15/4/2013: Advanced economies exports: converging in growth trends?

Quite an interesting new trend that emerged since the late 2000s and is reaching well into 2012-2013 so far is the trend of convergence in the rates of growth in exports of goods and services between euro area, the US and Japan.

Here are few charts:

 Note, the above correlations convergence is also confirmed on a 20 year rolling basis.

One thing is pretty clear from the above: while prior to 2004-2005 the US exports dynamics remained relatively weak compared to those of the euro area, since 2005, the picture has changed dramatically, with the US exports dynamics falling pretty much in line with those of the euro area.

Here are some interesting facts:

• On a cumulated basis, from 1981-2012, volume of exports has expanded from index reading of 100 in 1981 to 406 in 2012 for Japan, 352 for the UK, 505 for the US, 812 for the Advanced Economies and 715 in the euro area, highlighting the fact that the euro area overall cumulatively outperformed all other economies in the comparison group.
• Similarly, on cumulated basis, from 2000 (index=100) through 2012, volume of exports index rose to 156 in the case of Japan, 137 in the case of the UK, 156 in the case of the US, 227 in the case of the Advanced Economies and 237 in the case of the euro area, once again confirming euro area outperformance over the period.
• In contrast, on cumulated basis, from 2004 (index=100) through 2012, volume of exports index rose to 124.5 in the case of Japan, 122.1 in the case of the UK, 151.6 in the case of the US, 166.4 in the case of the Advanced Economies and 154.8 in the case of the euro area, showing closing gap in euro area outperformance compared to the US over the period.

The drivers for these changes are most likely a combination of factors including:

• Technological and supply chains convergence in traditional sectors;
• Increased openness in the euro area to trade;
• Changes in currency valuations with the introduction of the euro and the effects of the current crisis on currency valuations;
• Improving energy component of the total cost basis in the US, and
• Shift in exports growth toward services sectors (composition effects).

20/8/2012: China's 'This Time It's Different' turn?

Two charts and a table that are really self-explanatory. All via http://macromon.wordpress.com/:

This time, it's clearly very different...

15/6/2012: Few links worth checking out

Few worthy links accumulated over recent weeks:

What about that jobs creation by MNCs? Well, actually, its a net jobs loss: link here. Note that the net rate of jobs destruction amongst MNCs in the 2008-2011 period is roughly-speaking around 8-9%. Which is below that for the whole economy, but looks to be above that for the economy less construction and retail sectors. Hmmm...

EU Commission issued its guidelines for dealing with 'future' banking crises (assuming we end this one with some banking left for the future crises to challenge): link here.

Quick quote from Lobard Street Research on subordination in the Spanish 'rescue' case - the topic I covered for ages and that I believe is now also related to the ECB reluctance in engaging with secondary markets purchases of peripheral sovereign debt - link here.

Meanwhile, Spanish banks have now surpassed Italian bank in ECB borrowing: here.

Excellent as ever NamaWineLake blog on 18% performing loans ratio at NAMA: here. Stay tuned for my Sunday Times column this weekend where I cover European data on commercial real estate mortgages backed securities that will make Nama look, relatively, not that bad...

BIS blog post on their Q2 2012 quarterly: here. Some nice charts on international debt issuance, showing pick up in debt issuance in the wake of LTROs.

A position paper by Daniel Gros and Dirk Schoenmaker on Spain and Greece backstops: here. With some elements of the solutions that I've been advocating in my Sunday Times articles over the last few weeks - including deposits insurance. I disagree with them on the point that ESM should be used to recapitalize insolvent banks which are to be held in SPVs, presumably until they are 'repaired' to be fit for disposal. This is simply a prescription for de fact protectionism and politically motivated preservation of incumbents. In the end it will lead to European banking becoming fully politicised and ineffective. ESM can be used to cover losses in the banks, but insolvent banks should be shit down and their assets sold off to private investors and other banks to make certain that state-ESM-controlled zombies do not block the banking system.

A thought-provoking presentation on the state of the global economy by Raoul Pal: here.

2/4/2012: Two studies on Global Financial Crisis

An interesting analysis of the International Financial Crisis of 2007-2009 from Gary Gorton and Andrew Metrick, both Yale and NBER just out - see link here. Worth a read and contrasting with Taleb's excellent paper on same (earlier work than that of Gordon and Metrick) here.

13/09/2011: Latest research on Tax Havens & Safe Havens

A recent CEPR research paper (CEPR Discussion Paper No. 8570, "TAX HAVENS OR SAFE HAVENS" by Patrice Pieretti, Jacques-François Thisse and Skerdilajda Zanaj, from September 2011) attempts to explain -at least in theory - the policy choices of a small open economy (SOE) that wants to be a viable international banking center (IBC).

The basic dilemma faced by such an economy is that to attract IBC activity, the economy needs to choose between either becoming a tax haven, a safety haven or both for investors from large economy. In other words, the SOE is required to establish a competitive advantage relative to a large economy in terms of two possible instruments: taxation and institutional infrastructure.

The problem is that in reality, the same SOE will not be able to provide both - quality institutions and tax haven protection, since the latter contradicts the former. One can argue that in the past some tax havens were institutionally extremely robust, but in the current globalization-altered world, good institutions require compliance across the borders, not just within the country.

What the paper shows is that in such a setting, the tax haven can act as a catalyst to induce institutional reforms despite the fact that it cannot create institutional competitive advantage. The reason is that competition amongst tax havens drives institutional improvements in these IBCs.

As surveyed in the paper, a recent study by Dharmapala and Hines (2009) "investigated 209 countries and territories to determine which jurisdictions become tax havens and why. They found that successful jurisdictions are overwhelmingly small, but that they are especially well governed, with sound legal institutions and low levels of corruption. Poorly run jurisdictions fail to attract or retain foreign capital, and many do not even try. Thus, the quality of governance seems to matter for the existence of tax havens. According to Gonzalez and Schipke (2011), there is some empirical evidence that countries that apply stronger regulation rules have benefited from higher portfolio investments."

The CEPR study largely confirms this. The core conclusions are:

• "...whether the small country becomes a tax haven depends on the integration of financial markets and the intensity of the small country's comparative advantage."
• "The nature of government matters too to the extent that benevolent governments never build a tax haven. They prefer to erect an IBC through the provision of better institutional infrastructure."
• "By contrast, tax havens may emerge under Leviathan governments. This may explain why tax havens are developed in microstates where there is almost no conflict between social welfare and tax revenues because the local population benefits from the taxes which are mainly levied on foreign investors."
• "Our analysis also reveals that the presence of heterogeneous investors matters for the viability of the IBC and the nature of the policy mix."
• "IBCs need not be as bad as claimed in the media because they foster institutional competition which is beneficial to all investors."
• "Our results provide evidence that safe havens have a place in the global financial environment and provide benefits to governments, firms and households."
  

18/08/2011: VIX signals crunch time for the crisis

Summary:


Few charts on VIX - hitting historic, second highest ever, 1-day dynamic semi-variance range:
VIX itself above and intraday range below:

3mo dynamic STDEV showing emerging and reinforced trend up on semi-variance side:
And same for straight volatility (symmetric)
This, folks is a crunch time.

The reasons I bothered with this are here.

08/08/2011: What VIX tells us about today's markets meltdown

Let's chart what I called the Roy Lichtenstein-styled "KABOOM" moment for the markets today. Recall that by definition the CBOE Volatility Index (VIX) is "a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility."

Now, basically, VIX is as close to a pure price risk bet as we have. Again per CBOE: reported VIX index values represent "market estimate of expected volatility that is calculated by using real-time S&P 500 Index (SPX) option bid/ask quotes. VIX uses near-term and next-term out-of-the money SPX options with at least 8 days left to expiration, and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index."

Now to the charts.

Starting from the top, we have actual VIX itself - today's close at 48.00 which was:

• Still well below the historical max of 80.86 attained on 20/11/2008
• Well ahead of the historical average of 20.35 or January-2008 to present average of 27.21 or the average since January 2010 of 21.11
• Today's close VIX reading was 63rd highest daily reading for the entire history of the series and the highest since January 2010
• All 64 top readings (equal or above that attained today) were recorded in the period since January 2008.
  

Today's intraday spread of 35.65% is below Friday intraday spread of 45.52. However, the two readings are quite extraordinary:

• Intraday spread average for historical series is 3.01%, while since January 2008 through present intraday spread averaged 9.06%.
• Today's spread was 7th highest in history of the series, the 5th highest since January 2008 and the second highest (after last Friday's) since January 2010.
• Friday's intraday spread was the 5th highest daily spread in the history of the series and the 4th highest since the crisis start (January 2008)

To see just how extraordinary last couple of days are, consider two time horizons for volatility in VIX itself:
and a shorter horizon:
3mo dynamic standard deviation for today's close is only 433rd highest reading in the series history and the 60th highest since January 2010, while 1mo dynamic standard deviation is the 56th highest over entire history and the 5th highest since January 2010.

However, in terms of daily percentage changes, today's rise of 50% is the fourth highest daily increase since the beginning of the VIX history and the highest since January 2008.

In terms of 1mo dynamic semi-variance (measuring only variance for the days of increasing VIX index, in other words - only for those days when risk rises), the last chart above clearly shows that we are in for a treat in these markets.

Economics 27/06/2010: G20 - real stats and real issues

As G20 leaders undertake another attempt at injecting some balance into global economic order - with last meeting in Pittsburgh focused on stimulus strategies, while the current one in Toronto focusing on austerity - it is worth taking a look at the stakes.

Bank of Canada estimates that disorderly (or uncoordinated) exit from global stimulus phase of the recession can lead to a loss of up to USD7 trillion worth of output, primarily concentrated in the advanced economies.

However, the story is more complex than the simple issue of whether G20 nations should opt for a fiscal solvency or for a continued monetary and fiscal priming of the pump. Here are the key stats on the leading global economic blocks, revealing the structural imbalances that suggest the real problem faced by the advanced economies is the debt-driven nature of their fiscal and private sector financing.
First chart above shows Current Accounts for the main blocks, including the G20. Two things are self-evident from the chart. Firstly, the crises had a crippling effect on the overall trade flows from the emerging economies to the advanced economies, though this came about mostly at the expense of countries outside Asia Pacific. Second, crisis notwithstanding, IMF forecasts (data is from IMF April 2010 update to WEO database) the trend remains for unsustainable trade deficits for the Advanced Economies. European (read: German) surpluses of the last two decades are going to be wiped out in the post-crisis scenario, but it is clear that the US, as well as other advanced economies, will have to face a much more severe adjustment toward more balanced current account policies in years to come.

These adjustments will have to involve government finances:
Chart above shows government deficits, highlighting the gargantuan size of the fiscal measures deployed by the US and European countries, as well as a massive stimuli used in some 'Tiger' economies and China, over the latest crisis. This puts into perspective the size of the austerity effort that has to be undertaken to bring fiscal policies back to their more sustainable path. You can also see the relative distribution of these adjustments - the gap between the red line and the blue line. This gap is accounted for, primarily, by the UK, Japan and US and is much smaller than the overall Euro area contribution to G7 deficits.

But there is more to the deficits picture than what is shown above. Expressed in terms of percentages of GDP, the figure above obscures the true extent of the problem. So let's look at it in absolute dollar terms:
Now you can clearly see the mountain of debt (deficit financing) deployed in the crisis. Someone, someday will have to pay for this. It will be you, me, our children and grandchildren. Can anyone imagine that things will get back to pre-crisis 'normal' any time soon with this level of deficit overhang on the side of Governments alone?

What is even more disturbing in the picture is the position of Advanced Economies in the period between the two recessions. It is absolutely clear that Advanced Economies have lived beyond their fiscal means, even at the times of plenty, running up massive deficits in the years of the boom.

This puts to the test our leaders (EU and US) claims that the banking system reckless lending was a problem. The banks were not shoving cash at the Clinton-Bush-Obama administrations, or at European Governments. Instead, just as the banks were hosing their domestic economies down with cheap cash, courtesy of low interest rates, Western governments were hosing down their friends and cronies with deficit financing. The two crises might have been inter-related, but both fiscal profligacy and banks reckless risk-taking are to be blamed for our current woes.

Irony has it, neither the banks, nor the political profligates have paid the price for this recklessness.
Hence, the dire state of the governments' structural balances. As chart above shows, in the entire period of 20 years there was not a single year in which advanced economies (G7 or G20 or the Euro zone) have managed to post a structural surplus. Living beyond ones means is the real modus operandi for the advanced economies' sovereigns. Expressed in pure dollar terms:

Now, on to the levels of economic activity:
As I remarked on a number of occasions before, the whole idea of the Advanced Economies decoupling from the world is really a problem for the Euro area first and foremost. want to see this a bit more clearly?
Look at G7 plotted above against the Euro area and ask yourself the following question. G7 includes Japan - a country that is shrinking in its overall importance in the global economy. This contributes significantly to the widening gap between the world income and G7 income. But the region in real trouble is the Euro zone. Again, this puts Euro area problems into perspective:

• Anemic growth
• Poor relative performance in terms of absolute levels of activity

In short - decay? or put more mildly - Japanese-styled obsolescence? Whatever you might call it, the likelihood of the Euro area being able to cover its debts and reduce its deficits is low. Much lower than that for the US and the rest of G7 (ex-Japan).

Some revealing stats on savings and investment:
Clearly, chart above shows the opening of the gap between the need for demographically-driven savings growth in the advanced economies, where ageing population is desperately trying to secure some sort of living for the future, and the lack of real savings achieved. It also shows the downward convergence trend in rapidly developing economies, where younger population is finally starting to demand better standard of living in exchange for years of breaking their backs in exports-focused factories.

Yet, as savings rose during the peak in advanced economies (pre-crisis), investment was much less robust and it even declined in rapidly developing economies:
Why? Because of two things: much of domestic savings in Advanced Economies, especially in Europe, was nothing more than the Government revenue uplift during the boom. In other words, instead of European citizens keeping their cash to finance future pensions, Governments were able to increase expenditure out of booming tax revenues and borrowing against the booming savings rates. Ditto in the USofA (although to a smaller extent). In the mean time, Asia Pacific Tigers started to finance increasingly larger proportion of fiscal imbalances in Advanced Economies, driving down their domestic investment pools and shifting their domestic savings into foreign assets. Which, of course, is an exact replica of the Japanese global investment shopping spree of the 1980s - and we know where that has led Japan in the end...

So the scary chart for the last:
The big question for G20 this time around will be not the stated in official press conferences and statements - but will remain unspoken, although evident to all involved: Given that over the last 20 years, advanced economies financed their purchases of exports from the rapidly developing countries by issuing debt monetized through savings of the developing countries, what can be done about the current twin threat of excessive debt burdens in advanced economies and the shrinking savings in emerging economies?

This is a far bigger question that the USD7 trillion one posited by the Bank of Canada. It is a question that will either see some drastic changes in the ways world economy develops into the next 20 years, or the permanent decline of the advanced economies into Japan-styled economic and geo-political obsolescence.

Economics 12/04/2010: The next incoming train has left its first station

My current article on the longer term prospects for global economy, published in the current issue of Business & Finance magazine. This is an unedited version.

Forget the circus of the Euro zone Government’s bickering about Greece’s bailout package and the escapist idea of setting up the EU-own EMF. The real crisis in the Euroland is now quietly unfolding behind he scenes.

Finally, after nearly 15 years of denial, courtesy of the severe pain inflicted by the bonds markets, Brussels and the core member states are forced to face the music of their own making. The current crisis affecting Euro area economy is, in the end, the outcome of a severely unbalanced economic development model that rests on the assumption that exports-led economic expansions in some countries can be financed through a continued massive build up in financial liabilities by their importing partners.

Put more simply, the problem for the world going forward is that in order to sustain this economic Ponzi game, net importers must continue to finance their purchases of goods and services from net exporters by issuing new debt. The debt that eventually settles in the accounts of the net exporters.

One does not have to be versed in the fine arts of macroeconomics to see that something is wrong with this picture. And one does not have to be a forecasting genius to understand that after some 40 years of rising debts on the balance sheet of importing nations, the game is finally up. I wrote for years about the sick nature of the EU economy - aggregate and individual countries alike.

Last week, Lombard Street Research's Charles Dumas offered yet another clear x-ray of of the problem.


Source: Lombard Street Research, March 2010

As Dumas' chart shows, core Euro area economies are sick. More importantly, this sickness is structural. With exception of the bubble-driven catch-up kids, like Spain, Ireland and Greece, the Euro area has managed to miss the growth boat since the beginning of the last expansion cycle.

The three global leaders in exports-led growth: Germany, Japan and Italy have been stuck in a quagmire of excessive savings and static growth. Forget about jobs creation – were these economies populations expanding, not shrinking, the last 10 years would have seen the overall wealth of these nations sinking in per capita terms. Only the Malthusian dream of childless households can allow these export engines of the world to stay afloat. And even then, the demographic decline will have to be sustained through disposal of accumulated national assets. So much for the great hope of the exports-led growth pulling us out of a recession. It couldn’t even get us through the last expansion!

Over the last decade, the Sick Man of Europe, Italy has managed to post no growth at all, crushed, as Dumas’ put it, by the weight of the overvalued and mismanaged common currency. The Sick Man of the World, Japan has managed to expand by less than 0.8% annually despite running up massive trade surpluses. Germany’s ‘pathetic advance over eight years’ adds up to a sickly 3½% in total, or just over 0.3% a year. France, and the UK, have managed roughly 0.98% annualized growth over the same time. Comparing this to the US at 1.27% puts the exports-led growth fallacy into a clear perspective.

I wrote in these pages before that the real global divergence over the last 10 years has been driven not by the emerging economies decoupling from the US, but by Europe and Japan decoupling from the rest of the world. The chart above shows this, as the gap between European 'social' economies wealth and income and the US is still growing. But the chart also shows that Europe is having, once again, a much more pronounced recession than the US.

Europe's failure to keep up with the US during the last cycle is made even more spectacular by the political realities of the block. Unlike any other developed democracy in the world, EU has manged to produce numerous centralized plans for growth. Since the late 1990s, aping Nikita Khruschev's 'We will bury you!' address to the US, Brussels has managed to publish weighty tomes of lofty programmes - all explicitly aimed at overtaking the US in economic performance.

These invariably promised some new 'alternative' ways to growth nirvana. The Lisbon Agenda hodge-podge of “exporting out of the long stagnation” ideas was followed by the Social Economy theory that pushed the view that somehow, if Europeans ‘invest’ money they did not have on things that make life nicer and more pleasant for their ageing populations growth will happen. Brussels folks forgot to notice that ageing population doesn’t want more work, it wants more ‘free’ stuff like healthcare, public transport, social benefits, clean streets, museums and theatres. All the nice things that actually work only when the real economy is working to pay for them.

As if driven by the idea that economic development can be totally divorced from real businesses, investors and entrepreneurs, the wise men of Europe replaced the unworkable idea of Social Economy with an artificial construct labelled ‘Knowledge Economy’. This promised an exports-led growth fuelled by sales of goods and services in which we, the Europeans, are supposedly still competitive compared to our younger counterparts elsewhere around the world. No one in Brussels has bothered to check: are we really that good at knowledge to compete globally? We simply assumed that Asians, Americans, Latin Americans and the rest of the world are inferior to us in generating, commercializing, and monetizing knowledge. Exactly where we got this idea, remains unclear to me and to the majority of economists around the world.

The latest instalment in this mad carousel of economic programmes is this year's Agenda 2020 – a mash of all three previous strategies that failed individually and are now being served as an economically noxious cocktail of policy confusion, apathy and sloganeering.

But numbers do not lie. The real source of Euro area's crisis is a deeply rooted structural collapse of growth in real human capital and Total Factor productivities. And this collapse was triggered by decades of high taxation of productive economy to pay for various follies that have left European growth engines nearly completely dependent on exports. No amount of waterboarding of the real economy with cheap ECB cash, state bailouts and public deficits financing will get us out of this corner.

The real problem, of course, is bigger than the Eurozone itself. Exports-led economies can sustain long-run expansions only on the back of a borrowing boom in their trading partners. It is that simple, folks. Every time a Mercedes leaves Germany, somewhere else around the world, someone who intends to buy it will either have to draw down their savings or get a loan against future savings. Up until now, the two were inexorably linked through the global debt markets: as American consumers took out loans to buy German-made goods, Chinese savers bought US debt to gain security of their savings.

This debt-for-imports game is now on the verge of collapse. Not because the credit crunch dried out the supply of debt, but because the global debt mountain has now reached unsustainably high levels. The demand for more debt is no longer holding up. Global economic imbalances remain at unsustainable levels even through this crisis and even with the aggressive deleveraging in the banking systems outside the EU.

Take a look at the global debt situation as highlighted by the latest data on global debt levels. The first chart below shows the ratio of net importing countries’ gross external debt liabilities (combining all debts accumulated in public and private sectors, including financial institutions and monetary authorities) to that of their net exporting counterparts. The sample covers 20 largest importers and the same number of largest exporters.

Source: IMF/BIS/World Bank joint data base and author own calculations

As this figure illustrates, since mid-point of the last bubble at the end of 2005, the total external debt burden carried by the world’s importing countries has remained remarkably stable. In fact, as of Q3 2009, this ratio is just 0.3 percentage points below where it stood in the end of 2005. Compared to the peak of the bubble, the entire process of global deleveraging has cut the relative debt burden of the importing states by just 9.8%.

To put this number into perspective, while assets base of the world’s leading economies has fallen by approximately 35% during the crisis, their liabilities side has declined by less than 10%. If 2007 marked the moment when the world finally caved in under the weight of unsustainable debt piled on during the last credit boom, then at the end of 2009 the global economy looked only sicker in terms of long-run sustainability.

The picture is more mixed for the world’s most indebted economies.
Plotting the same ratio for the US and UK clearly shows that Obamanomics is not working – the US economy, despite massive writedowns of financial assets and spectacular bankruptcies of the last two years remains leveraged to the breaking point. The UK is fairing only marginally better.

Of course, Ireland is in the league of its own, as the country has managed to actually increase its overall share of global financial debt during this crisis courtesy of an out-of-control public expenditure and the lack of private sector deleveraging. Take an alternative look at the same data. Ireland’s gross external debt (liabilities) stood at a whooping USD 2.397 trillion in Q3 2009, up 10.8% on Q3 2007. Of these, roughly 45% accrue to the domestic economy (ex-IFSC), implying that Irish debt mountain stands at around USD 1.1 trillion or more than 6 times the amount of our annual national income.

Chart below shows gross external debt of a number of countries as a share of the world’s total debt mountain.
Source: IMF/BIS/World Bank joint data base and author own calculations

And this brings us to the singularly most unfavourable forecast this column has ever made in its 7 years-long history. Far from showing the signs of abating, the global crisis is now appearing to be at or near a new acceleration point. Given the long-running and deepening imbalances between growth-less net exporting states, like Germany, Japan and Italy and the net importers, like the US, we are now facing a distinct possibility of a worldwide economic depression, triggered by massive debt build up worldwide. No amount of competitive devaluations and cost deflation will get us out of this quagmire. And neither a Social Economy, nor Knowledge Economics are of any help here.

Paraphraisng Cypher in the original Matrix: “It means fasten your seat belt, Dorothy, ‘cause Kansas of debt-financed global trade flows is going bye-bye”.