some say - this is the seventh reduction in seven months. "Geez Louise!", as Woody Allen would say. It would have been better if they were to cut the rate once - seven months ago - to 1.25% and not pretend to be 'conservative'. More medicine quickly is what gets the sick back on their feet. Drip-feeding vitamins to a dying patient is not going to do much good. And hence, I am not impressed by today's cut.
More significant was the statement that the ECB delivered alongside the decision. This is worth to be discussed on several fronts:
1) It suggests (and Trichet hinted at the same) that the forthcoming growth data for Q1 2009 is going to be poor. Does ECB know something we don't? My forecast (see April 24 post) was for 1.1% decline - monthly. So quarterly decline of ca 3.3% or more than double on Q4 2008 (-1.6%). Can it be worse? Yes, it can - Germany is forecast to fall 5.6% in 2009, with most of the falling to be done in Q1-Q2 2009. My gut feeling is that no matter what the fall off in Q1 can be (and we will know today), we are now in a 3.5-4% decline territory for Q2 as well. Hold on to your seats, because if this is the case, ECB's posturing that we are at the end of the cuts cycle is a fantasy. Expect a cut to 0.75% in June-July. Why? Because if H1 contraction were to be in a 4-5% territory, we are going to post a similarly deep contraction for the whole year. And that would warrant serious intervention.
So on the net, I must revise my forecast - yet to be quantitatively confirmed (which I will do tomorrow once the Q1 figures are in) - downward, and my feeling is that the full year 2009 figure is now shaping to look like a 4-4.5% fall in the eurozone.
2)Trichet had to mention the 'tentative signs of stabilization' in the economy. Presuming he was not talking about the US, the phrase reflects lack of agreement within the council as to what is taking place in the real economy. This is good news for us, analysts, since we now are no longer alone in not knowing what is going on, but it is bad for the markets. Uncertainty is something that usually spurs the Fed to act, and ECB to stall. Hence, I suspect we will see a month-long pause before another 25bps cut is enacted. Remember, the patient - the euro area economy - is still in ICU...
3)Whether you call it quantitative easing or not, but the plan to purchase €60bn in covered bonds (CBs) is a joke. Brian Cowen alone would burn through that amount in a year (with NAMA - in a blink of an eye). And there are Austria, Italy, Greece, Portugal, Spain still waiting in line for a handout. CBs are debts backed by cash flows from underlying loans (e.g mortgages). It is the sort-of securitization product, with all the stuff - however toxic, as long as it is paying some sort of interest - bunched in. It does appear that Ireland and Spain are the two leading contenders for the first slot at the new 'ECB pawn brokers' window, as our banks have been shifting all sorts of pesky stuff across their books into the ECB already.
The only question to ask here - what will be the associated terms and conditions? We will know these only about a month from now when ECB actually sketches these. But I suspect Brian Lenihan will be phoning Trichet's people to find out the details starting from tomorrow. After all, survival of the Irish financials and the Exchequer is now hanging by the thread, and Mr Trichet has a pair of sharp scissors at his disposal. Significantly, of course, the ECB's newest plan is to come ahead of NAMA legislation, so here is a question: Is this new CBs-purchasing plan a tailor-made device for Ireland to be tested as a guinea pig in European financial rescue experimentation?
On a bit more positive note, the ECB stretched liquidity provision terms to 12 months. It also added the European Investment Bank to the eligible counterparties list, in effect creating an additional supply of credit - ca €40bn. Now, combined the ECB €60bn, plus the EIB's €40bn are just about covering the borrowing requirements for Biffonomics and Lenihanama.
Obamanomics might, just might, spell a real disaster for Ireland Inc...
It was 100-days in the Hot Seat for Barak Obama last week and, true to his promises to change America, the President has gone for his big pledge: to crack down on the use of offshore tax havens. This time around Ireland will have to do better than sending Mary Coughlan to Washington in order to keep the US taxman at bay.
A key initiative, announced Monday, would partially close a provision that allowed US companies to defer paying taxes on the profits they make on their overseas investments. Another proposed change is to close completely the loophole that allowed companies to treat foreign subsidiaries as non-resident in the US for tax purposes.
A report by the Congressional General Accounting Office found that 83 out of the US top 100 companies have set up subsidiaries in tax havens. Some $20bn in allegedly ‘lost’ annual revenue for Uncle Sam is at stake, as in 2004 – the latest year for which data is available – US MNCs paid just $16bn in Federal tax on foreign earnings of $700bn. That’s an effective rate of tax of ca 2.3%.
Now, an interesting twist in the proposals is to allow deferring tax payments only on R&D investments, so expect Ireland suddenly jump to the top of the league of nations in per capita R&D spending, should the White House plan go through Congress.
It is worth remembering that our much-loved Bill Clinton prepared an even more ambitious plan for shutting down tax havens that would have seen US investment here dry-out like a salty pond in the middle of Sahara. Much-disliked George Bush shelved it, saving our US MNCs-led economy. Now, another Democrat - ah they are such 'friends of Ireland' those Democrats - is going to fry us up crispy...
How're those 4% growth forecasts from DofF looking now?
Sunday, March 8, 2009
Germany and the Euro
This post is a response to a comment by Tim (here):
"I just heard that Germany is considering leaving the euro. ...What do you think?"
I have not heard such a rumor - at least not at any credible level. I would be surprised if such sentiment was gaining significant strength in Germany. Here is the latest data I could find and my understanding of what is happening.
Per Eurobarometer 70, December 2008, 56% of German population tend to trust in the ECB - a fall of 4 percentage points on Spring 2008. EU27 average was significantly lower at 48% (a fall of 2 percentage points on Spring 2008). This still places Germany as 13th ranked country in the EU27 in terms of overall trust in the ECB. Ireland is 14th with 52% (down 6 percentage points on Spring 2008). In general, decline in trust for ECB tends to be rising with the worsening in economic conditions: Portugal leads the fall with -10%, Spain follows with -8%, Ireland comes next.
Also significantly, the decline in those trusting ECB has translated into an even higher rise in those who tend not to trust the ECB (as opposed to those who declined to answer): in Germany, 8 percentage increase in those who do not trust the ECB, in Spain +13%, in Ireland +10%, and so on. This shows that people are actually becoming more decisive in their negative position vis-a-vis ECB policies. But, again, it does not show Germans swinging decisively against the Euro membership. In my view, the rising negative perception of the ECB is driven by the policy lags with which the ECB greeted the economic crisis between July 2007 and July 2008.
As far as I understand, there was no direct question on the Euro in the preliminary EB70 results available at this time.
Eurobarometer 69, Spring 2008, does show results for trust in Euro itself. Even before the crisis pushed Germany into a recession, only 17% of Germans tended to claim that their approval of the Euro is one of the top two reasons for supporting the ECB. Same as in Ireland, but below the EU27 average of 19%. Table below gives results for "QA25a Which of the following are the main reasons for trusting the European Central Bank?":
"QA26a Which of the following are the main reasons for not trusting the European Central Bank?" Table below shows response to the above question:
When it came to mistrusting the ECB, 18% of Germans named being against the Euro as one of the top two reasons for their position vis-à-vis the ECB.
These numbers do not show a significant doze of skepticism about the Euro amongst the Germans, but they do show that the two tails of the attitudes to Euro distribution are both ‘fat’ and virtually identical in size. In other words, anti-Euro enthusiasts are roughly as prevalent as Euro supporters in Germany. In Ireland, those mistrusting the ECB due to their dislike for the Euro are less numerous than those who support ECB because of the Euro.
Overall, 60% Europeans (EU27), 69% of Germans, and 87% of Irish approved of the Euro in Spring 2008. Going further back in time, Eurobarometer 68 (Autumn 2007) shows 68% of Germans supporting the Euro, 87% of the Irish doing the same. EU27 average was 61%. Eurobarometer 67 (Spring 2007) showed 71% of Germans supporting the Euro, as opposed to the EU27 average of 63% (Ireland – 88%).
So on the net, the trend in the EU27 is for a very slight decline in support for Euro from 63% in the Spring 2007 to 60% in Spring 2008. For Germans these figures were 71% to 69% and for Irish – 88% to 87%. This is hardly a sign of a decisive shift in opinion against the Euro.
It will be interesting to see, once full Eurobarometer 70 results are in, if there has been further erosion in support for the Euro. Most likely, given the current economic conditions, there would be a rising sense of pessimism. But I still doubt Germany will reach a swing point.
Needless to say, the implications of a German exit from the Euro would be disastrous for the global financial system and for Ireland in particular.
First there will be an effect of unwinding the Euro positions worldwide and a monumental mess of absorbing ex-Euro positions (assets and liabilities) into national currencies.
Second, there will be a logistical nightmare of reintroducing new exchange rates, as the original (EMU-entry point) exchange rates are no longer reflective of the actual economic conditions.
Third, there is a problem of divesting the ECB roles back to the national Central Banks and re-establishing these Central Banks' reputational capital.
Fourth, for countries like Ireland, indeed for the APIIGS, the end of the Euro would spell a massive and instantaneous devaluation. Imagine the trade flows and investment positions disruptions that would arise if the reintroduced 'punt' were to be devalued by ca 50% instantaneously.
Fifth, the Euro has become a part of the reserve currencies basket around the world. It is hard to see how the central monetary authorities around the world can unwind their Euro holdings in an orderly fashion in the current environment.
Sixth, the resulting crisis at the EU level - triggered by a removal of the fundamental pillar of EU expansionism and internal markets supports - will be of a magnitude equivalent to the current economic and financial crises combined. Amongst obvious economic implications, there will be a significant political cost of the tearing up of the entire fabric of the EU elite built on the singularly integrationsit agenda.
Fortunately, once again, I am not seeing any significant signs of the public opinion in Germany shifting decisively against the country membership in the Euro.
"I just heard that Germany is considering leaving the euro. ...What do you think?"
I have not heard such a rumor - at least not at any credible level. I would be surprised if such sentiment was gaining significant strength in Germany. Here is the latest data I could find and my understanding of what is happening.
Per Eurobarometer 70, December 2008, 56% of German population tend to trust in the ECB - a fall of 4 percentage points on Spring 2008. EU27 average was significantly lower at 48% (a fall of 2 percentage points on Spring 2008). This still places Germany as 13th ranked country in the EU27 in terms of overall trust in the ECB. Ireland is 14th with 52% (down 6 percentage points on Spring 2008). In general, decline in trust for ECB tends to be rising with the worsening in economic conditions: Portugal leads the fall with -10%, Spain follows with -8%, Ireland comes next.
Also significantly, the decline in those trusting ECB has translated into an even higher rise in those who tend not to trust the ECB (as opposed to those who declined to answer): in Germany, 8 percentage increase in those who do not trust the ECB, in Spain +13%, in Ireland +10%, and so on. This shows that people are actually becoming more decisive in their negative position vis-a-vis ECB policies. But, again, it does not show Germans swinging decisively against the Euro membership. In my view, the rising negative perception of the ECB is driven by the policy lags with which the ECB greeted the economic crisis between July 2007 and July 2008.
As far as I understand, there was no direct question on the Euro in the preliminary EB70 results available at this time.
Eurobarometer 69, Spring 2008, does show results for trust in Euro itself. Even before the crisis pushed Germany into a recession, only 17% of Germans tended to claim that their approval of the Euro is one of the top two reasons for supporting the ECB. Same as in Ireland, but below the EU27 average of 19%. Table below gives results for "QA25a Which of the following are the main reasons for trusting the European Central Bank?":
"QA26a Which of the following are the main reasons for not trusting the European Central Bank?" Table below shows response to the above question:
When it came to mistrusting the ECB, 18% of Germans named being against the Euro as one of the top two reasons for their position vis-à-vis the ECB.These numbers do not show a significant doze of skepticism about the Euro amongst the Germans, but they do show that the two tails of the attitudes to Euro distribution are both ‘fat’ and virtually identical in size. In other words, anti-Euro enthusiasts are roughly as prevalent as Euro supporters in Germany. In Ireland, those mistrusting the ECB due to their dislike for the Euro are less numerous than those who support ECB because of the Euro.
Overall, 60% Europeans (EU27), 69% of Germans, and 87% of Irish approved of the Euro in Spring 2008. Going further back in time, Eurobarometer 68 (Autumn 2007) shows 68% of Germans supporting the Euro, 87% of the Irish doing the same. EU27 average was 61%. Eurobarometer 67 (Spring 2007) showed 71% of Germans supporting the Euro, as opposed to the EU27 average of 63% (Ireland – 88%).
So on the net, the trend in the EU27 is for a very slight decline in support for Euro from 63% in the Spring 2007 to 60% in Spring 2008. For Germans these figures were 71% to 69% and for Irish – 88% to 87%. This is hardly a sign of a decisive shift in opinion against the Euro.
It will be interesting to see, once full Eurobarometer 70 results are in, if there has been further erosion in support for the Euro. Most likely, given the current economic conditions, there would be a rising sense of pessimism. But I still doubt Germany will reach a swing point.
Needless to say, the implications of a German exit from the Euro would be disastrous for the global financial system and for Ireland in particular.
First there will be an effect of unwinding the Euro positions worldwide and a monumental mess of absorbing ex-Euro positions (assets and liabilities) into national currencies.
Second, there will be a logistical nightmare of reintroducing new exchange rates, as the original (EMU-entry point) exchange rates are no longer reflective of the actual economic conditions.
Third, there is a problem of divesting the ECB roles back to the national Central Banks and re-establishing these Central Banks' reputational capital.
Fourth, for countries like Ireland, indeed for the APIIGS, the end of the Euro would spell a massive and instantaneous devaluation. Imagine the trade flows and investment positions disruptions that would arise if the reintroduced 'punt' were to be devalued by ca 50% instantaneously.
Fifth, the Euro has become a part of the reserve currencies basket around the world. It is hard to see how the central monetary authorities around the world can unwind their Euro holdings in an orderly fashion in the current environment.
Sixth, the resulting crisis at the EU level - triggered by a removal of the fundamental pillar of EU expansionism and internal markets supports - will be of a magnitude equivalent to the current economic and financial crises combined. Amongst obvious economic implications, there will be a significant political cost of the tearing up of the entire fabric of the EU elite built on the singularly integrationsit agenda.
Fortunately, once again, I am not seeing any significant signs of the public opinion in Germany shifting decisively against the country membership in the Euro.
Tuesday, January 27, 2009
Euro Area GDP forecast - Update I
Last month I predicted that the forward looking barometer of economic activity in the Euro-area, the €-coin indicator published by CEPR and Banca d’Italia will register a small temporary correction from its historically low level of -0.15% (growth of Euro-area GDP forecast) in December 2008. I also forecast that the Euro-coin indicator will follow the downward path in February back to -0.15% reading.
Alas, I was too optimistic. Today’s Euro-coin data shows that the measure of economic activity in the Euro-area has fallen once again, this time to -0.21% in January 2009. This changes both my original forecast for February 2009 Euro-coin indicator and for Q1 2009 GDP growth rate in the Eurozone.
My new forecasts are:
Alas, I was too optimistic. Today’s Euro-coin data shows that the measure of economic activity in the Euro-area has fallen once again, this time to -0.21% in January 2009. This changes both my original forecast for February 2009 Euro-coin indicator and for Q1 2009 GDP growth rate in the Eurozone.My new forecasts are:
- Eurozone GDP Growth rate: -0.8% in Q1 2009
- Euro-coin: -0.17-0.25 February-March 2009, with expected value of -0.22.
Monday, January 26, 2009
Eurzone's growing pain
Willem Buiter's post makes a timely and an obvious point that the new stage of the global financial crisis is beginning to pull Eurozone monetary structures apart. Buiter starts the argument by describing a rising tide of financial protectionism:
“Consequently, we have seen two forms of re-nationalisation of banking and finance. The first form of nationalisation has been the taking into partial or complete public ownership of banks and other financial institutions deemed too systemically important (too big, to interconnected or too politically connected) to fail. This has happened virtually everywhere... More examples will follow. The second form of re-nationalisation of banking and finance is the restriction of access to the fiscal and financial resources of the nation state just to those banks and other financial entities that have a significant presence in that nation state.”
Buiter points to the lack of coherent single fiscal policy platform for the EU as the underlying cause for these developments. In particular, he stresses that the Eurozone has common monetary policy, but national regulatory environments and fiscal polices, all pulling in different directions at the time of the crisis.
“The Eurozone is in a bit of a pickle here, because although it has a central bank with supposed uniform access to its resources for all Eurozone banks, regulation and supervision remain national and fiscal bail-outs (recapitalisation by the state, guarantees, insurance, loans or whatever provided by the sovereign) definitely remain national. When the central bank acts as market maker of last resort, as the Banca d’Italia is now doing in the Italian interbank market, it takes on significant credit risk which requires a fiscal back-up - the Italian Treasury. But that undermines the principle of equal treatment of banking institutions across the Eurozone...”
Solutions:
• either a “supranational fiscal authority with its own tax and borrowing powers, accountable to the European Parliament …and the Council...” or
• “…a pan-Eurozone fund, fully pre-funded and containing, say, 2 or 3 trillion euro to begin with. This Eurofund could be managed by the European Commission, subject to parliamentary oversight and control by the European Parliament and the Council. The fund could be drawn upon to provide financial assistance to systemically important troubled banks in the Eurozone, according to guidelines agreed by the EC, the EP, the Council and the ECB. …the fund [is] to raise its resources through the issuance of bonds that would be guaranteed jointly and severally by all Eurozone member states.”
Of course, there are other solutions, which Buiter omits for obvious political reasons. These include:
1. Doing nothing, threatening a disorderly collapse of the Euro, should the current crisis continue to deepen; or
2. Partially re-introducing parallel national currencies to run alongside the Euro.
The last option is a milder version of a ‘nuclear’ first option, but desperate times do call for desperate measures.
The two solutions Buiter proposes are about as realistic as Salvador Dali’s landscapes:
• A common fiscal policy is a complete non-starter at this time.
• While a joint EU15-wide fund would be welcomed by the EU officials – ever hungry to get more power – underwriting such a fund (in excess of 32% of the Eurozone 2008 GDP) will be crippling for national governments, especially at the time when their own finances are under immense pressure from banks bailouts and fiscal stimuli.
In addition, the ages old concern of Germany and other states that the fund will be abused by the less fiscally prudent states, e.g Italy, Spain and France, constrains its feasibility, while strained sovereign debt markets are constraining the feasibility of raising such amount of money to capitalize the fund.
In this framework, unless the current downturn is reversed in the next 3-6 months, it is clear that an evolutionary process of fiscal policy responses and monetary policy constraints across the Eurozone will be creating more incentives for Balkanization of the Euro. Short of lapsing into oblivious denial of the reality, it is only a matter of managing this process that the ECB can be concerned with at this moment in time.
“Consequently, we have seen two forms of re-nationalisation of banking and finance. The first form of nationalisation has been the taking into partial or complete public ownership of banks and other financial institutions deemed too systemically important (too big, to interconnected or too politically connected) to fail. This has happened virtually everywhere... More examples will follow. The second form of re-nationalisation of banking and finance is the restriction of access to the fiscal and financial resources of the nation state just to those banks and other financial entities that have a significant presence in that nation state.”
Buiter points to the lack of coherent single fiscal policy platform for the EU as the underlying cause for these developments. In particular, he stresses that the Eurozone has common monetary policy, but national regulatory environments and fiscal polices, all pulling in different directions at the time of the crisis.
“The Eurozone is in a bit of a pickle here, because although it has a central bank with supposed uniform access to its resources for all Eurozone banks, regulation and supervision remain national and fiscal bail-outs (recapitalisation by the state, guarantees, insurance, loans or whatever provided by the sovereign) definitely remain national. When the central bank acts as market maker of last resort, as the Banca d’Italia is now doing in the Italian interbank market, it takes on significant credit risk which requires a fiscal back-up - the Italian Treasury. But that undermines the principle of equal treatment of banking institutions across the Eurozone...”
Solutions:
• either a “supranational fiscal authority with its own tax and borrowing powers, accountable to the European Parliament …and the Council...” or
• “…a pan-Eurozone fund, fully pre-funded and containing, say, 2 or 3 trillion euro to begin with. This Eurofund could be managed by the European Commission, subject to parliamentary oversight and control by the European Parliament and the Council. The fund could be drawn upon to provide financial assistance to systemically important troubled banks in the Eurozone, according to guidelines agreed by the EC, the EP, the Council and the ECB. …the fund [is] to raise its resources through the issuance of bonds that would be guaranteed jointly and severally by all Eurozone member states.”
Of course, there are other solutions, which Buiter omits for obvious political reasons. These include:
1. Doing nothing, threatening a disorderly collapse of the Euro, should the current crisis continue to deepen; or
2. Partially re-introducing parallel national currencies to run alongside the Euro.
The last option is a milder version of a ‘nuclear’ first option, but desperate times do call for desperate measures.
The two solutions Buiter proposes are about as realistic as Salvador Dali’s landscapes:
• A common fiscal policy is a complete non-starter at this time.
• While a joint EU15-wide fund would be welcomed by the EU officials – ever hungry to get more power – underwriting such a fund (in excess of 32% of the Eurozone 2008 GDP) will be crippling for national governments, especially at the time when their own finances are under immense pressure from banks bailouts and fiscal stimuli.
In addition, the ages old concern of Germany and other states that the fund will be abused by the less fiscally prudent states, e.g Italy, Spain and France, constrains its feasibility, while strained sovereign debt markets are constraining the feasibility of raising such amount of money to capitalize the fund.
In this framework, unless the current downturn is reversed in the next 3-6 months, it is clear that an evolutionary process of fiscal policy responses and monetary policy constraints across the Eurozone will be creating more incentives for Balkanization of the Euro. Short of lapsing into oblivious denial of the reality, it is only a matter of managing this process that the ECB can be concerned with at this moment in time.
Monday, January 5, 2009
10 years of the Euro: Part III. Two notes
In two footnotes to these two posts on the Euro (Post I and Post II),
(1) A recent article by Maurice J.G. Bun and Franc J.G.M. Klaassen, titled "The Euro Effect on Trade is not as Large as Commonly Thought", published in the Oxford Bulletin of Economics and Statistics, Vol. 69, Issue 4, pp. 473-496, August 2007 provides an even more damming estimate of the poor Euro performance as trade-facilitation currency union:
"Existing studies on the impact of the euro on goods trade report increments between 5% and 40%. These estimates are based on standard panel gravity models for the level of trade. We show that the residuals from these models exhibit upwards trends over time for the euro countries, and that this leads to an upward bias in the estimated euro effect. To correct for that, we extend the standard model by including a time trend that may have different effects across country-pairs. This shrinks the estimated euro impact to 3%."
... and this is from two Dutch academics, not some 'Euro-skeptic' Americans or Brits... Ouch...
(2) The same issue of the Oxford Bulletin of Economics contained another article - previously published by the Austrian Central Bank - by Harald Badinger from the Europainstitut/ Department of Economics of Wirtschaftsuniversität Wien, titled "Has the EU’s Single Market Programme fostered competition? Testing for a decrease in markup ratios in EU industries". This research showed that using panel data covering 10 EU Member States over the period 1981 to 1999, for manufacturing, construction, and services, as well as for 18 detailed industries, the EU’s Single Market Programme has led to:
Once again, Ouch!..
(1) A recent article by Maurice J.G. Bun and Franc J.G.M. Klaassen, titled "The Euro Effect on Trade is not as Large as Commonly Thought", published in the Oxford Bulletin of Economics and Statistics, Vol. 69, Issue 4, pp. 473-496, August 2007 provides an even more damming estimate of the poor Euro performance as trade-facilitation currency union:
"Existing studies on the impact of the euro on goods trade report increments between 5% and 40%. These estimates are based on standard panel gravity models for the level of trade. We show that the residuals from these models exhibit upwards trends over time for the euro countries, and that this leads to an upward bias in the estimated euro effect. To correct for that, we extend the standard model by including a time trend that may have different effects across country-pairs. This shrinks the estimated euro impact to 3%."
... and this is from two Dutch academics, not some 'Euro-skeptic' Americans or Brits... Ouch...
(2) The same issue of the Oxford Bulletin of Economics contained another article - previously published by the Austrian Central Bank - by Harald Badinger from the Europainstitut/ Department of Economics of Wirtschaftsuniversität Wien, titled "Has the EU’s Single Market Programme fostered competition? Testing for a decrease in markup ratios in EU industries". This research showed that using panel data covering 10 EU Member States over the period 1981 to 1999, for manufacturing, construction, and services, as well as for 18 detailed industries, the EU’s Single Market Programme has led to:
- an increase in competition in the aggregate manufacturing, and – less robustly – for construction;
- a decrease in competition in most service industries since the early 1990s.
Once again, Ouch!..
Sunday, January 4, 2009
10 years of the Euro: Part II. Mid-term Euro trend
See a disclosure here
It is this (see Part I) political motivation for the Euro that now threatens to undermine the main reasons for arguing that the Euro is a success story. European elites see the strengthening of the Euro against the US dollar as a sign that the new currency is gaining the market share as a global reserve currency.
But the problem for the Euro is that gaining a market share in a largely symbolic market for reserve currency at the expense of losing a market share in the real trade markets is a Phyrric victory.
NBER paper by Michael Bordo and Harold James (NBER Working Paper 13815, February 2008) makes similar point in devoting quite a bit of space to the discussion of the Euro as an international currency. They identify the precise mechanics for politically motivated international demand for the Euro as an alternative to the US dollar.
Because of the demand for Euro as an international reserve vehicle is politically motivated, argue Bordo and James,
“It is – projecting into the future – quite conceivable that there will be moments at which massive political pressure, built up by underlying anti-globalization concerns and focused on the technical necessities of dealing with major international crises, leads to a serious onslaught against the ECB and against the euro.”
From politics to economic fundamentals
Furthermore, the strengthening of the Euro throughout 2008 has been largely driven not by the underlying strengths of the Eurozone economies, but by the interest rates differentials between the ECB, BofE and the US Fed.
Chart 1 shows the link between the FX market and the policy gap – the gap between the cost of central banks funding as determined by the difference between the actual (realised) monthly Federal Funds Rates and the minimum benchmark ECB Deposit Facility rate from August 2000 through December 2008 (the entire historical data available to us).
As this figure highlights, the current Euro crisis is a lagged aftermath of the policy crisis that saw the medium-run directionality of the Federal Reserve policy becoming the exact opposite of the ECB’s policy stance around November 2005. By July 2007, as the credit crisis first manifested itself, the ECB’s suicidal denial of the problem became even more clear as the Eurozone rates have actually risen in the face of collapsing credit markets, just as the Fed aggressively pursued rates cuts.
Of course, many other variables help driving the exchange rates especially in the long run (more on this in the next post). However, the link between the Euro value and the interest rates mismatch between the ECB and the Fed is a historical regularity, as shown in Figures 2 and 3 below.
Figure 2 above plots the relationship between the monetary policy gap and the Euro/USD exchange rate. This relationship is causal, strong (with 63% of variation in the FX exchange rate captured by variation in the policy gap) and robust over time. It is also economically significant, with every +25bps change in the gap between the US Fed rates and the ECB rates inducing a ca Euro 0.021 strengthening in the dollar. This assumes parity at USD1.43 per 1 Euro for the period selected.
Figure 3 shows a similar relationship between the synthetic Euro/Dollar rate (linked to the traded index designed to replicate the returns on holding Euro). In fact, both the synthetic index and the actual exchange rates reaction to the monetary policy gap are virtually identical at -8.2 points for the former and -8.5 for the latter.
So where do we go next?
Figure 4 shows the actual movements in the monthly EUR/USD exchange rate and its 6-months and 12-months moving averages.
The relationship between the three lines indicates that in Q3 2008 we have entered a new trend of strengthening dollar that, so far, has taken us back to the levels closer to the resistance levels of the early 2007. The fact that we have, since, returned back to the levels consistent with Q3 2007 is a worrying point, as it suggests that November-December correction in the extremely high valuations of the Euro is not likely to persist in time.
However, there is little certainty as to the near-term direction in the EUR/USD rate. Several forces are currently pulling the FX markets demand for both currencies in different directions:
(1) The monetary policy gap is set to close in the next few months as the ECB loosens the key rates more dramatically than the already bootstrapped Fed;
(2) The liquidity policy gap (not plotted in this post) is also set to narrow as the ECB will be playing catch up with the Fed on injecting liquidity into the markets. Note: ECB’s liquidity creation is likely to support sovereign bond markets across Europe’s weaker economies (Ireland, Greece, Italy, Spain, etc), while the US liquidity creation is going primarily into banking and financial sectors;
(3) Financial markets demand for Euro is likely to weaken relative to the US dollar around Q2 2009 as US stock markets and bond markets will strengthen relative to the Eurozone;
(4) Both the US and the Eurozone’s imports will stagnate as the US consumers continue to de-leverage and the Eurozone consumers suffer significant personal disposable income shocks. However, while the US consumers de-leveraging has been pretty much fully priced in the current valuations, the slowdown in the Eurozone’s consumer demand is yet to be reflected in the FX valuations;
(5) US exports will remain relatively more robust than those in the Eurozone;
(6) A relative strengthening of the US economy vis-à-vis that of the Eurozone countries starting with Q2 2009 is likely to further improve demand for dollars;
(7) Relatively more dynamic prices contraction in the real estate coupled with the falling cost of mortgages financing in the US as compared to the Eurozone will continue to push the dollar down against the Euro;
(8) Stronger fiscal stimuli in the US than in the Eurozone will tend to favour relative increases in demand for dollar.
(1)-(3), (5)-(6) and (8) will all tend to support relative devaluation of the Euro. (4) and (7) will imply stronger decline in foreign exchange demand in the Eurozone than in the US – a force that will tend to support further devaluation of the dollar.
On the net, the preponderance of fundamentals suggests strengthening of the dollar relative to Euro in the next 3-6 months into $1.30/€1-$1.35/€1 range, but the key to this process will be increased volatility of the 3-months and 6-month MA trends (as opposed to the volatility in the daily series). The signs of this process taking hold should be traceable by the 3-way crossovers in the actual monthly series (led by weekly series) and the 6- and 12-months MA lines, as shown in the historical plot in Figure 4 above.
It is this (see Part I) political motivation for the Euro that now threatens to undermine the main reasons for arguing that the Euro is a success story. European elites see the strengthening of the Euro against the US dollar as a sign that the new currency is gaining the market share as a global reserve currency.
But the problem for the Euro is that gaining a market share in a largely symbolic market for reserve currency at the expense of losing a market share in the real trade markets is a Phyrric victory.
NBER paper by Michael Bordo and Harold James (NBER Working Paper 13815, February 2008) makes similar point in devoting quite a bit of space to the discussion of the Euro as an international currency. They identify the precise mechanics for politically motivated international demand for the Euro as an alternative to the US dollar.
Because of the demand for Euro as an international reserve vehicle is politically motivated, argue Bordo and James,
“It is – projecting into the future – quite conceivable that there will be moments at which massive political pressure, built up by underlying anti-globalization concerns and focused on the technical necessities of dealing with major international crises, leads to a serious onslaught against the ECB and against the euro.”
From politics to economic fundamentals
Furthermore, the strengthening of the Euro throughout 2008 has been largely driven not by the underlying strengths of the Eurozone economies, but by the interest rates differentials between the ECB, BofE and the US Fed.
Chart 1 shows the link between the FX market and the policy gap – the gap between the cost of central banks funding as determined by the difference between the actual (realised) monthly Federal Funds Rates and the minimum benchmark ECB Deposit Facility rate from August 2000 through December 2008 (the entire historical data available to us).
As this figure highlights, the current Euro crisis is a lagged aftermath of the policy crisis that saw the medium-run directionality of the Federal Reserve policy becoming the exact opposite of the ECB’s policy stance around November 2005. By July 2007, as the credit crisis first manifested itself, the ECB’s suicidal denial of the problem became even more clear as the Eurozone rates have actually risen in the face of collapsing credit markets, just as the Fed aggressively pursued rates cuts.Of course, many other variables help driving the exchange rates especially in the long run (more on this in the next post). However, the link between the Euro value and the interest rates mismatch between the ECB and the Fed is a historical regularity, as shown in Figures 2 and 3 below.
Figure 2 above plots the relationship between the monetary policy gap and the Euro/USD exchange rate. This relationship is causal, strong (with 63% of variation in the FX exchange rate captured by variation in the policy gap) and robust over time. It is also economically significant, with every +25bps change in the gap between the US Fed rates and the ECB rates inducing a ca Euro 0.021 strengthening in the dollar. This assumes parity at USD1.43 per 1 Euro for the period selected.Figure 3 shows a similar relationship between the synthetic Euro/Dollar rate (linked to the traded index designed to replicate the returns on holding Euro). In fact, both the synthetic index and the actual exchange rates reaction to the monetary policy gap are virtually identical at -8.2 points for the former and -8.5 for the latter.
So where do we go next?Figure 4 shows the actual movements in the monthly EUR/USD exchange rate and its 6-months and 12-months moving averages.
The relationship between the three lines indicates that in Q3 2008 we have entered a new trend of strengthening dollar that, so far, has taken us back to the levels closer to the resistance levels of the early 2007. The fact that we have, since, returned back to the levels consistent with Q3 2007 is a worrying point, as it suggests that November-December correction in the extremely high valuations of the Euro is not likely to persist in time.However, there is little certainty as to the near-term direction in the EUR/USD rate. Several forces are currently pulling the FX markets demand for both currencies in different directions:
(1) The monetary policy gap is set to close in the next few months as the ECB loosens the key rates more dramatically than the already bootstrapped Fed;
(2) The liquidity policy gap (not plotted in this post) is also set to narrow as the ECB will be playing catch up with the Fed on injecting liquidity into the markets. Note: ECB’s liquidity creation is likely to support sovereign bond markets across Europe’s weaker economies (Ireland, Greece, Italy, Spain, etc), while the US liquidity creation is going primarily into banking and financial sectors;
(3) Financial markets demand for Euro is likely to weaken relative to the US dollar around Q2 2009 as US stock markets and bond markets will strengthen relative to the Eurozone;
(4) Both the US and the Eurozone’s imports will stagnate as the US consumers continue to de-leverage and the Eurozone consumers suffer significant personal disposable income shocks. However, while the US consumers de-leveraging has been pretty much fully priced in the current valuations, the slowdown in the Eurozone’s consumer demand is yet to be reflected in the FX valuations;
(5) US exports will remain relatively more robust than those in the Eurozone;
(6) A relative strengthening of the US economy vis-à-vis that of the Eurozone countries starting with Q2 2009 is likely to further improve demand for dollars;
(7) Relatively more dynamic prices contraction in the real estate coupled with the falling cost of mortgages financing in the US as compared to the Eurozone will continue to push the dollar down against the Euro;
(8) Stronger fiscal stimuli in the US than in the Eurozone will tend to favour relative increases in demand for dollar.
(1)-(3), (5)-(6) and (8) will all tend to support relative devaluation of the Euro. (4) and (7) will imply stronger decline in foreign exchange demand in the Eurozone than in the US – a force that will tend to support further devaluation of the dollar.
On the net, the preponderance of fundamentals suggests strengthening of the dollar relative to Euro in the next 3-6 months into $1.30/€1-$1.35/€1 range, but the key to this process will be increased volatility of the 3-months and 6-month MA trends (as opposed to the volatility in the daily series). The signs of this process taking hold should be traceable by the 3-way crossovers in the actual monthly series (led by weekly series) and the 6- and 12-months MA lines, as shown in the historical plot in Figure 4 above.
10 years of the Euro: Part I. Economic Dividend
Following one of the reader's suggestions, I decided to post some of my thoughts on the Euro and the direction of the EUR/USD and EUR/BPS exchange rates. This is the first blog post dealing with these issues.
A prior disclosure (see below)...
On December 29, 2008 Harvard’s Jeffrey Frankel – one of the world’s leading international macroeconomics experts wrote:
“By roughly the five-year mark after the launch of the euro in 1999, enough data had accumulated to allow an analysis of the early effects of the euro on European trade patterns. Studies include Micco, Ordoñez and Stein (2003), Bun and Klaassen (2002), Flam and Nordström (2006), Berger and Nitsch (2005), De Nardis and Vicarelli (2003, 2008), and Chintrakarn (2008)… Overall, the central tendency of these estimates seems to be a trade effect in the first few years on the order of 10-15%. None came anywhere near the tripling estimates of Rose (2000), or the doubling estimates (in a time series context) of Glick and Rose (2002).”
Reasons for relatively poor performance
In his 2008 paper, Frankel looks at the possible reasons for this poor (relative to the original expectations) performance of the common currency:
(1): It takes time for the effects on trade to reach full potential;
(2): Monetary unions have smaller effects on large countries than small countries, and
(3): The original estimates were spuriously high because bilateral currency links have historically been the result of bilateral trade links rather than the cause (the so-called endogeneity problem).
What Frankel found was that correcting for the first argument does not change the rate of underperformance of the Euro relative to the original expectations. In other words, “at the moment there is little evidence to support the lags explanation”. With respect to the second argument, Frankel established that “There is no tendency, overall, for currency unions to have larger effects on the trade of small countries than large.” Finally, testing the third explanation also shows that it fails “to explain the gap between the recent euro estimates and the historical estimates”.
What all of this suggests is that the original justification for the existence of the Euro – the idea that it will boos significantly economic competitiveness of the exports-driven Euro block of countries – is yet to be confirmed. Neither on its 5th birthday, nor on its 10th anniversary did the Euro show a significant (economically) prowess to drive economic development of the Eurozone.
Even more egregious is the fact that the estimated effectiveness of the Euro to generate exports growth did not appear to move up between January 1, 2004 and the end of 2008.
A handful of strengths
This is not to say that the Euro has been a failure. Frankel – long-time champion of the common currency – states in another article that: “Looking back, the euro has in many ways been more successful than predicted by the sceptics — many of them American economists.” The list of such successes that he provides relates only to the metrics which reflect the positive reception of the Euro and the ECB amongst the world economies.
More trouble ahead
However, as Frankel puts it:
“…some of the sceptics' warnings have come to pass: shocks have hit members asymmetrically; cushions such as US-type labour mobility have remained thin; and the Stability and Growth Pact has proven unenforceable. Furthermore, the popularity of the project with the elites does not extend to the public, many of whom are convinced that when the euro came to their country, higher prices came with it.”
The latter point is now being reinforced by the former across all European economies. In fact, popular decline of the Euro has been so steep in 2007-2008 that the Eurobarometer gauge of public opinion has shown declining willingness of the electorates in Germany, France, Italy and pretty much the rest of the Eurozone, to remain a part of the ECB-run common currency area in contrast to the upward support trend recorded in 2002-2006.
What is more problematic for the, still, relatively young currency is that the cost of the ‘one monetary policy – different economies’ strategy for the Euro might be a long-term suppression of growth across the entire Eurozone. If monetary policy were to become a tool for delivering European convergence, it might lead to the convergence benchmark being set at an anaemic growth trend of Germany, France and Italy. In other words, rather than pushing the slow growth larger Eurozone economies up, the Euro might be pushing faster growth ‘fringe’ economies (Ireland, Austria, Sweden and Finland, alongside the Accession 10 states that care to join common currency or peg to it) down.
Nobel Prize winning economist, Robert Fogel in a 2007 paper suggested that a rate of real GDP growth for the period 2000-2040 of 1.2 percent for the industrialized EU-15 will be only slightly higher than the 1.1 percent for Japan, but a “much lower than the 3.8 percent for the United states or 7.1 percent for India or 8.4 percent for China.”
A recent NBER paper by Michael Bordo and Harold James (NBER Working Paper 13815, February 2008) makes very similar point by stating that:
“In particular, there is the possibility for the EMU that low rates of growth will produce direct challenges to the management of the currency, and a demand for a more politically controlled and for a more expansive monetary policy. Such demands might arise in some parts or regions or countries of the euro area, but not in others and would lead to a politically highly difficult discussion of monetary governance.”
A litany of challenges
Bordo and James look into asymmetric regional shocks impact, labour mobility effects, wage and price flexibility conditions, and risk sharing mechanisms implicit under the Euro as discussed in the existent literature and find that in all of these issues, the Eurozone monetary policy institutions are inferior to the arrangements in the US.
“The most obvious threat to the single currency is usually held to arise out of the imperfect control and coordination of national fiscal policies,” say Bordo and James, going on to conclude, contrary to the pundits of greater federalism at the EU level that:
“A formalized system of fiscal federalism would however not necessarily deal with the problems of fiscal indiscipline on the part of member states. Indeed, the expectation of institutionalized transfers or bailouts following fiscal problems might well be expected to increase the incentives for bad behavior. Stricter observance of the existing system and its rules, on the other hand, might lead to pressure to reform. Fiscal reforms would in the longer run be expected to raise the rate of growth.”
Of course, to date, the EU has failed to enforce the code of fiscal discipline among its members. In fact, 2004-2005 saw a set of reforms aimed at diluting the Stability & Growth Pact criteria for fiscal performance.
Financial stability of the system is another area of challenge for the Euro, where the lack of coherent regulatory structure is the mirror image of the overly centralized monetary policy. Again, Bordo and Lames sum this up by saying that:
“The difficulty of an effective Europe-wide response to financial sector problems thus reflects a more general problem with respect to the making of monetary policy: there may be a different political economy of money in regions of the Euro-zone and EU member countries, leading to contradictory pressures on policy.”
All of this implies greater volatility around the trend for smaller and more open economies, so occasionally countries like Ireland will be going through more pronounced boom-and-bust cycles, but in the end, average (or potential) long-run growth will remain below that in the US, Canada, and the rest of the developed world.
Disclosure: I would like to explicitly state that I do not share in some analysts' view that Ireland would fare better outside the Eurozone, nor do I believe that the Euro has been a sort of a disaster. I see the Euro as a challenging and generally positive element of the European integration project. This view motivates my analysis of the weaknesses in the common monetary and currency policy to date. It is my desire to see a gradual strengthening of the European democracy and markets that inform my analysis. Sadly, I feel that this disclaimer is a necessity in the current climate of attacks on the freedom of thought and expression that characterise our (European) political and economic policy debates.
A prior disclosure (see below)...
On December 29, 2008 Harvard’s Jeffrey Frankel – one of the world’s leading international macroeconomics experts wrote:
“By roughly the five-year mark after the launch of the euro in 1999, enough data had accumulated to allow an analysis of the early effects of the euro on European trade patterns. Studies include Micco, Ordoñez and Stein (2003), Bun and Klaassen (2002), Flam and Nordström (2006), Berger and Nitsch (2005), De Nardis and Vicarelli (2003, 2008), and Chintrakarn (2008)… Overall, the central tendency of these estimates seems to be a trade effect in the first few years on the order of 10-15%. None came anywhere near the tripling estimates of Rose (2000), or the doubling estimates (in a time series context) of Glick and Rose (2002).”
Reasons for relatively poor performance
In his 2008 paper, Frankel looks at the possible reasons for this poor (relative to the original expectations) performance of the common currency:
(1): It takes time for the effects on trade to reach full potential;
(2): Monetary unions have smaller effects on large countries than small countries, and
(3): The original estimates were spuriously high because bilateral currency links have historically been the result of bilateral trade links rather than the cause (the so-called endogeneity problem).
What Frankel found was that correcting for the first argument does not change the rate of underperformance of the Euro relative to the original expectations. In other words, “at the moment there is little evidence to support the lags explanation”. With respect to the second argument, Frankel established that “There is no tendency, overall, for currency unions to have larger effects on the trade of small countries than large.” Finally, testing the third explanation also shows that it fails “to explain the gap between the recent euro estimates and the historical estimates”.
What all of this suggests is that the original justification for the existence of the Euro – the idea that it will boos significantly economic competitiveness of the exports-driven Euro block of countries – is yet to be confirmed. Neither on its 5th birthday, nor on its 10th anniversary did the Euro show a significant (economically) prowess to drive economic development of the Eurozone.
Even more egregious is the fact that the estimated effectiveness of the Euro to generate exports growth did not appear to move up between January 1, 2004 and the end of 2008.
A handful of strengths
This is not to say that the Euro has been a failure. Frankel – long-time champion of the common currency – states in another article that: “Looking back, the euro has in many ways been more successful than predicted by the sceptics — many of them American economists.” The list of such successes that he provides relates only to the metrics which reflect the positive reception of the Euro and the ECB amongst the world economies.
More trouble ahead
However, as Frankel puts it:
“…some of the sceptics' warnings have come to pass: shocks have hit members asymmetrically; cushions such as US-type labour mobility have remained thin; and the Stability and Growth Pact has proven unenforceable. Furthermore, the popularity of the project with the elites does not extend to the public, many of whom are convinced that when the euro came to their country, higher prices came with it.”
The latter point is now being reinforced by the former across all European economies. In fact, popular decline of the Euro has been so steep in 2007-2008 that the Eurobarometer gauge of public opinion has shown declining willingness of the electorates in Germany, France, Italy and pretty much the rest of the Eurozone, to remain a part of the ECB-run common currency area in contrast to the upward support trend recorded in 2002-2006.
What is more problematic for the, still, relatively young currency is that the cost of the ‘one monetary policy – different economies’ strategy for the Euro might be a long-term suppression of growth across the entire Eurozone. If monetary policy were to become a tool for delivering European convergence, it might lead to the convergence benchmark being set at an anaemic growth trend of Germany, France and Italy. In other words, rather than pushing the slow growth larger Eurozone economies up, the Euro might be pushing faster growth ‘fringe’ economies (Ireland, Austria, Sweden and Finland, alongside the Accession 10 states that care to join common currency or peg to it) down.
Nobel Prize winning economist, Robert Fogel in a 2007 paper suggested that a rate of real GDP growth for the period 2000-2040 of 1.2 percent for the industrialized EU-15 will be only slightly higher than the 1.1 percent for Japan, but a “much lower than the 3.8 percent for the United states or 7.1 percent for India or 8.4 percent for China.”
A recent NBER paper by Michael Bordo and Harold James (NBER Working Paper 13815, February 2008) makes very similar point by stating that:
“In particular, there is the possibility for the EMU that low rates of growth will produce direct challenges to the management of the currency, and a demand for a more politically controlled and for a more expansive monetary policy. Such demands might arise in some parts or regions or countries of the euro area, but not in others and would lead to a politically highly difficult discussion of monetary governance.”
A litany of challenges
Bordo and James look into asymmetric regional shocks impact, labour mobility effects, wage and price flexibility conditions, and risk sharing mechanisms implicit under the Euro as discussed in the existent literature and find that in all of these issues, the Eurozone monetary policy institutions are inferior to the arrangements in the US.
“The most obvious threat to the single currency is usually held to arise out of the imperfect control and coordination of national fiscal policies,” say Bordo and James, going on to conclude, contrary to the pundits of greater federalism at the EU level that:
“A formalized system of fiscal federalism would however not necessarily deal with the problems of fiscal indiscipline on the part of member states. Indeed, the expectation of institutionalized transfers or bailouts following fiscal problems might well be expected to increase the incentives for bad behavior. Stricter observance of the existing system and its rules, on the other hand, might lead to pressure to reform. Fiscal reforms would in the longer run be expected to raise the rate of growth.”
Of course, to date, the EU has failed to enforce the code of fiscal discipline among its members. In fact, 2004-2005 saw a set of reforms aimed at diluting the Stability & Growth Pact criteria for fiscal performance.
Financial stability of the system is another area of challenge for the Euro, where the lack of coherent regulatory structure is the mirror image of the overly centralized monetary policy. Again, Bordo and Lames sum this up by saying that:
“The difficulty of an effective Europe-wide response to financial sector problems thus reflects a more general problem with respect to the making of monetary policy: there may be a different political economy of money in regions of the Euro-zone and EU member countries, leading to contradictory pressures on policy.”
All of this implies greater volatility around the trend for smaller and more open economies, so occasionally countries like Ireland will be going through more pronounced boom-and-bust cycles, but in the end, average (or potential) long-run growth will remain below that in the US, Canada, and the rest of the developed world.
Disclosure: I would like to explicitly state that I do not share in some analysts' view that Ireland would fare better outside the Eurozone, nor do I believe that the Euro has been a sort of a disaster. I see the Euro as a challenging and generally positive element of the European integration project. This view motivates my analysis of the weaknesses in the common monetary and currency policy to date. It is my desire to see a gradual strengthening of the European democracy and markets that inform my analysis. Sadly, I feel that this disclaimer is a necessity in the current climate of attacks on the freedom of thought and expression that characterise our (European) political and economic policy debates.
Friday, December 26, 2008
Euro Area GDP forecast
Using Euro COIN data released last week, I constructed two trend points (short-run trend consistent with contraction from Q3 2006, and long-term trend consistent with entire time series from January 1999). These provide forecast for January-February 2009 Euro area GDP growth based on the trends and predictive power of the Euro COIN model. The series, including forecasts, plotted in the graph below, point to a continued and deepening contraction in the Eurozone economy through February 2009.
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