7/6/2012: Sunday Times June 3, 2012

This is an unedited version of my Sunday Times article from June 3, 2012.

In early 2008, Brian Cowen described Ireland’s predicament with a catchy phrase ‘We are where we are’. Ever since this became synonymous with gross incompetence, epic failure and outright venality of our elites.

Fast forward to May 2012. In the heat of the EU Referendum campaigns, both Government parties have paraded their up-beat assessments of the economy, their own stewardship and achievements. The factual record of the current Government on economic policies is only slightly ahead of that attained by their predecessors.

Don’t’ take my words for this. Look at just where exactly ‘we’ – Ireland – ‘are’ in the crisis after a year of stewardship by the Coalition.

We are officially in a recession. Both GDP and GNP have shrunk in the last half of 2011 and all indications are, growth is unlikely to have returned in Q1 2012 either. Should Ireland post another quarter of negative growth, we will join the club of Italy, Cyprus, the Netherlands and Portugal. This select group of the euro area countries have managed to record GDP declines in three consecutive quarters since the end of June 2011. For Ireland, this abysmal economic performance comes on foot of the overall 17.6% decline in GDP and 24.2% drop in GNP since 2007 peak through the end of 2011. This didn’t stop this Government from declaring, as its predecessors did, various ‘turnarounds’ and ‘improvements’ in the economy, as a part of their credit, even though so far, the actual record of this Government on growth is negative. Since the Coalition came into power, GDP grew just 0.7% and GNP shrunk 4.1%, investment is down 12.8%, personal consumption fell 1.6%, while expatriation of profits by the MNCs operating here rose 24.6%.

Despite accelerating emigration and ever-rising numbers of unemployed being reclassified as engaged in state-sponsored training programmes, the latest unemployment remains stuck at 14.3% exactly identical to that recorded a year ago. In May 2011, there were 444,400 people on the Live Register and 71,231 in various state training schemes, this month these numbers were 436,700 and 82,331, respectively. Year on year, numbers at risk of underemployment rose 3,131. The Government has claimed that it has helped creating some tens of thousands new jobs, ranging from MNCs-supported ‘smart economy’ workers to hospitality sector. In reality, once training programmes are added, the numbers of those drawing unemployment supports rose 3,400 over the tenure of this Coalition.

Not surprisingly, consumer demand – accounting for 52% of our overall economic activity (in comparison, net external trade in goods and services accounts for less than one half of that figure) – is shrinking. Hammered by the push toward debts deleveraging, higher taxes, losses of income due to shrinking earnings and strong inflation in state-controlled sectors, Irish consumers are running away from the shops. Retail sales, ex-motors, have fallen 2.3% year on year in April 2012 in value terms and 3.8% in volume. This marks the fourth consecutive month of dual declines in volumes and value and the steepest rates of declines since October 2011 for value series and since May 2011 for volume. Things used to be getting worse at a slower rate in retail services sector. Now they are getting worse at a faster rate.

Banks reforms are truly not paying off for the Government. The latest banks lending survey for April 2012 shows that Irish banks have uniformly tightened, not relaxed, lending to enterprises in Q1 2012, compared to no change in lending standards recorded in Q4 2011. Things have not improved in consumer lending either, with mortgages lending running at just 5% of the levels seen during the peak. Meanwhile, costs remained the same in Q1 2012 as in Q4 2011 across all sources of funding. Following the estimates of foreign analysts, mirroring this column’s earlier prediction, the Central Bank now quietly admits that more funds will be required to offset rising mortgages arrears. More capital will be called on to bring Irish banks balancesheets to Basel III standards in years to come.

We are nowhere near the end of the crisis relating to housing markets. In Q1 2012 the overall level of mortgages at risk of default or already in default has reached 15.3% of the overall outstanding mortgages, 19.3% of all mortgages balances. This compares to 11.1% for levels and 13.6% for balances a year ago.

The game of extend-and-pretend drags on, as the Government publicly makes bombastic pronouncements about ‘stabilization’ and ‘reforms’ achieved in the sector, while reluctantly admitting that mortgages books are in a mess. The strategic response to this is the Government’s hope that the EU will be forced to mutualize banks debts, shifting them off the books of the state.

Housing markets continue to contract and commercial real estate values are still declining. The latest Residential Property Price Index for April shows that overall national property prices are already 50% down on the peak. Two consecutive monthly rises in Apartments and Dublin sub-markets can be interpreted as either a nascent stabilization, or one of the already numerous ‘false starts’ soon to be followed by renewed prices contractions. Take your pick, but either way we are way off any real recovery here.

Since about mid-2011, the Government has been committing a twin fallacy of referencing our bond yields moderation as a sign of ‘improved confidence’ in its policies. In reality, after massive LTROs that saw billions of euros pumped by the Irish banks into Government bonds, Irish yields are now back at the levels seen in January 2012. Over the last 18 months, the Troika programme has seen billions of Irish bonds taken off the market. This, alongside with the lack of new issuance, has meant that our bonds yields no longer provide a signal as to the expected cost of Irish Government borrowing. Since April 2011, the volumes of Irish Government bonds held by foreign investors have fallen by some 20% - the third steepest rate of decline in Europe after Greece and Portugal. The rate of foreign investors’ exiting Irish Government bond holdings has accelerated once again in the last 2 months. Year on year, Irish Credit Default Swaps spread over Germany is up almost 8% and this week our CDS reached 720bps.

The fact is, even by the above metrics, the current relative stability of our fiscal, financial and economic conditions is being supported by exceedingly optimistic assessments of our future growth and fiscal potential. Currently, Ireland runs the highest level of Government deficits in the euro area. Even if we stick to the EU-IMF adjustment programme, based on Department of Finance projections, in 2015 Ireland’s structural deficit will be the second highest amongst the old euro area member states. And to get to this unenviable position, we will need to carry out some €8.6 billion worth of new cuts between Budget 2013 and Budget 2015, taking more than €9,500 in additional funds out of working families’ budgets.

We are where we are – in a worse place than we were a year ago. Given the rates of economic destruction experienced since the onset of the crisis in 2008, this is doubly damaging to the claimed Government credit of reforms. Economics of the crises tell us that, on average, the harder the fall, the faster is the rise in the recovery. Ireland seems to be bucking this historical trend with our L-shaped recession to-date.

CHARTS:

04/11/2011: October PMIs - risk of recession rising

Continuing with the analysis of the latest PMI figures for October 2011 for Ireland, this post is looking into the relationship between employment, PMIs and exports-led recovery both over historical horizon and the latest performance. The previous two posts dealt with detailed data on Manufacturing (here) and Services (here).

Manufacturing PMI posted a rise from 47.3 to 50.1 between September 2011 and October 2011, moving above 50 reading for the first time in 5 months. However, as explained in previous post this increase does not signal expansion, as 50.1 is statistically insignificant relative to 50. At the same time, employment sub-index for Manufacturing PMI remains in contraction at 47.1 (statistically significantly below 50) for the second month in a row.

Services PMI posted a slight improvement in the rate of growth at 51.5 in October, up from 51.3 in September, but once again, given the volatility in the series, these readings are not statistically different from 50 (no growth) mark. Meanwhile, Employment sub-index of Services PMI remains below water at 46 - same reading for both October and September.

Charts below show two core trends:

The trends are:

• Both manufacturing and Services PMIs are flatlining around 50 mark, signaling stagnation
• Both in Manufacturing and Services, there are no signs of easing in jobs destruction

Consistent with these trends, overall Services sector has moved from the position of relative jobless recovery signalled at the beginning of 2011 to border-line recession and jobs destruction in October. Manufacturing sector has moved from the optimal growth area (jobs creation and recovery) in the beginning of 2011 to a recession in October 2011.

In addition to weaknesses in employment and overall PMIs, October figures show deterioration in exports growth, with Manufacturing New Export Orders sub-index at 49.8 and below 50 for the second month in a row (note that 49.8 is statistically not significant compared to 50) and Services New Export Business sub-index at 50.1 (down from 53.1 in September). Both sub-indices show stagnant exports performance in the sectors. Chart below shows that we are now in a recession (albeit border-line) - vis-a-vis exports-led recovery in Manufacturing and are getting close to a recession in Services.

1/02/2011: Ireland's Manufacturing PMI

Boom times arrive in Irish manufacturing - according to the latest NCB Manufacturing PMI for Ireland.

Here are the updated charts and my commentary:
Strong drivers for PMIs in Manufacturing in January 2011 were:

• New orders (up to 58.8 in January 2011 against 53.2 in December 2010 and 12-mo average of 52.5), driven by New Export Orders (up to 60.3 in January 2011 against 54 in December 2010 and 12-mo average of 56.1).

Headline PMI rose to 55.8 from 52.2 in December signaling strengthening of growth in the sector. On seasonally adjusted basis, January 2011 reading was well ahead of 51.8 average reading for 12 months preceding, and 51.4 average reading for Q4 2010. In Q1 2010 the same average reading was 49.9 (signaling contraction in the sector) and in Q1 2009 it was 35.8 (a veritable disaster!).

A close-up:
Backlogs and inventories:
Again, good performance with all signlas going in the right direction here.

Employment index is now for the second month running showing expansion, which is good news. Bad news - employment index is still relatively weak. But this is the first two-months consecutive expansion signal we had since October-November 2007.

Worrisome trend is on output-input prices gap, which is showing significant inputs price pressures.

Let's take a look at employment figures a bit closer:
You can see the divergence between services and manufacturing PMIs in both core PMIs and employment index.

So mapping the recovery:
Right move, in right direction for manufacturing. Let's hope services surprise on the positive side as well...

It is worth remembering that:

• Manufacturing sector in Ireland is heavily exports-oriented and as such is less labour-intensive than more domestically-oriented manufacturing in, say, France
  
• Manufacturing in Ireland is less labour-intensive than services (which, per December - the latest data due for an update in the next few days - is still tanking)
• Net effect of manufacturing growth - on employment is negligible, but still great news!

Economics 4/7/10: Global PMIs signal some pressures ahead

Based on WSJ blogs info, I pooled together a comparative table for the last three months OECD Purchasing Managers Indices. An interesting dynamics for Ireland, compared to peers and some other countries (24 in total):
Note: relevant competitors are in bold.

An interesting observation on PMI levels:

• In April Ireland ranked 18th in terms of its PMI reading (remember, PMI above 50 signals expansion);
• In May, this rank improved to 15th;
• But in June we slipped to 20th place of 24 countries.

In terms of changes mom in PMI readings, we fared much better, registering:

• 3rd highest gain in mom between April and May;
• falling to 19th rate of change between May and June;
• between April and June we recorded 12th ranked result in terms of changes in PMI
  

Overall, within the sample of 24 countries, it is clear that April to June changes showed 17 countries of 24 posting declines in PMIs, with only Greece, Hungary and South Africa continuing to post contractions in activity (below 50).

Most notable is stellar performance of Switzerland.

Average PMI has declined from 56.1 in April to 53.9 in June, while standard deviation has fallen slightly from 4.4 in April to 4.3 in June. This means Irish PMI drop was broadly in line with the average.

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 02/10/2009: IMF World Economic Outlook

IMF released its World Economic Outlook for H2 2009 last night. Here are some highlights, more to come later tonight.

Summaries of IMF latest forecasts:

Next, I created an index of overall economic activity that is GDP-weighted. This index is geared in favor of Ireland and other smaller exporting economies by magnifying the effects of GDP growth (as opposed to GNP) and the effects of the current account (reflective of higher share of trade and FDI in Irish economy) and downplaying both price inflation (with larger share of domestic inflation in Ireland imported from abroad) and unemployment (with traditionally smaller both unemployment and labour force participation in Ireland).

Rankings based on the index: Based on the above index of economic activity, ranking countries in order of declining quality of economic environment, shows the extent of our performance deterioration: if in 2007 Ireland ranked 18^th from the top in the developed world, by 2010 we are expected to rank 29^th or fourth from the bottom.
Peer economies comparatives:
Based on the above table, we can compute a relative impact of the crisis 2008-2010 on our competitor economies. Chart below illustrates this, showing that when compared to other economies, only Iceland is expected to show more severe contraction in economic activity than Ireland. More importantly, the gap between Irish performance during the crisis and that of an average economy in our competitor group is 1.5 Standard Deviations away from the mean.
Property markets crisis estimates: based on IMF model of duration and amplitude of property busts, table below reports the relative impacts of the global property slump in the case of Ireland, comparative to the rest of the OECD:
Stay tuned for more...