22/10/2012: Is Ireland a 'Special Case' in the Euro area periphery?

Since the disastrously vacuous summit last Thursday and Friday, there has been a barrage of 'Ireland is special' statements from Merkel and other political leaders. The alleged 'special' nature of Ireland compared to Greece, Portugal and Spain is, supposedly, reflected in Irish banks being successfully repaired and Irish fiscal crisis corrected to a stronger health position than that of the other peripheral countries.

I am not going to make a comment on the banking system's functionality in Ireland compared to other states. But on the fiscal front, let's take a look. Per IMF:

• In 2012 we expect to post a Government deficit of 8.30% of GDP against Greece's deficit of 7.52%, Portugal's 4.99% and Spain's 6.99%. We are 'special' in so far as we will have the highest deficit of all peripheral countries.
• In 2013, Ireland is forecast to post a Government deficit of 7.52% of GDP against Greece's 4.67%, Portugal's 4.48% and Spain's 5.67%. Once again, 'special' allegedly means the 'worst performing'.
• In 2012, Ireland's structural deficit would have fallen from 9.31% of potential GDP in 2010 to 6.15% - a decline of 3.16 ppt. For Greece, the same numbers are 12.12% to 4.53% - a decline of 7.59 ppt or more than double the rate of austerity than in Ireland. For Portugal, these numbers are  8.96% to 4.09% - a decline of 4.87 ppt of more than 50% deeper reduction than in Ireland. For Spain: 7.32% to 5.39% - a drop of 1.93 ppt or shallower than that for Ireland.
• In 2013 in terms of structural deficit, Ireland (5.38% of potential GDP deficit) will be worse off than Greece (-1.06% of potential GDP), Portugal (2.28%) and Spain (3.52%)

Now, run by me what is so 'special' about Ireland's fiscal adjustment case?

Can it be that we are 'lighter' than other peripherals on debt?

• 2010 Government debt in Ireland stood at 92.175% of GDP and this year it will be around 117.743% - up 25.255% of GDP. For Greece this was respectively 144.55% of GDP in 2010 and 170.731% in 2012 - a rise of 26.181%, marginally faster than that for Ireland. For Portugal, gross Government debt was 93.32% of GDP in 2010 and that rose to 119.066% in 2012, an increase of 25.746%. Again, not far from Ireland's. And for Spain, these numbers were 61.316% to 90.693% - a rise of 29.377%. So while Spain is clearly the worst performer in the class, Ireland, Greece and Portugal are not that far off from each other.

Wait, what about economic reforms and internal devaluations? Surely here Ireland, with its exports-focused economy is a 'special' case?

• In 2012, Ireland is expected to post a current account surplus of 1.813% of GDP, against deficits of between 0.148% and 2.909% for the other three peripheral countries. This, of course, is not the legacy of Irish reforms, but of the MNCs operating from here.
• However, in terms of current account dynamics, Ireland is not that special. Between 2010 and 2012, Greece will reduce its current account deficit by 4.294 ppt, Ireland will improve its external balance by 0.674 ppt, Portugal by 7.105 ppt and Spain by 2.278 ppt. So Ireland is the worst performing country of four in terms of current account dynamics, while the best performing in terms of current account balance.

Now, do run by me what can it possibly mean for Ireland to be a 'special' case compared to Greece, Portugal and Spain?

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 24/01/2010: A Mexican stand-off: Eurozone v Greeks

It is nice to note that the theme picked up by the post below has been followed upon by the continued media debate today:

According Der Spiegel today: the European Commission warned that the euro area’s chances of survival would depend on adjusting the internal imbalances. DG Ecfin apparently claims in a new paper that internal imbalances would weaken confidence in the euro and endanger the cohesion of the monetary union. Rising deficits and weakening competitiveness in several countries, notably Ireland, Spain and Greece are singled out by the Commissions as the main causes of the pressure on the euro. DG Ecfin, allegedly says the necessary adjustment in the deficit countries will require wage moderation to address rising unemployment in the above countries.

And another one from today: here.

So what is going on with Greece? Not much, it appears. Just like Ireland did before it, Greece decided to throw some smoke around its fiscal debacle with promises of reaching the 3% SGP limit by 2012 (Ireland is now saying it will be 2014, although ESRI’s presentation last Monday was clearly showing they expect deficit to be well above 3% level then).

And like Ireland, Greece has elected to cut some easy expenditure targets – capital investment and irregular payments and some social services. Ireland has gone slightly further by imposing a modest cut on wages and passing a gratuitous tax on pensions in the public sector. Of course, wage cuts were far from what was necessary, while the pensions tax was not even enough to cover the expected future increases in pensions liabilities that will arise due to, frankly Marcian in its surreality, practice of indexing future public sector pensions to wage rises in the sector.

And so, like Ireland, Greece has not been reckoning with the reality of its deficits. Unlike Ireland, however, it was not able so far to fool the markets, and it was unable to raise taxes. And unlike Ireland, Greece was a serial offender on the front of deficits (see charts) in recent years, during the boom. Note, this, of course, does not reflect the fact that Greek’s deficit accounts for their banks supports measures (negligible), while ours does not (massive).
And this means, everyone is still wondering – what is going to happen with Greece?

Last week several significant statements were made on the subject. First, Handelsblatt reported that "the EU has put the thumb-screws to the Greeks", noting that "under massive European pressure the Greek government has agreed to have its state finances cleaned up faster than initially planned". Greece has now pledged to reduce its budget deficit from around 12.7% in 2009 to under 3% of GDP by the end of 2012.

Handelsblatt information de facto denied by senior EU figures. In an interview with Il Sole 24 Ore, ECB Executive Board Member Juergen Stark said that the EU would not help bail out Greece, arguing: "Greece is in dire straits: not only has the deficit reached very high levels, but the country has also witnessed a serious loss of competitiveness [haven’t Ireland?]. Such problems are not due to the global crisis, since they are substantially homemade. …Rules... are unequivocal: being part of the Monetary Union doesn't guarantee any right to claim for financial support by other member states."

Of course, if pressure was applied on Greece [per Handelblatt], there must have been some sort of a threat. What can such a threat be?

Could the EU officials told Greek Government ‘Shape up or you are out of the Eurozone’? Nope – no such possibility even in theory.

Could they have told the Greeks ‘If you don’t resolve the problems with you deficit optics, we can’t give you a bailout’? Oh, yes, that could have happened. In fact, the threat of ‘no EU goodies, unless…’ threat is just what EU has used before on other countries –Switzerland and Norway (access to EU markets), and Ireland and Denmark (access to ‘influence’ within the EU).

So let us take it as a possibility, no mat6ter how remote, that the EU folks told the Greeks to get working on some sort of a face-saving formula to allow for their rescue by the EU/ECB.

Last Friday Wall Street Journal reported that the EU Commission spokeswoman outright denied such a rescue plan being worked on, saying she wasn't aware of any financial bailout packages being arranged. But then, in an interview to Die Welt Chief Economist of Deutsche Bank Thomas Mayer (a man whose statements are not to be taken lightly) said: "The situation [in Greece] is more serious than it has ever been since the introduction of the euro. The trouble in Greece plays a key role for future development... If the Greece situation is handled badly, the Euro-zone could break down, or suffer major inflation. Neither the European Central Bank nor the Commission nor any other EU body can force Greece to implement necessary reforms in exchange for help."

What does he mean ‘no body in the EU can force Greece’? He means here not the political infeasibility of the EU actually slapping on the conditions on Greece to implement austerity measures in exchange for funding. That can be done. What cannot be achieved is the enforcement of such conditions.

The problem is really simple and, thus, grave.
The EU can give Greece a loan – via ECB, say, for 10 years at 2-3% per annum, in the amount of 30% of its debt. That would be fine. It will not solve Greece’s problem, but it will alleviate pressures on deficit side, as country interest bill will fall substantially, allowing it some room to reduce structural side of deficit more gradually. 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. They would have to require, as a condition of the loan, a constraint on Greek deficits going forward so severe that other PIGIES (note the renaming of the club – Austria is out, Estonia is in) don’t dare roll their massive deficits into debt into perpetuity in hope of a similar rescue.

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. Sounds fine in theory 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.

Martin Wolf of Financial Times: "the crisis in the eurozone's periphery is not an accident: it is inherent in the system. …When the eurozone was created, a huge literature emerged on whether it was an optimal currency union. We know now it was not. We are about to find out whether this matters."

Indeed, we are about to find out… hold on to your socks, folks.

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"...