16/8/2012: Italy's 'this time, it's different' moment

This time it's different for Italy now... according to an excellent article by Charles Wyplosz here. Read the whole thing, Wyplosz is excellent on the basics of the Italian situation.

Update: new link to the article.

25/02/2012: Poster-boys of Recovery?

So does this really, I mean really, look like a recovery to any one of you?

The chart above plots evolution of nominal GDP in current US dollars from the pre-crisis peak (set = 100 for every country) through years following the beginning of the crisis (t=0). All data - IMF WEO and September 2011-February 2012 country-specific updates.

11/07/2011: A simple guide to an EU bailout

How EU countries go bust - a Simple 13-steps Guide for Asking for Bailouts:

Stage 1: Deny the problem (debt/deficit/banks - or all three) exists
Stage 2: Blame the Markets (ban short selling 'speculation' and condemn irresponsible profiteering)
Stage 3: Announce first round of cuts to purely "increase markets confidence" (no need to actually want to implement them)
Stage 4: Deny again that problem exists ("Our resolute measures - stage 3 - have resolved the problem")
Stage 5: Claim your country is not like Portugal/Greece/Ireland/Iceland
Stage 6: Announce a turnaround in the economy's prospects (or the imminent arrival of one)
Stage 7: Blame domestic 'doomsayers' for 'turnaround' being delayed
Stage 8: Announce more fake/ineffective/unimplemented austerity
Stage 9: Claim solvency for the next 6-9mo ("We are pre-funded for... months")
Stage 10: Ask Ohli "Imagineerer" Rhen / Grabosso / Lag(behind reality)arde / Frumpy von Rompuy to confirm Stages 4, 5, 6, and 9 announcements during a trip to your country
Stage 11: Send a motorcade to the airport to meet ECB/IMF team and Ask for a Bailout.

Post Bailout:
Stage 12: Blame ECB/IMF/EU/Markets/Rating Agencies for collapse of your economy
Stage 13: Repeat from Stage 4 through 10 to arrive at Bailout-2...

Economics 28/05/2010: Spain's downgrade is a warning for Ireland

In a significant development today, Fitch cut Spain’s credit ratings to AA+ from AAA. This was expected.

What was unexpected and new in this development is the expressed reason for the cut.

Per reports, "Fitch said Spain’s deleveraging of record-high levels of household and corporate debt and growing levels of government debt would drag on economic growth." (Globe & Mail)

This puts pressure not only on the euro and European equities, but also on the rest of the PIIGS' sovereign bonds. Ireland clearly stands out in this crowd.

As I have shown here and more importantly - here, Ireland is by far the most indebted economy in the developed world. While it is true that a large proportion of our total external debt accrues to IFSC, even adjusting for that

• Our General Government Debt held externally is the fifth highest in the developed world;
• Our External Banks Debt is the highest in the world;
• Our Private Sector Debt (Total Debt ex Banks & Government) is the highest in the world; and
• Our Total External Debt is the highest in the world.

In addition, per IMF (see here) our budgetary position is one of the weakest in the world, including for the horizon through 2015 (here).

“The downgrade reflects Fitch’s assessment that the process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term,” Fitch’s analyst Brian Coulton said in a statement.

Fitch said "Spain’s current government debt would likely reach 78 per cent of gross domestic product by 2013 from under 40 per cent before the start of the global financial crisis in 2007." Irish debt is projected to reach 94% of GDP by 2015 (IMF) or 122% of GNP - the real measure of our income. If we factor in the cost of Nama and banks, Irish Government debt will reach 122% of GDP by 2015.

This puts into perspective the real scope for public spending cuts we must enact in this and next year's Budgets. The Government aim to reduce spending by a miserly €3 billion in each year through 2012 will not do the job here. We will have to do at least 2.5 times that much to get our house in order.

Economics 15/02/2010: Ireland and the Euro

Sunday Times, February 14, 2010.

Like a namesake of Federico Fellini’s 1983 classic, E la nave va (And the ship sails on), the Greek debt saga continues its course toward the increasingly inevitable default. Another week, another impenetrable web of announcements, and no real solutions. At this stage, the EU’s ability to resolve the crisis is no longer a matter of markets trust and the reputational costs for the euro are becoming more than evident.

So much so that conservative and forward-looking ECB is starting to think of contingency planning. A source close to Frankfurt has told me earlier in the week that some ECB economists are contemplating the likely run on the euro leading to a 20-25% devaluation of the currency to bring it virtually to parity with the dollar. If that happens, an interest rates hike of 50 basis points or more will be a strong possibility sometime before the end of Q3 2010. A derailment of the nascent economic recovery in the core euro zone countries will be virtually assured.
The plan, currently under discussion at the EU level, involves a guarantee on Greek debt, plus a package of subsidised loans both underwritten by other euro zone countries (re: Germany). The problem is that this is unlikely to be enough.

Greek problems are not cyclical and will not go away once the markets calm down. Country structural deficit, in line with Ireland’s is around 60-70 percent of the overall exchequer annual shortfall. And unlike Ireland, Greece is facing an acute problem refinancing its gargantuan public debt. Worse than that, the latest revelations concerning the complex derivative contracts used by the Greek authorities to hide a significant share of its deficit over the recent years clearly show that the country will have to be much more aggressive in scaling back its annual deficits in order to be able to issue new bonds. The EU latest plan does not facilitate any of these measures. Neither does it have a credible enforcement mechanism. Should Greece decide at any point in the future to renege on its obligations under the rescue package, the entire crisis will be replayed tenfold. And the threat of this gives the Greeks a trump card against the EU Commission under collective guarantees.

Thus, currently, there are only three economically feasible structural solutions to the ongoing crisis in the euro area.

The best option would be a massive injection of liquidity across the common currency area. Minting a fresh batch of euros worth around €1-1.5 trillion and disbursing the currency to the national Governments on a per-capita basis would allow the PIIGS some breathing room in dealing with their deficit and debt problems. At the same time, countries like Germany, with more fiscally sound public spending habits, would be able to use this money to stimulate domestic demand and savings through tax credits and investment.

The drawback of such a plan is that it can reignite inflationary pressures within the euro area. This risk, in my view, is misplaced. Given structural weakness in consumer demand and continued cyclical weakness in new business investment, it is unlikely that much of the freshly-minted cash will go anywhere other than savings. Incidentally, with most the money flowing back into the banking sector, the ECB can then use this increase in deposits to close down some of the asset-backed lending positions that euro area banks have built up with Frankfurt.

Two other solutions involve introduction of a parallel ‘weak’ euro for PIIGS, or an outright bailout of Greece, Portugal, and possibly Spain and Ireland, through a partial pay-down of these countries debts. Both would have dire consequences for the euro itself.

The logistics of running two parallel currencies within a block of countries under a single-handed management of the ECB will produce more than confusion in the markets. The monetary policy required for the ‘weak’ euro state would entail interest rates at roughly triple those in the ‘strong’ euro countries, with the resultant potential for an explosion of carry trades unfolding within a single monetary union.

In addition, there is no mechanism by which either Greece or any other country can be compelled to switch to a ‘weak’ euro. In Ireland’s case, being forced into a ‘weak’ euro will be a disaster for the longer term prospects of maintaining strong presence of the US and UK multinationals here who rely on out full membership in the common currency club to drive their transfer pricing.

An outright paydown of the PIIGS debts – no matter how tough the EU Commission gets in terms of talking up ‘conditional lending’ and ‘direct supervision’ provisos of such an action – will result in an unenforceable lending from Germany to the PIIGS.


From Ireland’s point of view, however, the inevitable outcome of all possible alternatives for dealing with Greece will be devaluation of the euro close to parity with the US dollar. And here may lie the best news Irish exporting firms have heard since the beginning of this recession.

Given the dynamics of our exports-producing sectors, Ireland desperately needs a shot in the arm to stay alive as economy through 2010.

Per CSO, our MNCs-dominated modern manufacturing – the source of most of our goods exports – has managed to post a spectacular 14.5% seasonally-adjusted drop in production in Q4 2009. Pharmaceuticals output declined a 7.5% in the last quarter, while computer, electronic and optical equipment sector – another pillar of our exporting activities was down 14.9% in December 2009. It all points to growing weakness in exports-driven high value added segment of our manufacturing. In short, Ireland can use a serious devaluation of the euro on the exporting side.

But a silver lining never comes without some cumulus clouds in tow.

A devaluation – while a boom for exporters – will act to reduce consumer spending and, through higher cost of imports, will further reduce income available for domestic savings and investment. Given the already abysmally low levels of personal consumption, it is highly likely that this will trigger more household defaults on debt and mortgages.

Furthermore, a devaluation can trigger rising inflation across the euro area which, once imported into Ireland, will undermine the gains in competitiveness achieved during the current crisis. For comparison, consider the case of Ireland v Greece. In his recent note, NIB’s Chief Economist, Ronnie O’Toole highlighted the fact that between mid 2008 and the end of 2009, Irish consumer prices have fallen some 4.6%. In contrast, Greece saw its prices rise some 2.3% over the same period. Of course, falling price levels imply that it is much easier for companies and governments to cut nominal wages. A new bout of inflation induced by the EU solutions to the Greek crisis can wipe out this advantage.

Alas, no one so far has noticed that in both, Ireland and Greece, a cut in nominal wages in line with inflation will do two things. One – it will leave real wages – the stuff that private sector producers really care about – intact. And it will be a magnitude of 3-4 times too little for repairing the Exchequer balance sheet. With both countries facing a 2010 deficit of 10-11% of GDP, a 5% cut in public sector wages is equivalent to applying Bandaid to a shark bite.

And a rise in euro area inflation will have an adverse impact on Irish exporters. Despite devaluation, many of our MNCs and indigenous exporting companies buy large quantities of raw and intermediate inputs from abroad. The rise in the cost of imports bill will partially cancel out the gains in final prices achieved due to devaluation. This is especially significant for the companies trading in modern higher value-added sectors, where geographically diversified multinationals use Ireland as a later stage production base with intermediate inputs coming from other EU countries and the US.

Lastly, a devaluation of the euro close to the dollar parity is likely to trigger monetary tightening by the ECB, with interest rates rising by 50 basis points in the next six months. Coupled with reduced provision of new liquidity by Frankfurt, the resulting credit crunch on the Irish banks will trigger a massive jump in the burden of mortgages here. Needless to say, even with booming exports, Ireland Inc will be in deep trouble as trade credits, corporate funding and personal loans will be pushed deep into red by rising costs of borrowing.

At this stage, we really are caught between a rock and a hard place.

Economics 08/02/2010: PIIGS or PIGS?

For those of you who missed my article in yesterday's Sunday Times, here is an unedited version of it, as usual:

This week marked a new low for the euro zone. Despite all the posturing by Brussels officials about Greek deficits and the incessant talking up of the euro by the ECB and the Commission, the events clearly show that the common currency is lacking credible tools to bring order to public finances of its member states. Thanks to the clientilist politicians and the electorate, keen on piling up debt to pay for perks and inefficient public services, the Greeks really blew it. Then again, given their performance over the last fifteen years – inclusive of massive persistent deficits and outright manipulation of official data to conceal them – about the only surprising thing in the ongoing Greek tragedy is that their bonds are still trading at all.

Much more interesting events, related to the Greek debacle, are unfolding in Ireland. Boosted by the factually erroneous, yet ideologically pleasing statements by international observers, Ireland’s image in the euro area has improved significantly since the publication of the Budget 2010.

Which, of course, is out of line with economic reality on the ground. Far from exiting the PIIGS club of sickest euro economies, comprised of Portugal, Ireland, Italy, Greece and Spain, we are now looking like a country to which the wrath of international bond markets might turn next, once Greece is dealt with.

Let me explain.

This week, writing in the Financial Times, a respected economist, Nouriel Roubini has clearly shown just how escapist is the current thinking about the state of public finances in Ireland.

"The best course [for Greece] would be to follow Ireland, Hungary and Latvia with a credible fiscal plan heavy on spending cuts that government can control, rather than tax hikes... This approach is working in Ireland – spreads exploded as public debt ballooned to save its banks, but came back in as public spending was cut by 20 percent."

Professor Roubini’s comment was echoed later in the day by ECB’s President Jean-Claude Trichet who lent unprecedented amount of good will to the ‘right policy choices’ made by Ireland.

Even our Department of Finance has not, officially, claimed such a thing.

First off - Irish fiscal adjustments from the beginning of the crisis to-date are split approximately 50:50 between higher tax burden and ‘savings’. This debunks Professor Roubini’s general analysis of our policies.

But more importantly, it shows that our Government policies have focused on providing fiscal and financial supports to a select few at the expense of the entire economy. Some €70 billion plus of real future taxpayers’ money has been already committed and €10-15 billion more is still waiting to be deployed post-Nama to rescuing Irish banks’ bondholders. Slightly less comfort was given to the developers who will get a three year holiday on loans repayments courtesy of the taxpayers.

In a real world, economic recovery can only start with ordinary households and businesses. In Ireland, public policy assumes that raising taxes and charges at the times of shrinking incomes and revenues to sustain banks bondholders and narrow interest groups within this society passes for ‘doing the right thing’.

International observers might overlook this fact. For them the costs of encountering a deep and prolonged Irish recession are nil. But for us, the spectre of the 1980s is painfully evident.

In contrast to Greece, Ireland has been hit by an unprecedented, in magnitude and duration, economic recession. Our house prices bust and financial assets collapse was deeper than that of Greece. We also are facing a much more severe banking crisis and a significantly more dramatic rates of deterioration in public deficits. Ditto for our unemployment levels and credit contraction rates.

Our sole claim to better health is a substantially lower existent public debt burden. Alas, this too is optical. In real per capita terms, total levels of debt in Ireland (combining public and private debts) are several times greater than those in Greece.

Even when it comes to budgetary adjustments – as far as Governments plans go – the Greeks are ahead of us. Starting from marginally higher deficit in 2009, the Greeks are planning to bring their deficit to within 3% of GDP limit by 2012. We are planning to do the same by 2014. Of course, both plans are unrealistic, but whilst the EU Commission will attempt to force the Greeks to comply with their target, no one will be closely monitoring our Government’s progress.

In summary, we are nowhere near exiting the PIIGS club.

But let’s take a look at the ‘Love the Irish Policies’ media circus going on in international press. Contrary to Professor Roubini statement, Irish Government has been unable to achieve meaningful cuts in public spending to-date. Instead, we delivered a reallocation of some funding from one side of public expenditure to another. ‘Cuts’ in majority of departments have been simply re-diverted to social welfare and Fas.

By Government-own admission, there will be no net reduction in public expenditure in Ireland since 2009. Department of Finance’s "Ireland – Stability Programme Update, December 2009" provides some stats. In 2009, Gross Current Government Expenditure in Ireland stood at €61,108 million. In 2010 it is budgeted to reach €61,872 million. The latter figure does not include the cost of recapitalizing the banks post-Nama. In 2011-2014 the Government is projecting the Gross Current Expenditure to rise steadily from €63,518 million to €65,768 million.

To Professor Roubini this might look like savings, but to me it looks like the Government continuing to leverage our economic future in exchange for avoiding taking necessary medicine now.

The only reasons why our deficits are expected to contract from 2011 through 2014 is because the Government has been slashing public investment, raising tax burden and is banking on a robust recovery after 2010.

Overall, DofF plans for a 2.8% cut in the General Government Balance in 2010, and that will leave us (per their rosy forecasts on growth and tax revenue) at 11.6% deficit relative to GDP, down a whooping 0.1 percentage point on 11.7% deficit achieved in 2009. Adding expected costs of banks recapitalization, our Government deficit can easily reach beyond 14-15 percent of GDP this year. Greece is now aiming for 8-9% deficit this year under a watchful eye of the Commission. Do tell me Budget 2010 qualifies us for being treated as a stronger economy than Greece.

Stripping out its interest rate bill, Greece is planning for lower per-capita state borrowing in 2010 than Ireland. But Irish Exchequer is planning to raise its borrowing this year by 3%. If international observers are correct, why would the Government that managed to cut its spending by 20% increase its borrowing? That would only make sense if the revenue is expected to fall by more than 20%. Yet Budget 2010 assumes tax revenue decline of only 4.7% in 2010 and an increase in non-tax revenues.

So what has Irish Government done to deserve such a sweet-heart treatment from the EU and Professor Roubini?

One word comes to mind – smart marketing. Budget 2010 simply took €4,051 million from one Government pocket and loaded it into another. Then, the Government promptly reversed itself out of some of the higher profile cuts, such as those imposed on higher earners in the public sector. Even at the highest point of estimates, the savings – before they get cancelled out by rising spending and falling revenue – amount to the total of 6.42% of the Gross Total Expenditure in 2009.

After 2 years of the deepest economic crisis in the euro area, we are now facing one of the heaviest upper marginal tax burdens in the developed world, and a deficit that is simply out of control. Hardly the road map to a recovery.