26/5/20: COVID19 Impact on Travel and Consumer Demand

Some dire numbers from Factset on changes in consumer preferences / sentiment through March-April 2020:

• "According to The Conference Board, consumer confidence has weakened significantly with the overall index falling from 118.8 in March to 86.9 in April, the lowest reading since June 2014." 
• "... older Americans (aged 55 and over) are much less optimistic than survey respondents under 55. This poses a problem as we look to economic recovery... [as] households in which the head of household is 65 years old or older represent 22% of total household expenditures in the U.S. In addition, this age group dominates spending at full-service restaurants and travel and lodging."

Things are getting worse in travel and transport sectors:

• "According to the International Air Transport Association, global air travel was down 52.9% in March compared to a year earlier, hitting its lowest level since the Global Financial Crisis."
• "In the U.S., jobs in air transportation fell by 27.4% in April."
• "The four major U.S. airlines—American, Delta, United, and Southwest—are prohibited from laying off or furloughing workers until after September 30 as a condition of receiving billions in payroll assistance as part of the CARES Act. But these carriers have been asking employees to take voluntary unpaid or lower-paying leaves, reduced hours, and early retirement."

On travel sector:

• "The April consumer confidence survey shows that just 31.9% of respondents intend to take a vacation within the next six months. This down from 54.9% in February and is the lowest reading ever in the 42-year history of this survey question."
• "We only have monthly personal consumption data through March... In March, consumption on accommodations was down 43.3% compared to February while air transportation had dipped by 53.5%." 

21/5/20: How Pitchforks See the Greatest Economy in the World

Folks with pitchforks don't care for nuance of financial wizardry. Or for econophysics of data-rich markets. They like simple, somewhat stylized facts. So here is how the world of the last 12 years looks to them:

Nothing to add.

5/5/20: A V-Shaped Recovery? Ireland post-Covid

My article for The Currency on the post-Covid19 recovery and labour markets lessons from the pst recessions: https://www.thecurrency.news/articles/16215/the-fiction-of-a-v-shaped-recovery-hides-the-weaknesses-in-irelands-labour-market.

Key takeaways:
"Trends in employment recovery post-major recessions are worrying and point to long-term damage to the life-cycle income of those currently entering the workforce, those experiencing cyclical (as opposed to pandemic-related) unemployment risks, as well as those who are entering the peak of their earnings growth. This means a range of three generations of younger workers are being adversely and permanently impacted.

"All of the millennials, the older sub-cohorts of the GenZ, and the lower-to-middle classes of the GenX are all in trouble. Older millennials and the entire GenX are also likely to face permanently lower pensions savings, especially since both cohorts have now been hit with two systemic crises, the 2008-2014 Great Recession and the 2020 Covid-19 pandemic.

"These generations are the core of modern Ireland’s population pyramid, and their fates represent the likely direction of our society’s and economy’s evolution in decades to come."

9/4/20: Ifo Eurozone Forecast Q1-Q3 2020: Covid19 Impacts

Germany's ifo Institute joint forecasts for Eurozone growth are out today. Bleak reading. The forecasts below assume that Covid-19 restrictions will be gradually lifted over the summer 2020.

Seasonally and working-day adjusted GDP growth:

From ifo forecast: "The economy in the euro area is expected to slide into a deep recession in the first half of 2020:

• GDP growth is forecast to be -2% in Q1 and -10% in Q2, followed by a recovery in Q3 with +8%. 
• Due to the lack of comparable events in the last decades and the unpredictable course of the pandemic, these estimates are subject to substantial uncertainty."
• "Gross fixed capital formation is also certain to decline, with -2% in Q1 and -10% in Q2, due to supply disruptions, planning uncertainty and a preference for liquidity."
• "Foreign demand is likely to contribute negatively to growth, as a result of the euro area’s exposure to recessive international trade and a struggling global economy."

Inflation environment:

Headwinds and risks: 

• "A more unfavorable course of the pandemic would require longer and possibly stricter containment measures...
• "Despite massive liquidity provision by governments and central banks, a prolonged downturn would then lead to liquidity strains in the economy. 
• Increased debt levels associated with low income flows and asset devaluations are likely to lead to solvency issues for thinly capitalized corporations and private households.
• An ensuing rise in loan defaults could in turn lead to problems in the banking sector." 
• "A resurgence of the European debt crisis on a large scale thus constitutes a non-negligible risk to the forecast."

25/3/20: More than €3bn: The Need for Stimulus in Ireland

"€3bn a month or more – the cost of offsetting the Covid-19 shock" my article for @thecurrency on the size of the fiscal/monetary stimulus required for Ireland. Available atr: https://www.thecurrency.news/articles/12547/e3bn-a-month-or-more-the-cost-of-offsetting-the-covid-19-shock.

14/2/20: Pandemics, Panics and the Markets

In my recent article for The Currency I wrote about the expected market effects of the 2019-nCov coronavirus outbreak: https://www.thecurrency.news/articles/8490/constantin-gurdgiev-pandemics-panics-and-the-markets.

While past pandemics are not a direct nor linear indicators of the future expected performance, the logic and the dynamics of the past events suggest that while the front end short term effects of pandemics on the economies and the markets can be significant, over time, rebounds post-pandemics tend to fully offset short run negative impacts.

Key conclusions from the article are:

• "...The market appears to worry little about public health risks, after their impact becomes more visible, although the onset of a pandemic can be associated with elevated markets volatility. This volatility is higher the faster the evolution of the health scare, but so is the market rebound from each crisis lows."
• "This is not say that investors have little to worry about in today’s markets. We are still trading in the heavily over-bought market, and concerns about global growth are not getting much of a reprieve from the newsflows. The good news is, to date, the latest global health crisis does not seem to be a trigger for a major and sustained sell off. The bad news is, we are yet to see its full impact."

9/9/19: Ireland and OECD: Income Tax Rates Comparatives

Based on the OECD data for 2018, Ireland is the second worst OECD country to earn income from work at the upper margin of earnings (167% of the average annual gross wage earnings of adult, full-time manual and non manual workers in the industry), compared to lower earners (67% of the average wage earnings). And although this story is not new (we were in the same position back in 2014), the gap in effective marginal taxes charged on the higher earners relative to lower earners is getting worse.

Here is the chart for 2014 data:

And a comparative 2018 data:

Back in 2014, nine of the OECD countries had zero or negative upper marginal tax rate penalty on higher wage earners. In 2018, the number rose to ten. In 2014, seven countries, including Ireland, had a tax rate penalty on higher wage earners in excess of 10 percentage points. In 2018, that number rose to eight. Ireland ranked second in terms of tax penalty on higher labour income tax burden relative to lower income in both 2014 and 2018. In 2014, our relative penalty stood at 18.961 percentage points, 2.753 percentage points below Sweden. In 2018, our relative penalty was 20.974 percent, 3.04 percentage points below Sweden. The OECD average penalty was 5.31 percentage points in 2018, down from 5.57 percentage points in 2014.

It is worth noting that in Ireland, voluntary spending on healthcare (indirect tax) is roughly 50 percent higher than it is in Sweden (https://data.oecd.org/healthres/health-spending.htm). Ireland spends less than half what Sweden does on early childhood education per pupil, and about 60 percent of what Sweden spends on tertiary education per pupil (https://data.oecd.org/eduresource/education-spending.htm). In other words, higher taxes on higher earners in Sweden seem to be purchasing substantially more services for taxpayers than they do in Ireland. Sweden also has older demographics and a somewhat functional military. Ireland has younger (lower health spending) demographics and not much in terms of a military expenditure. Of course, Swedish parliamentarians earned EUR 6,269 per month salary in 2918, when their Irish counterparts were paid EUR 7,878, but that hardly explains the gaps in spending and taxation systems.

So where all this tax penalty or surcharge on the higher earners levied on Irish residents is being spent? Clearly not on better financed education or health services, and not on military.

Another interesting way of looking at the figures is by comparing the actual tax rates. For those on 67% of average labour income, Ireland's rate of taxation in 2014 was 37.7 percent or 3.92 percentage points below the OECD average,. This fell in Ireland to 35.72 percent in 2018, while the gap with OECD average rose to 6.29 percentage points. If you consider OECD average to be a realistic metric for tax burden on lower earners, Irish lower earners were more substantially undertaxed in 2018 than they were in 2014. For higher earners, disregarding the fact that Irish upper marginal tax rates kick in at an absurdly low level, for wage earners of 167% of the average wage, Irish tax rates were 56.66% and 56.70 percent in 2014 and 2018, respectively. This means that in 2014, Irish higher earners tax rates were 9.34 percentage points above the OECD average and in 2018 these were 9.38 percentage points above the OECD average. In both cases, higher earners were taxed more severely in Ireland when compared to the OECD average. The matters are similar if we were to run a comparative between Ireland and OECD median tax rates, so there is no point of arguing that OECD data includes 'outlier' countries.

On a personal note, I do not think comparatives between Sweden and Ireland paint the latter in any better terms than the former. However, if one were to look at the OECD figures as some objective measures of tax burdens, Irish lower and higher earners (labour income) are overtaxed by the OECD 'norms' (average and median). When one takes into the account a relatively scarce supply of services to the taxpayers as well as a relatively higher out-of-pocket costs of the services supplied, things appear to be even worse. This is not a value judgement. It simply down to the plain numbers.

2/7/19: Inverted Yield Curve

Inverting U.S. yield curve is one of the best early indicators of recessions. Or at least it used to be... before all the monetary policy shenanigans of the last 11 years. Regardless, the latest U.S. Treasury yields dynamics are quite disquieting:

3/6/19: Three Periods in labor Force Participation Rate Evolution and Secular Stagnations

The state of the global labor markets is reflected not only in the record lows in official unemployment statistics, but also in the low labor force participation rates:

In fact, chart above shows three distinct periods of evolution of the labor force participation rates in the advanced economies, three regimes: the 1970s into 1989 period that is marked by high participation rates, the period of 1990-2004 that is marked by the steadily declining participation rates, and the period since 2005 that is associated with low and steady participation rates.

This is hardly consistent with the story of the labor markets spectacular recovery that is presented by the official unemployment rates. In fact, the evidence in the above chart points to the continued importance of the twin secular stagnations hypothesis that I have been documenting on this blog.

18/8/18: Monopolization trends in Advanced Economies: my column for CFR

My column for the Cayman Financial Review on the topic of structural monopolization of the global economy and the declining competitiveness. https://www.caymanfinancialreview.com/2018/08/14/breaking-the-medici-vicious-circle-monopolization-trends-in-advanced-economies/.

8/4/18: Talent vs Luck: Differentiating Success from Failure

In their paper, "Talent vs Luck: the role of randomness in success and failure", A. Pluchino. A. E. Biondo, A. Rapisarda (25 Feb 2018: https://arxiv.org/pdf/1802.07068.pdf) tackle the mythology of the "dominant meritocratic paradigm of highly competitive Western cultures... rooted on the belief that success is due mainly, if not exclusively, to personal qualities such as talent, intelligence, skills, efforts or risk taking".

The authors note that, although "sometimes, we are willing to admit that a certain degree of luck could also play a role in achieving significant material success, ...it is rather common to underestimate the importance of external forces in individual successful stories".

Some priors first: "intelligence or talent exhibit a Gaussian distribution among the population, whereas the distribution of wealth - considered a proxy of success - follows typically a power law (Pareto law). Such a discrepancy between a Normal distribution of inputs, suggests that some hidden ingredient is at work behind the scenes."

The authors show evidence that suggests that "such an [missing] ingredient is just randomness". Or, put differently, a chance.

The authors "show that, if it is true that some degree of talent is necessary to be successful in life, almost never the most talented people reach the highest peaks of success, being overtaken by mediocre but sensibly luckier individuals."

Two pictures are worth a 1000 words, each:

Figure 5 taken from the paper shows:

• In panel (a): Total number of lucky events and
• In panel (b): Total number of unlucky events 

Both are shown as "function of the capital/success of the agents"

Overall, "the plot shows the existence of a strong correlation between success and luck: the most successful individuals are also the luckiest ones, while the less successful are also the unluckiest ones."

Figure 7 shows:
In panel (a): Distribution of the final capital/success for a population with different random initial conditions, that follows a power law.
In panel (b): The final capital of the most successful individuals is "reported as function of their talent".

Overall, "people with a medium-high talent result to be, on average, more successful than people with low or medium-low talent, but very often the most successful individual is a moderately gifted agent and only rarely the most talented one.


Main conclusions on the paper are:

• "The model shows the importance, very frequently underestimated, of lucky events in determining the final level of individual success." 
• "Since rewards and resources are usually given to those that have already reached a high level of success, mistakenly considered as a measure of competence/talent, this result is even a more harmful disincentive, causing a lack of opportunities for the most talented ones."

The results are "a warning against the risks of what we call the ”naive meritocracy” which, underestimating the role of randomness among the determinants of success, often fail to give honors and rewards to the most competent people."

3/8/17: BRIC Composite PMIs: July

Having covered BRIC Manufacturing PMIs in the previous post (http://trueeconomics.blogspot.com/2017/08/3817-bric-manufacturing-pmis-july.html), and Services PMIs (http://trueeconomics.blogspot.com/2017/08/3817-bric-services-pmi-july.html), here is the analysis of the Composite PMIs.

Table below summaries current shorter term (monthly) trends in Composite PMIs:

Brazil has slipped into a new sub-50 Composite PMI trend in 2Q 2017 and, as of July, remains in the slump, although at 49.4, July Composite PMI reading signals much weaker rate of economic activity contraction than the June reading of 48.5. The problem for Latin America’s largest economy is that the hopes for an extremely weak recovery, set in 50.4 readings in April and May are now gone. In fact, 2Q 2017 average Composite PMI for Brazil stood at 49.8, which was stronger than July reading and marked the strongest performance for the economy since 3Q 2014. All in, July marked the start of the 14th consecutive quarter of Composite PMIs signalling economic recession.

Russia Composite PMI at the end of July stood at 53.4, a respectably strong number, signalling good growth prospects for the economy, but down from 54.8 in June and 56.0 in May. In fact, July reading was the lowest in 9 months. Given the economy’s performance in 1Q 2017, set against composite PMIs, the July and 1-2Q readings suggest that Russia is on track to record 1.0-1.5% growth this year, but not quite 2.0% or higher as expected by the Government. We will need to see 3Q and 4Q averages closer to 56-57 range to have a shot at above 1.5% growth.

China posted 2Q 2017 Composite PMI at 51.3, which is below July 51.9 reading. Still, July improvement is yet to be confirmed across the rest of 3Q 2017. China’s Composite PMI slowed from a recent peak of 53.1 in 4Q 2016 to 42.3 in  1Q 2017 and 51.3 in 2Q 2017.

India’s Composite PMI reflected wide-ranging weakening in the economy struck by both botched de-monetisation ‘reform’ and equally bizarre tax reforms. Sinking from appreciably strong 52.2 in 2Q 2017 to 46.0 in July, this fall marked the lowest PMI reading since 1Q 2009 and the second lowest reading on record. India’s economy has been in a weak state since 3Q 2016 when Composite PMI averaged 53.1. The PMI fell to 50.7 and 50.8 in 4Q 2016 and 1Q 2017 before recovering in 2Q 2017. This recovery is now in severe doubt. We will need to see August and September readings to confirm an outright PMI recession, but the signs from July reading are quite poor.

All in, in July, Russia was the only BRIC economy that came close (at 53.4) to Global Composite PMI reading of 53.5. Two BRIC economies posted a sub-50 reading. In 2Q 2017, Global Composite PMI was 53.7, with Russia Composite PMI at 55.4 being the only BRIC economy that supported global economic growth to the upside. In fact, Russia lead Global Composite PMIs in every quarter since  2Q 2016.

3/8/17: BRIC Services PMI: July

Having covered BRIC Manufacturing PMIs in the previous post (http://trueeconomics.blogspot.com/2017/08/3817-bric-manufacturing-pmis-july.html), here is the analysis of the Services Sector PMIs.

Brazil Services PMI continued trending below 50.0 mark for the third month in a row, hitting 48.8 in July, after reaching 47.4 in June. While the rate of contraction in the sector slowed down, it remains statistically significant. This puts an end to the hope for a recovery in the sector, with Brazil Services PMIs now posting only two above-50 (nominal, one statistically) readings since October 2014.

Russian Services PMI also moderated in July, although the reading remains statistically above 50.0. July reading of 52.6 signals slower growth than 55.5 reading in June. The Services sector PMIs are now 18 months above 50.0 marker, continuing to confirm relatively sustained and robust (compared to Manufacturing sector) expansion.

China Services PMI remained in the statistical doldrums, posting 51.5 in July gayer 51.6 in June. The indicator has never reached below 50.0 in nominal terms in its history, so 51.5 reading is statistically not significant, given PMIs volatility and positive skew. Overall, this is second consecutive month of PMIs falling below statical significance marker, implying ongoing weakness in the Services economy in China.

India’s Services PMIs followed Manufacturing sector indicator and tanked in July, hitting 45.9 (sharp contraction), having previous posted statistically significant reading for expansion at 53.1 in June. Volatility in India’s Services indicator is striking.

Table and chart below summarise short term movements:

Looking at quarterly comparatives, July was a poor month for Brazil Services sector, with July reading of 48.8 coming in weaker than already poor 49.0 indicator for 2Q 2017. In Brazil’s case, current recession in Services is now reaching into 12th consecutive quarter in nominal terms and into 15ht consecutive quarter in statistical terms. Russia Services PMI also moderated at the start of 3Q 2017 (52.6 in July) having posted average 2Q 2017 PMI of 56.0. Russia Services sector expansion is now into its 6th consecutive quarter (statistically) and seventh consecutive quarter nominally. The same, albeit less pronounced, trend is also evident in China (July PMI at 51.5 against 2Q 2017 PMI of 52.0). India Services PMI was under water in 4Q 2016, followed by weak (zero statistically) growth in 1Q 2017 and somewhat stronger growth in 2Q 2017. The start of 3Q 2017 has been marked by a sharp, statistically significant negative growth signal.

With Global Services PMI hitting 53.7 in July, against 53.8 average for 2Q 2017 and 53.6 average in 1Q 2017, BRIC economies overall are severely underperforming global growth conditions (BRIC Services PMI is now below Global Services PMI in 3 quarters running and this trend is confirmed at the start of 3Q 2017).

3/8/17: BRIC Manufacturing PMIs: July

BRIC PMIs for July 2017 are out, so here are the headline numbers and some analysis. 

Top level summary of monthly readings for BRIC Manufacturing PMIs is provided in the Table below:

Of interest here are:

• Changes in Brazil Manufacturing PMI signalled weakening in the economy in June that was sustained into July. Manufacturing PMI for Brazil has now fallen from 52.0 in May to 50.5 in June and to 50.0 in July. This suggests that any recovery momentum was short lived. 
• Russian Manufacturing PMI, meanwhile, powered up to 52.7 in July from 50.3 in June, rising to the highest level in 6 months. Good news: Russian manufacturing sector has now posted above-50 nominal readings in 12 consecutive months. Less bright news: Russian Manufacturing PMIs have signalled weak rate of recovery in 5 months to July and July reading was not quite as impressive as for the period of November 2016 - January 2017. Nonetheless, if confirmed in August-September, slight acceleration in Manufacturing sector can provide upward support for the economy in 3Q 2017, support that will be critical as to whether the economy will meet Government expectations for ~2% full year economic expansion.
• Chinese manufacturing PMI gained slightly in July (51.1) compared to weak May (49.6) and June (504.), but growth remains weak. Last time Chinese Manufacturing posted PMI statistically above 50.0 (zero growth) marker was January 2013. This flies in the face of official growth figures coming from China.
• India’s Manufacturing PMI fell off the cliff in July (47.9) compered to already weak growth recorded in June (50.9). Over the last 3 months, India’s Manufacturing sector has gone from weak growth, to statistically zero growth to an outright contraction.

Overall, GDP-weighted BRIC Manufacturing PMI stood at extremely weak 50.4 in July 2017, down from equally weak 50.6 in 2Q 2017. In both periods, BRIC Manufacturing sector grossly underperformed Global Manufacturing PMI dynamics (52.7 in July and 52.6 in 2Q 2017). Russia is the only country in the BRIC group with Manufacturing PMI matching Global Manufacturing PMI performance in July. Russian Manufacturing PMI was below Global Manufacturing PMI in 2Q 2017.

Net outrun: BRIC Manufacturing sector currently acts as a drag on global manufacturing growth, with both India and Brazil providing momentum to the downside for the BRIC Manufacturing PMIs.

Global trade protectionism: politics at its worst

To start with, here is a great quote from Jagdish Bhagwati - courtesy of the Cato Institute's Center for Trade Policy Studies:

"[L]abour union lobbies and their political friends have decided that the ideal defence against competition from the poor countries is to raise their cost of production by forcing their standards up, claiming that competition with countries with lower standards is “unfair”. “Free but fair trade” becomes an exercise in insidious protectionism that few recognise as such."
"Obama and Trade: An Alarm Sounds," Financial Times. January 9, 2009.


Lest anyone thought that one party controlling the Congress and the White House is such a handy idea, there is a welcome package for the EU's exporters being prepared by the Democrats.

According to the reports in today's press, President Obama's much-awaited $825bn stimulus package will include a “Buy America” clause - the American Steel First Act. The act will ensure that only US-made steel will be used in $64 billion of federally financed infrastructure projects.

Clearly, Anyone-but-the-Republicans EU leadership is going to see some nasty surprises from the new Administration - if not courtesy of Mr Obama himself, then certainly thanks to the good old protectionist traditional Democrats that Europeans love so much.

The initiative has already secured the House of Representatives Appropriations Committee blessing and is about to trigger a new Steel War with Europe. The EU Commission is already making noises about taking the US to WTO. The US, of course, signed and ratified the WTO's Government Procurement Agreement which requires it to grant fair access to its federally financed projects to all competitors.

If course, some EU states themselves are toying with 'Buy Domestic' types of rescue packages. France, usually the leader of the protectionist pack despite being economically open when it comes to French sales and investments abroad has squeezed in a €6bn aid package for its automakers that includes a commitment for them to purchase on French-made components.

In the UK, plans to give state aid to car makers are also reportedly to include assurances from the comapnies not to use funds outside the country.

A similar €4bn package of aid to Saab and Volvo in Sweden also came with the same strings attached.

And then there is a decision to reintroduce dairy export subsidies by the EU's Agricultural Commissioner, Mariann Fischer Boel. The measure is not only protectionist, but came despite the EU commitment in November 2008 not to introduce new trade barriers in order to allow the troubled Doha Round of global trade talks to be finalised with some face-saving dignity for the WTO.

So maybe in the end Mr Obama is an EU-like President?

Of course, the developing nations are also moving in quickly to shut some of their markets to foreign competition, but this is hardly a reasonable ground for EU and US to start erecting their own trade barriers. History offers a somber reminder: passage of the 1930 Smoot-Hawley Tariff Act in the US triggered a wave of tariff increases across the world. Within a year, average foodstuffs tariffs went up 53% in France, 60% in Austria, 66% in Italy, 75% in Yugoslavia, 80% plus in Czechoslovakia, Germany, Romania and Spain and more than doubled in Bulgaria, Finland and Poland. We all know what that led the world...

Talking up our economy

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

Here are few details:

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

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

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

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

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

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

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

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

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

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

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

Volatility falling?

In a rare piece of good news VIX index measuring (albeit imperfectly) revealed risk assessments in the US markets, has fallen below 40 on the final trading day of the year, for the first time since October 1. The VIX is the Chicago Board Options Exchange Volatility Index shows the market's expectations for volatility over a 30-day period.

As my students in Investment Theory course would know, only human imagination is a limit to the number of ways one can think about (and depict) market volatility. Here are three simple (my favourite criteria for empirical validity) ways of doing this.

Chart 1 plots VIX data since January 1990. This shows a dramatic fall in VIX reading since November highs. But, it also shows the cyclicality of VIX – an approximate 3:5:3 cycle of 3 years rising volatility trend, followed by 4-5 years of elevated ‘flat’ trend, concluding with a 3 years of falling trend. By this pattern, we are not out of the woods. Indeed, we have just finished the 3-year rising trend bit around mid 2008, implying that a long-term elevated volatility period may be still ahead for us.
Chart 2 plots intra-day variation in VIX (High-to-Close, alongside the same logic as semi-variance models of risk pricing). Note the unusually elevated red peaks since ca July 2007. This disputes the common claim that it took some time for credit markets troubles (starting in mid-Summer 2007) to feed through into the markets for real claims (assets with fundamental underpinnings). Once again, the latest moderation in VIX reading may be simply concealing the historically high volatilities in risk perceptions that drive daily markets.

Chart 3 shows three alternative, albeit slightly similar, measures of risk dynamics. Note that up until around mid February 2007, daily deviations in VIX readings measured as ‘High’-to-‘Low’ and ‘High-to-Close’ tracked one another and were roughly in line with the weekly Moving Average in the standard deviation. In other words, while risk itself might have been rising or falling over time, the uncertainty about the future risk levels was much lower and more static prior to the beginning of 2007.
This ‘calm’ was first challenged in February and then finally shattered in late September 2007. Once again, no matter how positive the latest decline in VIX to below 40 may sound, we are not of the woods yet.

Expect:
• More intra-day and intra-week volatility, and
• Less predictability in volatility trend.
2009 seas of financial market are going to be no less choppy than the ‘Perfect Storm’-torn 2008.

A train wreck of Irish economic policy

In managing the ongoing economic crisis, observing Irish Government policy can only be compared to watching a train wreck in slow motion. The banks re-capitalization scheme announced this week is just another example. By ignoring Ireland's impoverished and debt-overloaded consumers and companies, the latest plan will not deliver any real benefits to growth, credit flows or consumer/producer confidence.

One frame…

First, the rails buckle underneath as the Exchequer balance snaps under the weight of reckless public spending. Pop, pop – the fastenings fly off as tax line after tax line comes short. “No worries, we have a plan”, calls out the engineer. Enter the emergency budget – empty of any ideas as to how to mend the path or to lighten the load.

Then, the engine slumps oil-less. Banks hit the friction of bad corporate and household loans. The sparks of private unemployment fly. “All’s fine,” shouts the engineer, “we have insurance”. Emergency banks guarantee follows, but panic engulfs the carriages.

For what seems like an eternity the train pushes on. Dust, gravel and engine parts are shooting in all directions. Business insolvencies double year on year under the weight of the heaviest corporate debt load in the EU. Consumers crumble under the largest debt mountain in the OECD. Homes repossessions are on the rise and retail sales crash. The policy engine spins out of control: income, savings and consumption taxes go up and business rates increase. “The fundamentals are sound,” shout engineers. The rest of the world is selling off Irish shares and assets.

By the end of last week, the index of Irish financial companies shares has fallen 67% relative to the Black Monday of September 29th – the point that triggered the banks guarantee. “This will all end happily,” chirp engineers, “We’ll commission new reports, appoint new committees and issue more emergency responses.”

… to another

Enter this Sunday’s desperate ‘capitalization’ package. This promises to deliver some €10 billion to the banks in a swap for equity. The details, predictably, are sparse. Everyone expects the capital injections to be a copy-cat of those instituted by Germany and the UK – the countries hardly facing the same problems as Ireland. This implies a mixture of private and public funds to be made available to the banks with some token conditions, e.g dividends and management bonuses caps.

In a statement the Department of Finance said the plan will underpin the availability of loans to individuals and businesses.

Ooops. By-passing Ireland’s impoverished consumers and companies, the plan will not deliver any such benefits.

Elsewhere in Europe and the US, similar capitalization schemes have failed to reduce the cost of corporate borrowing or to restart lending to the households. In the UK, a £43 billion capital injection scheme has been in place for almost two months and the supply of consumer and business credit continues to fall - whether due to demand slowdown, lenders withdrawal from the market or both. In the US, massive banks’ capital supports have lowered the mortgage rates, but there is no meaningful increase in new mortgages uptake.

Three reasons for State-to-Banks recapitalization in-effectiveness

First, heavily indebted households are unlikely to take up new credit regardless of the cost. Short of the Government scheme to reduce the household debt or to increase after-tax incomes, no policy will shift consumers out of precautionary savings and into credit markets. So the retail sales will continue falling, businesses will suffer and consumers will keep on heading North for shopping. Our engineers, who two months ago raised VAT and now stubbornly refuse to back-down will see even less VAT revenue in 2009.

Second, heavily indebted Irish businesses can use new credit to either roll-over existent debts, or to finance short-term operational expenses, e.g export transactions. With exception of export credits, any new lending will simply re-arrange the deck chairs on the sinking Titanic of corporate Ireland. None of the new loans will go into capital acquisition, investment or hiring. These activities have stopped not because credit got dear, but because economic demand for goods and services has collapsed.

Third, for the banks, turning recapitalization proceeds into business loans will defeat the entire purpose of the scheme. Assuming re-capitalization is needed because bank’s capital is running too low relative to the size of the impaired or threatened loans, recapitalization must drive up the capital-to-loans ratio. Taking the money and using it to issue more loans will do exactly the opposite.

And this brings us to the issue of costs. The scheme will use the last of the remaining taxpayers’ money – the National Pensions Reserve Fund – to increase capital reserves of the banks. This means the state will no longer have any remaining capacity to inject a meaningful stimulus into the real economy. The consumers will go on cutting spending, business will go on laying off workers and the Exchequer will go on issuing new emergency responses. The more things change…