14/5/15: The Happiest Deflationary Consumers of Ireland... April 2015 Data.

Good thing Consumer Confidence is booming in Ireland, cause otherwise we might get a wind that domestic demand for goods and services is going nowhere:

Now, how would we get such an idea. you might ask? Well, simples.com : take a look at consumer prices:

Spot the trend? That's right: CPI was down 0.7% y/y in April and down 0.6% on average over the last 3 months.

And in case you want to see what 'sustains' at least some semblance of non-totally-collapsing prices? Why here it is:

Well, the only reason we are not a complete basket case come inflationary dynamics is thanks to tobacco and alcohol (up whooping 26.5% over the pre-crisis average thanks to tax extraction by the State), and electricity and rents (pushing housing, water, electricity, gas etc up 7.1% over the pre-crisis levels - you might also call that tax extraction, for much of these increases goes to fund semi-states and quangos and soon-to-come Irish Water), Health (where much of the 'savage cuts' were just something masking the actual hikes in cost of services to those of us who pay for them), and Education (where state extraction of funds was so rampant as outpace by a factor of 10 overall inflation in the economy), and Restaurants & Hotels (where the cut in Vat did nothing to alleviate price pressures on consumers), and a bunch of state-related and regulated prices that went into Miscellaneous category.

And so just as with retail sales, deflation is now consistent with rising consumer confidence. Happiness attained, at last. Just never ask what happens to demand when prices (imported from the rest of the Euro area) start creeping up across all sectors... that is something polite Irish economy forecasters don't want to talk about...

23/4/15: Where the Bad of Deflation Looks Good...

You know the theory of the 'Bad of Deflation' - I wrote about it before... the story goes as follows: if prices fall, and consumers expect them to continue to fall, then rational consumers will withhold their demand, delaying their purchases in anticipation of lower price in the future. The result will be: reduced demand today, lower investment by the firms in future production, lower investment in innovation, stagnation, layoffs, recession... locust... fire balls falling from the skies and pestilence of the kind that only Central Bankers can save us from.

You also know my response to this, especially in the current macroeconomic conditions: falling prices support household real incomes and increase households' ability to finance debt and debt deleveraging, while sustaining at least some semblance of civilised demand.

But don't take my word for this. Here is a handy chart plotting... deflation in the price of hard drives:

It's source is here: https://www.thatdatadude.com/interactive-chart-hard-drive-prices-1950-2010

Do let me know if you know of any evidence that demand for hard drives has been 'delayed' by consumers or that innovation has 'stopped' in fear of lower prices/returns by companies, or if you have seen locust swarming around...

5/3/15: Russian Economy: External Trade, Inflation and Wages

Quick digest of top news relating to Russian economy:

Customs receipts for Russian Federation in February 2015 reached RUB393.7 billion down 30% y/y. January-February receipts were RUB840 billion or 19.6% down y/y. Full year 2014, customs receipts amounted to RUB7.1 trillion - up 8.5% y/y.

Much of the decline is down to imports collapse: imports were down over 2014 by USD29 billion or 9.5% y/y to USD286 billion in 2014 from USD315 billion in 2013. Only three countries saw increased exports into Russia: U.S., Kazakhstan and Brazil. Largest declines in export to Russia were in Ukraine (31.9%), Japan (19.5%) and Belarus (15.6%). By category of imports: largest declines in Russian imports were in passenger vehicles (21.9%), heavy transport equipment and agricultural equipment and machinery (22.3%), engines and power trains (13.2%), household appliances (20%), milk and dairy products (17.5%), pharmaceuticals (13.1%), and alcoholic beverages (12.3%). Imports categories that posted y/y increases in 2014 were: computer equipment (8.6%), telecommunications equipment (6.9%), household chemicals (4.4%) and heating equipment (3.8%).

Given decline in external trade, largest adverse impact of the Russian crisis is being felt in Armenia and Ukraine.

• Armenia received remittances from Russia to the tune of 10% of its GDP in 2012, which fell to around 6% by the end of 2014. Armenia's net exports into Russia accounted for roughly 3% of GDP, while Russian investors account for roughly 50% of total foreign investment stocks.
• Ukraine received remittances from Russia amounting to 2.1% of GDP in 2012 and Russia accounted for roughly 25% of Ukrainian exports. Russian investors account for around 5% of the stocks of foreign direct investment in Ukraine.

Inflation: January inflation printed at 3.9% m/m, or 15% y/y. February 2015 inflation reached 16.7% y/y. Food prices rose 23.3% y/y in February, against 6.9% y/y inflation in food prices in February 2014. M/m February inflation was 2.2% m/m, suggesting potentially a slowdown in the rate of inflation. Some shorter term data suggest that over the first week of March, weekly CPI stood at 0.2% - the lowest weekly reading since October 2014. Good news, for many, bad news for many more: vodka prices fell 0.4% in February.

Wages: A recent survey by a large recruitment company, the Hay Group, showed that 75% of businesses are planning to raise wages in 2015. RBC has details (in Russian): http://top.rbc.ru/economics/04/03/2015/54f706b39a7947103b521853 E-commerce enterprises are planning largest wage hikes (+11.3% on average), followed by Industry sector (+10%), media (9.7%), chemical sector (+9.4%). None of the wage hikes planned are matching expected inflation: Central Bank of Russia forecasts 2015 year-end inflation at 12-12.4% and average inflation during 2015 at 15.8%.

An interesting report in RBC on the proposals for economic reforms from the Russian Union of Industrialists and Entrepreneurs (sort-of Russian IBEC), РСПП (see here: http://top.rbc.ru/economics/04/03/2015/54f724ea9a79472c640c6f5e). According to RSPP, Government response to the crisis should focus on achieving further liberalisation in the economy. First pillar of the proposals focuses on early stage reforms, especially those aiming to stabilise the financial situation in the corporate sector. Second pillar contains 73 specific Government and regulatory decisions that should be suspended to reduce their adverse impact on corporate sector.



Note: those who are interested to learn more about the above topics or the business and economic environment in Russia can contact me to arrange a more in-depth one-on-one briefing.

18/2/15: Inflation Expectations and Consumers' Readiness to Spend

In an earlier post I provided a rough snapshot of the evolving relationship between inflation and consumer demand. But here is a fresh academic paper covering the same subject:

Bachmann, Rüdiger, Tim O. Berg, and Eric R. Sims. 2015. "Inflation Expectations and Readiness to Spend: Cross-Sectional Evidence." American Economic Journal: Economic Policy, 7(1): 1-35. https://www.aeaweb.org/articles.php?doi=10.1257/pol.20130292 (h/t to @CHCEmsden for this link)

From the abstract: the authors examined "the relationship between expected inflation and spending attitudes using the microdata from the Michigan Survey of Consumers. The impact of higher inflation expectations on the reported readiness to spend on durables is generally small, outside the zero lower bound, often statistically insignificant, and inside of it typically significantly negative. In our baseline specification, a one percentage point increase in expected inflation during the recent zero lower bound period reduces households' probability of having a positive attitude towards spending by about 0.5 percentage points."

In other words, when interest rates are not close to zero, consumers expecting higher inflation do lead to a weak, statistically frequently zero, uplift in readiness to increase durable consumption (type of consumption that is more sensitive to price variation, and thus should see a significant positive increase in consumption when consumers anticipate higher inflation).

But when interest rates are at their zero 'bound', consumers expecting higher inflation in the future tend to actually cut their readiness to spend on durables. Not increase it! And this negative effect of future inflation on spending plans is "significantly negative".

Now, give it a thought: the ECB is saying they need to lift inflation to close to 2% from current near zero (stripping out energy and food). Based on the US data estimates, this should depress "households' probability of having a positive attitude towards spending" by some 1 percentage point or so. In simple terms, there appears to be absolutely no logic to the ECB concerns with deflation from consumer demand perspective.


Update: a delightful take on deflation from Colm O'Regan: http://www.bbc.com/news/blogs-magazine-monitor-31489786. And a brilliant vignette on prices, markets, consumers and ... thought for deflation too: http://www.eastonline.eu/en/opinions/hobgoblin/economics-elsewhere-three-tales-that-may-rock-the-boat by @CHCEmsden h/t above.

20/11/2014: Oil Prices: Supply and Demand Drivers

An interesting BofE note on links between commodities prices & UK inflation: http://www.bankofengland.co.uk/publications/Documents/inflationreport/2014/ir14nov4.pdf

A key chart - from global perspective - is this one:

Main points are:

1. 2014 demand growth is way down, driven primarily by contracting demand in the OECD economies (advanced economies rot) and to a lesser extent relatively flat (compared to 2000-2007) growth in non-OECD economies.
2. Supply from non-OPEC sources is way up, while OPEC is cutting back. Net effect - growth in supply is way above 2000-2007 average.

This suggests that OPEC will have little room to cut continued growth in supply, while some restoration in demand should take place if the OECD economies post more robust growth in 2015. Still, it is hard to see how the above dynamics can support oil prices in USD100+/b over the next 12-15 months.

29/8/2014: Tea-leafing at ECB: Someone Takes Them Seriously...

This chart, courtesy of Credit Swiss, via @FGoria shows y/y Euro area HICP inflation against ECB projections for the same:

This has to put sorcery and fortunetelling to shame...

10/8/2014: Inflating Away the Public Debt? Not so fast...

There is a lot of talk amongst Irish and european policymakers about the big great hope for deflating public debts across euro area periphery: the prospect of inflation taking chunks out of the real debt burdens. This hope is based on a major misunderstanding of history. In many a cases, in the presence of debt overhang, higher inflation does help erode the real value of debt. Alas, "While across centuries and countries, a common way that sovereigns have paid for high public debt is by having higher, and sometimes even hyper, inflation, this rarely came without some or all of fiscal consolidation, financial repression, and partial default (Reinhart and Rogoff, 2009)." This quote starts the new NBER paper, titled "Inflating Away the Public Debt? An Empirical Assessment" by Jens Hilscher, Alon Raviv, and Ricardo Reis )NBER Working Paper No. 20339, July 2014)

In other words, it remains to not entirely clear just how effective inflation can be in current environment, given there are no defaults and there are no direct and aggressive financial repression measures implemented in the majority of the advanced economies, yet.

The NBER paper takes on the issue from the U.S. debt perspective. Per authors, "…with U.S. total public debt at its highest ratio of GDP since 1947, would higher inflation be an effective way to pay for it?"

"Providing an answer requires tackling two separate issues:

1. "The first is to calculate by how much would 1% unanticipated and permanently higher inflation lower the debt burden. If all of the U.S. public debt outstanding in 2012 (101% of GDP) were held in private hands, if it were all nominal, and if it all had a maturity equal to the average (5.4 years), then a quick back-of-the-envelope answer is 5.5%.1 However, we will show that this approximation is misleading. In fact, we estimate that the probability that the reduction in U.S. debt is as large as 5.5% of GDP is below 0.05%. The approximation is inaccurate since the underlying assumptions are inaccurate. The debt number is exaggerated because large shares of the debt are either held by other branches of the government or have payments indexed to inflation and the maturity number is inaccurate because it does not take into account the maturity composition of privately-held nominal debt."
2. "The second issue is that assuming a sudden and permanent increase in inflation by an arbitrary amount (1% in the above example) is empirically not helpful. After all, if the price level could suddenly jump to infinity, the entire nominal debt burden would be trivially eliminated. It is important first to recognize that …if investors anticipated sudden infinite inflation, they would not be willing to hold government debt at a positive price. Second, the central bank does not perfectly control inflation, so that even if it wanted to raise inflation by 1% it might not be able to. Moreover, there are many possible paths to achieving higher inflation, either doing so gradually or suddenly, permanently or transitorily, in an expected or unexpected way, and we would like to know how they vary in effectiveness. Therefore, it is important to consider counterfactual experiments that economic agents believe are possible."

The authors "calculate novel value-at-risk measures of the debt debasement due to inflation, and ...consider a rich set of counterfactual inflation distributions to investigate what drives the results. Using all these inputs, [authors] calculate the probability that the present value of debt debasement due to inflation is larger than any given threshold. The 5th percentile of this value at risk calculation is a mere 3.1% of GDP, and any loss above 4.2% has less than 1% probability. Interestingly, much of the effect of inflation would fall on foreign holders of the government debt, who hold the longer maturities. The Federal Reserve, which also holds longer maturities, would also suffer larger capital losses."

The paper also "…explores the role of an active policy tool that interacts with inflation and is often used in developing countries: financial repression. It drives a wedge between market interest rates and the interest rate on government bonds, and acts as a tax on the existing holders of the government debt. We show that extreme financial repression, where bondholders are paid with reserves at the central bank which they must hold for a fixed number of periods, is equivalent to ex post extending the maturity of the debt. Under such circumstances inflation has a much larger impact, such that if repression lasts for a decade, permanently higher inflation that previously lowered the real value of debt by 3.7% now lowers it by 23% of GDP."

In short, there is no miracle inflationary resolution of the U.S. debt conundrum. And similarly, there is probably none for the euro area sovereigns stuck with debts in excess of 90-100% of GDP. The pain of inflation alone is simply not enough to magic away debts. Instead, the pain of inflation will have to be coupled with the added pain of financial repression, and in the euro area case, this pain will befall more domestic investors and savers, than in the U.S. case simply due to differences in debt holdings. While no one expects the financial repression in the euro area to match that deployed in Greece and Cyprus, one can expect the financial repression measures (higher taxation in general, higher taxation of savings and overseas investments, higher rates of cash extraction from consumers via public sector pricing and higher concentrations in the financial services sector to increase rates of cash extraction by the banks) are here to stay and to most likely get worse before things can improve a decade later.

The myth of higher inflation as a (relatively) painless salvation to our debt ills is getting thinner and thinner...

1/4/2014: An ECB challenge...

A quick chart plotting euro area's challenge on deflationary side. Taking annual average HICP indices rebased back to 100=1996 for a number of countries and positing the data against the same for the US:

You can clearly see downward divergence in the euro area starting from 2010 on...

12/2/2014: Jobless Recoveries post-Financial Crises: Solutions Menu?

Next few posts will be touching on some interesting new research papers in economics and finance… in no particular order. Please note, no endorsement or peer review analysis from me here.

To start with: NBER WP 19683 (http://www.nber.org/papers/w19683) by Calvo, G., Coricelli, F. and Ottonello, P. "JOBLESS RECOVERIES DURING FINANCIAL CRISES: IS INFLATION THE WAY OUT?" from November 2013.

The paper discusses 3  traditional policy tools to mitigate jobless recoveries during financial crises: 

• inflation
• real devaluation of the currency, and  
• credit-recovery policies. 

The nominal exchange rate devaluation tool not being available to the euro area economies independently of the ECB, we have by now heard a lot about inflation (the need for). At the same time, real devaluation tool includes fabled European cost-competitiveness measures. 

Here's the pre-cursor to the paper: "The slow rate of employment growth relative to that of output is a sticking point in the recovery from the financial crisis episode that started in 2008 in the US and Europe (a phenomenon labeled “jobless recovery”). The issue is a particularly burning one in Europe where some observers claim that problem economies (like Greece, Italy, Ireland, Spain, and Portugal) would be better off abandoning the euro and gaining competitiveness through steep devaluation. This would be a momentous decision for Europe and the rest of the world because, among other things, it may set off an era of competitive devaluation and tariff war."

Hypotheticals aside, the study starts by "digging more deeply into the relationship between inflation and jobless recovery, also considering the possible role of real currency depreciation and resource reallocation (between tradables and non-tradables)."

As authors note: "This discussion is particularly relevant for countries that, being in the Eurozone, cannot follow a nominal currency depreciation policy to mitigate high unemployment rates 

(e.g. Greece, Italy, Ireland, Spain, and Portugal)."

First finding is that there is "some evidence suggesting that large inflationary spikes (not a higher inflation plateau) help employment recovery. Even in high-inflation episodes, inflation typically returns to its pre-crisis levels…" so the effects of the induced inflation wear out quasi-automatically.

Second finding is that "(independent of inflation) financial crises are associated with real currency depreciation (i.e., the rise in the real exchange rate) from output peak to recovery. This shows that the relative price of non-tradables fails to recover along with output even if the real wage does not fall, as is the case in low-inflation financial crisis episodes. This implies that, contrary to widespread views, nominal currency depreciation may eliminate joblessness only if it generates enough inflation to create a contraction in real wages; real currency depreciation or sector reallocation might not be sufficient to avoid jobless recovery if all sectors are subject to binding credit 

constraints that put labor at a disadvantage with respect to capital." In other words, there goes Argentina's fabled hope for recovery via devaluations.

Third finding extends the second one to the case closer to euro area peripherals: "Similarly, for countries with fixed exchange rates, “internal” or fiscal devaluations during financial crises are likely to work more through reductions in labor costs than changes in relative prices and sectoral reallocation obtained through taxes and subsidies affecting differentially tradable and non-tradable sectors." In other words, internal devaluations work, and they work via cost competitiveness gains and exporting sector repricing relative to domestic.

Tricky thing, though: "However, neither nominal nor real wage flexibility can avoid the adverse effects of financial crises on labor markets, as wage flexibility determines the distribution of the burden of the adjustment between employment and real wages, but does not relieve the burden from wage earners." which means that a jobless recovery is more likely under internal devaluation scenario.

Fourth finding: "Our findings highlight the difficulty in simultaneously preventing jobless and wageless recoveries, and suggest that if the goal is to avoid jobless recovery, the first line of action should be an attempt to relax credit constraints." Oops… but credit constraints are not being relaxed in the case of collapsed financial systems and debt overhang-impacted households in the likes of Ireland.

More on this: "Only direct credit policies that tackle the root of the problem seem to be able to help unemployment and wages simultaneously. …common sense suggests the following conjectures. In advanced economies, quantitative easing operations, especially if they involve the purchase of “toxic” assets, can have an effect on increasing firms’ collateral and relaxing credit constraints that affect employment recovery." But, of course, in Ireland these measures failed to trigger such outcomes - Nama has been set up for two years now and credit restart is still missing. May be one might consider the fact that targeting of bad assets purchases is needed? May be buying up wasteful real estate assets was not a good idea and instead we should have pursued purchases and restructuring of mortgages? Sort of what Iceland (partially and with caveats) did?

Overall, tough conclusions all around. 

10/2/2012: Few thoughts on the global policy crisis

What makes me really concerned nowdays is not the ongoing crisis, but the logical and numeric impossibility of the mounting policy "solutions' to the crisis. Here's a quick synopsis. Take a look around the world:

• Bank of England repeated QE rounds in the face of £1 trillion+ debt pile is a strategy for growth via debasement of the currency
• Fed's continued unrelenting QE is much the same
• ECB has been debasing any real connection between banks, real economy and banks profits via uninterrupted injection of cash into banks - giving a license to earn free profits on interest margins while monetizing already excessive Government debts. Real economy, of course, gets hammered by sterilization via reduced real credit flows. The end game - moral hazard of massive proportions in the financial sector across Europe
• EU itself is hell-bent on debasing real incomes and wealth of its citizens by implementing the Fiscal Compact as the sole policy tool for dealing with the crisis
• Obama Administration is debasing, in contrast with EU, the future generations' wealth and income by continuing to spend Federal dollars like a drunken sailor arriving in a casino
• Ireland's Government is actively debasing the entire domestic economy, oblivious to the reality that households and businesses deleveraging is being prevented by banks and Government deleveraging - all for the sake of grand posturing of "We will pay all our debts" variety
• Japan is engaged in an active pursuit of debasing Government balancesheet as the debt bubble spreads to Japanese Government bonds - now in negative yields
• China is debasing its monetary and fiscal policies to deliver a 'soft landing' to the massive train wreck of its vastly bubble-like property and banking sectors

Close your eyes and think - how will the world be able to reverse out of these disastrous desperate policies in years ahead without completely shutting off growth via high interest rates, destabilized savings-investment links and in the presence of ever-rising public, private and corporate debts? What levels of inflation will be required to 'inflate' out of this mess? What degree of real wealth destruction has to be imposed on the ordinary people to sustain these gambles without a structured, orderly and coordinated restructuring of debts? What asset class and geography hedge can protect you from this avalanche of disastrous policy choices by the Western leaders?

09/06/2011: CPI data for May

Consumer Price Inflation data for May is out today. Recall that a month ago, higher mortgage costs and oil prices pushed inflation to a 30-month high, with prices in April up 0.4% mom and 3.2% yoy. This was the second highest rate of annual inflation since 2008. This time around, the catalyst for inflationary pressures was supposed to be mortgages costs, as ECB hike of 25bps in April was expected to feed through to retail rates. CSO is very careful about this aspect of inflation, having issued in the latest release an explanatory note (see below). Market expectation, consistent with my view expressed in December-January issue of Business & Finance magazine, is for inflation to average around 2.8-3.1% in 2011.

Now, on to today's data:

• May CPI rose 0.1% mom - below the markets expectations and below 0.6% mom rise in May 2010. Yoy inflation was at 2.7% in May 2011, again below expectations in the market.
• HICP - omitting, among others, cost of mortgages, car and home insurance, car taxes etc (see CSO note on this in the main release) - posted 0% change mom against 0.3% increase mom in May 2010. Annual HICP rose 1.2% relative to May 2010.

Charts to illustrate - first CPI, then two indices of prices:
In annual terms, largest increases were posted in

• Housing, Water, Electricity, Gas & Other Fuels - up 8.5% after posting 11.8% rise in April and 12.5% in March. Within the category, Rents posted a 1.0% decline yoy and 0.1% increase mom, while mortgages interest costs posted a 0.6% mom rise and 20.1% increase yoy. Electricity, gas & other fuels sub-category posted a 1.0% decline mom and 6.6% rise yoy with Liquid fuels falling 3.8% mom and rising 17.9% yoy.
• Miscellaneous Goods & Services posted a 8.4% increase yoy primarily driven by Insurance (+15.9% yoy) of which Health Insurance (+21.6% yoy, but -0.6% mom) was the biggest culprit. Motor car insurance was up 7.6% yoy and 0.7% mom.
• Communications were up 4.1% yoy - driven solely by 4.3% rise yoy in Telephone & communication services.
• Health was up 4.0% yoy - hospital services up 11.4% yoy (no change mom) followed by Pharmaceutical products (+2.5% yoy and 0% change mom)
  

Deflation was recorded in

• Furnishings, Household Equipment & Routine Household Maintenance (-1.9% yoy and -0.1% mom) with strong deflationary momentum in Furniture & furnishings (-5.7%), and Major household appliances (-4.0%)
  
• Education - down -1.3%- driven by 1,8% yoy decline in Other education and training and -1.4% drop in Third level education. On the opposite side of the spectrum, Primary education costs rose 1.3% yoy and Second level education costs were up 0.8% yoy.
  

Charts to illustrate these trends:

As usual - an imperfect measure of state v private sector controlled prices - first straight forward state-controlled or dominated or influenced sectors:

Next - an index of prices in two broadly defined sectors:
One point worth making - the above chart clearly shows that inflation has moderated in state-controlled sectors. It remains to be seen if this welcome change mom will translate into a longer term trend.

Finally, a point, as promised above, on the issue of mortgages costs. CSO provides a handy explanation of their terminology on page 10 of the main release, from which I quote here:

"... current approach to measuring mortgage interest in the CPI reflects the situation in the base reference period December 2006 when the standard variable rate was dominant. Subsequently, tracker mortgages have become more popular. This did not give rise to any difficulties while the standard variable and tracker mortgage interest rates moved broadly in line with one another, which would be the normal expectation. However, the decoupling that has taken place since August 2009 has resulted in dramatically different trends emerging. For example, between September 2009 and September 2010 the standard variable rate increased from 2.93% to 3.66% whereas the tracker rate did not change. The Mortgage Interest component of the CPI, which is largely determined by the trend in the standard variable rate, increased by 25.1% as a result and contributed +1.25% to the overall change in the All Items index. It is crudely estimated that the latter impact would have been reduced by between 0.2% and 0.5% had the Mortgage Interest component been calculated on a current weighting basis."

So what CSO are saying is that current mortgages costs metric overstates the overall impact of mortgages costs increases on CPI because more mortgages, since 2006, were issued in the form of tracker mortgages. That's fine, but there is also a sticky problem of the weights assigned to all spending categories, which are all based on December 2006. If since December 2006 the following changes took place:

1. Overall costs of mortgages rose relative to other costs,
2. Home ownership proportion in population rose (which could have been due to emigration out of the country selecting predominantly non-homeowners, for example),
3. There have been significant exits from tracker mortgages and fixed-rate mortgages since 2006 (perhaps due to either selection bias in defaults or due to bias in favor of fixed rate mortgages in maturing mortgages, for example)
   

Then the weights used for this sub-category of spending might be below their current levels, off-setting the above effects of tracker mortgages.

An interesting chart: destruction of wealth

Here is an interesting set of charts I came across in doing some work recently. All are for the US and all showing some very disturbing long run trends:

First chart: US CPITwo things are worth noticing here:

1. The absolutely scary rate of inflation since the end of WWII through today, and
2. The absolutely scary length of deflationary periods.

It is worth focusing in a bit more depth on the second point (the first one being obvious to all).

In general, there were 3 periods of persistent deflation since 1774. These are plotted in the chart below.
Guess what - all three lasted more than 14 years before bottoming out and two managed to last 29 and 32 years. Scary stuff, if you believe deflation is bad.
Now, consider the real cost of unskilled labour over time. Chart below plots the time series since 1774, showing that starting with the late stages of the Great Depression on through roughly early 1970s the real (CPI-deflated) cost of unskilled labour was rising at an unprecedented rate. This cost peaked in the early 1980s and fell into the early 1990s. Ironically, as President Clinton battled the harbinger of the 'Giant Sucking Sound from the South' - Ross Perot - in US Presidential elections, the unskilled labourers of America were about to get a boost in their wages. The cost of unskilled labour has risen since 1994 through 2003 - just as the US economy was evolving skills-intensive sectors (IT and finance) and expanding trade with Mexico. Irony has it - the period of active low-skilled jobs creation of 2003-2007 (construction boom) saw real wages of the same fall!

Looking at the raw (nominal) cost of unskilled labour, there is a clear pattern of correlation between the wages of the lowest earners and the CPI. Chart below illustrates. Again, really dramatic stuff is the rate of rise in the nominal cost of labour that takes place from the late 1960s through today.
Scatter plot below shows the same in more detail. There are 2 clear periods in the US history in the relationship between inflation and unskilled labourers real wages. The first period - 1774 through roughly 1969/1970 is the period of a positive relationship, with real wages rising at a faster rate than CPI. Of course, this is the age of industrial might of the US. Post 1970, the relationship is that of a gently declining real unskilled wages relative to CPI.
What about other measures of purchasing power? Taking the value of the standardized consumer bundle of goods, chart below plots the dollar cost of purchasing such a basket alongside the CPI. There is a close relationship between the two series, but in general, the value of consumer bundle underlies the CPI. Convergence of the two series is achieved in 1967-1972, to be broken down following the oil shocks of the 1970s, and then again since 2004.

The following chart highlights long-term trends in the co-movements between the cost of unskilled labour and the cost of the consumption bundle. As with real unskilled labour wages vs CPI, there are broadly speaking two distinct periods in the relationship between the wages and consumption costs. In the period prior to 1970 increases in wages outpaced the rise in the cost of consumer basket. Since 1970, however, the relationship reversed, with wages rising, while the cost of consumer basket falling.Hence, overall, although real wages have declined in the recent years, the average consumption basket cost has declined faster than the unskilled labour costs. This implies that while wage disparity between the skilled and unskilled labourers (the driver of the CPI) might have risen, the unskilled labourers are still better off today than ever before, thanks to the WalMart effect of driving down the cost of the average consumption bundle.

The chart below plots the awesome power of value destruction in the US dollar purchasing power.

These charts present an interesting evolution of the US economy, from my point of view. They also suggest that:

1. The current deflationary period might last much longer than many of us, including myself, anticipate, although there is an added component to the above equation - the role of the exchange rates. Should dollar appreciate from its currently relatively low levels, the international dimension of the US deflation will be erased.
2. The inflationary trend - measured either as a function of CPI, or a function of PPP, is unlikely to reverse from its long-run upward trend.
   

Daily Economics 20/04/09 - US debt problem

For those impatient - there is an estimate of Ireland Inc debt at the bottom... that can be compared with the US debt...

What is going on with the US economy? I expected the figures coming out on economic front (and earnings front outside the Federally financed banks) to be bad, but today's numbers are poor by all measures. According to the Fed's Conference Board, the index of leading economic indicators fell 0.3% in March, after a dip of 0.2% in February (revised up). But decomposition is telling:

• Building permits were the largest negative contributor in March, as builder have finally started to cut production in honest - much of this backed by the decreases in new starts, as finance committed to projects in 2008, signed for in 2007, has dried up. This is a welcome sign, as outstanding stock of unsold houses has to be pared back before any real recovery (as opposed to cliff-and-bottom bouncing) takes place.
• Stock prices, and the index of supplier deliveries also registered large negative contributions to the index in March, showing that real activity is continuing to deteriorate at, seasonally significantly faster rate. There is no spring bounce for now, and these are leading indicators, suggesting that any recovery upwards will require some new alchemy from the White House and the Fed.
  
• The real money supply was the largest positive contributor as the Feds printing presses were working overnight amidst deflation. And another sizeable positive push came from the yield spread - a sign that some of the future support might be waning - yield spreads narrowing is underpinned by lower Fed rates (not by healthier financial system, for banks are continuing to drop dead at an accelerating rate - 25 as of today in 2009 alone, and counting). So as the Fed has run out of options (short of setting negative nominal rates - e.g issuing loans with a principal repayment at a discount to the face value of the issued loan) and spreads are likely to start widening into the future as: (a) Uncle Sam's borrowing will remain buyoant, (b) debt refinancing will run rampant, and (c) Fed's helicopter drops of money thin out.
  

"There have been some intermittent signs of improvement in the economy in April," per Ken Goldstein, economist at the Conference Board. Overall, six of the 10 indicators were negative contributors, three were positive, and one was steady. Say what, Ken? Picture below is a telling one:
What Ken-omist from the Fed is referring to is the renewed momentum in the deterioration of the Leading Econ Indicators index that started in December (after a short 1-month flat) and has been going steady through March. The index has failed to bounce up in consecutive 9 months. Current Economic Conditions index is now converging downward to LEI, suggesting that unless things improve significantly in the next couple of months, simple psychology of the markets will lead to a renewed push down on LEI (the vicious cycle of self-fulfilling prophecies might commence).

Overall, in the six months to April 1, the index fell 2.5%, it declined 1.4% in the previous six months before that.

So about the only thing positive I can report has nothing to do with the Fed's own indicators, but with the decline in the new unemployment claims reported last week. If the decline persists for the next 6 weeks or so, then using comparisons with the last 6 recessions, we are at the point of inflection in economic recovery sometime now. But it is a big if, since the series can be reasonably volatile and their deviations from the monthly moving average can be significant (see here).

And here is a good chart on inflation expectations for the US (from the Fed: here) - care to argue this? or shall we start taking pressure on commodities-linked stuff in preparation for the new 2% inflation bout?


Paul Krugman on Ireland today: a good one from Krugman here. But an even better one from a comment to his article by PMD: "...Krugman and most of our own home-grown economists appear to regard cuts in public spending as being the same as tax increases. They have a model in their head with credit and debit on two sides and they are studiously agnostic about how the government should go about balancing the books. Those of us who work in the real economy know that increasing taxes on the productive part the economy - and that's 'productive' as in 'productivity' as in the only way to generate real wealth as in the only way to escape recession / depression - will dampen its productivity and, therefore, harm its capacity to generate wealth in the future - i.e. escape recession. All this 'sharing the pain' talk is just code for: we'll confiscate private sector wealth in order to avoid reform in the public sector. You can imagine a rich Titanic passenger on a half empty lifeboat blowing his nail and calling out to a dying pleb in the sea 'Chilly for this time of year. Isn't it?' I profoundly disagree with the reversion to the cargo cult school of economic management: let rich foreigners turn up and employ us. What on earth do we pay these mandarins for if the best they can come up with is 'something will turn up'? There are core domestic issues of productivity that are not being addressed." I couldn't have put it any better than this myself!

Lorenzo 'the Not-so-Magnificent' Smaghi... (or should it be Maghi?) is ECB's latest loose cannon... In an interview with FT Deutschland, Lorenzo Bini Smaghi of the ECB predicted that the Euro-zone recovery will follow the mirror image of a J-curve – a shallow recovery after the fall. Ok, I agree with this. In fact, I have warned for some months now that any recovery in the Euro-zone and Ireland in particular will be shallow and slow and will leave the continent at the trend growth rate of below 0.75% GDP, with Ireland at below 1% GDP pa. ECB's latest would-be-forecaster also 'predicted' a persistent and significant fall in potential growth rates going forward. Another thing Smaghi went into is inflation expectations: "'Inflation expectations are moving upwards (in euro area, U.S. and U.K.); no expectations of deflation," said the text of his presentation. Again, another theme I've been hammering about for some time now.

But... (S)maghi appeared to suggest that non-conventional monetary policy action would be likely soon, without giving any details. What this might be? Negative nominal interest rates? Unlikely. A policy of accepting all and any bonds issued by the member states? Brian Lenihan can wish... It is all but inevitable that the ECB will have to rescue Ireland and some of the other APIIGS. Such a rescue will have to be unconventional and not only because there is no existent convention within the Euro framework for doing so, but because as Smaghi stated in his presentation, households across Europe have lost faith in sustainability of public finances and have started to hoard cash. Nowhere more apparent than in Ireland. After surviving through a decade of anaemic (embarrassingly low, by some standards) economic growth, this is the second greatest threat point for the Euro.

A pat on the back: A stoodgy, but occasionally interesting quasi-official Euro economics website/blog: EuroIntelligence.com has the following 'news' item today. A long recession, a shallow recovery: The IMF has prereleased chapters 3 and 4 of its WEO. This is from the introduction of chapter 3 “…recessions associated with financial crises tend to be unusually severe and their recoveries typically slow. Similarly, globally synchronized recessions are often long and deep, and recoveries from these recessions are generally weak. Countercyclical monetary policy can help shorten recessions, but its effectiveness is limited in financial crises. By contrast, expansionary fiscal policy seems particularly effective in shortening recessions associated with financial crises and boosting recoveries. However, its effectiveness is a decreasing function of the level of public debt. These findings suggest the current recession is likely to be unusually long and severe and the recovery sluggish.”

Imagine this! See here for March 3 post that uses the exact precursor to Chapter 3 release... Oh dear, sometimes it is worth checking if a 'new' release is actually 'news'...

ESB's disgraceful entry into 'stimulus' economics has moved on to the next stage. As I noted in two earlier notes, the ESB plan for 'jobs creation' is an affront to the idea of competition and consumer interests (here), as well as an insensitive move at the time of economic hardship for many (here). Now, as today's IT reports (here) we are also looking at more Georgian Dublin demolitions... Is this predatory and arrogant monopoly ever going to brought under normal market controls? And is Irish Times ever going to become a paper where journalism stops being platitudinous to state monopolies and all-and-any 'Green' / 'sustainable' labels and starts seeing the likes of ESB for what they really are? And per wages and earnings in ESB... well, indeed in the entire public sector, see this excellent blog post from Ronan Lyons here. A must read.


A late Sunday thought - with Obamamama economics, how much debt is the US economy carrying?

Well, there are many sources of debt:

• National debt = currently at $11.2 trillion (per US National Debt Clock calculator here);
• Federal bailout commitments = so far set at $12.8 trillion (up from $4 trillion left by the previous Administration, per March 30 report by Bloomberg here);
• Federal entitlements commitments under Medicare and Social Security obligations = $52 trillion in current debt from the Federal Government to the system or $117 trillion in the present value of unfunded obligations (per National Center for Policy Analysis, as of December 2009, here);
• Private sector corporate and financial liabilities = $17 trillion (per US Federal Reserve numbers of December 2008, here)
• Private households liabilities $13.8 trillion (ditto), mortgages $10.5 trillion (here and a breakdown here) = $24.8 trillion.
  

Total = $117.8 - 172.8 trillion or 829.6-1,217% of 2008 GDP!
Financed at the current 30-year US Treasury rate of 3.79%, the interest payment on this debt alone will be $4,465-6,549 bln per annum - up to 46.1% of the country annual GDP.

We are not considering the pesky issue of the derivative instruments issued within the US system. These are notional debts, but they can come back and bite you as well. Per the Office of the Comptroller of the Currency (here), as of the end of Q4 2008 US held:

• interest rate derivatives to the tune of $164 trillion;
• CDS at $15.9 trillion,
• other stuff: FX, equities, commodities -based derivatives, to the total of $20.5 trillion

So Derivatives grand total of $200.4 trillion.

Which brings US total debt obligations to $318.2-373.2 trillion = upwards of 2,628% of US GDP!

Considering that the US current population is 306,251,267, the total US debt per capita is between $1.31mln and $1.22mln, with a servicing cost of up to $46,185 per annum per person!

And amidst this, Obama is talking traditional Democratic drivel of 'spending the economy out of a recession'? While Paul Krugman is wailing that not enough is being spent?

Can anyone really doubt that inflation is around the corner? If so, consider the above figures and do tell me how can the US get out of this corner without a massive debt write-off via inflation and sustained devaluation? Dollar at 1.75 to the Euro in two years time and interest rates in double digits?

Now on to Ireland Inc's debt:

• National debt = currently at €54.245bn (per NTMA here);
• Government bailout commitments = so far set at €400bn (here) under Banks Guarantee Scheme, €70bn (my estimate in the forthcoming B&F article) under NAMA, €87bn (here); Sub-total = €557bn;
  
• Public entitlements commitments under Pensions, Social Welfare and Health obligations = €75bn (Pensions: here), €66.3bn (€38bn per annum spending on health, wages & social welfare taken over 30 years horizon with deficit of 10% per annum over term) in the present value of unfunded obligations; Sub-total = €141.6bn;
  
• Private sector corporate and financial liabilities = Monetary Financial Institutions: €810bn, inc of IFSC, corporate sectors: €551bn; Direct Investment: €183.6bn (here); Sub-total = €1,544.6bn
  
• Private households liabilities (per my earlier estimates here) = €150bn.
  

Total = €2.45 trillion or 1,440% of 2009 GDP!
Financed at the current 5-year rate over 30 year horizon (roll-over) of 4.5%, the interest payment on this debt alone will be €110.25bn per annum - up to 64.9% of the country annual GDP. Put differently - the debt/liabilities of this economy are currently amounting to ca €555,048 per every person living in Ireland...

Deflation is cemented, but Government rip-off continues

The above table, courtesy of Ulster Bank's economics team, is revealing.

CPI is now anchored firmly in the deflation zone at -1.7% for February - a record rate of deflation since Q1 1960 (when CPI fell 2%). Prices actually fell 0.4% last month, but because in February 2008 prices grew by 1.2%, the overall difference amounted to -1.7%. So don't be surprised if you are not feeling that easing on your household budget (other than house payments), yet.

The HICP harmonised measure (ex mortgage rates) fell to +0.1%, the lowest in history (since 1997). This implies that CPI fall off was dominated by the ECB-driven declines in the cost of mortgage finance. The average mortgage cost declined 8% in February and is now down 26% on a year ago. This is certainly helping many households to stay afloat, given rapid deterioration in after-tax disposable personal incomes and rising unemployment.

Now, do the math - if the ECB rate-cuts cycle is to run out of steam by H2 2009, as expected at ca 0.75-1% level, total savings on average mortgage will amount to a total of 33% off their peak. Assuming an average mortgage burden of 30% of the household budget at the peak, this will shift overall mortgage burden to ca 22% of the budget. Assuming income tax, VAT and other housholds-related measures stay on course laid out in Budget 2009, mini-Budget will result in a fall in the household disposable income of 3-5%. Add in expected fall in earned income (due to slowdown and rising unemployment) and we have a recession-induced 13-19% decline in the disposable income. Thus, the average mortgage burden for the household will rise back to 26% at the bottom of the ECB rates-cut cycle, virtually canceling any positive effects of the ECB rates cuts on households' balance sheets.

Another feature of the figures above is the collapse in prices in the clothing and footware sector - normally the sales end in February (between 2002-2008, February saw the first monthly increases in prices in this category for the year, averaging some 12%). This year, the increase was only 7.5% - lowest since 2000.Overall, in January we recorded the steepest drop off in prices in this category in the Eurozone.

But as always, it was in the Government controlled/regulated sectors where price changes were out of sync with the rest of economy. Health insurance costs were up 21%, house insurance was up 17%. Education was up 5.5% in February after a 5.6% increase in January, health was up 4.8% in February after an increase of 5.8% in January. Government-sponsored rip-off of consumers is still alive and kicking. (Note: of course, house insurance is not directly priced by the state, although it is a part of the regulated sector. Possible causes for the rise in house insurance in recent months might include inclement weather payouts and, more importantly, insurers using all means possible to strengthen their capital reserves positions. The latter is a function of regulation and markets assessment of inherent risks. Both, in turn, are functions of the public sector actions/inactions, although indirectly).

While private sector prices were down 0.1% in the last 12 months, Government-controlled prices were up and the rate of increases is accelerating. In 12 months to January 2009: Gas prices were up 20%. Health insurance +19%, Electricity +17%, Bus and Rail transport +13% & +9% respectively, Hospital services +7-9% (out-patient v in-patient). Total Government-controlled inflation +14% for regulated services in year to February 2009.

Overall, I expect the CPI to average -3% for 2009 as a whole.