29/7/2012: One ugly chart

One ugly euro chart:

Nothing new, of course, just an illustration.

21/05/2012: Sunday Times 20/5/2012: Euro area crisis - no growth in sight

Here's my Sunday Times article from May 20, 2012. Unedited version, as usual.

Welcome to the terminal stage of the Euro crisis. Only two years ago European press and politicians were consumed with the terrifying prospects of a two-speed Europe. This week, preliminary estimates of the Euro area GDP growth for the first quarter of 2012 have confirmed that the common currency area, instead of bifurcating, has trifurcated into three distinct zones.

In the red corner, we have the pack of the perennially struggling economies of Cyprus, Greece, Italy, Portugal and Spain. The Netherlands, with annual output contraction of -1.3% in Q1 2012, matching that of Italy, has quietly joined their ranks. These countries all have posted negative growth over the last six months if not longer. Cyprus, Italy, and Portugal, alongside the Netherlands, registering negative growth over the last three quarters. Ireland and Malta, two other candidates for this group are yet to report their Q1 2012 results, with the former now officially in a recession since the end of 2011, while the latter having posted its first quarter of negative growth in Q4 2011.

In the blue corner, Belgium, France, and Austria all have narrowly missed declaring a recession in the last quarter, while posting 0.5% annual growth or less.

Lastly, in the green corner, Estonia, Finland, Germany and Slovakia have served as the powerhouse of the common currency area, pushing the quarterly growth envelope by between 0.5% and 1.3%.

The red corner accounts for 40% of euro area entire GDP, the blue corner – for 29%. All in, less than one third of the euro area economy is currently managing to stay above the waterline.

Looking at the picture from a slightly different prospective, out of the Euro 4 largest economies, France has shown not a single quarter of growth in excess of 0.3% since January 2011. In the latest quarter it posted zero growth. Germany – the darling of Europe’s growth strategists – has managed to deliver 0.5% quarterly growth in Q1 2012 on foot of 0.2% contraction in Q4 2011. Annual growth rates came at an even more disappointing 1.2% in Q1 2012, down from 2.0% in Q4 2011. Italy decline accelerated from -0.7% in Q4 2011 to -0.8% in Q1 2012, while Spain has officially re-entered recession with 0.3% contraction in Q4 2011 and Q1 2012.

The Big 4 account for 77% of euro area total economic output. Not surprisingly, overall EA17 growth was zero in Q1 2012 both in quarterly terms and annual terms. The latest leading indicator for euro area growth, Eurocoin, reading for April 2012 shows slight amplification of the downward trend from March. In other words, things are not getting better.

The best countries in terms of overall hope of economic recoveries – net exports generators, such as Austria, Belgium, Ireland, and the Netherlands, are all stuck in either the twilight zone of zero growth or in a years-long recession hell.

Ireland’s exporting sectors have been booming, with total exports rising from the recession period trough of €145.9 billion in 2009 to €165.3 billion in 2011. However, the rate of growth in our exports has been slowing down much faster than projected for 2012. If in 2010 year on year total exports expanded 8.1% in current prices terms, in 2011 the rate of growth was 4.8%. Our overall trade surplus for both goods and services grew 12.8% in 2011 – impressive figure, but down on 19.7% in 2010.

So far this year, the slowdown continues.

The latest PMI data suggests that manufacturing activity is likely to have been flat in Q1 2012. Latest goods exports data, released this week, shows that the sector posted zero growth confirming overall readings from the PMI. The value of trade in goods surplus steadily declined since January 2012 peak of €3,813 million to €3,023 million in March 2012, and in annual terms, Q1 2012 surplus for merchandise trade is now down €99 million on 2011. Although the quarter-on-quarter reduction appears to be small due to relatively shallow trade surplus recorded in January 2011, March seasonally-adjusted trade surplus is down 22% or €850 million on March 2011. With patents expiring, the latest data shows that exports of Medical and pharmaceutical products fell €772 million in Q1 2012 compared to Q1 2011. Overall, comparing first quarter results, 2011 registered seasonally-adjusted annual growth of 7.9% in exports and 15.2% in trade surplus. 2012 Q1 results are virtually flat, with exports rising 0.03% and trade surplus rising 0.8%.

Looking at the geographical composition of our merchandise trade, until recently, our exports and trade surplus were strongly underwritten by re-exportation by the US multi-nationals into North America of goods produced here. This too has changed in Q1 2012, despite the fact that the US has managed to stay outside the economic mess sweeping across Europe. In three months through March 2012, Irish exports to the US have fallen 19.3% and our trade surplus with the US has shrunk 47.1% from €3.33 billion to €1.76 billion.

Services are more elusive and more volatile, with CSO reporting lagging the data releases for goods trade, but so far, indications are that services activity remained on a very shallow growth trend through Q1 2012. As in Manufacturing, Services demand has been driven once again by more robust exports, and as for Manufacturing, this fact exposes us to the potential downside risk both from the on-going euro area crisis and from the clear indication that our domestic economy continues to shrink even after an already massive four years-long depression.

No matter how we spin the data, the reality is that exports generation in Europe overall, and in Ireland in particular, is still largely a matter of trade flows between the slower growth North American and European regions.

In many ways than one, Ireland is a real canary in the mine, because of all Euro area economies excluding the Accession states, Ireland should be in the strongest position to recover and because our exporting sectors continue to perform much better than the European average. Yet the recovery is nowhere to be seen.

Instead, the growth risks manifested in significant slowdown in our external trade activity and in overall manufacturing and services sectors are now coinciding with the euro entering the terminal stage of the crisis.

Since the beginning of this week, Belgian and Cypriot, Austrian and Dutch, virtually all euro area bonds have been taking some beating. In the mean time, credit downgrades came down on Italy and Spain, and the Spanish banking system was exposed, at last, as the very anchor that is likely to drag Europe’s fifth largest economy into EFSF/ESM rescue mechanism. This week, in a regulatory filing, Spain’s second largest bank, BBVA stated that: “The connection between EU sovereign concerns and concerns for the health of the European financial system has intensified, and financial tensions in Europe have reached levels, in many respects, higher than those present after the collapse of Lehman Brothers in October 2008.” Meanwhile, Greek retail banks have lost some 17% of their customers’ deposits since mid-2011 and this week alone have seen the bank runs accelerating from €700 million per day on Monday-Tuesday, to over €1.2 billion on Wednesday.

This is not a new crisis, but the logical outcome of Europe’s proven track record of inability to deal with the smaller sub-component of the balance sheet recession – the Greek debt overhang. Three years into the crisis, European leadership has no meaningful roadmap for either federalization of the debts or for a full fiscal harmonization. There is no growth programme and the likelihood of a credible one emerging any time soon is extremely low. Structural reforms are nowhere to be seen and productivity growth as well as competitiveness gains remain very shallow, despite painful adjustments in private sector employment and wages. Inflation is running well above the targets. Austerity is nothing more than a series of pronouncements that European leaders have absolutely no determination to follow through. EU own budget is rising next year by seven percentage points, while Government expenditure across the EU states is set to increase, not decrease.

In short, three years of wasteful meetings, summits, and compacts have resulted in a rather predictable and extremely unpleasant outcome: aside from the ECB’s long term refinancing operations injecting €1 trillion of funds into the common currency’s failing banking system, Europe has failed to produce a single meaningful response to the crisis.

CHARTS:

Box-out:  Speaking at this week’s conference of the Irish economy organized by Bloomberg, Department of Finance Michael Torpey has made it clear that whilst one in ten mortgagees in the country are now failing to cover the full cost of their loans, strategic defaults amount to a negligible percentage of those who declare difficulty in repayments. This statement contradicts the Central Bank of Ireland and the Minister for Finance claims that the risk of strategic defaults is significant and warrants shallow, rather than deep, reforms of the personal bankruptcy code. Furthermore, the actual levels of mortgages that are currently under stress is not 10% as frequently claimed, but a much higher 14.1% - the proportion corresponding to 108,603 mortgages that have either been in arrears of 30 days and longer, or were restructured in recent years and are currently not in arrears due to a temporary reduction in overall burden of repayments, but are at significant risk of lapsing into arrears once again. The data, covering the period through December 2011 is likely to be revised upward once first quarter 2012 numbers are published in the next few weeks. In brief, both the mortgages arrears dynamics and the rise of the overall expected losses in the Irish banking system to exceed the base-line risk projections under the Government stress tests of 2011 suggest that the state must move aggressively to resolve mortgages crisis before it spins out of control.

15/12/2011: Euro zone and Euro Big 4 forecasts

Here's the latest summary of the Insee forecasts for Euro Big 4 and euro zone as a whole:

These are largely consistent with the Eurocoin forecasts to-date. Do note in the table above that unique Irish strength of 'exports-led recovery'. When it comes to 2010 exports growth - Ireland recorded growth of 8.07% (QNA data) in overall exports expansion, les than euro area's 10.9%, Italy's 8.9%, Spain's 13.5%, Germany's 13.4% and France's 9.3%... and these are all large economies (with less openness to trade than Ireland).

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.
  

Economics 21/08/2009: Economic Outlook - Things to Fear

Being in the Dolomites puts me into a long-term thinking mood. So here we are – a post on some of my long run thinking.

In a recent post I wrote about the probability of the L-shaped recovery now standing at and even 1/3 split with the probability of the recovery being V-shaped or W-shaped. I motivated this estimate by the references to some of the US economy fundamentals.

A different world beacons

Think growth dynamics in the long run. Usually, a recovery is led by a small fiscal stimulus and a moderate easing of the monetary conditions. These come after a number of quarters of tighter fiscal and monetary conditions pre-crisis. And both act to moderate fall-offs in household and business investment, plus arise in unemployment in the environments of relatively unchanged long-term savings/investment ratios and a temporary shock to transient consumption.

We are in a different world today from a ‘normal’ recessionary cycle, and this warrants my concern that the recovery dynamics are likely to be highly uncertain.

Fist, think the investment cycle. Investment – both household and corporate – is down and it is down structurally. The structural nature of this downturn is most likely due to the shifting pattern for investment financing into the years ahead. Gone is the leverage and originate model of lending. We are in the new brave world of deposit and originate model, where capital financing will be held back by the need to generate significant deposits.

Even an era of sustained precautionary savings by the households is not going to change this reality. Why? Because in years before the current crisis, leveraging model meant that a deposit of, say, $100 in a bank translated into the lending out of some $960 or more into the economy. With deposit and originate model, the same deposit is going to see first round lending of no more than $90 out into the economy. Once the hovering of excess liquidity into banks capital is done with, we might move to a lending of slightly above the deposit rate, say $100 plus a wedge between the borrowing rate and deposit rate. But this is hardly going to get us above $110 even in most pessimistic inflationary scenario. In the mean time, the banks are going to beef up their capital reserves by skimming retail clients – so returns to savings will quickly turn negative. Never mind the returns, households will still hoard cash as sticky unemployment will breath fear into their hearts – the new era of the hearts of darkness will set in ushered by the elevated risk aversion.

Second, think precautionary savings. If in traditional recession precautionary savings cycle exhausts itself within a span of 2-3 quarters post recession on-set, in the current one, the savings rates are still climbing up, corporates are still hoarding whatever cash they can generate and the late payments gap is widening, not shrinking. This suggests to me that we might see the US savings rate finally moving in the direction the majority of economists in the 1990s wished it would be heading – into possible high single digits or even double digits. The trade wars of the 1930s might be replaced by a slow decay in world trade due to shrinking US (and also European) consumption expenditure. Not as nasty of a proposition as the Depression era ‘beggar thy neighbour’ policies, but a much longer behavioural shift that is more benign in the short run, but is much more damaging in the long term.

Third, think of the place we came from when we entered this recession. That place was Alice in Wonderland mondo bizarro of excessive liquidity sloshing across global boundaries and asset classes and fiscal policies of prolificacy that made even the US Republicans (traditionally pro-balanced budget conservatives) into the spending-happy traditional Democrat-types. In this environment, lack of global inflation was only sustained through a combination of extreme asset bubbles formation (housing, equities, carry trade-financed speculative real estate allocations, excessively optimistic M&As and commodities bubble that rivalled anything we’ve seen since the Dutch Tulip craze. But looking forward, this environment was ‘corrected’ in the recession through another massive injection of liquidity and another substantial hike in public deficits worldwide. It might be a forced measure for Obama Administration to prop up the entire US economy by pumping more steroids of public spending and running printing presses at the Treasury 24:7, but this activism has to go somewhere real, and it will go into real long term inflation and a new asset bubble generation, along with higher taxation.

Ronald Regan inherited from the Democratic Party’s leading historical disaster (Jimmy ‘The Peanut’ Carter) presidency one of the sickest economies in the US history. But one thing he did not inherit was decades-long appreciation of the US deficits. Subsequently, Regan was able to cut taxes while re-channelling fiscal spending into new programmes. Obama’s successor (who is now increasingly looking set to come in 2013) won’t have this luxury. Neither will Angela Merkel’s successor, or Brian Cowen’s or Gordon Brown’s. High tax era is upon us in the developed world and this means we are going to lose in the economic game. This impending tax regime fiasco will be far more damaging to the West’s economic standing in the world than the oil price inflation can ever be.

Fourth, inflation is coming. I wrote about it before and I keep saying this over and over again: if you think double digit yields on US debt are the stuff of science fiction, think again. Someone will have to pay for the orgy of new fiscal debt creation and that someone will have to borrow hard. The new borrowing – the rollovers of the past, plus the interest rates of the future, compounded by the Obamanomics and the Democrats appeasing their traditional constituencies will be exacerbated by the need to rescue the next wave of ‘economic recession victims’ – the states and municipalities. That these are going to be predominantly amongst the Democratic party strongholds (e.g California) will only make matters worse. So what little liquidity will be added over time will be consumed in an orgy of new debt issuance by the Feds and the states and municipalities. The pyramid scheme whereby Feds-created cash will be rolled into Feds-backed Government borrowings will mean investment slowdown will be deeper and more permanent than the point one above suggests.
Inflating and devaluing out of this mess will set the stage for the graduate de-dollarization of the global economy, further undermining the US.

So high inflation, lower growth, lower real rates of return on deposits, lower lending origination and thus lower investment all form the prospects for L-shaped recovery. At the same time, sheer magnitude of liquidity pumping into the global economy via loose monetary policy on top of the previous decade-long monetary easing might, just might, usher a new age of asset bubbles. From oil and gold to banal fertilizers and regulatory-driven forestry – commodities will reign as perceived, if unreal, inflation hedges. Exotics of risk aversion assets might turn out to be even more exotic, more technical and thus less stable than the securitized and repackaged real estate loans of the Mid-Naughties. If they do, a V-shaped recovery is a possibility, as is a W-shaped one. Both will be short-lived, but at least we will get to enjoy one more run of the madness.

About the only silver lining to this long-term Western Winter will be the fact that Europe will be faring even worse than the US with Italian-style slog contaminating the entire EU, inclusive of the Accession states.

So where do we stand?

An L-shaped recovery offers a period of zero (or near zero) real growth post-recession. The V-shaped one represents a robust recovery post-recession. The W-shaped scenario is the one where recession will be followed by a significant bull run, followed by another collapse before the recover set in.

In my view, however, all those who paint the current economic environment in one of these historically known categories miss the majour point — because of the changed relationship between perceived and real risks and our systemic household, banking and corporate responses to these, we are entering a recovery that has elements of all three scenarios. This is risking to be a PQR recovery – a recovery based on Public and Quoted Risks. Now, it is a handy feature of the alphabet that letter PQR are smack in between letters pairs of K and L (denoting traditionally Capital and L-shaped recovery) and V and W shape of recovery descriptors.

PQR is not a simple average of L and V-shapes, some sort of a root sign-shaped recovery. It is a recovery that starts from the top of the previous cycle, heads for depths severe of a recession, rises in a volatile fashion above the floor and flattening out at an equally volatile new floor of suppressed long term growth. It is the stuff that makes superpowers lose their supremacy positions and that led to disintegration of mighty super states of the old.

Historically, recessions follow a V-shaped scenario. The dynamics are as follows:
First businesses cut production through the downturn: capital investment grounds to a halt, layoffs cut less productive workforce and maintenance and capital replacement drop to below amortization;
Second, businesses stop cutting at the point where their capacity still exceeds demand, and they go for correcting the supply overhang by reducing costs and inventories;
Once demand troughs, the depletion of inventory means that any new demand will translate into increased output, sapping the excess capacity;
Capital expenditure rises on the maintenance and amortization side, but no new capital is added, so profits improve and war chests are replenished by the healthier businesses to take on some of their competitors;
Increased corporate profits support strategic drive in increasing capacity to address future demand – employment and investment rise;
High rates of money creation and fiscal stimuli (with priorities going from tax cuts, to public investment in infrastructure upgrading, to Uncle Sam’s shopping for consumption spending, and not the other way around) help the process of orderly de-leveraging and maintenance of excess capacity by businesses.

We, thus, have Public Risk – the risk of permanent deficit financing and the under-saturation of public debt with liquidity (see below). We have Quoted Risk – the risk of higher equity and commodities volatilities as desperately shallow liquidity pools are chasing higher returns in the new era of diminished tolerance for risk amongst retail investors. We have a PQR recession – an alphabet soup of messy noise along a shallower than before and flat growth rate.

A PQR recession dynamics will be as follows:
First businesses cut production below the point where their capacity is less than the expected medium term demand;
The supply overhang will be short-term managed to a supply undercut by reducing costs and inventories much deeper than before;
Once demand troughs, the depletion of inventory means that any new demand will translate into increased inflation, triggering some monetary tightening that will trigger renewed push for precautionary savings and the W-shape will emerge;
Capital expenditure will have to increase on the maintenance and amortization side as even the minimal levels of capital will begin to fall apart at a rate not seen since the collapse of the USSR, but no new capital will be added, so profits will improve;
The improvement in the profits will drive us up the last leg of W, but there will be no build up in corporate war chests as liquidity will remain tight;
Instead, strategic drive in increasing capacity to address future expected demand will mean that employment and investment will rise faster in the BRICs and the rest of the world than in the OECD;
Fiscal stimuli with priorities of Obama administration implying more spending on immediate Uncle Sam consumption of stuff from the Democratic Party cronies, followed by lower public investment creation and not followed by tax cuts, but by tax increases will mean that no productive capacity will be underpinned in the productive US sectors, yielding their competitive positions globally to newcomers from Asia;
The US economy will settle into a permanently lower rate of growth characterized by relatively frenzied swings from Public Capital Formation schemes to Private Risk Premia increases and back to Public Capital.
A PQR paradigm. QED

How do we know this?

We now are wiser than in October-December 2008 and it is now more than apparent that the US fiscal stimulus misconceived (in a rushed atmosphere of a sever crisis) and misdirected (at the least productive sectors of the US economy where mis-aligned long term incentives will prevent any future productivity growth springing the green shoots). Fiscal stimulus in the US did not help significantly to deleverage households, so monetary easing did not restart demand for borrowing. Fiscal stimulus, in the Obama administration conception, did not prop up capacity preservation in productive sectors of the US economy and was wasted instead on the Big 3 Auto-monsters and the larger, less productive financial institutions. Fiscal stimulus did nothing to get the Americans out of negative equity and thus did absolutely nothing to reduce incentives for precautionary savings. This means that consumption growth is simply not going to happen, folks. Not at the rates pre-crisis and not even at the rates of post IT-bubble recession.

Monetary policy is also going to fail in everything but inflation generation. US private sector credit remains in the doldrums a year after the efforts to repair it began and the US wounded and undercapitalized financial system continues to struggle with the ghosts of looming future losses.
The longer-term theme in the US is the emergence of the two polar opposites as demographic drivers of the economy. On the one hand, ageing assets-holding population will have no access to liquidity as home sales will remain subdued by the massive overhang in unoccupied properties still crowding the market and by the banks unwillingness to lend on real estate assets. On the other hand, high savings –geared younger population will be consuming less and repatriating more. Think of the Latin Americanization of the US population with the resultant outflow of financing from the younger second generation US workers to their first generation American parents who will move back to Latin America to get better quality of life in return for their savings.

So future consumption will be depressed by financial system, demographic changes and the overall change in risk aversion across the US population. As an interesting side-bar, in the mid 2008 the number of Google search hits for ‘Paris Hilton’ – an imperfect signifier of the younger generations presence in the economy – has been overshadowed by the number of search hits for that key word of the Wal-Mart generation of greying retirees: ‘coupons’.

The downsizing of American consumption-driven economy has begun. And this is hardly an encouraging sign for the V-shape theorists.

Europe’s moment of sickness

This leaves us at the point for comparing the US with its today’s competitors. The sick state of the nation on the western shores of the Atlantic will be predictably mirrored with an even deeper decay on the eastern shore of the pond. As US continues to improve productivity – albeit at a much slower pace – European society, geriatrically-challenged, hamstrung by the trade unions, obsessed with preserving the status quo of wealth distribution and increasingly anti-immigrant and anti-innovation will suffer even more. Increased consumer demand from China and India, Brazil and possibly Russia will go some way to prop up German manufacturing, but more and more of those fine BMWs and Mercs will be stamped out in the US, assembled in Free-to-work states of the US South, designed in the Free-to-dream states of the US West and financed from the Free-to-invest states of the US Midwest and Northern Atlantic corridor. German manufacturing will sing the same blues as British manufacturing did before it. What will remain will be a museum trinket shop – a place where Ferraris and Bugattis will still be made backed by subsidies from the US- and elsewhere-based ‘German’ production of actually demanded goods.

Investment themes of a PQR recession

There will be new themes for the investment markets in years ahead. These themes will be about more active management of volatility and use of volatility spells to the same purpose as we used the international ‘growth’ stocks in the past – to get ahead of the benchmarks. Another theme will be maintaining sane returns once the risk of dollar devaluation is taken into account. Third theme will be the rise of global volatility. Displacement of the US and EU from the pedestal of global leaders in future growth (the first one still coming, the latter having already taken hold) is not going to take place because some other power will emerge as being better in absolute terms. Unlike almost all other deaths of the superpowers (with exception of the collapse of Rome), this one will not result in an immediate emergence of a heir apparent to the US dominance. China – the sickly giant that will be seen as having toppled the US – will not be able to bear torch for the rest of the world primarily because it has no model of its own, no engaging or charismatic ideology. And this will mean that the world of investment will be jittery, uncertain, fast changing worldwide.

Prepare for some serious volatility management, folks. PQ to QR to PQ across the horizontal axis, US to BRICs to Asia to US to Latina America to the BRICs across the vertical one, and across all asset classes on the Z-axis. Shall I remind you that complexity of PQR recession is by even alphabetic standards much more significant than that of L, V or W?

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?

Daily Economics 24/04/09: Euro area forecast and Irish Travel Data

Irish Travel Stats are now available on CSO website through Q4 2008. Charts below illustrate the main trends:

First, domestic travel trends. All categories of domestic travel are in expenditure intensity (Euro spent per night) except for the holidays trips. This represents a departure from the generally upward trend prior to 2008.
However, in line with a small increase in the numbers of trips taken domestically, the overall spending remains relatively well underpinned.
International travel by the residents of Ireland has held up relatively flat or increased for all broader destinations. Length of stay also held up well.
Length of stay abroad has declined (in line with recent trends) for holidaymakers, and has risen - against the previous trend - for those visiting friends/relatives and other categories. There has been a significant increase in the length of stay for business travellers.

The decline in the overall overseas spending by Irish residents travelling abroad has been significant and driven largely by the decline in the expenditure of Irish holidaymakers abroad. Business travellers visiting abroad have reduced their spending only marginally, while other categories of Irish residents travelling overseas have seen a small (insignificant) increase in overall expenditure.
Lastly, considering Irish travellers spending by their destination country, EU15 countries clearly stand out as the dominant spending destination for Irish visitors within the broader EU25 or indeed EU27. Despite or strong connections with Poland and a host of other ECE countries, there is virtually no evidence of Irish residents spending much of their cash in those countries. North America follows EU15 as the most favourite destination for our Euros, with Asia& Middle East managing to outperform Australia & New Zealand in competing for our cash.

Eurocoin results are in for April so the chart below updates my forecast for Euroarea leading indicators and for GDP growth for the Euro area for May:
As you can see, Eurocoin improvements, predicted in March, have indeed taken place, which in my view signals that May is likely to see this leading indicator for growth in the Eurozone climbing higher. However, my longer view is that leading indicators are going to suffer a seasonally adjusted fall-off at the end of Q2, retesting the lows of -0.6. Thus, my forecast for Q2 2009 growth stands at -1.1%.

Daily Economics 20/04/09 - US debt problem

For those impatient - there is an estimate of Ireland Inc debt at the bottom... that can be compared with the US debt...

What is going on with the US economy? I expected the figures coming out on economic front (and earnings front outside the Federally financed banks) to be bad, but today's numbers are poor by all measures. According to the Fed's Conference Board, the index of leading economic indicators fell 0.3% in March, after a dip of 0.2% in February (revised up). But decomposition is telling:

• Building permits were the largest negative contributor in March, as builder have finally started to cut production in honest - much of this backed by the decreases in new starts, as finance committed to projects in 2008, signed for in 2007, has dried up. This is a welcome sign, as outstanding stock of unsold houses has to be pared back before any real recovery (as opposed to cliff-and-bottom bouncing) takes place.
• Stock prices, and the index of supplier deliveries also registered large negative contributions to the index in March, showing that real activity is continuing to deteriorate at, seasonally significantly faster rate. There is no spring bounce for now, and these are leading indicators, suggesting that any recovery upwards will require some new alchemy from the White House and the Fed.
  
• The real money supply was the largest positive contributor as the Feds printing presses were working overnight amidst deflation. And another sizeable positive push came from the yield spread - a sign that some of the future support might be waning - yield spreads narrowing is underpinned by lower Fed rates (not by healthier financial system, for banks are continuing to drop dead at an accelerating rate - 25 as of today in 2009 alone, and counting). So as the Fed has run out of options (short of setting negative nominal rates - e.g issuing loans with a principal repayment at a discount to the face value of the issued loan) and spreads are likely to start widening into the future as: (a) Uncle Sam's borrowing will remain buyoant, (b) debt refinancing will run rampant, and (c) Fed's helicopter drops of money thin out.
  

"There have been some intermittent signs of improvement in the economy in April," per Ken Goldstein, economist at the Conference Board. Overall, six of the 10 indicators were negative contributors, three were positive, and one was steady. Say what, Ken? Picture below is a telling one:
What Ken-omist from the Fed is referring to is the renewed momentum in the deterioration of the Leading Econ Indicators index that started in December (after a short 1-month flat) and has been going steady through March. The index has failed to bounce up in consecutive 9 months. Current Economic Conditions index is now converging downward to LEI, suggesting that unless things improve significantly in the next couple of months, simple psychology of the markets will lead to a renewed push down on LEI (the vicious cycle of self-fulfilling prophecies might commence).

Overall, in the six months to April 1, the index fell 2.5%, it declined 1.4% in the previous six months before that.

So about the only thing positive I can report has nothing to do with the Fed's own indicators, but with the decline in the new unemployment claims reported last week. If the decline persists for the next 6 weeks or so, then using comparisons with the last 6 recessions, we are at the point of inflection in economic recovery sometime now. But it is a big if, since the series can be reasonably volatile and their deviations from the monthly moving average can be significant (see here).

And here is a good chart on inflation expectations for the US (from the Fed: here) - care to argue this? or shall we start taking pressure on commodities-linked stuff in preparation for the new 2% inflation bout?


Paul Krugman on Ireland today: a good one from Krugman here. But an even better one from a comment to his article by PMD: "...Krugman and most of our own home-grown economists appear to regard cuts in public spending as being the same as tax increases. They have a model in their head with credit and debit on two sides and they are studiously agnostic about how the government should go about balancing the books. Those of us who work in the real economy know that increasing taxes on the productive part the economy - and that's 'productive' as in 'productivity' as in the only way to generate real wealth as in the only way to escape recession / depression - will dampen its productivity and, therefore, harm its capacity to generate wealth in the future - i.e. escape recession. All this 'sharing the pain' talk is just code for: we'll confiscate private sector wealth in order to avoid reform in the public sector. You can imagine a rich Titanic passenger on a half empty lifeboat blowing his nail and calling out to a dying pleb in the sea 'Chilly for this time of year. Isn't it?' I profoundly disagree with the reversion to the cargo cult school of economic management: let rich foreigners turn up and employ us. What on earth do we pay these mandarins for if the best they can come up with is 'something will turn up'? There are core domestic issues of productivity that are not being addressed." I couldn't have put it any better than this myself!

Lorenzo 'the Not-so-Magnificent' Smaghi... (or should it be Maghi?) is ECB's latest loose cannon... In an interview with FT Deutschland, Lorenzo Bini Smaghi of the ECB predicted that the Euro-zone recovery will follow the mirror image of a J-curve – a shallow recovery after the fall. Ok, I agree with this. In fact, I have warned for some months now that any recovery in the Euro-zone and Ireland in particular will be shallow and slow and will leave the continent at the trend growth rate of below 0.75% GDP, with Ireland at below 1% GDP pa. ECB's latest would-be-forecaster also 'predicted' a persistent and significant fall in potential growth rates going forward. Another thing Smaghi went into is inflation expectations: "'Inflation expectations are moving upwards (in euro area, U.S. and U.K.); no expectations of deflation," said the text of his presentation. Again, another theme I've been hammering about for some time now.

But... (S)maghi appeared to suggest that non-conventional monetary policy action would be likely soon, without giving any details. What this might be? Negative nominal interest rates? Unlikely. A policy of accepting all and any bonds issued by the member states? Brian Lenihan can wish... It is all but inevitable that the ECB will have to rescue Ireland and some of the other APIIGS. Such a rescue will have to be unconventional and not only because there is no existent convention within the Euro framework for doing so, but because as Smaghi stated in his presentation, households across Europe have lost faith in sustainability of public finances and have started to hoard cash. Nowhere more apparent than in Ireland. After surviving through a decade of anaemic (embarrassingly low, by some standards) economic growth, this is the second greatest threat point for the Euro.

A pat on the back: A stoodgy, but occasionally interesting quasi-official Euro economics website/blog: EuroIntelligence.com has the following 'news' item today. A long recession, a shallow recovery: The IMF has prereleased chapters 3 and 4 of its WEO. This is from the introduction of chapter 3 “…recessions associated with financial crises tend to be unusually severe and their recoveries typically slow. Similarly, globally synchronized recessions are often long and deep, and recoveries from these recessions are generally weak. Countercyclical monetary policy can help shorten recessions, but its effectiveness is limited in financial crises. By contrast, expansionary fiscal policy seems particularly effective in shortening recessions associated with financial crises and boosting recoveries. However, its effectiveness is a decreasing function of the level of public debt. These findings suggest the current recession is likely to be unusually long and severe and the recovery sluggish.”

Imagine this! See here for March 3 post that uses the exact precursor to Chapter 3 release... Oh dear, sometimes it is worth checking if a 'new' release is actually 'news'...

ESB's disgraceful entry into 'stimulus' economics has moved on to the next stage. As I noted in two earlier notes, the ESB plan for 'jobs creation' is an affront to the idea of competition and consumer interests (here), as well as an insensitive move at the time of economic hardship for many (here). Now, as today's IT reports (here) we are also looking at more Georgian Dublin demolitions... Is this predatory and arrogant monopoly ever going to brought under normal market controls? And is Irish Times ever going to become a paper where journalism stops being platitudinous to state monopolies and all-and-any 'Green' / 'sustainable' labels and starts seeing the likes of ESB for what they really are? And per wages and earnings in ESB... well, indeed in the entire public sector, see this excellent blog post from Ronan Lyons here. A must read.


A late Sunday thought - with Obamamama economics, how much debt is the US economy carrying?

Well, there are many sources of debt:

• National debt = currently at $11.2 trillion (per US National Debt Clock calculator here);
• Federal bailout commitments = so far set at $12.8 trillion (up from $4 trillion left by the previous Administration, per March 30 report by Bloomberg here);
• Federal entitlements commitments under Medicare and Social Security obligations = $52 trillion in current debt from the Federal Government to the system or $117 trillion in the present value of unfunded obligations (per National Center for Policy Analysis, as of December 2009, here);
• Private sector corporate and financial liabilities = $17 trillion (per US Federal Reserve numbers of December 2008, here)
• Private households liabilities $13.8 trillion (ditto), mortgages $10.5 trillion (here and a breakdown here) = $24.8 trillion.
  

Total = $117.8 - 172.8 trillion or 829.6-1,217% of 2008 GDP!
Financed at the current 30-year US Treasury rate of 3.79%, the interest payment on this debt alone will be $4,465-6,549 bln per annum - up to 46.1% of the country annual GDP.

We are not considering the pesky issue of the derivative instruments issued within the US system. These are notional debts, but they can come back and bite you as well. Per the Office of the Comptroller of the Currency (here), as of the end of Q4 2008 US held:

• interest rate derivatives to the tune of $164 trillion;
• CDS at $15.9 trillion,
• other stuff: FX, equities, commodities -based derivatives, to the total of $20.5 trillion

So Derivatives grand total of $200.4 trillion.

Which brings US total debt obligations to $318.2-373.2 trillion = upwards of 2,628% of US GDP!

Considering that the US current population is 306,251,267, the total US debt per capita is between $1.31mln and $1.22mln, with a servicing cost of up to $46,185 per annum per person!

And amidst this, Obama is talking traditional Democratic drivel of 'spending the economy out of a recession'? While Paul Krugman is wailing that not enough is being spent?

Can anyone really doubt that inflation is around the corner? If so, consider the above figures and do tell me how can the US get out of this corner without a massive debt write-off via inflation and sustained devaluation? Dollar at 1.75 to the Euro in two years time and interest rates in double digits?

Now on to Ireland Inc's debt:

• National debt = currently at €54.245bn (per NTMA here);
• Government bailout commitments = so far set at €400bn (here) under Banks Guarantee Scheme, €70bn (my estimate in the forthcoming B&F article) under NAMA, €87bn (here); Sub-total = €557bn;
  
• Public entitlements commitments under Pensions, Social Welfare and Health obligations = €75bn (Pensions: here), €66.3bn (€38bn per annum spending on health, wages & social welfare taken over 30 years horizon with deficit of 10% per annum over term) in the present value of unfunded obligations; Sub-total = €141.6bn;
  
• Private sector corporate and financial liabilities = Monetary Financial Institutions: €810bn, inc of IFSC, corporate sectors: €551bn; Direct Investment: €183.6bn (here); Sub-total = €1,544.6bn
  
• Private households liabilities (per my earlier estimates here) = €150bn.
  

Total = €2.45 trillion or 1,440% of 2009 GDP!
Financed at the current 5-year rate over 30 year horizon (roll-over) of 4.5%, the interest payment on this debt alone will be €110.25bn per annum - up to 64.9% of the country annual GDP. Put differently - the debt/liabilities of this economy are currently amounting to ca €555,048 per every person living in Ireland...

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.