Economics 06/04/2010: Return of the markets

Another 'Must Read' from WSJ - Gary Becker on Obamanomics, health care reform and why Americans will opt once again for Smaller Government with more checks and balances on the power of bureaucracy. Read it here.

Perhaps the most insightful - from our point of view here in Ireland - is Becker's arguments about interest groups-driven poor legislation that ossifies into innovation-choking regulatory diktat absent proper competition between interest groups acting as a (limited) check on the corrupting power of tax-and-spend politics.

having just returned from the Western sea board, I can testify to that corrupting power. Take a small town, popular with summer vacationers, I visited. Bungalows piled mile-high - crowding each other and older homes. Local county councilors own, per local paper expose, many of these, with some holding mortgages on 7-9 of such vacation properties, with section 30 tax breaks attached to make the deal sweeter. Scores of developments (not one-offs) were built in violation of planning permissions granted. And scores of planning permissions were granted in violation of the standard building codes.

As a friend of mine has described the countryside: 'You have D4 folks with homes, back then, worth some €4-5 million rushing to buy public-housing-styled vacation homes for a €1 million-plus with an illusion that these were to be their country retreats. And the Government was dishing out tax breaks...'

We clearly have no competing interest groups - just a Social partnership feeding party.

Economics 18/03/2010: Services Inflation in Ireland

CSO released an interesting set of new stats on price inflation in select services. Per experimental Services Producer Price Index (SPPI) average prices charged by domestic service producers to other businesses in Quarter 4 2009, were on average 4.1% lower in the year when compared with the same period last year.

The most notable changes in the year were:

• Architecture, Engineering and Technical Testing (-9.7%),
  
• Computer Programming and Consultancy (-8.5%),
• Advertising, Media Representation and Market Research (-7.2%),
  
• Freight and Removal by Road (-5.2%) and Air Transport (+6.3%).
  

Services Prices increased by 0.4% in the quarter. This compares to a decrease of 2.3% recorded in Q3 2009.

The most significant quarterly price decreases were in

• Freight and Removal by Road (-2.2%),
  
• Postal and Courier (-1.4%) and
  
• Sea and Coastal Transport (-1.4%).
  

There was an increase of 4.8% in Air Transport.

Now, what CSO report did not show is the following. While deflation in higher value added, human capital-intensive services was rather significant, mid-range value-added services saw much more moderate deflation, with low value added labour-intensive sectors such as security services holding up almost unchanged over time. Chart below illustrates:
For all the talk about improved competitiveness, transport-related services costs are still on the upward trend:
And this is before Carbon Taxes kicked in.

Another interesting point to be made here is that the first chart above appears to suggest that deflation is almost not happening at the level of sectors that are labour intensive - industries most impacted by the minimum wage. In more wage-flexible sectors, where human capital drives value added to much higher levels, inflation is running negative. This has two implications going forward, should this trend persist:

1. Despite all the talk about the 'poor' bearing the brunt of the crisis, at least as far as prices charged for services indicate so far, there is most likely stronger deflation of wages at the higher end of wages distribution;
2. While competitiveness of our traded and higher value added services is increasing, competitiveness of our domestic services (anchored in higher labour intensities) is not improving significantly.
   

Economics 02/10/2009: IMF World Economic Outlook

IMF released its World Economic Outlook for H2 2009 last night. Here are some highlights, more to come later tonight.

Summaries of IMF latest forecasts:

Next, I created an index of overall economic activity that is GDP-weighted. This index is geared in favor of Ireland and other smaller exporting economies by magnifying the effects of GDP growth (as opposed to GNP) and the effects of the current account (reflective of higher share of trade and FDI in Irish economy) and downplaying both price inflation (with larger share of domestic inflation in Ireland imported from abroad) and unemployment (with traditionally smaller both unemployment and labour force participation in Ireland).

Rankings based on the index: Based on the above index of economic activity, ranking countries in order of declining quality of economic environment, shows the extent of our performance deterioration: if in 2007 Ireland ranked 18^th from the top in the developed world, by 2010 we are expected to rank 29^th or fourth from the bottom.
Peer economies comparatives:
Based on the above table, we can compute a relative impact of the crisis 2008-2010 on our competitor economies. Chart below illustrates this, showing that when compared to other economies, only Iceland is expected to show more severe contraction in economic activity than Ireland. More importantly, the gap between Irish performance during the crisis and that of an average economy in our competitor group is 1.5 Standard Deviations away from the mean.
Property markets crisis estimates: based on IMF model of duration and amplitude of property busts, table below reports the relative impacts of the global property slump in the case of Ireland, comparative to the rest of the OECD:
Stay tuned for more...

Economics 24/09/2009: There used to be a real economy in there...

Enough of Nama, for now. Data from CSO is coming thick.

Initial estimates for the second quarter of 2009 show year on year declines in both GDP (-7.4%) and GNP (-11.6%), with the gap between GDP and GNP widening. Compared with the corresponding quarter of 2008, GDP at constant. Quarter-on-quarter, GDP remained constant in Q2 2009, while GNP slid 0.5%. It is worth recalling that GDP-wise Q1 and Q2 2008 were already negative growth territory, so current ‘stabilization’ comes on top substantial declines taken in 2008.

Predictable sources of declines: consumer spending (down 6.8% yoy), capital investment (down 24.4% in Q2 2009 yoy), net exports are up yoy boosted by MNCs (goods manufacturing) and by collapse in imports. Industry output down 11.3% yoy and within construction sector – 30.8%. Every sector is posting fall-offs.

Incidentally, do tell me there is demand for credit out there that urgent we have to break the back of the entire country to repair it. I can't see one - capital investment tanked, so companies are not in a mood to invest in future capacity (see stocks changes, too), while personal consumption is bouncing at the bottom, every time a little lower. Oh, I get it, if only the banks were issuing new loans, we all can go out, borrow some more dosh to pay for... hmm... Brian Cowen's excesses in spending? But back into non-Nama land:

Q1 2009 annual rate of decline was 13.1%, so Q2 decline looks positively slower at 11.6% when it comes to GNP at constant prices. For GDP these figures were 9.3% and 7.4%. But, of course, one has to remember that Q1 2009 annual changes were against Q1 2008, when both GDP and GNP grew by 0.1%. Q2 2009 changes, however, came on top of 0.4% growth in GDP and 0.6% growth in GNP.

In constant euros, our Q1 2009 GNP, at €35,182mln was comparable to the level of income in Q1 2005 (€35,238mln), while Q2 2009 GNP of €35,175mln was below that recorded in Q2 2005 (€35,862mln).

Gross domestic capital formation has fallen to €7,659mln in Q2 2009 down from €8,217mln in Q1 2009. We are now at the lowest level in capital formation terms since the end of 2002 (as far as these series stretch). Physical change in stocks has totalled -€911mln in Q1 and Q2 2009 the greatest cumulative drop for half-year of any year on record (since the start of 2003).

Two charts below illustrate some less apparent trends:
Services balance is deteriorating as financial and legal services exports are suffering. Of course, our hospitality and tourism exports have fallen off as well, thanks to economically illiterate Budget 2009. This is a point of alarm. Our exports of services are now below those recorded in 2007 in constant prices. Our total exports have fallen 2.5% in Q2 2009 (yoy) – a less deeper cut than in Q1 2009 when total exports contracted 3.0%. Goods exports have fallen 3.1% in Q1 2009 and 3.7% in Q2 2009, so things are getting worse here. Services exports contracted 2.8% in Q1 2009 and -0.9% in Q2 2009. Imports overall have declined 10.6% in Q1 and hen 7.1% in Q2 2009 – better than before, but still third deepest fall since the series revision in Q1 2004. Goods imports are down 22.3 in Q2 2009 yoy – marginally better than 24.8% contraction in Q1 2009.

Table below compares trade performance relative to corresponding quarters of 2007:


The above chart shows that taxes, public administration and defence contributions to GNP are falling over time – since Q1 2007 and despite April Budget and October 2008 budget, this fall continues today. This is not to be confused with the falling cost of Government in terms of taxation-exerted drag on growth. The decline in Government share of GNP is reflective of two things:
(1) there has been a marked decline in capital investment (i.e we still waste piles of cash on non-investment activities);
(2) the rising interest rate bill on Government debt is now adversely impacting GNP.

Now, GNP/GDP gap illustrated…
Self explanatory, really.

Now, recall those evil Americans who, according to our Taoiseach and his Cabinet members, gave Ireland this recession... Chart below illustrates:
Yeps, they (Americans) sneezed, Europe got a slight fever, the UK is out with a major flu and Ireland is... well... Ireland is busy dumping tens of billions in cash it does not have on public sector wages, social welfare payoffs and, next best thing to Partnerships - Nama...

Economics 10/08/2009: Industrial production blues and fun-NAMA

Brian Lucey has an open petition on NAMA on his site (here):
http://brianmlucey.googlepages.com/namapetitionandoireachtasemails
which is, in my view, spot on in terms of what each member of Oireachtas should read before the NAMA debate takes place.


Before we begin with CSO's data on industrial production - few NAMA posters are posted below, so do make sure you get to the end of this post...


CSO data on industrial production was published earlier today. Trumpets are blowing that things are turning around for Ireland Inc. But hold your horses...

On an annual basis production for Manufacturing Industries for June 2009 was 4.3% higher than in June 2008. So turnaround is here, then? Well, no... The most significant changes were in:

• Basic pharmaceutical products and preparations (+35.1%),
  
• Other manufacturing (+25.9%) and
  
• Computer, electronic and optical products (-17.7%).

What does the above mean? Pharma guys are chugging along in transfer pricing / tax optimization, but computers and electronics - hammered by exits and layoffs and the collapse in private investment worldwide - can't even master a tax optimization scheme. I mean, Table 3 in CSO release clearly shows this sector having suffered the greatest layoffs of all other sectors in proportional terms, and of all other Modern sectors in absolute and proportional terms.

The seasonally adjusted volume of industrial production for Manufacturing Industries for the three month period April to June 2009 was 2.0% lower than in the preceding three month period. This is volatile stuff, so 3-mo aggregates are a bit more telling.

The “Modern” Sector, comprising a number of high-technology and chemical sectors, showed an annual increase in production for June 2009 of 16.0% - the same transfer pricing argument holds. But there was a decrease of 16.6% in the “Traditional” Sector.

The seasonally adjusted industrial turnover index for Manufacturing Industries was 1.9% lower in the three month period April to June 2009 when compared with the preceding three month period. Now, outside the current crisis, turnover is actually less volatile than production volumes, and yet now it tracks almost 1:1 the more volatile series. What's going on? I am not sure, but one potential explanation is that we have gone into a severe enough jobs/production capacity cutting mode earlier this year to allow for some stabilization during May-August period. Of course, this means September-October turnover will make or break our stabilization. If turnover falls, new layoffs will be coming. If it rises, well, if it rises by a hell of a lot, then hiring might commence.

On an annual basis turnover was 0.6% lower when compared with June 2008.

Now, few interesting charts:
Taking a closer look above, compare the changes over the last four months reported relative to sector activity in 2005 (the 100 line):

• In March 2009, 8 sectors performed above their 2005 levels in volumes. In June, the number was 6.
• But in April 2009, this number was 5, while in May it was 3...

In effect, the whole manufacturing sector is sick and the disease is not new to this crisis. Read through this chart above - it is really, really telling. The same chart with monthly changes May-June (preliminary results, of course for June) - 11 sectors show no improvement, 9 show improvement.

Now step back for a bit of a broader view:
Self-explanatory, but few notes worth making:

• Capital goods are slightly up +4.66% mom in June, but that is after being slightly down -2.83% in May, so change on March 3.75%, but on April only 1.7%. Not exactly a robust start of a new cycle here, but not a disaster.
• Intermediate goods down - MNCs might be scaling back for summer.
• Consumer goods up, but no durables - weather effect?

Unfortunately, CSO can't get their act together on surveying new orders for all sectors, so we have a snapshot of what's happening in the very limited number of areas. But what the chart below really shows us is our dependence on MNCs - yeah, those American (and other countries') companies who are still trading, if only because of our tax arbitrage opportunity...

Credit for the following due to:
http://img7.imageshack.us/img7/5391/namahaughey.jpg
http://i38.photobucket.com/albums/e146/vgupload/sofew02.png

ESRI's latest outlook: more waffle, less real news

The ESRI - a largely Government-sponsored quasi-official 'research' institute has issued another of its macroeconomic updates. This one is available here.

In case some people have not noticed it yet (presumably, someone employed in a state-sponsored organization might be detached from everyday reality of our economic collapse), ESRI opens its latest missive with the following statement:
"The combination of the domestic housing bubble unwinding and a world financial crisis has particularly unpleasant consequences for the Irish economy. However, while the bursting of the property bubble makes things much worse ... up to a half of Ireland’s current problems with the public finances and in the labour market arise from the global financial and economic crisis – they would have happened anyway no matter how appropriate fiscal policy had been over the last decade."

So let us get things right here: according to ESRI, at least half of our problems are attributable directly to the Government fiscal policies. Out of the other (at the most) half, domestic housing bubble is not attributable to the Government fiscal policies. So, dear ESRI 'researchers', narrowly targeted tax breaks for developers and property purchases, over-stimulation of construction in the areas with no demand (National Spatial Strategy, hotels, various tax-sections apartments etc), linkages between tax revenue being raised out of property transactions and fiscal spending - these are not related to our fiscal policies and 'would have happened anyway'? How? By spontaneous self-combustion?

ESRI goes on: "The structural [fiscal] deficit is relatively invariant to short term fluctuations in the outside world and is, thus, a more certain and appropriate target for fiscal policy. Our research suggests that the structural deficit this year is of the order of 6-8% of GDP... If Ireland did not currently face a structural deficit, then the appropriate public policy response would have been to let the “automatic stabilisers” work. ... However, we do have a serious structural deficit, which became apparent early last year. This problem, together with the severity of the recession and uncertainty about when a recovery can be expected, means that there is no option but to take severe action to substantially reduce that structural deficit."

Several things here:

1. The structural deficit in fiscal policies has become apparent to the ESRI only at the beginning of last year. They could not see the structural problems emerging since 2004 when the Irish Exchequer chose to pump vast amounts of stamp-duty and other property tax revenues surpluses into current expenditure, permanently raising the latter despite a temporary nature of revenue collected. Indeed, the ESRI has for years egged the Government to raise spending. They issued dozens of papers on 'relative' poverty, the need for more 'investment' in public services, denied for years that there was a significant surplus in public sector remuneration and so on. Now they tell us that the structural deficits are a recent thing?
   
2. The ESRI, despite stating that only 'up to a half' of fiscal problems is due to fiscal policies misfires, still manages to attribute jobs losses and unemployment to world recession. Yet, most of our unemployment increases in 2008 were driven not by the IFSC layoffs (which are attributable to global crisis in financial services) but by contraction in domestic construction. Surely this was not due to something that was happening in Bear Sterns or Lehmans?
3. Note that the ESRI implicitly assumes that global economic recovery will lead to a recovery in Ireland - an assumption that is simply undefended in their analysis.

"Before taking account of measures to be announced in the budget on the 7th of April, the general government deficit in 2009 is likely to substantially exceed 10 per cent of GDP." Well, at last, this blog's forecasts are being followed by ESRI (see here), albeit with almost two months delay!

Back to the structural deficits: "It would probably be appropriate for fiscal policy this year and next year to work to roughly halve the structural deficit by the end of 2010. As the economy recovers in 2011 and in subsequent years, further action of a less draconian nature would be needed to reduce the structural deficit to below 3 per cent of GDP by 2013 and to eliminate it by around 2015."

Note my emphasis - up until yesterday, the Government was targeting the total deficit reduction to 2.5% in 2013. Now, ESRI is telling us that we should reduce the structural deficit (which is by their estimate accounting for roughly 7% out of ca 12% total deficit) to below 3%. So do the math - the overall deficit for 2013, according to the ESRI should be somewhere around 4-5% - well above the 3% EU limit.

So how can we do this? According to the ESRI: "In making cuts in expenditure, priority should be given to areas where services are inefficient or of low value. If the public wishes to preserve the current level of public services, then revenues will have be to be raised to between 35 per cent and 40 per cent of GNP. Under these circumstances it seems likely that a substantial increase in tax revenue, combined perhaps with more user charges, will be required to restore the public finances to a sustainable growth path. In choosing the mix of sources of additional revenue it will be important to take account of the likely effects of higher taxes on the labour market. This would argue for developing new sources of revenue such as taxes on carbon and on property."

Ok, I agree with property tax - although it should be structured not as a function of property value (as this will discourage property upgrades and will do nothing to improve land-use efficiency), but as a value of the land on which the property is located, as this will encourage more efficient use of land and will remove distortionary subsidy to developers.

But what about 35-40% of GNP as a tax base? If you consider my budgetary update from this morning (here), you can see that assuming GNP falls 8% this year, this target implies tax revenue of €56.6bn in 2009 - or ca 77% more than the Government is likely to collect under Budget 2009 provisions. How on earth will the Government be able to raise such taxes? In December 2008 report, total tax revenue for 2008 was shown at €40.8bn, total 2007 revenue was €47.9bn. So in effect, the ESRI gang is suggesting we raise tax revenue in excess of pre-crisis levels by some18.2%?

This is mad, irresponsible and dangerous. And this is what informs Government decisions in this country!

Daily Economics Update 24/03/2009

Ireland:

I tried to resist commenting too much on Brian Cowen's remarks today concerning the extended borrowing he envisions for Ireland Inc in 2009. I tried, but this is simply an extraordinary statement from a person who is

• either clearly not capable of thinking straight in the crisis or
  
• from a politician, so cynical and obsessed with self-preservation that he is willing to preemptively surrender this nation's hope for economic survival in order to throw another bone to his political cronies.

Either way, Cowen today has managed to achieve nearly impossible in virtually a single breath:

• Putting Ireland closer to fiscal insolvency - by enhancing the (already significant) uncertainty as to how much he will borrow in 2009 (and through 2013) and on which terms (will Ireland be forced to continue borrowing short, front loading 2011-2013 deficits to finance Brian's 'Partners' today?);
• Destroying his own reputation by telling the world that he cannot be trusted on any of his future policy pronouncements (undoing his own pre-commitment to keep the deficit under 10% he stated that no budgetary projection, including yet to be published mini-Budget, from this Government can be trusted);
• Showing that this Government will flip flop not only on soft targets (e.g promises not to tax us to death), but also on hard ones (including his commitments to the EMU);
• Destroying whatever hopes the ECB and the EU Commission might have had that this Government can be a responsible participant in the EMU;
• Forcing the bonds markets into a situation where, from now on, no pricing of Irish debt paper can be conducted on a basis of rational valuation.
  

Only 3 weeks ago, Cowen was fully committed to keeping 2009 borrowing under 9.5% of GDP. He is now telling the world that this was all a matter for him to change his mind over. Perhaps the only reason for such an extraordinary statement I can think of is that possibly (I am speculating here), Cowen saw preliminary figures from the Exchequer revenue for March. Even then, there has to be a real 'nuke' in these figures to justify such a public humiliation of this economy in the eyes of the developed world.

Cowen said in his address that he is not willing to sacrifice the real economy on the altar of public finances. Coming from him, this is rich. Cowen and his Government

• raised taxes in October 2008 and again in December 2008, and is going to raise them in April - 3 times in 7 months - amidst the wholesale collapse of the real economy (incidentally, these tax hikes were necessitated by the decisions on run-away train of public current expenditure growth that he adopted during his tenure as the Minister for Finance);
• raised VAT and other taxes directly impacting businesses, employment and public economic welfare, as his incompetent Minister for Enterprise sat silently beside him;
• raised levies, taxes and charges on all workers, including those who lost their jobs and then cynically turned around to wage an oratorical crusade about 'equality' and 'shared pain';
  
• paid public sector wage increases and then clawed some of these back, posturing as if a heroic leader who broke the mold 'to do the right thing';
• got in bed with trade unions in the Summer 2008 to produce a partnership agreement that committed the private sector taxpayers to servitude to public sector wage demands;
  
• once again cowardly moved into the new Partnership Talks last night as an excuse to surrender his policy making authority;
• presided over a largely failed set of actions on the banks that shored up (temporarily) Irish Developers Country Club at the expense of the real economy;
• watched idly as the real economy was falling off the cliff between June 2008 and October 2008;
• made wild promises of reforms and productivity enhancements in the public sector and delivered none;
• blamed everyone - from Americans to the World - for our economic ills, but not a single time managed to tell the nation that he is sorry for serial errors of judgment his Government committed in only 9 months in power;
• appointed the most incompetent person imaginable to run the key ministry in charge of our real economy (and no, I do not mean DofF here); and now
  
• turned our entire budgeting process into a public farce...

This is really rich!

Richard Brutton put it perfectly when he said today that “The spectacle of a Government thrashing around, unable to set any clear framework for a Budget that is just two weeks away is damaging our international reputation. It is damaging the confidence of markets from whom we hope to borrow €24 billion this year... This Government is destroying its authority to provide ...leadership.”

May I add that it is also destroying the real economy - the same one that Brian Cowen claims to be protecting.


International:

March McKinsey survey of economic conditions is out today, showing that "the percentage of the executives who say economic conditions have gotten worse at the national level hasn’t increased, but fewer than a third expect an upturn this year... 53 percent expect profits to drop in the first half of 2009, and the number expecting to shed workers has jumped eight percentage points in six weeks." Companies that are thought of as being well managed in the downturn are likelier:

• to be reducing both operating costs and capital spending,
• not weakening operations a great deal, and
  
• "are also likelier than others to be improving productivity".

Here is an interesting one: "overall, the results show that most companies are not actively seeking more cash." So there is no significant demand for credit, then? As I've been saying all along, it is hard to imagine that during the extreme hangover period following the leveraging binge that the corporates have embarked upon in the mid-2000s there will be strong demand for new credit.


US:

Existent sales up, prices up and now new home sales are up as well - what is the world (ok, the US) is turning into? Well, not anything resembling of a bull market, at least not yet. Per data released today, new homes sales were up 4.7% in February relative to the record low (since 1963) reached in January, but sales are still down 43.8% compared to February 2008. I worry that this is not a floor yet, but a slight bounce before further falls. Even if the current level signals an upturn in sales, things are bound to remain testing for a while, as inventory overhang remains enormous. A 2.9% fall in inventories of unsold homes in February still leaves 12.2-months worth of stuff unsold - up full 3 months on February 2008.

But there is more noisy data coming out today - there was an unexpected and a welcome rise in orders for durable goods - the first increase after six-straight-monthly declines. Offsetting the gain in February somewhat was a sharp downward revision to orders in January (from -4.5% in preliminary estimate, to -7.3% decline).

The best piece of analysis on this is on Bloomberg (here). In my own view - setting aside defense spending and consumer stuff - the gains are reflective most likely of amortization cycle (replacement of capital goods delayed during the previous 15 months) than due to capital inventories build up. There is also a strong 'noise' component to the rebound - given the precipitous fall in orders in Q4 2008, when durable goods orders fell at a rate not seen since the late 1950s.

The fact that we are seeing all this volatility in economic series away from the unrelenting downward trend is a good signal. In my view, as I said before, this is a sign that the markets are now seriously testing the floor of this recession. In other words, I now expect similar modest gains in some parameters and stabilization of other parameters through May, followed by the first positive gains in the capital spending and declines in new unemployment claims in June-August. This will put the US economy onto recovery path by mid-Q3-early-Q4.