Economics 29/04/2010: Debt crisis is spreading

Another credit downgrade from S&P, this time for Spain, from AA+ to AA with negative outlook, based on the outlook for years of private sector deleveraging and low growth. Spain, as you can see, is severely in red in terms of debt, ranking 14th in the world. Spain's external liabilities stand at 186.1% or $2.55 trillion (as of 2009 Q3) against estimated 2009 GDP of $1.37 trillion.

The country is actually worse off in terms of debt than Greece which has ranks 16th at debt at 170.5% of GDP or $581.68 billion, with 2009 GDP of $341 billion.

Of course, Ireland is world's number 1 debtor nation with external debt of 1,312% of GDP (IFSC-inclusive) of $2.32 trillion in Q3 2009 against the GDP of $176.9 billion. Of course, part of this debt is IFSC, but then, again, we really do not have a claim on our GDP either, with GNP being a more real measure of our income. So on the net, our debts - the actual Irish economy's debts - are somewhere in the neighborhood of 740%. This is still leagues above the UK - the second most indebted nation in the world - which has the debt to GDP ratio of 'only' 426%!

The S&P also provided estimate for expected recovery rate on Greek bonds, which the agency put at 30-50%. In other words, S&P expects investors in Greek bonds to be paid no more than 30-50 cents on the euro. Yesterday on twitter I suggested that "Greek debt should be renegotiated @ 50cents on the euro - severe default. Portugal's @ 80 cents - mild default, Irish @ 70-75 cents". Looks like someone (S&P) agrees. Before it is too late, before German and other European taxpayers have poured hundreds of billions of euro into the PIIGS black hole of delinquent public finances, Europe should cut losses and force Greece and Portugal to renegotiate their liabilities. If Ireland and Spain were to elect to follow, so be it. Of course, in Irish case, the debt re-negotiations should cover private debts, not public debt.

Just how many billions of euros are EU taxpayers in for for the folly of admitting Greece - a country that spent 90 years of the last 180 (since 1829) in defaults on its debts - into the common currency area? Well, Greek 2-year bonds were traded at yields of 26% yesterday at one point in time. This is pricing that's in excess of pretty much every developing country, save for basket cases which practically cannot issue bonds at all.

IMF's Dominique Strauss Kahn has told Bundestag yesterday that Greek package will be

• €100-120bn for three years;
• Which means German taxpayers are on the hook for €67 billion over 3 years, not €25 billion that Germany ‘s economics minister was signing for in the original deal;
• Ireland's contribution will also have to rise to €4 billion over 3 years, not €500 million we originally were told we will have to contribute;
• Greece will not be forced to restructure or reschedule debt
• The loans to Greece will be subordinated to existent bondholders, which means that if in the end Greece does pay 30-50 cents on the euro to the latter, European taxpayers will be lucky to get 10 cents on the euro.

The whole deal is now looking like a massive subsidy for Greece and entails absolutely no protection to European taxpayers.

But internationally, EU news are getting darker and darker by the minute. Last night Bloomberg reported that EU countries are in for estimated €600 billion bill for the fiscal crises that have spread across the block. That's the cost, in the end, of all the tacky policy follies that Brussels endorsed and pushed through over the last 10 years -

• from the Lisbon Agenda, which was supposed to deliver EU to the position of economic superiority over the US by 2010,
  
• to the Social Economy, which was supposed to deliver... well, who knows what...
  
• to the Knowledge Economy, which was aiming to turn us all into brains in a Petri Dish
• to the absolutely outlandish HIPCI and HIPCII agendas wholeheartedly embraced by the EU, which were supposed to deliver debt relief to the world's real basket cases (before Greece and other PIIGS took the spotlight away from them), and the rest of the international white elephants.

The problem, of course, is that €600 billion price tag for fiscal excesses has generated preciously little in returns (despite what folks at Tasc keep telling us about the fiscal stimulus) which means we will have to pay for it out of our long term wealth. The same wealth that has been demolished by the recession and the financial markets collapse!

Economics 24/02/2010: Greeks, Germany and the euro

There is a fine mess going on in Athens. And it is both

• detrimental to the Euro; and
• predictable (see here).

Exactly a month ago to date, I have predicted that Greece is going into a Mexican standoff with EU. We now arrived at exactly this eventuality (see this link to a good summary of Greek Government views - hat tip to Patrick).

Back on January 24th, I wrote:

"The EU can give Greece a loan – via ECB... But the EU will have to impose severe restrictions on Greek fiscal policy in order to discourage other potential would-be-defaulters today and in the future. That won’t work – the Greeks will take the money and will do nothing to adhere to the conditions, for there is no claw back in such a rescue.

Alternatively, the EU might commit ECB to finance existent Greek debt on an annual basis. This will allow some policing mechanism, in theory. If Greeks default on their deficit obligations, they get no interest repayment by ECB in that year. ...but what happens if the Greeks for political reasons default on their side of the bargain?

If ECB enforces the agreement and stop repayment of interest, we are back to square one, where Greece is once again insolvent and its insolvency threatens the Euro existence. Who’s holding the trump card here? Why, of course – the Greeks. And, should the ECB play chicken with Greeks on that front, the cost of financing Greek bonds will rise stratospherically, and that will, of course, hit the ECB as the payee of their interest bill.

Thus, in effect, we are now in a Mexican standoff. The Greeks are dancing around the issue and promising to do something about it. The EU is brandishing threats and tough diplomacy. And the problem is still there."

There are three possible outcomes from the standoff:

• Greece backs down and Germany accepts an apology - which pushes us back to square one, with Greeks still in the need of funds and EU still without a plan;
• Greece goes for the broke and remains within the euro, implying a rapid and deep (ca 30%) devaluation of the euro; or
• Greece is forced out of the euro (there is, of course, no mechanism for such an action).

The first option is a delay in the inevitable; the last one is an impossible dream for fiscally conservative member states. Which leaves us only with the second option.

And incidentally, the only reason German bunds are still at reasonably low yields is because Germany is linked to Greece (and other PIIGS) only via common currency. Imagine what yields the German bunds might be at if a full political union was in place?

This, of course, flies in the face of all those who preach political federation as EU's answer to structural problem of hinging desperately diverse economies to common currency.

So hold on to your pockets - after the Exchequer raided through them via higher taxes; Greek default will prob their depths through devaluation. And then you'll still be on the hook for our banks claiming their share in an exercise of rebuilding their margins.

Economics 20/01/2010: Long term comparatives for Ireland

Some time ago I promised to publish some long term macroeconomic comparatives for Ireland relative to other small open economies of Europe. Here they are (all data is courtesy of the IMF's Global Economic Outlook dataset with some forecasts adjusted to reflect Government own forecasts in Budget 2010):

First output gap as percent of potential GDP

There is really no doubting who's worse off in this picture. And notice how much more dramatic is our output gap volatility compared to, say, Austria - another small, but more stable economy, despite it having a massive exposure to high growth and high volatility Eastern and Central European countries.

Next, we have GDP per capita.

Several features of the chart are worth highlighting.

Obviously, Iceland is now on the path, per IMF to close the gap between themselves and us in terms of GDP per capita. Dynamics-wise, it is expected to do better relative to Ireland than it ever did in the period since the late 1990s through the bubble. Taking medicine on time and in full, obviously pays for Iceland. Back in 1999 Ireland moved onto a path of GDP per capita in excess of Iceland. In 2009 it moved on the path of GDP per capita converging with Iceland.

Who's doing better here? By the end of 2014, Iceland is expected by the IMF to fully recover from the crisis, reaching peak GDP per capita once again, after a shorter recession than the one enjoyed by Ireland. And Iceland will do so with faster growth in population than Ireland will (see later charts).

Under DofF dreamy assumptions, Ireland too will reach its pre-crisis peak by 2014, but it would have taken us a year longer to get there than Iceland. And this is under DofF assumptions.

Now, I also provide my own forecast - somewhat gloomier than that of the Government - which implies that i do not expect Ireland to reach the pre-crisis peak income per capita any time soon. And this dynamic will be paralleled by a slower growing population.

Also, do remember - our GDP is not a measure of our income (GNP is), while for Icelanders the two measures are more closely related.

Next inflation as measured by CPI:
Do tell me we are just fine with 5% deflation in the current cycle. Not really, folks. In order to get us back to price levels that imply competitiveness, we need a good 40% deflation if not more.

Unemployment - the one that we are being told is getting better now that 'the worst is already behind us' per official Government view:
Again, think Iceland and Greece. Greece is a good one in particular - their unemployment was high since the late 1980s. Ours was low since the mid 1990s and sub-zero since 2001. But, thanks to our 'head-in-the-sand' economic policies during the current crisis - we are now at the top of the league.

Demographics - some say this is our saving grace, the golden 'get-out-of-the-slump' card:
Nothing spectacular that I can spot here. And these are IMF projections that lag in incorporating what we, on the ground already know - the rapid depletion of our foreign workers' population and waves of young Irish people leaving the country.

Let's take a look at employment (as opposed to unemployment) as % of the total population. basically, the higher the number, the lower is the country dependency ratio (in other words, the greater is the number of people working than the number of people they support):
We were doing pretty well - just below Iceland and Switzerland. Post crisis, Iceland will retain its second best position, but we will slide below Lux. Again, this is in the environment where our population will be growing slower than that of Lux...

General Government Balance:
Well, yes - per Brian Lenihan we have taken the necessary steps... Did we? How is fooling who here? Iceland will be ahead of us with default and without a mountain of international bondholders' and depositors' liabilities on the shoulders of its people. We will both, destroy our public finances and our private households' finances as well. All for what? To make sure we do not upset banks bond holders? But wait - these figures do not reflect Nama and its cost. They do not reflect future bank recapitalisations. Were they to do so, our Government Balance would have fallen way beyond 16-18% mark.

But let us take a different look at the same figure:
Now, remember all the talk about Charlie McCreevy being a profligate spender as the Minister for Finance. Actually, not really. Over his tenure - longer than that of his successor, McCreevy presided over relatively mild deterioration in fiscal position. Primary balance under McCreevy in cumulative terms was close to break even. Under Minister Cowen things spun out of hand. Noticeably, Minister Lenihan is doing a much better job than his predecessor, although it is hard to say whether he is doing it because he actually believes in some sort of fiscal discipline or because he simply cannot borrow all the money he would like to borrow.

Current account balance:
For an economy that is staking its survival on exports (and we really do not have much of hope of doing otherwise), we are not looking all too strong in 2010-2014 projections by the IMF. Iceland, in contrast, is looking mighty alright relative to us, having undergone massive devaluation. Again, our deflation at home is simply not enough to compensate for the fact that we cannot devalue the grossly expensive euro.

Let me take you through more comparatives. Back to Government deficits. Now, recall there are two components to deficit - structural (due to chronic overspend) and cyclical (due to a recession).
Again, notice how Greece and Austria are on virtually identical path, although Greece is above Austria. This means that on average, the share of their overall deficit that is structural is relatively the same. If Greeks were to cut their structural deficit relative to its position today, their overall deficit will decline by a lower percentage than the same drop for Ireland. In Ireland's case, we have smaller cyclical deficit than the Greeks do, but greater structural deficits. Relative to Austrians, we are simply a drunken sailor hitting the first pub on the shore.

Take a closer look at the Irish data alone:
In the 1980s through late 1990s - much lower structural deficits than since 1998. Why? I guess Bertie really was a profligately spending socialist of the old variety.

Last chart: just to drive home the same point as before: Note the dramatic deterioration in structural balances under Mr Cowen - throughout his years as Minister for Finance, he was spending not only the money he had (shallower surpluses than his predecessor), but also the money he did not have (deeper structural deficits), leveraging lavishly future generations' wealth. Mr McCreevy, in contrast, really was spending what he had, with structural deficits starting to cause problems in his tenure only around 2002.
And one last point to make - notice how our structural deficit has caught up with its 5-year moving average line. This suggests that even in the Budget 2010 we still did not do enough to reverse longer term trend leading us deeper and deeper into permanent insolvency.

Paraphrasing Fianna Fáil's 2002 general election slogan: "A Little Done, More To Do"...