17/7/2013: Wrong Austerity Compounds the Failures of the Monetary Union

Recent CEPR paper DP9541 (July 2013), titled "Debt Crises and Risk Sharing: The Role of Markets versus Sovereigns" by Sebnem Kalemli-Ozcan, Emiliano Luttini, and Bent E Sørensen (linked here: www.cepr.org/pubs/dps/DP9541.asp) used "a variance decomposition of shocks to GDP", in order to "quantify the role of international factor income, international transfers, and saving in achieving risk sharing during the recent European crisis."

Basic idea of the exercise was that a lack of saving in good times may reduce consumption smoothing in bad times, forcing households to cut back their spending and consumption more dramatically once recession hits.

Under perfect risk sharing, the consumption growth of individual countries should be completely independent from all other factors, conditional on world consumption growth.

The authors of the study "calculate how much of a shock to GDP is absorbed by various components of saving, in particular government saving, and other channels, such as net foreign factor income for the sub-periods 1990-2007, 2008-2009, and 2010." The key finding here is that "overall, risk sharing in the EU was significantly higher during 2008-2009 than it was during the earlier period, but total risk sharing more or less collapsed in 2010." Notably, 2010 is the year when European economies embarked on 'austerity' path, primarily and predominantly expressed (especially in the earlier stages) in tax increases. It is worth noting that there virtually no reductions in public spending during 2009 or 2010 across the EU and even in countries where spending was cut, such as Ireland, much of the reductions came from indirect taxation - e.g. transfers of health spending from public purse to private insurance.

Further, the authors "study how the crisis a affected risk sharing for "PIIGS" countries (Portugal, Ireland, Italy, Greece, and Spain), which were at the center of the sovereign debt crisis, compared to non-PIIGS countries (Austria, Belgium, Denmark, Finland, France, Germany, the Netherlands, Sweden, and the United Kingdom)."

Again, the findings are revealing: "For 1990-2009, risk sharing was mainly due to pro-cyclical government saving but the amount of risk sharing from government saving turned negative in 2010 for the PIIGS countries: government saving increased at the same time as GDP decreased." In other words - this is the exact effect of austerity as practised by the EU periphery.

"For [euro area peripheral] countries our measure of overall risk sharing turns negative because (conditional on world consumption growth) the decline in GDP in 2010 was accompanied by a more than proportional decline in consumption. This mirrors the behavior of emerging economies where government saving typically is counter-cyclical as shown by Kaminsky, Reinhart, and V egh (2005)."

Crucially, the study shows that there is basically no risk-sharing mechanism that operates on the entire euro area level. Even common currency zone - via lower interest rates - does not deliver risk sharing in 2010 and has potentially a very weak effect in 2008-2009 period. Worse, for the euro area peripheral states, euro has been a mechanism that seemed to have removed risk sharing opportunities both in and out of the crisis:

"…although non-PIIGS countries shared a non-negligible amount of risk during 2000{2007 while the PIIGS shared little risk in those years: in the good year 2005, consumption increased faster than GDP leading to "negative risk sharing." In 2008 and 2009 the major amount of GDP risk is shared for non-PIIGS with low consumption growth rates in spite of large drops in GDP, with the amount of risk shared in 2008 over 100 percent (positive consumption growth in spite of negative GDP growth). For the PIIGS, consumption declined very little in 2008 in spite of a large drop in GDP, while the drop in GDP in 2009 clearly led to declining consumption and, in 2010, consumption fell by almost as much as GDP, indicating little risk sharing."

Top line conclusion: once the authors "decompose risk sharing from saving into contributions from government and private saving", data reveals "that fiscal austerity programs played an important role in hindering risk sharing during the sovereign debt crisis."

24/9/2012: Euro peripherals Building & Construction activity

Here's a chart updating to latest data index of Building & Construction sector activity in the peripheral euro area states:

As inspired by @StephenKinsella: "Ouch!"

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.

4/5/2012: Fitch Bells: Ringing de Panic?

Yesterday, Fitch Ratings issued an interesting report, titled "The Future of the Eurozone: Alternative Scenarios". The report sounds alarm bells over what some markets participants have thought of as a 'past issue' - the risks of contagion from Greece to the Euro area periphery.

Fitch Ratings core view is that the eurozone will 'muddle through' the crisis, surviving in its current composition,  while taking 'gradual steps towards closer fiscal and economic integration'. 


The interesting bit comes in the discussion of possible alternatives and the associated probabilities of these alternatives. According to Fitch, there is rising (not falling, as we would expect were LTROs and Greek debt restructuring, plus the Fiscal Compact and the ESM working) risk of a protracted growth slowdown or political shock or some other shock triggering either a possible facilitated Greek exit from the Euro or a disorderly Greek exit from the common currency.


And, crucially, according to Fitch, this risk cannot be discounted. 


This bit is where Fitch's assessment is identical to mine and contradicts that of the majority of Irish 'green jersey' economists: the tail risk of a disorderly unwinding of the euro is non-zero and rising, while the disruption or cost associated with such a outcome is by far non-trivial. Prudent risk management policy would require us to start contingency planning and addressing the possible realisation of such a risk. Instead, we are preoccupied in navel gazing through the lens of the Fiscal Compact, and not even at our own 'navel', but at the European one.


Fitch view is that a full break-up and demise of the euro is probabilistically highly unlikely. This belief is based on Fitch foreseeing large financial, economic and political costs of a break-up. More interestingly, Fitch determines that a partial break-up of the euro zone - with one or more countries exiting the common currency -  would "risk severe systemic damage, although cannot be discounted". 


For those thinking we've done much to resolve the systemic euro crisis (by doing much we usually mean creation of EFSF and agreeing ESM, deploying LTROs and restructuring Greek debts, and putting in place the Fiscal Compact), Fitch has some nasty surprises. Basically, Fitch believes (and I agree with their assessment here), that "additional measures will be needed to resolve the crisis. These are likely to include some dilution of national fiscal sovereignty [beyond the current austerity programmes and Fiscal Compact], potentially some partial mutualisation of sovereign liabilities [basically - euro bonds of sorts] and resources [some transfers to peripheral states], as well as measures to enhance pan-eurozone financial supervision and intervention, combined with further institutional reforms to strengthen eurozone economic governance". Basically, you can read this as: little done, much much much more to do still...


It gets worse.


Of all the alternative scenarios presented, Fitch believes that the most likely scenario will involve a Greek exit, with Greece re-denominating its debt in a new currency and default on its bonds again. Per Fitch, the core danger will be to Cyprus, Ireland, Italy, Portugal and Spain based on:

1. Greek exit creating an 'exit precedent' for the already distressed economies
2. Greek default impacting adversely other peripheral countries banks (especially true for Cyprus)
3. Greek default increasing the risk of capital flight from the countries
4. Greek default triggering a run on peripheral bonds just around the time when the 2013 'return to markets' horizon is in the crosshair.

Just as I usually do in my presentations on the topic, Fitch distinguishes two potential paths to Greek 'exit' - a structured and unstructured or 

• an "orderly variation with an effective eurozone policy response and minimal contagion" and 
• a "disorderly variation", involving "material contagion to the periphery and a significant increase in contingent liabilities facing the core".

Ouch, I must say, for all the folks who lost their voice arguing that my views are 'unreasonable' and 'scaremongering'. Sorry to say it, risk management approach to dealing with reality requires taking a probabilistically-weighted expected costs scenarios of the downside into the account. Simply shouting "all is sustainable here, nothing to bother with" won't do.

14/3/2012: Daily CDS moves

On the foot of yesterday's widening, CDS for Belgium and Italy posted very significant, close to 5%+ tightening. Portugal is now clearly euro area's 'second weakest prey' and the lions are out, still hungry after Greece:

Nice tightening on Germany - down 5.34% and that amidst rising US yields. Albeit, of course, it is harder now to price CDS post-Greek fiasco, so demand is probably being compressed while supply is on the rise due to adverse impact on overall demand/supply balance in pricing CDS as insurance contracts (which they are not, not after Greece).

All data courtesy of CMA.

13/3/2012: CDS moves

On the day Fitch upgraded Greece to B-/Stable from selective default rating, some PIIGS continued to get hammered: 5 year CDS moves with implied probability of default:

Courtesy of CMA.

And per @forexlive - here's analysis of the Fitch move:

"Fitch has begun rating Greece’s new issues at B-, which is deeply into ‘junk’ territory. To put that in perspective, it’s eight notches below Ireland, which Fitch has rated at BBB+ and six notches below Portugal at BBB-. It’s also below Rwanda, Argentina and Ukraine. The current yield on the new 10-year benchmark is 19.01%."

Yep, markets have a strange 'memory'...

9/2/2012: Interesting chart on Euro area deposits

Here's an interesting chart from Credit Suisse via zerohedge:

Now, it's not the blue line that worries me and the others (EAP5=Euro Area Periphery states or PIIGS). It's the massive dip in the grey line. Given there's little deleveraging of consumers and corporates in France and Germany and that there is little it terms of concerns for stability of German banks (whether or not this sense of security is justified or not), the chart suggests that deposits are flying out not just in fear of local banks risks, but in fear of the euro risks.

The link to zerohedge post is here.

8/2/2012: A more pleasant Sovereign arithmetic

And for a rather more pleasant sovereign arithmetic, here's an interesting table from the Global Macro Monitor (link here) summarizing yoy movements in 5 year CDS:

Frankly speaking, all of this suggest some severe overshooting in CDS and bonds markets on upward yield adjustments over time followed by repricing toward longer term equilibrium. What this doesn't tell us whether we have overshot equilibrium or not... Time will tell.

7/2/2012: An unpleasant risk arithmetic

Here's the guys Irish authorities trust so much on risk assessment, they contracted them to do banks stress tests - PCARs - back in 2010-2011. Note: this is a statement of fact, not an endorsement by me. The Blackrock folks produce quarterly report on sovereign risks and this the summary chart from the latest one - Q1 2012. Negative numbers refer to higher risks:

So Greece leads, Portugal follows, Egypt and Venezuela are in 3rd and 4th place worldwide of the riskiest nations league and then, in the fifth place is Ireland, followed by Italy. And here's the summary of the euro area ratings:

Yes, bond yields have been improving significantly, including due to both fundamentals and banks liquidity steroids, which is a good news. The bad news, yields have been declining for other countries as well and investors' relative sentiment is not improving as much as the absolute levels of yields declines suggest.

Today, one of the Irish Stuffbrokerages claimed in a note that: "The country’s success in meeting its targets under an EU/IMF bailout without social or political unrest and its export-focused economy has enabled it to dodge the recent Eurozone downgrades by S&P and Fitch and distance itself from fellow bailout recipients Greece and Portugal. " Distancing we might be, but the neighborhood we are lumped into is not changing as the result of this distancing. At least not for now.

Please note, the assessments above are consistent with CMA analysis based on CDS spreads, covered here.

16/1/2012: Summary of S&P move and more

In the wake of the S&P action it is a good idea to put side-by-side some ratings on euro area countries. here are S&P ratings before and after downgrade along with CMA ratings and CDS data for Q1 2009 beginning of the crisis) and Q4 2011.

Per S&P: "...the agreement [between euro zone member states in December 2011 attempting to address the crisis] is predicated on only a partial recognition  of the source of the crisis: that the current financial turmoil stems  primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness  between the eurozone's core and the so-called "periphery". As such, we believe  that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national  tax revenues."

In other words, it's growth, stupid. And herein lies the main problem for Europe. While EU might - if forced hard enough - jump onto a more sustainable fiscal spending path (cut deficits and structural deficits) - the EU has absolutely no record of creating pro-growth conditions or environments. In fact, in a bizarre response to the S&P moves:

• France is discussing an increase in VAT as the means for stimulating productivity growth, while
• Austria is planning wealth taxes and increase in retirement age as its response to economic growth challenge.

Now, where do you start in dealing with this lunatic asylum? 

13/1/2012: EU27 External Trade - Greece falling out of trade picture

As German lawmakers are putting pressure on the parties in the PSI negotiations in Greece with calls for Greece to exit the Euro to devalue and regain competitiveness have some serious basis in real economic performance of the country.

Today's data on trade balance across EU27 clearly shows that Greece is unable to sustain serious debt repayments under the current arrangements. Here are the details:

The first estimate for November 2011 euro area (EA17) trade surplus came in at €6.9 bn surplus, against the deficit of -€2.3 bn in November 2010. October 2011 trade balance was +€1.0 bn, against a surplus of +€3.1 bn in October 2010.

In November 2011 compared with October 2011, seasonally adjusted exports rose by 3.9%, while imports remained unchanged.

The first estimate for the November 2011 extra-EU27 posted trade deficit of -€7.2 bn, compared with a deficit of -€16.8 bn in November 2010. In October 2011 the trade balance extra-EU27 was -€11.2 bn, compared with -€9.5 bn in October 2010.

In November 2011 compared with October 2011, extra-EU27 seasonally adjusted exports rose by 2.8%, while imports fell by 0.6%.

EU27 detailed results for January to October 2011:

• The EU27 deficit for energy increased significantly (-€317.5 bn in January-October 2011 compared with -€246.4 bn in January-October 2010)
• Trade surplus for manufactured goods rose to +€198.9 bn compared with +€136.4 bn in the same period of 2010. 
• The highest increases were recorded for EU27 exports to Russia (+28%), Turkey (+23%), China (+21%) and India (+20%), and for imports from Russia (+26%), Norway (+21%), Brazil and India (both +20%). 
• The EU27 trade surplus increased slightly with the USA (+€60.8 bn in January-October 2011 compared with +€60.1 bn in January-October 2010) and more significantly with Switzerland (+€24.1 bn compared with +€16.6 bn) and Turkey (+€21.3 bn compared with +€14.7 bn). 
• The EU27 trade deficit fell with China (-€132.2 bn compared with -€139.8 bn), Japan (-€16.1 bn compared with -€18.3 bn) and South Korea (-€3.9 bn compared with -€9.6 bn), but increased with Russia (-€76.0 bn compared with -€61.1 bn) and Norway (-€38.7 bn compared with -€29.8 bn). 
• Concerning the total trade of Member States, the largest surplus was observed in Germany (+€129.2 bn in January-October 2011), followed by Ireland and the Netherlands (both +€35.9 bn) and Belgium (+€10.1 bn). The United Kingdom (-€98.2 bn) registered the largest deficit, followed by France (-€72.5 bn), Spain (-€40.1 bn), Italy (-€24.2 bn), Greece (-€16.9 bn), Portugal (-€13.3 bn) and Poland (-€12.0 bn).

Some charts:

The charts above clearly show that:

• Of all PIIGS, Ireland is the only country showing capacity to generate significant trade surpluses, with Irish merchandise trade surplus of €2.5bn in November being the second highest in EU 27 in absolute terms and the highest in terms relative to GDP. Exactly the same is true for Irish trade surplus recorded in October. Irish trade surplus in November was almost as large as the combined surpluses of all other countries with positive trade balance, ex-Germany (€2.9bn).
• In November 2011 Ireland posted the third fastest rate of mom growth in exports in EU27 (+8.3%), the effect compounded by the 9.4% drop (4th deepest in EU27) in imports.
• In contrast, Greece posted a 14.4% contraction in its exports in November 2011 compared to October 2011 - the largest drop of all countries in EU27. Greek trade balance in October stood at a deficit €0.1 billion and in November 2011 this widened to €0.2 billion.

So in terms of trade, Ireland is not Greece, and Greece is not showing any signs of ability to sustain internal debt adjustment within the euro structure.

9/1/2012: Week opener: Merkozy continuing to ignore Greek realities

Today's meeting between Sarkozy and Merkel is being framed in the context of continued pressures across the euro area (see report on the meeting here). More ominously - within the context of the euro area leadership duet ignoring the latests warning signs for Greece.

Per Der Spiegel report, IMF has changed its analysis of the Greek rescue package agreed in July 2011 in-line with IMF changes in forecasts for Greek economy in the latest programme review in December 2011. Specifically, IMF lowered its forecast for growth from -3% to -6% GDP.

Der Spiegel cites IMF internal memo in claiming that the Fund is viewing existent Greek programme (including to 50% 'voluntary' haircut on Greek bonds currently under negotiations) as insufficient to stabilize the Greek economy and fiscal situation. The Fund is, reportedly, considering 3 possible options to alleviate the latest set of growth pressures:

• New austerity measures for Athens - a measure that in my view will only exacerbate immediate pressures on Greece and will lead to dangerous destabilization of political situation in the country, leading to even more second order adverse effects on growth (e.g. prolonged strikes and rioting);
• Deeper haircuts on Greek debt held by private institutions - in my opinion this will lead to more contagion from Greece to euro area banks and sovereigns and should be, instead complemented by writedowns of Greek debt held by the ECB, to match existent private sector arrangements;
• Increase in the euro zone bailout funds - in my view, this measure is currently outside the feasibility envelope for Europe and, if attempted, will lead to increased cost of euro area borrowing and have a knock on effect of higher cost of lending to countries currently in the Troika programme. It is also important to note that the EFSF head Klaus Regling is aiming to raise EFSF guarantees to foreign investors to 30%, thus reducing the leverage ratio from 4-5 times to 3 times. This will lower EFSF's theoretical borrowing capacity even further.

The IMF note reports are effectively matched by the statement from the senior Germany Finance Ministry adviser made Saturday, who tole the Greek press that a 50% haircut on Greek debt will not be enough to restore sustainability to Greek fiscal dynamics.

In effect, three of out three IMF 'options' cited will exacerbate the crisis, not resolve it. And there is no Option 4 on the books.

2/12/2011: Euro crisis: wrong medicine for a misdiagnosed patient

There's been much talk about the fiscal union and ECB money printing as the two exercises that can resolve the euro area crises. The problem is that all the well-wishers who find solace in these ideas are missing the very iceberg that is about to sink the  Eurotanic.
 (image courtesy of the ZeroHedge.com):

Let's start from the top. Euro area's problem is a simple one:

• There is too much debt - public and private - as detailed here, and
• There is too little growth - including potential growth - as detailed here.

Oh, and in case you think that discipline is a cure to debt, here's the austerity-impacted expected Government debt changes in 2010-2013, courtesy of the OECD:

In other words, it's not the lack of monetary easing or fiscal discipline, stupid. It's the lack of dynamism in European economy.

Let me explain this in the context of Euro area policies proposals.

• The EU, including member states Governments, believes that causality of the crisis follows as: Loss of market confidence leads to increased funding cost of debt, which in turn causes debt to become unsustainable, which in turn leads to the need for austerity and thus reduces growth rates in the Euro area economies.
• My view is that low growth historically combined with high expectations in terms of social benefits have resulted over the decades in a build up of debt, which was not sustainable even absent the economic recession. Economic recession caused the tipping point in debt sustainability beyond which markets lost confidence in European fundamentals both within the crisis environment, but also, crucially, beyond cyclical recession. My data on structural deficits (linked above) proves the last point.

So while Europe believes that its core malaise is lack of confidence from the markets, I believe that Europe's real disease is lack of growth and resulting high debt levels. Confidence is but a symptom of the disease. 

You can police fiscal neighborhood as much as you want (and some policing is desperately needed), but you can't turn European economy from growth slum to growth engine by doing so. You can also let ECB buy all of the debt of the Euro area members, but short of the ECB then burning the Government bonds on a massively inflationary pyre, you can't do away with the debt overhang. Neither the Euro-bonds (opposed by Germany) nor warehousing these debts on the ECB balance sheet (opposed by Germany & the ECB) will do the trick. Only long-term growth can. And in that department, Europe has no track record to stand on.

Take Italy as an example. Charts below illustrate the country plight today and into 2016. I use two projections scenarios - the mid-range one is from the IMF WEO for September 2011, the adverse one is incorporating OECD forecasts of November 2011, plus the cost of funding Italian debt increasing by 100bps on the current average (quite benign assumption, given that it has increased, per latest auctions by ca 300bps plus).

As chart below shows, Italy is facing a gargantuan-sized funding problem in 2012-2016. Note that the time horizon chosen for the assessment of fiscal sustainability is significant here. You can take two assumptions - the implicit assumption behind the Euro area policy approach that the entire problem of 'lack of markets confidence' in the peripheral states can be resolved fully by 2013, allowing the peripheral countries access to funding markets at costs close to those before the crisis some time around 2013-2014. Or you can make the assumption I am more comfortable with that such access to funding markets for PIIGS is structurally restricted by their debt levels and growth fundamentals. In which case, that date of regaining reasonable access to the funding is pushed well past 2015-2016.

Government deficits form a significant part of the above debt problem in Italy (see below), but what is more important is that even with rosy austerity=success model deployed by the IMF, the rate of decline in Italian public debt envisioned in 2013-2016 is abysmally small (again, see chart below). This rate of decline is driven not by the lack of austerity (deficits are relatively benign), but by the lack of economic growth that deflates debt/GDP and deficit/GDP ratios and contributed to nominal reductions in both debt and deficits.

But the proverbial rabbit hole goes deeper, in the case of Italy. IMF projections - made before September 2011 - were based on rather robust euro area-wide growth of the first quarter of 2011. Since then two things have happened: 

1. There is a massive slowdown in growth in Italy and across the euro area (see here), and
2. Cost of funding Italian debt has risen dramatically (see the second chart below).

These two factors, imperfectly reflected in the forecasts yield my estimation for Italian fiscal sustainability parameters under the 'adverse' scenario.

The above shows why, in the case of Italy, none of the solutions to the crisis presented to-date will work. Alas, pretty much the same applies to all other peripheral countries, including Ireland.

Which means that the latest round of euro area policies activism from Merkozy is simply equivalent to administering wrong medicine in greater doses to the misdiagnosed patient. What can possibly go wrong here?

14/09/2011: Ireland & Portugal are allowed to restructure some of their sovereign debts

The EU Commission issued its proposals for altering terms and conditions of loans extended under the EFSM (and same is expected for EFSF). The details of release are here.

The move comes after July 21 EU summit agreement to alter these terms and took surprisingly long to deliver. This has nothing, I repeat - nothing - to do with the claimed efforts by the Irish Government to secure similar reductions over recent months. The reductions come on the foot of the EU-wide deal for Greece.

Per Commission statement: "The Commission proposes to align the EFSM loan terms and conditions to those of the long standing the Balance of Payment Facility. Both countries should pay lending rates equal to the funding costs of the EFSM, i.e. reducing the current margins of 292.5 bps for Ireland and of 215 bps for Portugal to zero. The reduction in margin will apply to all instalments, i.e. both to future and to already disbursed tranches."

Two critically important points here:

• The reductions, especially for Ireland, are significant in magnitude and will improve Ireland's cash flows and net small reduction in debt burden over time. However, much of these are already factored in recent debt and deficit projections.
• The reductions are retrospective, which is a very important point for Ireland.

Further per EU Commission statement: "...The maturity of individual future tranches to these countries will be extended from the current maximum of 15 years to up to 30 years. As a result the average maturity of the loans to these countries from EFSM would go up from the current 7.5 years to up to 12.5 years."

Two more important points follow from the above:

• Extended maturity in combination of lower coupon on borrowings imply significant cuts in NPV of our debt from EFSM, which, in turn, means that under current EU Commission proposal we will undergo a structured credit event (aka - an orderly default). When this course of action was advocated by myself and others calling for the Irish government to force EU hand on providing for structured default, we were treated as pariahs by the very same 'green jersey' establishment that now sings praise to the EU largess.
  
• Second point is that, as I have noted back in July, this restructuring implies longer term maturity period and can result in total net increase in our overall debt repayments, were we to delay implementation of austerity measures. The silver lining, folks, does have a huge cloud hanging over it.

Lastly: "...the new financial terms will bring benefits such as enhanced sustainability and improved liquidity outlooks. Moreover, indirect confidence effects through the enhanced credibility of programme implementation should result in improved borrowing conditions for the sovereign as well as the private sector."

In effect the above implies that absent such reductions and maturity extensions, Ireland and Portugal are unable to remain on a "sustainable" path and/or lack or experience a deficit of "credibility" whne it comes to their adjustment programmes. That, of course, is plainly visible to all involved.

So here we are, folks - we now had:

1. Bank defaulting on some of its liabilities - and cash machines kept on working
2. Government undergoing debt restructuring - and cash machines keep on working.

Not the end of the world, is it?

13/11/2011: What do PIIGS tell us about EU's economic convergence thesis

Working with the industrial production indices today, I found it interesting to compare the PIIGS in terms of their respective industrial performance over the years. The chart below does exactly that, but first few numbers, using annual averages of monthly data for 1990-present

• Annualized production index in the Euro area had risen from 85.95 in 1990 to 105.58 in the first 6mo of 2011 - a rate of increase in the sector of 0.94% annually
• Irish industrial production over the same period rose from 31.54 to 146.43 an increase of 7.23% annually on average. We are currently at the historic peak in terms of annual averages of 146.43 slightly above 2010 level of 145.53 when our industrial activity surpassed the pre-crisis peak of 145.43 attained in 2007.
  
• Spain's industrial output index rose from 80.63 in 1990 to 85.97 in 2011 (though H1 so far) an increase of 0.29% per annum on average. Spain's industrial production peaked in 2007 at 108.79.
  
• Italy's industrial production dropped from 85.59 in 1990 to 85.48 in 2011 so far, in effect the rate of growth just below zero on average annually. Italy's industrial activity peaked in 1992 and has been declining since then.
  
• Greece's data only goes as far back as 1995 and from that base the country industrial production shrunk from 79.12 to 74.16 over the 1995-present, an annualized rate of decrease in production of 0.4%. In fact, Greek industrial output activity peaked in 2000 and has been on decline since then.
• Portugal's data is available only since 2000 and within the span of 2000-present, Portuguese industrial output index fell from 100 to 85.55 - an annualized rate of decline of 1.3%. Portuguese output maxed-out back in 2002 at less-than-impressive 102.05 or just 2.05% above 2000 level.

Now, another interesting issue is just how much was the crisis responsible for in terms of derailing any potential convergence in industrial activity between the PIIGS and the Euro area average. In all of the countries concerned, and in the Euro area 17 aggregate data, the crisis is marked by the contraction of industrial activity in 2008. Re-based to 2007=1000, data shows that:

• EU 17 remains at 93.40% of 2007 operating levels
• Ireland has exceeded 2007 peak production levels by 0.69% in H1 2011
• Greece remains at 25.35% below peak 2007 capacity and the situation is worsening
  
• Spain has seen a slight improvement on 2010 levels in H1 2011, but is still suffering a 21% decline in industrial capacity relative to pre-crisis peak
• Italy's industrial output recovered only slightly off the cyclical low, reaching the average of 84.33 in H1 2011, some 15.67% below pre-crisis levels
• Portugal's industrial activity fell in 2008, and 2009, rebounded slightly in 2010 and is now falling again. As of the end of H1 2011, industrial output index stood at 11.3% below the pre-crisis levels.
  

So overall, the data suggests that despite extremely anemic growth in the Euro area in terms of industrial production since 1990, no PIIGS country other than Ireland was on convergence path to the Euro area levels of activity. The gap in industrial performance between the countries and Euro area has grown in Greece, Italy and Portugal, and failed to converge in Spain (where growth rate was more than 3 times slower than in the Euro area).

Ireland stands alone as the economy where the much hyped convergence thesis (one of justifications for the Euro area and indeed the EU overall existence) holds. Irony has it, in Ireland this convergence was achieved, of course, almost exclusively due to MNCs. So the EU can say thank you to the US, UK, some EU and ROW investments for proving the convergence thesis in just one out of 5 examined economies.

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...

07/07/2011: What's in the interest rates hikes

Working away on the data for PIIGS, I was interested in a question, what if the ECB were to go to the equilibrium repo rate consistent with the current inflation & growth environment?

In a recent post (here) I did analysis of the ECB historical rates in relation to eurocoin leading indicator of growth. This chart is reproduced here with suggested ranges for the repo rates consistent with current and with higher inflation.
So if the equilibrium rates are in the neighborhood of 2.25-2.75 percent, what would 1% increase in interest rates from June 2011 rate of 1.25% do to the cost of fiscal debts financing across the PIIGS?

Using IMF projections for debt levels for PIIGS through 2016 and assuming that all interest payments are financed out of deficits / borrowing, the chart below shows the extent of the increase in the cost of interest charges on government debt by 2016:
This translates into an increase in the annual cost per capita (2016 forecast) of:

• €560.48 in Greece
• €834.84 in Ireland
• €546.74 in Italy
• €309.24 in Portugal
• €319.02 in Spain

Overall, the increases in interest costs for PIIGS will amount to ca €47.06 billion per annum or 1.23% of the PIIGS GDP and 0.44% of the Euro area GDP. Oh, and by the way, this does not take into account the additional costs of financing banks lending by the ECB.

So that should put into perspective my view of today's hike in the ECB rate, expressed earlier here. So happy wrecking ball swinging, Mr Tri(pe)chet & Co.

16/02/2011: Heading for another round of crisis pressures?

Two nice charts, lest we forget where the crisis is at:

Greek 10y sovereign bonds:
And Irish 10y sovereign bonds
Both courtesy of Goldcore, both are daily yields over 1 year.

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 20/04/2010: IMF report on global financial stability

IMF's GFSR report for Q1 2010 is out today, and makes a fantastic, albeit technical reading of the global financial system health. Ireland features prominently.

First, Ireland, alongside with Austria, the Netherlands and Belgium are the four leading countries responsible for contagion of markets shocks to the rest of the Euro area. Own fundamentals drove, per IMF team, Irish sovereign bond spreads more than those for any other country in the common currency area, dispelling the Government-propagated myth that our crisis was caused by the US and the global financial markets collapse. Chart below - from the report - illustrates:
Between October 2008 and March 2009, Ireland's contribution to cross-Euro contagion was 12.3% of the total Euro area distress probability - second highest after Austria (16.7%). For the period of October 2009 - February 2010, the picture changed. Greece came in first in terms of distress contagion risk - at 21.4%, Portugal second with 18.0%. Ireland's role declined to 8.1% - placing us 6th in the list of the worst contagion risk countries. A positive achievement, beyond any doubt. But again, IMF attributes the entire probability of the risk of contagion from Ireland to the Euro zone down to domestic fundamentals, not external crisis conditions.

This progression has not been all that rosy for the sovereign bonds:
Notice that Ireland's term structure of CDS rates has barely changed in Q4 2009-Q1 2010. Why is that so? Despite the Budget 2010 being unveiled in between, the markets still perceive the probability of Ireland defaulting on sovereign debt in 5 years times relative to 1 year from now as pretty much unchanged. This would suggest that the markets do not buy into the Government promise to deliver a significantly (dramatically and radically) improved debt and deficit positions by 2015! In other words, the Budget 2010 has not swayed the markets away from their previous position, leaving Ireland CDS's term structure curve much less improved than that of the other PIIGS.

Here is another nice piece of evidence. Guess who's been hoovering up ECB lending?
And if you want to see just why Irish banks will be raising mortgage rates regardless of what ECB is doing, look no further than this:
The chart above, of course, covers 2008 - the year when Anglo posted spectacular results and AIB raised dividend. Imagine what this would look like if we are to update the figure to today. Also notice that in terms of return on equity, Irish banks were doing just fine with low margins back in 2008 and before. The reason for this is that our lending model allowed for that anomaly: banks were literally sucking out tens of billions of Euro area cheap interbank loans and hosing down a tiny economy with cash. As long as the boom went on, it didn't matter whether the bankers actually had any idea why and to whom they were lending. Now, the tide has gone out, and guess who's been swimming naked?

Interesting note on the equity markets. looking at historic P/E ratios, the IMF staff concludes that back in February 2010 "For advanced economies, equity valuations are within historical norms". Except for Ireland, which deserves its own note: "Forward-looking price-to-earnings ratios of Ireland appear elevated due largely to sharp downward revisions in earnings projections."

So, read this carefully: Irish stocks were overvalued - based on forecast forward P/Es - back in the time of the paper preparation. Using z-scores (deviation of the latest measure from either the historical average or the forward forecast based on IMF model) for Irish equities are: +2.1 for shorter horizon (a simplified 96% chance of a downward correction) and +0.9 for longer term forecasts (roughly 63% chance of downward adjustment). In other words, the market is overpriced both in the short term and in the long run. Worse than that, we have the highest short and long term horizon over pricing in the world!

In housing markets, our price/rent ratio z-score is +1.1 (74% probability of deterioration), which means we are somewhat close to the bottoming out but are not quite there. How big is the 'somewhat' the IMF wont tell, but it looks like we are still 1.1 standard deviations above the equilibrium price. Price to income ratio - the affordability metric is at +0.8 stdevs, so prices might still have to fall further to catch up with fallen incomes (57% probability).