5/2/19: The Myth of the Euro: Economic Convergence

The last eight years of Euro's 20 years in existence have been a disaster for the thesis of economic convergence - the idea that the common currency is a necessary condition for delivering economic growth to the 'peripheral' euro area economies in the need of 'convergence' with the more advanced economies levels of economic development.

The chart below plots annual rates of GDP growth for the original Eurozone 12 economies, broken into two groups: the more advanced EA8 economies and the so-called Club Med or the 'peripheral' economies.

It is clear from the chart that in  growth terms, using annual rates or the averages over each decade, the Euro creation did not sustain significant enough convergence of the 'peripheral' economies of Greece, Italy, Portugal and Spain with the EA8 more advanced economies of the original euro 12 states. Worse, since the Global Financial Crisis onset, we are witnessing a massive divergence in economic activity.

To highlight the compounding effects of these annual growth rates dynamics, consider an index of real GDP levels set at 100 for 1990 levels for both the EA8 and the 'peripheral' states:

Not only the divergence is dramatic, but the euro area 'peripheral' economies have not fully recovered from the 2008-2013 crisis, with their total real GDP sitting still 3.2 percentage points below the pre-crisis peak (attained in 2007), marking 2018 as the eleventh year of the crisis for these economies.  With Italy now in a technical recession - posting two consecutive quarters of negative growth in 3Q and 4Q 2018 based on preliminary data, and that recession accelerating (from -0.1% contraction in 3Q to -0.2% drop in 4Q) we are unlikely to see any fabled 'Euro-induced convergence' between the lower income states of the so-called Euro 'periphery' and the Euro area 8 states.

4/6/18: Italy is a TBTF/TBTS Problem for ECB

In my previous post, I talked about the Too-Big-To-Fail Euro state, #Italy - a country with massive debt baggage that is systemic in nature.

Here is Project Syndicate view from Carmen Reinhart: https://www.project-syndicate.org/commentary/italy-sovereign-debt-restructuring-by-carmen-reinhart-2018-05.

An interesting graph, charting a combination of the official Government debt and Target 2 deficits accumulated by Italy:

Quote: "With many investors pulling out of Italian assets, capital flight in the more recent data is bound to show up as an even bigger Target2 hole. This debt, unlike pre-1999, pre-euro Italian debt, cannot be inflated away. In this regard, it is much like emerging markets’ dollar-denominated debts: it is either repaid or restructured."

The problem, of course, is the ECB position, as mentioned in my article linked above. It is more than a reputational issue. Restructuring central bank liabilities is easy and relatively painless when it comes to a one-off event within a large system, like the ECB. So no issue with simply ignoring these imbalances from the monetary policy perspective. However, the ECB is a creature of German comfort, and this makes any restructuring (or ignoring) of the Target 2 imbalances a tricky issue for ECB's ability to continue accumulating them vis-a-vis all other debtor states of the euro area. Should a new crisis emerge, the ECB needs stable (non-imploding) Target 2 balance sheet to continue making an argument for sustaining debtor nations. This means not ignoring Italian problem.

Here is the picture mapping out the problem:

Source: http://sdw.ecb.europa.eu/servlet/desis?node=1000004859

Reinhart warns, in my opinion correctly, "In the mildest of scenarios, only Italy’s official debt – held by other governments or international organizations – would be restructured, somewhat limiting the disruptions to financial markets. Yet restructuring official debt may not prove sufficient. Unlike Greece (post-2010), where official creditors held the lion’s share of the debt stock, domestic residents hold most of Italy’s public debt. This places a premium on a strategy that minimizes capital flight (which probably cannot be avoided altogether)."

In other words, as I noted years ago, Italy is a 'Too-Big-To-Fail' and a 'Too-Big-To-Save' or TBTF/TBTS problem for the euro area.

4/6/18: Italy's Problem is Europe's Problem

My article on Italian (and Spanish and Dutsche Bank) mess in Sunday Business Post: https://www.businesspost.ie/business/italys-problem-europes-problem-417945.

Unedited version of the article here:

This fortnight has been a real roller-coaster for the European markets and politics. Only two weeks ago, I wrote about the problems of rising political populism in Italy and Spain as the signals of a broader trend across the block’s member states. This week, in Spain a no confidence motion in Mariano Rajoy’s rule played a side show to Rome’s drama.

The timeline of events in Italy provides the background to this week’s lessons.

The country has been governed by a lame-duck executive since mid-2016. Fed up with Rome’s gridlock, in March 2018 general election, Italians endorsed a parliament split between the populist-Left M5S and the far-Right group of parties led by the League. Month and a half of League-M5S negotiations have produced a shared policies platform, replete with radical proposals for reshaping country’s Byzantine tax and social welfare systems. The platform also contained highly controversial proposals to force the ECB to write down EUR250 billion worth of Government debt, a plan for restructuring fiscal rules to allow the country to run larger fiscal deficits, and a call for immigration system reforms.

On Monday, the President of the Italian Republic, Sergio Mattarella, a loyal Euro supporter, vetoed the League-M5S candidate for the economy ministry, Eurosceptic Paolo Savona. The result was resignation of the League-M5S Prime Minister-designate, Giuseppe Conte, and a threat of an appointment of the unpopular technocrat, Carlo Cottarelli, an ex-IMF economist nicknamed Mr. Scissors for his staunch support for austerity, as a caretaker Prime Minister. By Thursday night, Conte was back in the saddle, with a new coalition Government agreed and set to be sworn in on Friday.

Crisis avoided? Not so fast.

Risk Blow Out

The markets followed the political turns and twists of the drama. On Tuesday, Italian bonds posted their worst daily performance in over 20 years. The spike in the 2-year bond yield was spectacular, going from 0.3 percent on Monday morning to 2.73 percent on Tuesday, before slipping back to 1.26 percent on Thursday. The 10-year Italian bond yield leaped from 2.37 percent to 3.18 percent within the first two days, falling to 2.84 percent a day after.

Source: FT

To put these bond yields’ movements into perspective, at the week’s peak yields, the cost of funding Italian EUR2.256 trillion mountain of Government debt would have risen by EUR45 billion per annum - more than the forecast deficit increases under the reforms proposed in the League-M5S programme.

Thus, despite the immediate crisis yielding to the new Coalition, a heavy cloud of uncertainty still hangs over the Euro area’s third largest member state. Should the new Government fail to deliver on a unified platform built by an inherently unstable coalition, the new election will be on offer. This will likely turn into a plebiscite on Italy’s membership in the Euro. And it will also raise a specter of another markets meltdown.


The Italian Contagion Problem

The lessons from this week’s spike in political uncertainty are three-fold. All are bad for Italy and for the entire euro area. Firstly, after years of QE-induced amnesia, the investment markets are now ready to force huge volatility and rapid risk-repricing into sovereign bonds valuations. Secondly, despite all the talk in Brussels and Rome about the robustness of post-2011 reforms, the Italian economy remains stagnant, incapable of withstanding any significant uptick in the historically-low borrowing costs that prevailed over recent years, with its financial system still vulnerable to shocks. Thirdly, the feared contagion from Italy to the rest of the Eurozone is not a distant echo of the crises past, but a very present danger.

Italy’s debt mountain is the powder keg, ready to explode. The IMF forecasts from April this year envision Italian debt-to-GDP ratio dropping from 131.5 percent at the end of 2017 to 116.6 percent in 2023. However, should the average cost of debt rise just 200 basis points on IMF’s central scenario, hitting 4 percent, the debt ratio is set to rise to 137 percent. This Wednesday bond auction achieved a gross yield of 3 percent on 10-year bonds. In other words, Italy’s fiscal and economic dynamics are unsustainable under a combination of higher risk premia, and the ECB monetary policy normalisation. The risk of the former was playing out this week and will remain in place into 2019. The latter is expected to start around November-December and accelerate thereafter.

With the government crisis unfolding, the probability of Italy leaving the Euro within 12 months, measured by Sentix Italexit index jumped from 3.6 percent at the end of the last week to 12.3 percent this Tuesday before moderating to 11 percent at the end of Thursday. This puts at risk not only Italian Government bonds, but the private sector debt as well, amounting to close to EUR2 trillion. A rise in the cost of this debt, in line with Government debt risk scenarios, will literally sink economy into a recession.

As Italian Government bonds spreads shot up, other European markets started feeling the pain. Based on the data from Deutsche Bank Research, at the start of 2018, foreign banks, non-bank investors and official sector, including the Euro system, held ca 48 percent of the Italian Government debt.  In Spain and Portugal, this number was closer to 65 percent. In other words, the risk of falling bonds prices is both material and broadly distributed across the European financial system for all ‘peripheral’ Euro states.

Source: DB Research

As a part of its quantitative easing program, the ECB has purchased some EUR250 billion worth of Italian bonds. A significant uptick in risk of Italy’s default on these bonds will put political pressure on ECB. Going forward, Frankfurt will face greater political uncertainty in dealing with the future financial and fiscal crises.

Research from the Bank for International Settlements puts Italian banks’ holdings of Government bonds at roughly EUR 450 billion. Ten largest Italian banks have sovereign-debt exposures that exceed their Tier-1 capital. As the value of these bonds plunges, the solvency risks rise too. Not surprisingly, over the last two weeks, shares of the large Italian banks fell 10-20 percent. These declines in equity prices, in turn, are driving solvency risks even higher.

Beyond the Italian banks, French financial institutions held some EUR44 billion worth of Italian bonds, while Spanish banks were exposed to EUR29 billion, according to the European Banking Authority.

The second order effects of the Italian risk contagion play through the other ‘peripheral’ euro area bonds. As events of this week unfolded, in line with Italy, Spain, Portugal and Greece have experienced relatively sharp drops in their bonds values. All three are also subject to elevated political uncertainty at home, made more robust by the Italian crisis.

Thus, if the Italian government bond yields head up, banks’ balance sheets risks mount through both, direct exposures to the Italian Government bonds, and indirect effects from Italian contagion on the broader government debt markets, as well as to the private sector lending.

At the end of this week, all indication are that the Italian contagion crisis is receding. The new risk triggers are shifting out into late 2018 and early 2019. The uneasy coalition between two populist moments, the M5S and the League, is unlikely to survive the onslaught of voter dissatisfaction with the state of the economy and continued immigration crisis. At the same time, the coalition will be facing a highly skeptical EU, hell-bent on assuring that M5S-League Government does not achieve much progress on its reforms. All in, the new Government has between six and twelve months to run before we see a new election looming on the horizon.

The Italian crisis might be easing, but it is not going away any time soon. Neither the Spanish one. Oh, and with a major credit downgrade from the Standard & Poor’s and the U.S. Fed, here goes the systemic behemoth of European finance, the Deutsche Bank.

21/5/28: Trouble is brewing in the Euro paradise

My article for the Sunday Business Post on the continued risk/VUCA from politics of populism to the Euro area reforms and stability: https://www.businesspost.ie/business/trouble-brewing-euro-paradise-416876.

7/6/17: European Policy Uncertainty: Still Above Pre-Crisis Averages

As noted in the previous post, covering the topic of continued mis-pricing by equity markets of policy uncertainties, much of the decline in the Global Economic Policy Uncertainty Index has been accounted for by a drop in European countries’ EPUIs. Here are some details:

In May 2017, EPU indices for France, Germany, Spain and the UK have dropped significantly, primarily on the news relating to French elections and the moderation in Brexit discussions (displaced, temporarily, by the domestic election). Further moderation was probably due to elevated level of news traffic relating to President Trump’s NATO visit. Italy’s index rose marginally.

Overall, European Index was down at 161.6 at the end of May, showing a significant drop from April 252.9 reading and down on cycle high of 393.0 recorded in November 2016. The index is now well below longer-term cycle trend line (chart below). 

However, latest drop is confirming overall extreme degree of uncertainty volatility over the last 18 months, and thus remains insufficient to reverse the upward trend in the ‘fourth’ regime period (chart below).

Despite post-election moderation, France continues to lead EPUI to the upside, while Germany and Italy remain two drivers of policy uncertainty moderation. This is confirmed by the period averages chart below:

Overall, levels of European policy uncertainty remain well-above pre-2009 averages, even following the latest index moderation.

12/4/17: European Economic Uncertainty Moderated in 1Q 2017

European Policy Uncertainty Index, an indicator of economic policy risks perception based on media references, has posted a significant moderation in the risk environment in the first quarter of 2017, falling from the 4Q 2016 average of 307.75 to 1Q 2017 average of 265.42, with the decline driven primarily by moderating uncertainty in the UK and Italy, against rising uncertainty in France and Spain. Germany's economic policy risks remained largely in line with 4Q 2016 readings. Despite the moderation, overall European policy uncertainty index in 1Q 2017 was still ahead of the levels recorded in 1Q 2016 (221.76).

• German economic policy uncertainty index averaged 247.19 in 1Q 2017, up on 239.57 in 4Q 2016, but down on the 12-months peak of 331.78 in 3Q 2016. However, German economic uncertainty remained above 1Q 2016 level of 192.15.
• Italian economic policy uncertainty index was running at 108.52 in 1Q 2017, down significantly from 157.31 reading in 4Q 2016 which also marked the peak for 12 months trailing period. Italian uncertainty index finished 1Q 2017 at virtually identical levels as in 1Q 2016 (106.92).
• UK economic policy uncertainty index was down sharply at 411.04 in 1Q 2017 from 609.78 in 4Q 2016, with 3Q 2016 marking the local (12 months trailing) peak at 800.14. Nonetheless, in 1Q 2017, the UK index remained well above 1Q 2016 reading of 347.11.
• French economic policy uncertainty rose sharply in 1Q 2017 to 454.65 from 371.16 in 4Q 2016. Latest quarterly average is the highest in the 12 months trailing period and is well above 273.05 reading for 1Q 2016.
• Spain's economic policy uncertainty index moderated from 179.80 in 4Q 2016 to 137.78 in 1Q 2017, with the latest reading being the lowest over the five recent quarters. A year ago, the index stood at 209.12.

Despite some encouraging changes and some moderation, economic policy uncertainty remains highly elevated across the European economy as shown in the chart and highlighted in the chart below:

Of the Big 4 European economies, only Italy shows more recent trends consistent with decline in uncertainty relative to 2012-2015 period and this moderation is rather fragile. In every other big European economy, economic uncertainty is higher during 2016-present period than in any other period on record. 

6/9/16: The Pain in Spain: Growth vs Structural Deficits

FocusEconomics have published an interesting research note on Spanish economy. 

The country has been muddling through 

1. An ongoing political crisis - with already two elections failing to produce a Government and the latest failed efforts at forming one last week suggesting there is a third round of voting ahead - and 
2. The long-running fiscal crisis - with the EU Commission initiating series of warnings about Spain's failure to comply with the Fiscal Compact criteria and warning that the country is falling behind on deficit targets

Yet, despite these apparent macro risks, the economy of Spain has been expanding for some time now at the rates that are ahead of its other EURO 4 peers (Germany, France and Italy). 

In a guest post below, FocusEconomics shared their research with Trueeconomics readers:

The Pain in Spain: Robust GDP growth cannot mask the persistent structural deficit

Spain’s robust GDP growth despite the ongoing political impasse has made the headlines time and time again. The panel of 35 analysts we surveyed for this month’s Consensus Forecast expect GDP to expand 2.8% in 2016, one of the fastest rates in the Eurozone this year, before decelerating to 2.1% in 2017. 

And yet both Spain’s Independent Authority for Fiscal Responsibility (Airef) and the European Commission have warned in recent months that Spain is relying too heavily on GDP growth to reduce its deficit while neglecting much-needed progress with structural reforms to reduce its sizeable structural deficit (the part of the overall deficit which is adjusted for temporary measures and cyclical variations). This leaves it vulnerable to its deficit increasing in the future should economic conditions become unfavorable again. 

According to the Airef, without further reforms, a structural deficit of approximately 2.5% will still persist in Spain in 2018. 

Meanwhile, the European Commission predicted in its updated spring forecast that the structural deficit will reach 3.2% that year—well beyond the new 2.1% revised structural deficit target for 2018 (as part of an overall 2.2% deficit target) that it recently announced in July. Spain’s general government deficit is the sum of the deficits of the central government, the regional governments, the local authorities and the social security system, and most of the overshoot is expected to come from the underperformance of the regional governments and social security. Spain has gradually been reducing its overall general government deficit in recent years, albeit not at the speed stipulated by the European Commission, but it is the persistence of the structural part of the deficit that is the main cause for concern.

After deciding last month to waive the budgetary fine on Spain for missing its targets, the European Commission set a new series of targets up until 2018 in order finally to bring Spain’s overall deficit below the long-targeted 3% that year. In 2016 it expects Spain to meet an overall general government deficit target of 4.6%, not more than 3.1% of which is expected to be a structural deficit. This is in line with the European Commission’s updated spring forecast for the country, since it has decided not to impose additional adjustment requirements on Spain this year (attributing this in part to the fact that lower-than-expected inflation, which is out of the government’s control, has hindered deficit reduction efforts this year). In 2017 and 2018, however, the Spanish government will have to implement structural reforms to make savings equivalent to 0.5% of GDP each year to bring its structural deficit down to 2.6% in 2017 (as part of an overall deficit target of 3.1% that year) and 2.1% in 2018 (as part of an overall deficit target of 2.2%). Achieving this will require a strong government able to press ahead with a reform program—something which currently looks rather a panacea. Spain’s ongoing failure to form a new government since the first inconclusive elections in December last year may not have impacted the current resilience of its GDP growth, but it certainly puts its fiscal compliance in jeopardy and prolongs the structural problems of its economy.

The agenda ahead is tight. Under the Spanish Constitution, 1 October is the deadline for the government to present its proposed 2017 budget to the Spanish Parliament. And under the EU’s rules, the European Commission must receive the budget (which must, of course, indicate how Spain will meet the required 2017 targets) by 15 October, or Spain faces a fine. Spain is still struggling to form a government after two elections in the last nine months and looks highly unlikely to have a new government in place by October that is able to push through a budget with the requisite reforms. Mariano Rajoy, who heads the current caretaker Popular Party (PP) government and is seeking to be sworn in as prime minister again, failed to garner sufficient support at both his first investiture attempt on 31 August (for which he would have needed an absolute majority in his favor) and his second attempt on 2 September (at which a simple majority would have sufficed). He might have another attempt at being appointed after the regional elections in the Basque Country and Galicia at the end of September if by chance the circumstances look more favorable by then, but otherwise Spain will probably be going to the polls again on 25 December, in what would be an unprecedented event. Even if a new government is formed by some miracle, it looks highly likely to be a weak one that might not manage to last long, let alone implement a convincing reform program.

Click on the image to enlarge

A closer look at the political turmoil

Spanish parties are simply not used to formal coalition politics at central government level, and don’t seem to be willing to adapt to the times in a hurry. Since 1982, either one or other of the two main parties, the conservative PP and the Socialist Party (PSOE), had always managed to form either a majority government or alternatively a strong minority government, in the latter case achieving working majorities by striking mutually beneficial deals with regionally-based nationalist parties—especially in the Basque Country and Catalonia—to secure their support in the Spanish Parliament (a classic case of “I’ll scratch your back if you scratch mine”). Neither party was prepared for two quite successful newcomers—the populist left-wing Podemos (“We Can”) and the centre-right Citizens party (C’s)—coming along to break up their longstanding dominance, at the same time as the pro-independence wave in Catalonia makes reviving the traditional mutual support arrangements with the Catalan nationalist parties impossible. 

The re-run elections held on 26 June have so far simply resulted in another stalemate. The PP won again and this time managed to increase its seats from 123 to 137, but it still fell far short of an absolute majority of seats (176) in Spain’s Parliament. The only plausible option for Rajoy in the circumstances is to form a minority government, since both the PSOE and C’s ruled out the possibility Rajoy had initially advocated of a “grand coalition” comprising the PP, the PSOE and potentially C’s too—an option which market participants had considered the most likely to deliver the structural reforms Spain needs, but which would not have provided the “government of change” that so many Spanish citizens voting for new parties seek. Rajoy had managed to reach an agreement with C’s (32 seats) for it to support his investiture attempts on 31 August and 2 September, as well as the commitment of the one MP from the Canary Coalition (CC) to do the same, but he failed to secure the 11 abstentions he would also have needed to be voted in on the second attempt with a simple majority. This would have required some of the PP’s arch rival the PSOE to abstain, and PSOE leader Pedro Sánchez remains absolutely adamant that his party will continue to vote against Rajoy instead. Sánchez is in a weak position since the PSOE declined at the re-run elections and is under pressure from Unidos Podemos (an electoral coalition between Podemos, the United Left party and some other smaller left-wing forces), so he is not in a strong position to try and form a government himself, but he does not want to lose yet more voters to Unidos Podemos by being seen to allow or to prop up a conservative government either. It looks like only an internal crisis within the PSOE could possibly change the circumstances.

There is an outside chance that Rajoy could attempt an investiture vote again after the Basque regional elections on 25 September, if it looks like he might be more likely to get the Basque Nationalist Party (PNV)—which has 5 seats in the Spanish Parliament—on board then, to continue to boost his numbers and up the pressure on the PSOE to deliver the final few abstentions. The only plausible circumstance in which the PP might stand any chance of getting the PNV on side is if, after the Basque regional elections, the PNV itself finds it needs the PP’s support to be able to govern in the Basque region. This is not totally beyond the realm of possibility, since the PNV is likely to win the Basque elections with a minority of votes and could struggle to form a working majority, especially if its traditional ally, the Basque Socialist party (PSE)—the Basque federation of the PSOE—declines as expected amid the rise of Podemos, which could potentially build alliances with other left-wing forces including the Basque anticapitalist and secessionist EH Bildu coalition of parties. Podemos is proving particularly attractive in the Basque Country (and Catalonia too) given that it is the first Spanish party to support the idea of self-determination for Spain’s constituent territories. Indeed, the PNV itself, a traditionally centre-right party which is struggling to attract the younger generations of Basque voters, is far from immune to the risk of losing some of its voters to the populist party: at the Spanish general election re-run in June, it was significant that Unidos Podemos beat the PNV not only in terms of votes but also seats in the PNV’s traditional Basque stronghold of the province of Vizcaya (one of the three provinces making up the Basque region). In these changing circumstances, the PNV could possibly end up needing the support of the PP in the Basque Parliament in order to govern, which would inevitably require it to return the favour in the Spanish Parliament, but this is only one of various possible outcomes at this stage and the PNV certainly looks highly unlikely to contemplate this option as anything but a very last resort.  

Summing up

Overall, the political impasse thus looks set to continue for the foreseeable future—though if we’re looking for silver linings, at least Spain’s nearly nine-month hiatus is still nowhere near Belgium’s 2011 record of 19 months without a government. Spain faces unprecedented challenges as it undergoes a fundamental political transformation stemming from the widespread disillusionment with existing political institutions and actors and the emergence of new players, not to mention the territorial crisis due to the Catalan challenge to the integrity of the Spanish state. While Spain’s GDP growth has remained remarkably resilient in recent quarters, there is no room for complacency. The country’s persistent structural deficit—which cannot be effectively addressed during the current political deadlock—still renders its economy particularly vulnerable to future changes in economic climate and puts the country on a collision path with Brussels over the required fiscal consolidation trajectory. 

Author: Caroline Gray, Senior Economics Editor, FocusEconomics

4/5/16: Canaries of Growth are Off to Disneyland of Debt

Kids and kiddies, the train has arrived. Next stop: that Disneyland of Financialized Growth Model where debt is free and debt is never too high…

Courtesy of Fitch:

Source: @soberlook

The above in the week when ECB’s balancehseet reached EUR3 trillion marker and the buying is still going on. And in the month when estimates for Japan’s debt/GDP ratio will hit 249.3% of GDP by year end

Source: IMF

And now we have big investors panicking about debt: http://www.businessinsider.com/druckenmiller-thinks-fed-is-setting-world-up-for-disaster-2016-5. So Stanley Druckenmiller, head of Duquesne Capital, thinks that “leverage is far too high, saying that central banks and China have allowed for these excesses to continue and it's setting us up for danger.”

What all of the above really is missing is one simple catalyst to tie it all together. That catalysts is the realisation that not only the Central Banks are to be blamed for ‘allowing the excesses of leverage’ to run amok, but that the entire economic policy space in the advanced economies - from the central banks to fiscal policy to financial regulation - has been one-track pony hell-bent on actively increasing leverage, not just allowing it.

Take Europe. In the EU, predominant source of funding for companies and entrepreneurs is debt - especially banks debt. And predominant source of funding for Government deficits is the banking and investment system. And in the EU everyone pays lip service to the need for less debt-fuelled growth. But, in the end, it is not the words, but the deeds that matter. So take EU’s Capital Markets Union - an idea that is centred on… debt. Here we have it: a policy directive that says ‘capital markets’ in the title and literally predominantly occupies itself with how the system of banks and bond markets can issue more debt and securitise more debt to issue yet more debt.

That Europe and the U.S. are not Japan is a legacy of past policies and institutions and a matter of the proverbial ‘yet’, given the path we are taking today.

So it’s Disneyland of Debt next, folks, where in a classic junkie-style we can get more loans and more assets and more loans backed by assets to buy more assets. Public, private, financial, financialised, instrumented, digitalised, intellectual, physical, dumb, smart, new economy, old economy, new normal, old normal etc etc etc. And in this world, stashing more cash into safes (as Japanese ‘investors’ are doing increasingly) or into banks vaults (as Munich Re and other insurers and pension funds have been doing increasingly) is now the latest form of insurance against the coming debt markets Disneyland-styled ‘investments’.

25/10/15: Grifols and the Ghosts of OECD

An interesting set of contrasts: one company, one move, two reports.

Last week, Irish and Spanish press reported on the Spanish Multinational pharma Grifols moving most of its operations from Spain to Ireland. Here are two examples of reports:
- One from Spain (http://economia.elpais.com/economia/2015/10/24/actualidad/1445711002_780890.html?id_externo_rsoc=TW_CM) focusing on tax optimisation reasons behind the Grifols' move; and
- One from Ireland (http://www.irishtimes.com/business/health-pharma/spanish-healthcare-firm-grifols-to-create-140-jobs-1.2401541) without a single mentioning of tax issues. You can also see this one from the Irish Examiner (http://www.irishexaminer.com/business/grifols-creates-140-jobs-in-dublin-360972.html) which also fails to mention tax issues.

Spanish report quotes Grifols CFO on the issue of tax optimisation. Irish reports say absolutely nada about the topic.

Spanish report references the statement that Grifols will channel all of its non-Spanish and non-US revenues via Ireland (a practice used for tax optimisation by many MNCs based here). But both Irish reports linked above fail to mention this quite material fact.

Remember OECD BEPS ‘reforms’? When someone doesn’t want to know the obvious, one doesn’t have to worry about the obvious…

18/10/15: Is Ireland a Euro Periphery Outlier? Some Historical Data

How unique is Ireland within the club of euro peripheral countries? Well, historically, rather unique. Alas, sometimes for the reasons not entirely in our favour.

The following are excerpts from the recent ECB paper titled “Fiscal policy adjustments in the
euro area stressed countries: new evidence from non-linear models with state-varying thresholds”.

Quote: “Fiscal policy authorities of Greece, Ireland, Portugal and Spain are shown to have, on average, historically followed a "spend-and-tax" model of fiscal adjustment, where government spending is decided by the political process, and the burden of correcting fiscal disequilibria is entirely left to the tax instrument.”

Of course, ‘historically’ here means over the period 1960-2013 for all countries, with exception of Spain (1970-2013).

But before then, what were the pre-conditions (thresholds) for taking action? “During the 1960-2013 period for Greece, Ireland and Portugal and during the 1970-2013 period for Spain, we find that the threshold estimate for the budget deficit-to-GDP ratio, which led to different fiscal correction regimes, was on average 4.90% for Greece, 5.10% for Ireland, 3.22% for Portugal and 3.12% for Spain.”

In other words, Ireland had the greatest tolerance - over the entire period - for deficits, opting to wait until average deficit as % of GDP would hit above 5.1%, well above Greece (4.9%) and the rest of the peripheral states.

So now, let’s tackle the more recent period, from the start of the Euro: “When considering the period after 1999, this overall picture worsens for Greece and Portugal and improves for Ireland. Moreover, the results for Ireland and Spain are driven by the financial crisis period. In particular for Ireland, the decoupling dynamics of the government spending reflects the support to the financial sector. In fact, when considering the pre-crisis EMU period between 1999 and 2007, the threshold for fiscal adjustment in Ireland and Spain are estimated to be positive; namely, the regime change took place when the budget balance was in surplus. Conversely, the fiscal deficit-to-GDP thresholds estimated at 5.32% for Greece and 4.08% for Portugal remained rather high.”

The above basically boils down to the following: since 1999, growing economies of Ireland and Spain allowed two countries to substantially reverse pro-cyclicality of deficits and significantly reduce thresholds for budgetary actions. This did not happen in Greece and Portugal. While Ireland gets a pat on the back for pre 2007 period, it is hardly unique in this achievement.

But despite the gains of the 1999-2007, things did not change all that much within the structure of deficits and adjustments. So per ECB paper “Looking at the effects of the economic cycle, we find that fiscal deficit-to-GDP ratio was not reduced in Greece, Ireland and Portugal with the improvement in economic activity. Consequently, during the contractionary times, fiscal corrections became more costly, as tax adjustments became a priority in an attempt to restore fiscal discipline.”

In other words, we were not unique in the way we handled the underlying structure of public spending imbalances, despite having substantially reduced the fiscal action thresholds.

But may be during the peak of the crisis we widened up? Indeed, ECB offers some positive evidence in this direction, but it also argues that the same took place in Spain and Portugal. “The results also suggest that during a financial crisis the fiscal deficit-to-GDP threshold was relaxed in Ireland and Spain, while it was reduced in Portugal. By relaxing the fiscal deficit-to-GDP threshold (in an attempt to stave off deep recessionary pressures) Ireland and Spain relied on business cycle improvements to raise tax revenues. Given the tendency by Portuguese authorities to improve the fiscal imbalances during a financial crisis, these figures make sustainability concerns for Ireland, Portugal and Spain less of an issue compared to Greece, in an historical perspective.”

Which, once more, does not really identify Ireland as a ‘unique’ case amidst the imprudent (but learning) peripherals.

“The results …suggest that during a financial crisis the fiscal deficit-to-GDP threshold was relaxed from 5.10% to 6.99% in Ireland and from 3.12% to 4.00% in Spain, while it was reduced from 3.22% to 1.92% in Portugal.” In other words, Irish Government thresholds actually worsened in the financial crisis, albeit most of that worsening is attributable to the Government decision to rescue Irish banks.

Overall, as table below illustrates, Ireland has managed to perform best during 1999-2007 period in fiscal adjustment thresholds terms, while Spain was the overall best performer in 1999-2013 period and over the entire sample.

My handy addition to the chart are red boxes (highlighting worst performers) and green boxes (best performers) when it comes to budgetary adjustment thresholds.

This completes the arguments about Ireland’s alleged uniqueness as an outlier to the group of peripheral states: with exception of the period during which our property and financial sectors bubbles were inflating to unprecedented proportions, Ireland was pretty much a ‘normal’ peripheral state when it comes to fiscal management. Celtic Tiger et al…

So let's hope the latest Budget 2016 does not return us back to the historical record track...

17/5/2015: BlackRock Institute Survey: N. America & W. Europe, April

BlackRock Investment Institute released the latest Economic Cycle Survey results for North America and Western Europe:

"This month’s North America and Western Europe Economic Cycle Survey presented a positive outlook on global growth, with a net of 48% of 56 economists expecting the world economy will get stronger over the next year, compared to 52% from previous report. The consensus of economists project mid-cycle expansion over the next 6 months for the global economy. At the 12 month horizon, the positive theme continued with the consensus expecting all economies spanned by the survey to strengthen or stay the same except Canada and Denmark."

Country results 6 months forward compared to current conditions assessment:

Note: (0,0) Corner point denotes Austria, Denmark, Norway, Spain, Sweden and the Netherlands

Country results 12 months forward:

"Eurozone is described to be in an expansionary phase of the cycle and expected to remain so over the next 2 quarters. Within the bloc, most respondents described Finland, Greece and Italy to be in a recessionary state, with the even split between contraction or recession for Portugal. Over the next 6 months, the consensus shifts toward expansion for Italy. Over the Atlantic, the consensus view is firmly that North America as a whole is in mid-cycle expansion and is to remain so over the next 6 months except Canada where the consensus is split between mid-cycle or late-cycle states."

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

1/4/15: H-W Sinn "Europe’s Easy-Money Endgame"

A very interesting op-ed by Professor Hans-Werner Sinn of German Ifo Institute for Project Syndicate: http://www.project-syndicate.org/commentary/euro-demise-quantitative-easing-by-hans-werner-sinn-2015-03

The problem outlined by Professor Sinn is non-trivial.

"...for countries like Greece, Portugal, or Spain, regaining competitiveness would require them to lower the prices of their own products relative to the rest of the eurozone by about 30%, compared to the beginning of the crisis. Italy probably needs to reduce its relative prices by 10-15%. But Portugal and Italy have so far failed to deliver any such “real depreciation,” while relative prices in Greece and Spain have fallen by only 8% and 6%, respectively".

As Professor Sinn notes, there are four possible solutions:

1. "Europe could become a transfer union, with the north giving more and more credit to the south and later waiving it." 
2. "The south can deflate." 
3. "The north can inflate." 
4. "Countries that are no longer competitive can exit Europe’s monetary union and depreciate their new currency."

So here's the problem, correctly identified by Professor Sinn: "Each path is associated with serious complications. The first creates a permanent dependence on transfers, which, by sustaining relative prices, prevents the economy from regaining competitiveness. The second path drives many debtors in crisis countries into bankruptcy. The third expropriates the creditor countries of the north. And the fourth may cause contagion effects via capital markets, possibly forcing policymakers to introduce capital controls".

Now, note: Ireland has opted for the second path. Any surprise we are driving people into bankruptcy in tens of thousands (once current legal queue is taken into account), along with multiple businesses?

But back to Prof Sinn's analysis. Remember the ECB QE? Ok, says Prof Sinn, suppose it delivers on target inflation of just under 2%. What does it mean for internal devaluations in the 'peripheral' Europe?

"If, say, southern Europe kept its inflation rate at 0% and France inflated at a rate of 1%, Germany would have to inflate by a good 4%, and the rest of the eurozone at 2% annually, to reach a eurozone average of slightly less than 2%. This pattern would have to continue for about ten years to bring the eurozone back into balance. At that point, Germany’s price level would be about 50% higher than it is today."

The problem, thus, is an unresolvable dilemma, since with that sort of arithmetic, we are in a tough bind:

• Either Germany runs mild inflation, while the 'periphery' runs outright deflation, allowing - over a painfully long period of time (decade or more) to devalue the imbalances, or
• Eurozone pursues Mr Draghi's objective of 'just under' 2% inflation across the entire Euro area at the expense of Germany (and the rest of the already shrunken 'core').

Do note, I have argued before that deflation in the 'periphery' is not a bad thing, as it allows for the interest rates to remain low (servicing cost of household and corporate debts is lower) and deleveraging of the households and companies to be less painful, while sustaining some domestic demand through increased purchasing power of incomes. So I agree with Professor Sinn's criticism of the ECB QE programme. 

The problem is that this means, as Professor Sinn rightly suggests, continued suppression of demand (the 'austerity' bit).

The choice faced by Europe are ugly. All of them. And there are no guarantees for any of them to actually work. And the cause of this problem is singular: creation of a political currency union. For anyone who says that Greece, Italy, Portugal, Cyprus, Ireland and Spain have caused their own problems, the replies are both simple and complex: 

• The simple one: absent the euro, their problems would have been by now solved by a combination of the old-fashioned defaults and devaluations. 
• The complex one: absent monetary transfers (lower interest rates and ample bank liquidity flowing cross-borders) with the EMU from the late 1990s through 2007, the imbalances generated in the 'peripheral' economies would never have been this large. Which means that the simple reply above would have been even more easy to apply.

7/3/15:Euro Area GDP per capita: the legacy of the crisis

I have posted previously on the decline in GDP per capita during the current crises across the euro area states, the US and UK. Here is another look:

Let's take GDP per capita at the peak before the crisis.

For some countries this would be year 2007, for others 2008. Keep in mind, many comparatives in the media and by analysts treat the peak as 2008. This is simply not true. Only 89countries of the sample of 20 countries comprising EA18, plus US and UK have peaked their GDP per capita in real terms in 2008, the rest peaked in 2007. Hence, for the former countries, the GDP per capita decline started in 2009 and the for the latter in 2008. Now, take GDP per capita declines cumulated over the years when the GDP per capita was running, in real terms, below the peak. Again, the sample of the countries is not homogeneous here: for some countries, GDP per capita regained pre-crisis peak by 2011 (Germany, Malta and Slovak Republic), by 2013 (Austria and U.S.) and by 2014 (Latvia). For all the rest of the countries, the GDP per capita peak was not regained through 2014.

Now, let's plot the overall cumulated losses over the years of the crisis (over the years from the crisis start through either the year prior to regaining pre-crisis GDP per capita levels for the countries where this was attained, or through 2014 for the countries that did not yet recover pre-crisis levels.

Chart below plots these in euro terms (remember, this is loss through end of crisis or 2014 per capita) (note figures for UK and US are in their respective currencies, not Euro):

Thus, per above, in Greece, cumulative GDP per capita losses during the crisis (through 2014) amount to around EUR42,200, while in Malta cumulative losses from the start of the crisis through the end of the crisis in 2011 amounted to around EUR500 per capita.

Since the crisis was over, before 2014, across 6 countries (in other words the regained their pre-crisis peak GDP per capita levels in inflation-adjusted terms), it is worth to note that through 2014, in these countries, losses have been reduced.  In Austria, through 2014, cumulative losses on pre-crisis GDP per capita levels stood at EUR 2,107 per capita, in Germany there was a cumulative gain of EUR4,078 per capita, in Latvia a cumulative loss of EUR5,696 per capita, in Malta a cumulative gain of EUR1,029 per capita, in Slovak Republic a cumulative gain of EUR1,352 per capita and in the U.S. a cumulative loss of USD258 per capita

Taking the above figures covering either gains  or losses from the start of the crisis in each country through 2014 as a percentage of the pre-crisis peak GDP per capita, the losses/gain due to the crisis through 2014 amount to:

And that chart really tells it all. 

27/12/2014: Geography of the Euro Area Debt Flows

The debate about who was rescued in the euro area 'peripheral' economies banking crisis will be raging on for years to come. One interesting paper by Hale, Galina and Obstfeld, Maurice, titled "The Euro and the Geography of International Debt Flows" (NBER Working Paper No. w20033, see http://www.nber.org/papers/w20033.pdf) puts some facts behind the arguments.

Per authors, "greater financial integration between core and peripheral EMU members had an effect on both sets of countries. Lower interest rates allowed peripheral countries to run bigger deficits, which inflated their economies by allowing credit booms. Core EMU countries took on extra foreign leverage to expose themselves to the peripherals. The result has been asset-price bubbles and collapses in some of the peripheral countries, area-wide banking crisis, and sovereign debt problems."

The causes explained, the paper maps out "the geography of international debt flows using multiple data sources and provide evidence that after the euro’s introduction, Core EMU countries increased their borrowing from outside of EMU and their lending to the EMU periphery."

So braodly-speaking, core euro area economies funded excesses. Hence, in any post-crisis rescue, they were the beneficiaries of transfers from the 'peripheral' economies and taxpayers.

Some details.

According to Hale and Obstfeld, "one mechanism generating the big current account deficits of the European periphery could be summarized as follows: after EMU (and even in the immediately preceding years), compression of bond spreads in the euro area periphery encouraged excessive borrowing by these countries, domestic lending booms, and asset price inflation. We further argue that a substantial portion of the financial capital flowing into the European periphery was intermediated by the countries in the center (core) of the euro area, inflating both sides of the balance sheet of the large financial institutions in the euro area core."

So, intuitively, lenders/funders of the asset bubbles should be bearing some liability. And it would have been the case were the funds transmitted via equity or direct asset purchases (investment from the Core to the 'periphery' in form of buying shares or actual real estate assets). Alas they were not. "These gross positions largely took the form of debt instruments, often issued and held by banks. Thus, EMU contributed not only to the big net deficits of the peripheral countries, but to inflated gross foreign debt liability and asset positions for nonperipheral countries such as Belgium, France, Germany, and the Netherlands – countries that all experienced systemic banking crises after 2007."

Debt, as we know it now, has precedence over equity when it comes to taking a hit in a crisis, and debt is treated on par with deposits. Hence, "the tendency for systemically important banks to increase leverage in line with balance sheet size …implied a substantial increase in financial fragility for these countries’ financial sectors."

In the short run, prior to the crisis, leveraging up from the Core into the 'periphery' had a stimulative effect on asset bubbles. "Four main factors contributed to the suppression of bond yields in the European periphery after the introduction of the euro.
- First, the risk of investing in the European periphery declined with the advent of the euro due to investor assumptions (perhaps erroneous) about future political risks, including the possibility of official bailouts.
- Second, transaction costs declined and currency risk disappeared for euro area investors investing in the periphery countries.
- Third, the ECB’s policy of applying an identical collateral haircut to all euro area sovereigns, notwithstanding their varied credit ratings, encouraged additional demand for periphery sovereign debt by euro area financial institutions, which, moreover, were able to apply zero risk weights to
these assets for computing regulatory capital. The EU’s recent fourth Capital Requirements
Directive continues to allow zero risk weights for euro area sovereign debts, even though the borrowing countries cannot print currency to pay their debts.
- Fourth, financial regulations in the EU were harmonized and the euro infrastructure implied a more efficient payment system though its TARGET settlement mechanism."

Crucially, all four factors combined to reinforce each other giving "…core euro area financial institutions a perceived comparative advantage in terms of lending to the periphery, and this would also likely have affected financial flows from outside to both regions of the euro area.

In line with the above, the authors find:
- "...strong evidence of the increase in the financial flows, both through debt markets and
through bank lending, from core EMU countries to the EMU periphery."
- "… that financial flows from financial centers to core EMU countries increased, but predominantly due to increased bank lending and not portfolio debt flows.
- "In addition, …evidence from the syndicated loan market that is broadly consistent with the core EMU lenders having a comparative advantage in lending to the GIIPS."

Net conclusion: "The concentration of peripheral risks on core EMU lenders’ balance sheets helped to set the stage for the diabolical loop between banks and sovereigns that has been at the heart of the euro crisis."

Authors quote other sources on similar: “German banks could get money at the lower rates in the euro zone and invest it for a decade in higher yielding assets: for much of the 2000s, those were not only American toxic assets but the sovereign bonds of Greece, Ireland, Portugal, Spain, and Italy. For ten years this German version of the carry trade brought substantial profits to the German banks — on the order of hundreds of billions of euros ... The German advantage, relative to all other countries in terms of cost of funding, has developed into an exorbitant privilege. French banks exploited a similar advantage, given their major role as financial intermediaries between AAA-rated countries and higher yielding debtors in the euro area.” (From Carlo Bastasin, Saving Europe: How National Politics Nearly Destroyed the Euro, Washington, D.C.: Brookings, 2012, page 10.)

Charts below summarise flows from Core markets to 'peripheral' markets

CPIS is stock of portfolio debt claims from CPIS data in real USD:

BISC is stock of total international bank claims from consolidated BIS data in real USD:

BISL Flow is valuation-adjusted flows of total cross-border bank claims from locational BIS data in real USD:

And conclusions: "Not only did peripheral countries borrow more after EMU; in addition, financial institutions in the core of the euro area expanded their balance sheets to facilitate peripheral deficits, thereby increasing their own fragility. This pattern set the stage for the diabolical feedback loop between banks and sovereigns that has been such a powerful driver of the euro area's recent crisis."

So next time someone says that 'periphery' is to be blamed for the causes of the crisis, send them here. for in finance, like in dating, it takes two to tango…

26/12/2014: Advanced Economies: Public Debt Explosion 2008-2014

Some interesting insight into the legacy of the Great Recession that we are carrying over into 2015. From the start of 2008 through 2014:

• Average increase in gross debt of all advanced economies was 27.2 percentage points of GDP, with a range from a decrease of 21 percentage points for Norway and an increase of 88.5 percentage points for Ireland. Thus, the average annualised rate of increase in government debt over the period was around 3.47 percentage points of GDP with a range of -2.76 percentage points annualised decline for Norway and a 9.48 percentage points annualised increase in Ireland.
• Average change in the gross government debt of the group of countries where debt declined over the crisis was -12.0 percentage points of GDP. There were only 3 countries in this group.
• Average increase in gross government debt of the group of countries with benign levels of increase (levels of increase consistent roughly with offsetting GDP contraction over the crisis period) was 4.8 percentage points of GDP. There were only 5 countries in this group and only two of these were in Europe, with none (at the time of the crisis onset) being members of the euro area.
• Average increase in gross government debt within the group of countries where debt rises were moderately in excess of contraction in the economy was 16.4 percentage points of GDP.
• Average increase in gross government debt within the group of countries with debt increases significantly in excess of economic contraction was 26.6 percent of GDP.
• Average increase in the government debt within the group of countries with severe debt overhang was 60.4 percentage points of GDP, with a range of increases in this group between 41.6% for the U.S. at the lower end and 88.5% of GDP for Ireland at a higher end.

Chart above summarises these facts and also highlights the extent to which Ireland's government debt increases were out of line with experience in all other countries, including Greece and all other 'peripheral' economies.

The average rise in gross government debt across all peripheral economies 2008-2014 was 56.5 percentage points of GDP (excluding Ireland), which is more than 1/3 lower than that for Ireland. Our closest competitor to the dubious title of worst performing sovereign in terms of debt accumulation is Greece, which experienced a debt/GDP ratio increase almost 1/4 lower than Ireland.

And in case you wonder, our Government's net debt position is not much better:

15/12/2014: BlackRock Institute Survey: North America & Western Europe, December 2014

BlackRock Investment Institute released the latest Economic Cycle Survey results for North America and Western Europe:

"This month’s North America and Western Europe Economic Cycle Survey presented a positive outlook on global growth, with a net of 52% of 84 economists expecting the world economy will get stronger over the next year, compared to net 47% figure in last month’s report." Back in October, the proportion was 43% and in September it was 55%. The consensus of economists project mid-cycle expansion over the next 6 months for the global economy - same as in October and November.

"At the 12 month horizon, the positive theme continued with the consensus expecting all economies spanned by the survey to strengthen or stay the same except Finland, Sweden and Norway." Norway featured as an exception in October report and November. Back in October and November reports, expected deviation from stronger trend was also reported for Belgium.

"Eurozone is described to be in an expansionary phase of the cycle and expected to remain so over the next 2 quarters. Within the bloc, most respondents described Finland and Italy to be in a recessionary state, with the even split between contraction or recession for Greece, France and Portugal. Over the next 6 months, the consensus shifts toward expansion for both Finland and Italy." These results were broadly consistent with october and November reports.

"Over the Atlantic, the consensus view is firmly that North America as a whole is in mid-cycle expansion and is to remain so over the next 6 months." Again, this was in line with October and November reports.

 Note: Red dot denotes Austria, Canada, Denmark, Ireland, Spain and Switzerland.

For comparative purpose: October survey mapping 6 months out:

Previous report was covered here: http://trueeconomics.blogspot.ie/2014/10/6102014-blackrock-institute-survey-n.html

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

6/10/2014: BlackRock Institute Survey: N. America & W. Europe, September 2014

BlackRock Investment Institute released the latest Economic Cycle Survey results for North America and Western Europe. Here are the main points (emphasis and comments are mine):

"This month’s North America and Western Europe Economic Cycle Survey presented a positive outlook on global growth, with a net of 55% of 98 economists expecting the world economy will get stronger over the next year, compared to net 59% figure in last month’s report [and 81% in July survey]."

Global outlook: "The consensus of economists project mid-cycle expansion over the next 6 months for the global economy. At the 12 month horizon, the positive theme continued with the consensus expecting all economies spanned  by the survey to strengthen or stay the same except France, Finland and Belgium.

Regional outlook: Euro Area: "Eurozone is described to be in an expansionary phase of the cycle and expected to remain so over the next 2 quarters. Within the bloc, most respondents described Greece, Italy and France to be in a recessionary state [same outcome was recorded back in August survey], with the even split between contraction or recession for Belgium and Finland [in August survey, this applied to Portugal and Finland]. Over the next 6 months, the consensus shifts toward expansion for Greece and Italy [with Italy being a new addition to this list compared to August survey]."

US and North America: "Over the Atlantic, the consensus view is firmly that North America as a whole is in mid-cycle expansion and is to remain so over the next 6 months." [Same result as in August survey].


Two charts to illustrate:

Previous month results are here: http://trueeconomics.blogspot.ie/2014/08/2382014-blackrock-institute-survey-n.html

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

1/10/2014: That Exports-Led Recovery... in Germany

And a Scary Chart of the Day prize goes to @IanTalley who produced this gem:

That's right, Germany is now officially producing more stuff that its people can't afford than China...

But its a good thing, for it means that people in countries like Italy, Spain, Greece, Portugal, Cyprus etc who owe Germany money can buy more stuff from Germany they can't quite afford either, except for the credit supplied from Germany funded by the credit they take from Germany... Confused? Try confused.edu for some academic analysis... or just look at KfW bank latest foray into Ireland (apparently it took months of planning to get us to this absurdity http://www.independent.ie/business/irish/kfw-deal-to-fund-irish-firms-was-months-in-the-planning-29896868.html).

26/9/2014: Those Fabled Euro Area Structural Reforms: Greece, Spain, Portugal & Italy

EU Commission has published some interesting research on structural reforms in Italy, Spain, Portugal and Greece (strangely, no Ireland or Cyprus).

The full paper is available here: http://ec.europa.eu/economy_finance/publications/european_economy/2014/pdf/ee5_en.pdf

But here is an interesting set of charts, showing the effect of the said 'reforms' on the economies of these 'peripheral' states.

First chart shows employment growth against productivity growth in 2001-2008 and 2008-2013:

Above clearly shows that in two 'peripheral' countries covered, namely Portugal and Spain, productivity (as measured by value added per hour worked) rose during the crisis period, while the same fell in Greece and Italy. Productivity growth accelerated over the crisis period in Portugal and Spain and de-accelerated in Italy and literally fell off the cliff in Greece. And in all four economies, hours worked collapsed.

This all means two things:

• Firstly, jobs destruction failed to sustain growth in productivity in Italy and Greece (in other words, the two economies suffered jobs losses dispersed across all sectors of activity), while jobs destruction did sustain improved productivity for the remaining active workforce in Spain and Portugal (where jobs destruction was more concentrated in several domestic sectors, such as retail and construction). 
• Secondly, given that all four economies developed broadly similar 'structural reforms' packages, albeit with varying degree of implementation, the above suggests that the said reforms had zero-to-negative effect on economic performance in Italy and Greece, and potentially positive effect in Spain and Portugal. This is basically equivalent to saying that reforms overall effectiveness is not anchored in the structure of reforms, but is rather being driven by something else, something more idiosyncratic. Or, alternatively, that the reforms had no discernible effect whatsoever and instead nature of jobs destruction is driving differences in productivity growth.

The second chart shows annual trajectory in hours worked against productivity growth from 2008 through 2013.

Again, the above chart shows that in all four economies, relationship between productivity growth and employment is broadly negative. The diagonal line shows two segments of the chart: above the line, jobs destruction / creation effects are dominated by productivity growth effects. Below the line, the opposite takes place. So in a summary, the chart shows that the dominant driver in every economy as jobs destruction, not productivity growth. If structural reforms are of any significant help in driving productivity of workers, one would expect at least one of the economies to perform above the diagonal line. None do.

Quite surprisingly (or may be not) EU Commission offers an entirely opposite arguments on reforms efficacy. Even in the case of Greece - a country where both employment and productivity collapsed, the Commission paper argues that "Greece made a substantial adjustment in terms of employment while productivity stopped falling down". The folks in Commission believe that once the economy is completely exhausted on the downside, the lack of further declines is a sign of 'reforms-driven improvements'. This is about as crazy as cheering the fact that a lifeless body at the bottom of the empty pool is no longer falling.

Here is the Commission own guide to the above charts:

Do tell me which of the four countries locates in 'jobless growth' (early stage of reforms and structural changes working) area? Do note that other area of "Repositioning (growth less restructuring)" - which sounds exactly what it is: mindless demolition of jobs in hope that such a move can improve the remaining average. This is the best the 'periphery' has been able to achieve so far under the watchful eye of the EU Commission boffins.

22/9/2014: Where TLTROs dare to go?..

Last week I wrote about the disappointing nature of the first round of TLTROs by the ECB (http://trueeconomics.blogspot.ie/2014/09/1892014-quite-disappointing-tltro-round.html). Now, some more evidence that TLTROs are at best replacing / swapping liquidity in LTROs maturities without materially changing the nature of the banks assets holdings. Remember, the objective of TLTROs is to inject funds into corporate lending, not sustain or increase flows of funds into sovereign debt markets... which means sovereign yields should not be falling in connection to TLTROs.

So guess what's happening?

H/T for the chart to @DavidKeo

The chart above shows several things:

1. Both Spanish and Italian yields are falling across all maturities in excess of 1 year.
2. The margin from lending to the Spanish and Italian Governments (yield on bonds less cost of TLTRO funds) is lower across all maturities post TLTRO issue than before.
3. Margin declines are not uniform across maturities, and generally steeper at longer maturities. 

Are the banks taking up TLTROs pushing up prices of Government debt?.. That would mean more disconnection between the monetary policy objectives and outcomes, right?..