26/1/15: If not Liquidity, then Debt: ECB's QE competitive limping

I have written before, in the context of QE announcement by the ECB last week (see here: http://trueeconomics.blogspot.ie/2015/01/2312015-liquidity-fix-for-euro-what-for.html) that the real problem with the euro area monetary and economic aggregates has nothing to do with liquidity supply (the favourite excuse for doing all sorts of things that the ECB keeps throwing around), but rather with the debt overhang.

In plain, simple terms, there is too much debt on the books. Too much Government debt, too much private debt. The ECB cannot even begin directly addressing the unspoken crisis of the private debt. But it is certainly trying to 'extend-and-pretend' public and private debt away. This is what the fabled EUR1.14 trillion (or so) QE announcement is about: take debt surplus off the markets so more debt can be issued. More debt to add to already too much debt, therefore, is the only solution the ECB can devise.

While EUR1.14 trillion might sound impressive, in reality, once we abstract away from the fake problem of liquidity, is nothing to brag about. Take a look at the following chart:

Forget the question in red, for the moment, and take in the numbers. Remember that 60% debt/GDP ratio is the long-term 'sustainability' target set by the Fiscal Compact - in other words, the long-term debt overhang, in EU-own terminology, is the bit of debt above that bound. By latest IMF stats, there is, roughly EUR3.5 trillion of debt overhang across the euro area 18, just for Government debt alone. You can safely raise that figure by a factor of 3 to take into the account private sector debts.

Which puts the ECB QE into perspective: at the very best, when fully deployed, it will cover just 1/3rd of the public debt overhang alone (actually it won't do anything of the sorts, as it includes private and public debt purchases). Across the entire euro area economy (public and private debt combined) we are talking about the 'big bazooka' that aims to repackage and extend-and-pretend about 10-11% of the total debt overhang. Not write this off, not cancel, not burn... but shove into different holding cell and pretend it's gone, eased, resolved.

This realisation should thus bring us around to that red triangle and the existential question: What for? Between end of 2007 and start of 2015, the euro area has managed to hike its debt pile by some EUR3 trillion, after we control for GDP effects. Given that this debt expansion did not produce any real growth anywhere, one might ask a simple question: why would ECB QE produce the effect that is any different?

The answer, on a post card, to the EU Commission, please.

6/8/2012: Financial Crises, Recessions and Government Debt

Another interesting chart from The Great Leveraging, by Alan M. Taylor, CEPR DP 9082. This one shows “Excess” Credit Growth (in other words the extent of credit contraction during the crisis) and the Paths of Real GDP in Normal (blue line) and Financial Recession (red line) Contingent on Initial Public Debt Levels.

Here's Taylor's own explanation: Figure 12 from work in progress (Jorda, Schularick, and Taylor, forthcoming) studies the impact of a similar "marginal treatment" [shock of 1% per annum extra loan to GDP growth during the expansion prior to the crisis over an above normal long run levels of growth - and recall that in Ireland's case this rate was probably 3-5 times the shock considered by Jorda et al], subject to starting Government debt/GDP ratio condition (taken as 0% of GDP to 100% of GDP). The central forecast lines - solid lines - provide for assumed 50% of GDP starting assumption for public debt to GDP ratio.

"First look at normal recessions (blue dashed line, dark shaded fan). Extra credit growth in the prior expansion is correlated with mild drag in the recession, say 50-75bps in the central case, but the effect is small, and does not vary all that much when we condition on public debt to GDP levels (the dark fan is not that wide). Now look at financial crisis recessions (red solid line, light shaded fan). Extra credit growth in the prior expansion is correlated with much larger drag, almost twice as large at 100-150bps, and the impact is very sensitive to public debt to GDP levels going in (the light fan is very wide). At public debt to GDP levels near 100% a sort of tailspin emerges after a financial crisis, and the rate of growth craters down from the reference levels by 400bps at the end of the window. Recall, effects in this chart are shown as non-cumulative."

This is serious stuff, folks. In effect the chart above shows that, had Ireland entered the crisis with, say 80% Government debt/GDP ratio, we would have been losing some 2.03% percent on average annually over 6 years. Funny thing - we are, so far on track to exceed this number.

Many say we had a very enviable, low Government debt to GDP ratio at the onset of the crisis - officially - at 44.23% in 2008. Alas, that is platitudinal bull when it comes to hard reality. The problem for the argument involving the 44% figure above is that starting with 2008, Ireland promptly loaded onto the shoulders of the Exchequer massive banks debts, which have pushed Irish Government liabilities up by at least €67 billion, or well above 90% of GDP. Not all of this was taken as debt (NPRF funds) and not all of this was taken as immediate debt (with banks recaps running into 2011), but as far as resources available to combat the crisis go [something that low Government debt at the onset of the crisis should have allowed], banks resolution measures exerted direct drag on Irish Exchequer capacity to use low initial debt levels to fund transition out of the crisis. In other words, as the real data and comparison of it to Taylor's results show, the idea of our low initial starting debt levels being a boom to our situation is bollocks.

Thus, in terms of the chart above, we are closer to 80-90% starting point for debt/GDP ratio for the onset of the crisis period (thanks to Brian Cowen's Government efforts). Which implies that over the 6 years horizon of the crisis, we should expect a cumulative decline in the economy GDP of ca 12%. The fact that over the last 5 years we have seen our GDP declining by 9.52% (using IMF data and 2012 forecast) means only one thing: more pain is yet to come.

1/8/2012: Some interesting notes on Debt and Growth

Some interesting long-term relations between Government debt and economic growth. No comment, but few stats and charts:

First - levels of debt and levels of growth:

Weak, negative relationship above.

Now, rates of change in debt y/y and growth:

Much stronger negative relationship above. Of course, we would expect that negative growth would lead to growth in debt/GDP ratio due to stimuli and due to simple fact of shrinking GDP.

Here's the matrix of average rates:

What do we have?

• Both debt and economy expanding (pro-cyclical expansion): 144 episodes in 1980-2012 period, debt growth on average is 3.172%pa against GDP growth on average of 2.086%pa.
• Recession counter-cyclical growth in debt against contracting GDP: 43 episodes, average growth rate in debt 8.847% and average growth rate in GDP is -2.389%. 
• Countercyclical contraction in debt during economic growth periods: 123 episodes, with average contraction in debt of -2.582% and corresponding (accompanying) expansion in the GDP of 3.782%

So conclusions: during expansions, debt shrinks, but by less than economy grows. During contractions, debt expands but by more than the decline rate in the economy. Worse than that - pro-cyclicality dominates counter-cyclicality. There are more episodes when debt grows during economic expansion than when debt grows during economic contractions. The average rates of debt expansion during economic expansion are greater than the average debt contraction rate during economic expansions. The gap is on average annually of ca 0.6% of GDP in terms of debt growth exceeding debt contraction during episodes of economic growth.

It is worth to note that EA12 are not unique by a significant margin when compared to Advanced economies sample: