Economics 12/8/10: Irish July CPI: Deflation is over, for the State sectors

“Consumer Prices in July, as measured by the CPI, remained unchanged in the month,” says CSO. Hurrah, the end of deflation then? “This compares to a decrease of 0.8% recorded in July of last year. As a result, prices on average, as measured by the CPI, were 0.1% lower in July compared with July 2009.”
Sounds like the good news. But… “The EU Harmonised Index of Consumer Prices (HICP) decreased by 0.1% in the month, compared to a decrease of 0.8% recorded in July of last year. As a result, prices on average, as measured by the HICP, were 1.2% lower in July compared with July 2009.”

Err, of course, HICP excludes the cost of housing. And the cost of housing has been going up in Ireland courtesy of the banks. So let me see:

• Deflation is bad, because it signals lower returns for businesses, induces consumers to save excessively and stops investment;
• Inflation is ok, then, as long as it reverses the three ‘bads’ caused by deflation.
  

So our ‘good news’ of the ending of deflation isn’t good at all, then. Why? Because, per CSO: most notable changes in the year were decreases in (see charts below)

• Clothing & Footwear (-8.5%) - competitive sector;
  
• Food & Non-Alcoholic Beverages (-3.8%) - relatively competitive sector; and
  
• Furnishings, Household Equipment & Routine Household Maintenance (-3.4%) - buyers' market.
  

There were increases in

• Education (+9.2%) - state controlled,
  
• Housing, Water, Electricity, Gas & Other Fuels (+5.5%) - state- and banks-controlled, and
  
• Transport (+2.7%) - state-controlled in terms of costs and charges.

Which of course means that prices have risen primarily in state- and banks- controlled sectors. These sectors inflation does not induce businesses to invest (as they are forced to pay higher costs and do not see increased revenue in their core activities), it does not induce people to consume (as they continue to save even more in anticipation of banks coming for their money through mortgages increases) and it does not result in increased returns to productive business activity (as higher costs shrink margins). The CPI excluding mortgage interest showed no change in the month and was down by 1.0% in the year.

Let’s plot that relationship between state-controlled prices and private sector prices, weighted by their respective weights in overall CPI basket:

No further comment needed, I presume.

Economics 24/01/2010: Consumer side of the economy equation

Before posting my Sunday Times article, couple of interesting links from elsewhere:

Myles Duffy on Revenue's 2009 figures - here. Good and concise view.

Excellent essay on Google v Apple battle and why Google just might be losing it - here.

Now to my article, as usual, unedited version:

The latest retail sales figures show continued weakness in consumer demand through November 2009 with core sales (ex-motors) up a poultry 0.3% in volume and down 0.3% in value on October. In twelve months to December, Irish retail sector has recorded a massive 8.2% drop in the volume of sales, while the value of good and services sold collapsed 12.9%.

This weakness in retail sales is important for three reasons – both overlooked by the analysts. First, this was a month usually characterised by higher spending in anticipation of Christmas holidays. Second, this was the beginning of the Christmas season that concluded the decade and came after extremely poor 2008 holidays shopping. Penned up demand was great, going into November, but consumers opted to stay away from the shops. Third, even November retail sales were out of synch with forward looking consumer confidence indicators.

Combined, these facts suggest that the retail sector is suffering from a structural change that is here to stay, even if the broader economic activity and consumer confidence were to bounces into positive growth.

This observation is far from trivial. Despite all of our hopes for a recovery based on exports, any growth momentum in the economy can be sustained only on the back of improving private consumption and investment. In Q3 2009, the latest for which data is available, personal consumption of goods and services accounted for 63.5% of our GNP and over 50% of GDP. During the crisis, due to a much deeper collapse in investment, the importance of consumer spending has increased. At the peak of the bubble in 2007, consumption spending amounted to 57% of our national output.

Retail sales form a significant component of the overall consumer expenditure and it is also strongly correlated with other components, especially communications and professional services. These links are highlighted by the anaemic revenues generated by mobile and fixed line service providers, and dramatic declines in demand for insurance.

Thus, overall, retail sales offer some insight into what is going on at the aggregate personal consumption level.

Earlier this week, PwC released an in-depth analysis of emerging trends in Irish retail sector that sound a warning for the future of our consumer economy. The report found that in response to the crisis, some 55% consumers are now reporting lower spending on goods and services, while 65% are saying they are spending more time shopping for value.

Over the last year, only aggressive price cuts kept the volume of sales from reaching the levels of 1999-2000 in real terms. 71% of Irish retailers have increased their promotional activities, while 67% have offered aggressive discounts (63% of retailers plan further realignments of costs in 2010).

In other words, the impact of the current economic crisis on consumer behaviour has been deeper than a normal recessionary dynamic would support. PwC survey has found that 53% of all retailers believed the changes in consumer attitudes to shopping we are witnessing today are long term or permanent in nature.

This permanent nature of change is due to what in a 2004 theoretical paper on household consumption I called ‘learning-by-consuming’ effect. While searching aggressively for better value, the households simultaneously improve their expenditure efficiency and discover that buying cheaper does not always mean sacrificing quality. PwC research confirms my theoretical model by showing that 86% of consumers who shopped for value perceived cheaper goods to be of the same quality as higher priced goods.

The permanence of change in consumer behaviour is worrisome. Barring dramatic improvements in consumer willingness to spend, two negative developments will persist in our economy.

First, any return to growth will be short-lived and prone to sudden reversals with the risk of a double-dip recession.

Second, any recovery absent robust growth in private expenditure will imply further widening of our GDP/GNP gap as MNCs tear away from the lagging domestic economy. Over the long run, this gap will have to be closed either through a massive downsizing of the foreign investment sector (as costs bear down on companies operating here), or via a return of another credit bubble. Neither development would be welcomed.

In the nutshell, we can expect retail price deflation to continue in 2010. According to NCB Stockbroker’s economist Brian Devine, further deflation in 2010 can lead to a statistical bounce in overall retail sales. “With prices declining, consumer confidence stabilizing and consumer attitudes shifting towards value expect the volume of retail sales to grow in 2010,” says Devine. But, “job losses and emigration will weigh on overall consumption and as such we can expect consumption to contract marginally in 2010."

In other words, the prognosis for improved consumer confidence carrying sustained recovery in 2010 is not good.
Should the changes in consumer behaviour be permanent, we can expect consumption to grow at 1.5-3% per annum as wages stabilize and the savings rate begins to decline from its 2009 high of over 11%. And even from this low growth scenario, the risks are firmly to the downside.

Given the expected impact of Nama on mortgage interest rates, credit and deposit rates, it is highly likely that our savings will remain elevated well through the first half of this decade. The ESRI forecasts personal savings rates to stay above 10% through 2013 and close to 8% thereafter. In contrast, over 2000-2007 our savings rates averaged just above 6%. Higher savings, of course, will mean lower consumer spending and private investment. Rising cost of borrowing and credit will add to our woes.

Finally, subdued consumer spending means lower Exchequer revenue through VAT and Excise duties. This is likely to lead to higher tax burden in Budget 2011 and a further downward pressure on consumer spending.
In this environment, the Government simply cannot afford inducing more uncertainty and pressure on already over-stretched households’ balance sheets. Restoration of consumer confidence requires an early and committed signal from the Exchequer that Budget 2011 will not see new increases in taxation. From here on through 2014, all and any fiscal adjustments should take the form of permanent cuts to public expenditure and elimination of tax loopholes, not a series of raids on taxpayers’ incomes.

The Government should also reverse its decision to limit Banks Guarantee coverage of ordinary deposits to Euro100,000 that is scheduled to come into force later this year. Lower guarantee protection will act to increase precautionary savings as well as deplete the already razor thin deposits base in Irish banks. The twin effects of such an eventuality will be greater demand for public capital from our financial institutions, plus lower consumer spending. Does Irish economy need another twin shock just as the recession begins to bottom out?


Box-out: It appears that despite all pressures, the Government is staunchly refusing to carry out a public inquiry into the causes of our banking sector crisis. Instead of confronting with decisiveness this matter of overarching public interest, our Taoiseach has resorted to deflecting all queries with his favourite catch phrase: “We are where we are”. One wonders whether the Government would be as willing to use this phrase if the subject of the proposed inquiry was a series of major transport accidents, or a systemic failure in our health sector. Institutions responsible for over 80 percent of the entire banking sector in the country came close to a collapse and have to be rescued by the taxpayers at a total cost (including Nama) of Euro72-89 billion or 46-57 percent of our annual national output. What else but a fully public inquiry with live television coverage of all hearings can one expect in a democratic society? An inquiry into the systemic failure of our financial system must be not only public, but comprehensive. It should cover all the lending institutions in receipt of state assistance as well all policy-setting, regulatory and supervisory bodies – from the Financial Regulator to the Department of Finance – responsible for ensuring stability of our financial system. This inquiry should have powers to fine those who failed in fulfilling their contractual and/or statutory duties. And it must be conducted by people who have no past (since at least the year 2000) or present connections with the any of institutions called in for questioning. Anything less than that will be an affront to all hard working men and women of this country who are expected to pay for the mess caused by the systemic failures in our banking sector.

Economics 13/12/2009: News and confirmations

A quick post - per Sunday Times report today, Irish Nationwide will need 1.2-2 billion in recapitalization post-Nama. This beats my estimate for the society provided here. To remind you - back in October 2009 I estimated that post-Name demand for capital will be:

• AIB €3.2-3.5bn in equity capital post-Nama;
• BofI €2.0-2.6bn;
• Anglo €4.5-5.7bn;
• INBS/EBS & IL&P €1.1-1.2bn.
• Total system demand for equity will be in the range of €9.7-12.4bn.

Since then it was confirmed by various reports and estimates that:

• AIB will require €3.0-3.5bn in equity capital;
  
• BofI will need €2.2-2.6bn;
• Anglo will need up to €5.7bn;
• INBS will require total of €1.2-2bn.

To err on conservative side, I am still sticking to the range of €9.7-12.4bn for total demand.


On retail sales side: October figures released last week show continued weakness across consumer spending - despite some bounce up in car sales (+1.4 mom). Total sales fell 0.3% mom and ex-motors sales declined 1.7% erasing all gains made in September. Core sales 9e-motors) are now at 2005 levels down 13% from the November 2007 peak. Despite seasonal shopping going into Christmas, 'other goods' sales (including toys, jewelry, sports wear etc) posted a drop of 4%. Furniture and lighting posted a fall of 3.2% and would have probably fallen even further if not for Ikea. This, of course implies that a rational forecast for 2010 should be in the region of 3% fall in retail sales, compounding the 7% drop in 2009 and leaving retail sales at some 84% on 2007 peak. More urgently, staying on the established trend, December retail sales are risking to sink 10-15% on 2008, which might trigger a new wave of layoffs in January-February 2010.

Services Exports data also released last week shows that our services trade deficit has widened in 2008 relative to 2007 by 370% as imports rose much faster than exports.
The detailed data clearly shows that we lack geographic diversification of exports in most services, with 76% of our services exports (allocated to specific geographic destinations) destined for Europe. And we are failing to benefit from substantial cost savings from outsourcing services to Asia - with just 2.4% of our services imports coming from Asia (Asia accounted for 7.9% of our exports of services).

In higher value added services:

• Virtually all insurance services exports went to Europe (69%) and the US (22.1%);
• Financial services exports went to Europe (67.2%), the US (10.45%), and Asia (10.3%), but some 12% of financial services were traded into offshore centres;
• Computer services posted a massive surplus, as usual, with 86.7% of all exports flowing to Europe, and just 1.07% to the US, while Asia received 8.7%;
• Other business services exports - comprising a number of high value-added subcategories - went to Europe (69.7%), US (only 4.5%) and Asia (12.9%).

Once again, poor diversification to new markets suggests that Irish services exports might be in danger of heading for a slow growth path tied to the fortunes of stagnation-bound EU. Diversification out of this predicament will require serious efforts on behalf of the Government to provide meaningful exports credit insurance and some sort of the foreign exchange risk offset mechanism. Otherwise, Ireland is at a risk of becoming the back water to Europe's slow growth model.

Economics 10/09/09: A dive into CPI discovers ESB and B Gais monsters

Consumer prices posted the first increase in August - up 0.4% mom on July or double the consensus forecast. This is the first monthly rise since September 2008. Prices rose helped by the nasty predictables, though:

• mortgage repayments were up 3.4% on average - although mortgage repayments are still down 48.2% yoy, the latest tick up is a clear sign that the banks are starting to 'repair' their margins and are driving cost of mortgage financing up - bad news for already demoralized consumers;
• the above trend is likely to accelerate: Irish banks' mortgage rates were the third lowest in the EU in June 2009 (only Portugal and Finland had lower average rates), but this is somewhat simplistic of a comparison as majority of current borrowers in Ireland are taking or holding variable rate or tracker mortgages. In contrast, in other countries of the Eurozone, much higher percentage of mortgages issued are in fixed terms of much longer duration than those in Ireland. But one has o be also concerned with the riskiness of Irish mortgages to the banks - Irish banks spot 173% average loans/deposits ratios and this is a mad level of leveraging for the sector, comparable to the worst 'offenders' - the poorly performing UK banks;
• a bit more on housing costs: "In the month, price increases were recorded for liquid fuels (i.e. home heating oil) (+9.4%) and mortgage interest (+3.4%). Price decreases were recorded for rents (-2.4%) and bottled gas (-0.4%)." Rents falling - bad news for housing markets then;
  
• ex-mortgages (HICP) was up 0.2% in August in mom terms (yoy term we are still in deflation at -2.4%, for comparison Euro area overall HICP is down 0.2% yoy in August - 12 times less than Ireland's);
• but this August things still were worse than a year ago - back in August 2008 mom inflation was 0.5%, this August it is lower at 0.4% despite a massive deflation since then.

In addition to the above main points, other worrying things are in the pipeline for inflation.

Transport costs rose 1.1% mom due to higher cost of fuel (as some analysts claimed in their rushed notes). Alas, CSO detailed sub-indices show that it was not petrol that was the main culprit: "In the month, price increases were recorded for air fares (+7.0%), bus fares (+3.8%), petrol (+1.7%), maintenance & repair (+1.4%), diesel (+1.2%), other vehicle costs (which includes parking fees and car rental charges) (+0.8%) and motor cars (+0.4%). Price decreases were recorded for other transport (-4.3%), spare parts & accessories (-1.8%), sea transport (-1.6%) and bicycles (-0.7%)." So in short - private sectors are still competing on price, but state bus monopoly is ripping off the customers, while airlines are scrambling to cover losses.

"Education costs decreased by 0.3% in the month and increased by 3.9% in the year to August 2009. This compares to an increase of 6.5% for the year to August 2008. A price decrease was recorded for other education & training (-0.7%)." No savings on third level or any level education in sight then which means - wait, CSO won't tell you this in their summary -

• cost of primary education in this country has gone up by 7.6% yoy in August 2008-August 2009 period;
• cost of secondary education went up 7.1% yoy;
• cost of third level education is up 4.5%

We really are doing everything possible to increase the level of educational attainment for kids and adults in Ireland, aren't we?

Of course there was no easing of costs of our two grand state monopolies: ESB and Bord Gais. Year on year, the former dropped 10.9% and the latter rose 6.5%, so given their weights in expenditure, the basket of these two energy sources lost roughly 5.2% of its value. But in the same period of time, oil dropped 36% and gas dropped 63%, so the actual spot market price savings on the basket should have been around 44.9%. Ok, allow for a profit margin of a whooping 10% (we are in a recession) and a cost margin of 15%. Still, you get something to the tune of 25-27% savings that is not being passed onto consumers by ESB and Bord Gais.

Ah, the costs of our glorious state monopolies. I know, some will stop reading here, but - folks, the Exchequer (the same one who is 'protecting' taxpayers interests in Nama, allegedly) is the sole owner of these rip-off monopolies! Shouldn't Brian Lenihan 'protect' taxpayers from their abuses? That would give him at least some credibility in claiming that he actually acts in the interest of this country's people...


I must confess - after Pat McArdle's retirement, I stopped quoting from the Ulster Bank notes. But here is a rare exception: "For the year as a whole we expect an average consumer price fall of 4.2% [CPI, I presume], which would represent the greatest decrease since the 6.4% drop in 1931". A nice piece of history, folks, and possible a good forecast target too.

Market View: Lenihan's Cod Oil Sales Trip?

Weekly round up
We are in a thaw though don’t bet on this being a sign of global warming. The markets have shown some (to some not surprising) bounce in the latest (bear) rally. Across the world and here in Ireland. But the winter isn’t over, yet.

First where it all started from: the US. Some encouraging news:

• The U.S. trade deficit narrowed by 9.7% in January to $36bn, the lowest monthly gap since October 2002. This marks a sixth consecutive decline in the trade deficit, the first case of such extended contraction since the new data collection started in 1992. Oil and petroleum products deficit fell to $14.7bn in January, the lowest since September 2004. Trade deficit with China widened to $20.57bn relative to $20.31bn in the same month last year. Lower prices for inputs and commodities helped. In exports, main decreases were in the areas of capital goods and industrial goods – reflective of the global investment slowdown. Ditto in the area of imports (except that capital goods imports were down less than exports, suggesting companies continue to travel down the cost curve. Details here).
• US University of Michigan/Reuters consumer sentiment index notched up in March to 56.6 from 56.3 one month ago. While this beats analysts’ expectations (55.0), the improvement is hardly significant to signal any improvement in consumer spending and borrowing going forward. This is despite March being the first month of Obama’s massive stimulus plan – not exactly a ringing endorsement (for more on this see here)
  

So the last week came to be a somewhat bullish one with flat US Treasuries, low single-digit gains in commodities and a rally in stocks (up ca 10-14%) with commercial real estate-leading markets, like REITs. Up over 20%.
US Dollar has lost some ground on the Euro, further underlying markets desire to see continued strengthening of the US trade balance. In this beggar-thy-neighbour climate, good news for US is bad news for exports-driven Ireland.

Financials
JP Morgan and Morgan Stanley (first chart below) illustrate the rally for the financials. Most of the sector gains were probably due to rising levels of speculative news flow. If this is a signal of a renewed focus on balance sheet health, expect the rally to turn into a deep correction. Bank of America (BAC) – up some 85% during the week – is a case in point. There is no fundamentally new development, yet this week’s statements about improving outlook on profitability pushed the stock to the top of the financial shares (Citibank (C), Wells Fargo (WFC) etc) performance rankings. The second chart below illustrates, while highlighting the relatively poor performance of non-financials.

Irish Markets
Pretty much the same picture holds for Irish markets. Two of the three remaining banks led the positive momentum with few features of note:

1. Volumes were relatively weak (running at ca ½ of the 52-weeks daily averages);
2. IL&P underperformed (with the markets having little faith in the bank side of the insurer, as in the past);
3. Overall ISEQ posted a lacklustre performance for the week, signaling that the main concerns about Irish economy’s fundamentals are still there.
   

These are illustrated below and show continued theme of volatility around a relatively flat broad markets trend - something I predicted a month ago.
The above concerns, of course are to continue next week as well.

Ireland Inc Sales Pitch
It is now being rumored that Mr Lenihan is going on that 'road trip' to showcase Ireland to UK (and other international) investors. Here is a list of problems that I would put to him at such a sales meeting. All of these basically ask the same question - why would any investor expose herself to Ireland today.

1. Fiscal position: all the indications are that Minister Lenihan will opt for a ‘soft’ solution – raising taxes and refusing to inflict real cuts on the public sector. Thus, ‘savings’ on the current expenditure side will be pushed into 2011 or later as the Minister ‘cuts’ numbers through natural attrition. Taxes will hammer the economy today. Only an insanely naïve person can be convinced by such a strategy.
   
2. Corporate credit: debts problems continue to plague Irish companies, with more roll-overs and re-negotiations of the covenants. This will be compounded in weeks ahead by an accumulation of arrears to contractors and suppliers. Mini-Budget will spell a war of attrition between smaller services providers and larger contracting companies as the former struggle to extract payments in the environment where Messrs Lenihan and Cowen sneaking deeper into peoples' (and thus companies') pockets.
3. Corporate outlook: PE ratios are still too high for Ireland Inc, implying that there is more room for downgrades. In the US, there is more clarity as to the 2010 PE ratios supported by the markets, with a range in 15-20 perceived to be the top during the recovery part of the cycle (whenever this happens). So the expected downgrading room that is still remaining in, say S&P500 is -150 points or ca 20%. In Ireland, the same figures imply probably a range of sustainable 2010-2011 PE ratios of ca 10 (again assuming that we see some recovery starting in 2010 and companies actually living up to the idea of proper disclosure of losses and impairments – something that few of them have done to date). So the bottom line is that we can see ISEQ travelling all the way to 1,470-1,500 before hitting a sustainable U-turn, while IFin might be tumbling down to 200-215.
4. Earnings and demand are going to continue falling in months to come. Although much of this is already built into expectations, the actual numbers are not yet visible through the fog of corporate denial. Banks still lead in terms of balance sheets opacity and the Government is doing nothing less than destroying in a wholesale fashion private workers’ ability to stay afloat on mortgages repayment and consumption. Dividend yields are now poised to continue downward well into 2010 (optimistically) or even past 2011 (pessimistically). So any bottoming-out of the market will coincide with an on-set of an inverted J-styled recovery – we are not getting back to 4-5% long term growth trend once we come out of this recession. A poultry 2% would be a miracle and a Belgian-style 1.2-1.5% GDP growth over the long run is a more likely scenario.
5. Global growth for Ireland Inc is not going to be a magic bullet. The Government has wasted all chances of reforming the least productive sectors in this downturn and is hell-bent on protecting our excessively high cost base. This means we are unlikely to benefit from any serious global growth upturn.
6. Increased global reliance on Governments interventions is going to hurt Irish exports in the long run as national Governments will tend to reduce incentives for outsourcing, leading many MNCs to gradually unwind transfer pricing activities here in Ireland. There is absolutely no chance our Enterprise Ireland-sponsored companies are going to be able to take up the slack.
7. No recovery in Ireland will be possible until house prices and commercial real estate values stabilize and start improving. High debt, diminishing ability to repay existent loans (courtesy of Government raiding households finances to pay for waste in the public sector and a growing army of consultants – e.g Alan Ahearne & Co) all mean that there is no prospect for a return in house values growth until, possibly, well after 2013. Absent such a recovery, there will be no sustained rallies in other asset classes.
8. Finally, there is a psychological shift that is underway when it comes to Irish public perceptions of asset markets. This shift is now counter-positing a 40-50% decline in house prices against a 90% decline in most popular equity categories and a wipe-out of investors in nationalized (and potentially yet to be nationalized) banks. The return of a growth cycle is unlikely to trigger significant movement of households’ cash into Irish stocks. This will be further compounded by the aversion to leveraging and continued credit rationing (induced via new banking regulations and investor hysteresis).
   

So the conclusion is a simple one – Irish equities recovery is nowhere near becoming a reality. Expect further turbulence on a generally downward trajectory in weeks ahead, followed by a potential spike of misplaced short-term optimism in the wake of the mini-Budget. Once the investors work through the forthcoming Government decisions, it will be down again for ISE.

Talking up our economy

Today, Brian Cowen has issued a Bertiesque warning to commentators 'talking down Irish economy'. I beg to disagree. Firstly, the problem Ireland is facing is not that some commentators want to uncover the truth, but that our Government is failing to listen to anyone, save for a handful of public sector mandarins and political appointees. Secondly, lest anyone accuses myself of scaremongering, I remind our Taoiseach and his Cabinet that I have publicly put forward a constructive proposal for dealing with the current crisis as far back as in August 2008.

Here are few details:

In August 2008 edition of Business&Finance magazine, I predicted that Ireland will continue its downward trajectory in terms of stock market valuations and economic performance unless the Government were to tackle the issue of public sector overspend and consumer debt. In early October, from the same platform, I re-iterated a call for the Government to get serious with the problem of rising household insolvencies and corporate debt burden. At that time, I provided an outline of a basic plan that I hereby reproduce (some of the modifications to the original plan were featured in my article in Business&Finance in November).

Here is a bold, but a realistic proposal for moving the Government beyond its current position of playing catch up with deteriorating fundamentals. The Exchequer should:

• Announce a 10% reduction across the entire budget and an up to 60% cut on the discretionary non-capital spending under the NDP, generating ca €12-15bn in savings. The cut should include a 100% suspension of all overseas assistance until the time the economy returns to its long-term growth path of ca 2.5-3%.
• Cut, permanently, 10% of the public sector employment (effecting back office staff alone), saving ca €1bnpa after the costs of the measure are factored in.
• Freeze pensions indexation in the public sector for 2008-2015 and make mandatory a 50% contribution to all pensions plans written in the public sector, generating ca €1-2bn in savings.
• Stop the unfunded contributions to the NPRF, saving some €1.5bn per annum.
  

Combining all the savings, the Government should be able to :

• Bring 2009-2010 deficits to within the Eurozone limits; and
• Supply temporary tax refunds of ca €5,000pa per household in 2009-2010 ring-fenced for pensions plans and mortgages funding only.
  

The resulting capital injection of ca €7.5bn pa will be able to:

1. de-leverage the households (amounting, by the end of 2010 to a ca 25% reduction in the total households’ debt), improving consumer sentiment and re-starting housing markets;
2. help recapitalize the banks and improve their loans to capital ratios more efficiently than a debt buy-back, a nationalization, a direct injection of capital from the Exchequer or a debt guarantee.
   

It will result in a sizeable (ca 5% of the entire economy) annual stimulus, without triggering inflationary pressures associated with the Santa-like Government subsidies or consumption incentives.

This proposal implies no burden on the future generations, as the entire stimulus will be paid from the existent fiscal overhang and the set-aside public funds, with the public pensions covered by the contributory schemes.

Lastly, to achieve a morally justifiable and economically stimulative recapitalization of the banks, the plan would require Irish institutions receiving any additional public financing to issue call options on ordinary shares with a strike price set at the date of the deposit and maturity of 5 years. These shares should be distributed to all Irish households on the flat-rate basis.

Thus, assuming the need for additional capital injections of €6-9bn in the Irish financial institutions through 2010 (over and above the €7.5bn pa injected through mortgages repayments and pensions re-capitalizations), Irish households will be in the possession of options with a face value of €4,000-6,000 per household, thus increasing their financial reserves. At the time of maturity, assuming options are in the money, the Exchequer will avail of a special 50% rate of CGT on these particular instruments. Assuming that share prices appreciation of 40% between 2009 and 2014, the CGT returns to the Exchequer will yield ca €1.8bn, ex dividend payments.

Lessons from the US Consumer Confidence data

US Consumer Confidence indicator (CCI) posted a new record low in the pivotal month of December. According to the Conference Board :
“CCI, which had increased moderately in November, declined to a new all-time low in December. The Index now stands at 38.0 (1985=100), down from 44.7 in November. The Present Situation Index plummeted to 29.4 from 42.3 last month. The Expectations Index decreased to 43.8 from 46.2 in November.”

Current conditions

“Those claiming business conditions are "bad" increased to 46.0% from 40.6%, while those claiming business conditions are "good" declined to 7.7% from 10.1% last month.”
This suggests that pessimism is taking a stronger hold amongst those who were previously either neutral or optimistic – a sign that this downturn is now being felt not only at the lower margin of earnings distribution, but also at the core middle and upper-middle classes.

Exactly the same dynamic – falling numbers of previously optimistic respondents, along with ‘marginal’ respondents – was evident in the assessment of the labor market:
“Consumers' assessment of the labor market was also considerably more negative than a month ago. Those saying jobs are "hard to get" rose to 42.0% from 37.1% in November, while those claiming jobs are "plentiful" decreased to 6.2% from 8.7%.”

Short-term expectations

Probably the worst piece of today's news relates to the future expectations. In a marked departure from the current conditions trend short-term expectations have shown greater polarization of US consumers away from the center, with marginal respondents migrating toward either greater optimism, or pessimism.

“Those anticipating business conditions to worsen over the next six months increased to 32.8% from 28.3%, while those expecting conditions to improve rose to 13.4% from 11.5%. The outlook for the labor market was also somewhat mixed. The percentage of consumers anticipating fewer jobs in the months ahead increased to 41.0% from 33.7%, while those expecting more jobs increased to 9.7% from 9.2%. The proportion of consumers anticipating an increase in their incomes decreased to 12.7% from 13.1%.”

Lessons for Ireland

In light of the US data, over the next two-three months we should expect:

• Further deterioration in consumer confidence here, as to date, both the comparative dynamics of the Irish time-series and the underlying fundamentals for CCI in Ireland have been closely following those in the US;
• Deeper declines in expectations component in Ireland than in the US, as underlying 'misery index' fundamentals for Ireland are showing much more negative future dynamics for Q1-Q2 2009;
• Significantly stronger shift of previously marginal and optimistic consumers toward deeper pessimism (with respect to both their perceptions of current conditions and future expectations) as Irish downturn starts to feed through to the middle and upper-middle classes at an accelerating rate starting with January.