5/4/21: The Coming Wave of Financial Repression

 

In a recent article for The Currency, I covered the topic of the forthcoming wave of financial repression, as Governments worldwide pursue non-conventional fiscal tightening in years to come: Make no mistake, financial repression is coming in the US: https://thecurrency.news/articles/36547/make-no-mistake-financial-repression-is-coming-in-the-us/. 

20/4/15: Greece moves in with public sector capital [cash] controls

And... we have first round of [long-expected] capital controls in Greece: http://www.ft.com/intl/fastft/310542/athens-forces-local-governments-send-cash-central-banks. Per Bloomberg report, this covers term deposits: http://www.bloomberg.com/news/articles/2015-04-20/greece-moves-to-seize-local-government-cash-as-imf-payment-looms.

Which means... capital controls and an impact [of unknown magnitude so far] on capital spending and multi-annual spending lines, let alone on current spending.

Update: in response to some questions on the above, here is my view of risks arising from the above move by the Greek Government:

1. This points to a rather desperate situation in terms of cashflow in Greece. With three payments of maturing debt looming, Greek Government is now clearly and openly signaling lack of cash. As such, this move is a potential precondition to a default, although it is not necessarily a signla of such.
2. Transfer of cash into CB accounts means that the central authorities can have a more direct control over expenditure by the local authorities, which can have a negative impact on payments of current liabilities (e.g. wages, salaries, bonuses, pensions etc) and on some contracts, including capital expenditure and procurement contracts. Non-payments and payments delays to contractors are likely to rise as well.
3. Over longer term, such procedures can have adverse impact on local authorities investment plans.
4. Finally, transfer of cash implies reduction in deposits in the commercial banks which are currently experiencing significant private deposits withdrawals. The net impact is to further destabilise banking sector balance sheets. 

3/1/2015: Trade Protectionism Since the Global Financial Crisis

A year ago, ECB paper by Georgiadis, Georgios and Gräb, Johannes, titled "Growth, Real Exchange Rates and Trade Protectionism Since the Financial Crisis" (ECB Working Paper No. 1618. http://ssrn.com/abstract=2358483) looked at whether the current evidence does indeed support the thesis that "…the historically well-documented relationship between growth, real exchange rates and trade protectionism has broken down."

Looking at the evidence from 2009, the authors found that "the specter of protectionism has not been banished: Countries continue to pursue more trade-restrictive policies when they experience recessions and/or when their competitiveness deteriorates through an appreciation of the real exchange rate; and this finding holds for a wide array of contemporary trade policies, including “murky” measures. We also find differences in the recourse to trade protectionism across countries: trade policies of G20 advanced economies respond more strongly to changes in domestic growth and real exchange rates than those of G20 emerging market economies. Moreover, G20 economies’ trade policies vis-à-vis other G20 economies are less responsive to changes in real exchange rates than those pursued vis-à-vis non-G20 economies. Our results suggest that — especially in light of the sluggish recovery — the global economy continues to be exposed to the risk of a creeping return of trade protectionism."

One thing to add: the above does not deal with trade-restrictive policies relating directly to financial repression, such as outright regulatory protectionism of incumbent domestic banks and asset managers, or direct and indirect subsidies pumped into the incumbent banking system.

9/3/2014: Financial Repression, Debt Crises & Debt Restructuring: R&R Strike Again

According to Reinhart and Rogoff recent (December 2013) paper "Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten" (by Carmen M. Reinhart and Kenneth S. Rogoff, IMF Working Paper WP/13/266, December 2013 http://www.imf.org/external/pubs/ft/wp/2013/wp13266.pdf) many economies in the advanced world will require defaults, as well as drastic measures of Financial Repression, including savings taxes and higher inflation as debt levels reach a 200-year high.

You can read the entire paper, so I am just going to summarise some core points, albeit at length.


R&R open up with a statement that is more of a warning against our complacency than a claim of our arrogance: "Even after one of the most severe crises on record (in its fifth year as of 2012) in the advanced world, the received wisdom in policy circles clings to the notion that advanced, wealthy economies are completely different animals from their emerging market counterparts. Until 2007–08, the presumption was that they were not nearly as vulnerable to financial crises. When events disabused the world of that notion, the idea still persisted that if a financial crisis does occur, advanced countries are much better at managing the aftermath..."

This worldview is also not holding, according to R&R: "Even as the recovery consistently proved to be far weaker than most forecasters were expecting, policymakers continued to underestimate the depth and duration of the downturn."

The focal point of this delusional thinking is Europe, "…where the financial crisis transformed into sovereign debt crises in several countries, the current phase of the denial cycle is marked by an official policy approach predicated on the assumption that normal growth can be restored through a mix of austerity, forbearance, and growth."

The point is that European (and other advanced economies' policymakers are deceiving the public (and themselves), believing that they "…do not need to apply the standard toolkit used by emerging markets, including debt restructurings, higher inflation, capital controls, and significant financial repression. Advanced countries do not resort to such gimmicks, policymakers say. To do so would be to give up hard-earned credibility, thereby destabilizing expectations and throwing the economy into a vicious circle."

Note: per R&R "“Financial repression” includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and generally a tighter connection between government and banks. It often masks a subtle type of debt restructuring."

The warning that stems from the above is that "It is certainly true that policymakers need to manage public expectations. However, by consistently choosing instruments and calibrating responses based on overly optimistic medium-term scenarios, they risk ultimately losing credibility and destabilizing expectations rather than the reverse."

It is worth noting as a separate point in addition to the above issues that:

1. Financial repression in its traditional means (forcing public debt into investment portfolio of captive funds, such as pension funds, reducing real returns on savings, tax on savings, bail-ins of private investors etc) in the case of the advanced economies are running against demographic changes, such as ageing of these societies. Just as the economies reliance on savings and pensions rises, financial repression is cutting into the economies savings and pensions.
2. Higher inflation is associated with higher interest rates in the longer term, which can have a devastating impact on debt-burdened households. Hence, deleveraging of the sovereigns cuts against the objective of deleveraging the real economy (households and companies). This is most pronounced in the case of countries like Ireland.
3. Strong point from R&R on austerity. In many cases, advanced economies debate about austerity is 0:1 - either 'do austerity' or 'do expansionary fiscal policy'. This is superficial. Per R&R: "Although austerity in varying degrees is necessary, in many cases it is not sufficient to cope with the sheer magnitude of public and private debt overhangs."

So the key lessons from the past are as follows.

Lesson 1: "On prevention versus crisis management. We have done better at the latter than the former. It is doubtful that this will change as memories of the crisis fade and financial market participants and their regulators become complacent."

Figure 1. Varieties of Crises: World Aggregate, 1900–2010

A composite index of banking, currency, sovereign default, and inflation crises (BCDI), and stock market crashes (BCDI+stock) (weighted by their share of world income)


Lesson 2: "On diagnosing and understanding the scope and depth of the risks and magnitudes of the debt. What is public and what is private? Domestic and external debt are not created equal. And debt is usually MUCH bigger than what meets the eye."

R&R are not shying away from the bold statements (in my view - completely warranted): "The magnitude of the overall debt problem facing advanced economies today is difficult to overstate. The mix of an aging society, an expanding social welfare state, and stagnant population growth would be difficult in the best of circumstances. This burden has been significantly compounded by huge increases in government debt in the wake of the crisis, illustrated in Figure 2. …As the figure illustrates, the emerging markets actually deleveraged in the decade before the financial crisis, whereas advanced economies hit a peak not seen since the end of World War II. In fact, going back to 1800, the current level of central government debt in advanced economies is approaching a two-century high-water mark."

Figure 2. Gross Central Government Debt as a Percentage of GDP: Advanced and Emerging Market Economies, 1900–2011 (unweighted average)

Things are even worse when it comes to external debt, as Figure 3 illustrates.

Figure 3. Gross Total (Public plus Private) External Debt as a Percentage of GDP: 22 advanced and 25 Emerging Market Economies, 1970–2011

Note the 'exponential' trend on the chart above since the 1990s...

This is non-trivial (as per Figure 2 conclusions). "The distinction between external debt and domestic debt can be quite important. Domestic debt issued in domestic currency typically offers a far wider range of partial default options than does foreign currency–denominated external debt. Financial repression has already been mentioned; governments can stuff debt into local pension funds and insurance companies, forcing them through regulation to accept far lower rates of return than they might otherwise demand. But domestic debt can also be reduced through inflation."

And, as Figure 4 illustrates, public and external debts overhang are just the beginning of the troubles: "the explosion of private sector debt before the financial crisis. Unlike central government debt, for which the series are remarkably stationary over a two-century period, private sector debt shows a marked upward trend due to financial innovation and globalization, punctuated by volatility caused by periods of financial repression and financial liberalization."

Figure 4. Private Domestic Credit as a Percentage of GDP, 1950–2011 (22 Advanced and 28 Emerging Market Economies)

Lesson 3: "Crisis resolution. How different are advanced economies and emerging markets? Not as different as is widely believed."

R&R (2013) show "five ways to reduce large debt-to-GDP ratios (Box1). Most historical episodes have involved some combination of these."

As R&R note, "the first on the list is relatively rare and the rest are difficult and unpopular." But more ominously, "recent policy discussion has tended to forget options (3) and (5), arguing that advanced countries do not behave that way. In fact, option (5) was used extensively by advanced countries to deal with post–World War II debt (Reinhart and Sbrancia, 2011) and option (3) was common enough before World War II."

Beyond the fact that the two measures have precedent in modern history of the advanced economies, there is also the issue of the current crisis being of greater magnitude than previous ones.

"Given the magnitude of today’s debt and the likelihood of a sustained period of sub-par average growth, it is doubtful that fiscal austerity will be sufficient, even combined with financial repression. Rather, the size of the problem suggests that restructurings will be needed, particularly, for example, in the periphery of Europe, far beyond anything discussed in public to this point. Of course, mutualization of euro country debt effectively uses northern country taxpayer resources to bail out the periphery and reduces the need for restructuring. But the size of the overall problem is such that mutualization could potentially result in continuing slow growth or even recession in the core countries, magnifying their own already challenging sustainability problems for debt and old age benefit programs."


The authors conclude that "…if policymakers are fortunate, economic growth will provide a soft exit, reducing or eliminating the need for painful restructuring, repression, or inflation. But the evidence on debt overhangs is not heartening. Looking just at the public debt overhang, and not
taking into account old-age support programs, the picture is not encouraging. Reinhart, Reinhart, and Rogoff (2012) consider 26 episodes in which advanced country debt exceeded 90 percent of GDP, encompassing most or all of the episodes since World War II. (They tabulate the small number of cases in which the debt overhang lasted less than five years, but do not include these in their overhang calculations.) They find that debt overhang episodes averaged 1.2 percent lower growth than individual country averages for non-overhang periods. Moreover, the average duration of the overhang episodes is 23 years. Of course, there are many other factors that determine longer-term GDP growth, including especially the rate of productivity growth. But given that official public debt is only one piece of the larger debt overhang issue, it is clear that governments should be careful in their assumption that growth alone will be able to end the crisis. Instead, today’s advanced country governments may have to look increasingly to the approaches that have long been associated with emerging markets, and that advanced countries themselves once practiced not so long ago."


What R&R are showing in their paper is that Financial Repression already underway is hardly inconsistent with the potential for further restructuring and repression. They also show that the current crisis is still unresolved and ongoing and that the current de-acceleration in crisis dynamics is not necessarily a sign of sustained recovery: things are much longer term than 1-2 years of growth can correct for. In the mean time, as we know, the EU continues on the path of shifting more and more future crisis liabilities onto the shoulders of savers and investors, while offloading more and more public debt overhang costs onto the shoulders of taxpayers. All along, the media and our politicians keep talking down the risks of future bailouts, bail-ins and structural pain (lower growth rates, higher interest rates, higher rates of private insolvencies).


Note: You can read more on the rather lively debate about the effects of debt on growth by searching this blog for "Reinhart & Rogoff" Some of the links are here:

• 14/2/2014: Debt & Growth: New IMF Paper: http://trueeconomics.blogspot.ie/2014/02/1422014-debt-growth-new-imf-paper.html
• 31/12/2013: Debt and Growth: Consumption Crowding-Out Channel http://trueeconomics.blogspot.ie/2013/12/31122013-debt-and-growth-consumption.html
• 27/10/2013: Financial Repression, Economic Suppression & Budget 2014 http://trueeconomics.blogspot.ie/2013/10/27102013-financial-repression-economic.html
• 9/10/2013: Returning to Reinhart & Rogoff Debate http://trueeconomics.blogspot.ie/2013/10/9102013-returning-to-reinhart-rogoff.html
• 2/7/2013: Village June 2013: Real Effects of Government Debt Overhang? http://trueeconomics.blogspot.ie/2013/07/272013-village-june-2013-real-effects.html
• 17/6/2013: On Debt of the Nations & Euro Crisis: 2 links http://trueeconomics.blogspot.ie/2013/06/1762013-on-debt-of-nations-euro-crisis.html
• 10/10/2012: Irish Real Economic Debt - Busting Records http://trueeconomics.blogspot.ie/2012/10/10102012-irish-real-economic-debt.html
• 26/09/2011: Ireland's Debt Overhang - unprecedented, unmanageable & unsustainable http://trueeconomics.blogspot.ie/2011/09/26092011-irelands-debt-overhang.html

11/1/2014: Don't mention the 'D' word in the Eurozone, yet...

Bloomberg this week published a note analysing the GDP performance of the euro area countries during the Great Depression and the Great Recession: http://www.bloomberg.com/news/2014-01-06/europe-s-prospects-looked-better-in-1930s.html. The unpleasant assessment largely draws on the voxeu. org note here: http://www.voxeu.org/article/eurozone-if-only-it-were-1930s.

Perhaps the most important (forward-looking) statement is that in the current environment "complying with the EU's debt-sustainability rules will entail severe and indefinite budget stringency, clouding the prospects for growth still further". This references the EU Fiscal Compact and 2+6 Packs legislation.

And on a related note, something I am covering in the forthcoming Sunday Times column tomorrow (italics in the text are mine and bold emphasis added):

"What are the fiscal lessons? First, avoid deflation ... at all costs. ... Beyond that, the options in theory would seem to be financial repression, debt forgiveness, debt restructuring and outright default. Financial repression, the time-honored remedy, would seem to be out of bounds... and EU governments aren't yet ready to contemplate the alternatives [debt forgiveness, restructuring and defaults]. At some point, they will have to. In the 1930s, the situation didn't look so hopeless."

But why would the default word creep into the above equation?

Update: and another economist calling for debt restructuring/default denouement: http://www.voxeu.org/article/why-fiscal-sustainability-matters#.UtJWBR7i-nh.gmail
I know, I know - everything has been fixed now, so no need to panic...

29/11/2013: McKinsey estimates of QE effects on economies

Recent paper by McKinsey Global Institute, published November 2013 and titled "QE and ultra-low interest rates: Distributional effects and risks" looked at the effects of exceptional monetary policy measures implemented by the central banks in the US, the UK, Japan and the euro area since 2007.

"More than five years [since the beginning of the crisis] …central banks are still using conventional monetary tools to cut short-term interest rates to near zero and, in tandem, are deploying unconventional tools to provide liquidity and credit market facilities to banks, undertaking large-scale asset purchases—or quantitative easing (QE)—and attempting to influence market expectations by signaling future policy through forward guidance. These measures, along with a lack of demand for credit given the global recession, have contributed to a decline in real and nominal interest rates to ultra-low levels that have been sustained over the past five years."

The "ultra-low interest rates have produced significant distributional effects if we focus exclusively on the impact on interest income and interest expense." as the result:


McKinsey's core findings include:

• ƒ"Between 2007 and 2012, ultra-low interest rates produced large distributional effects on different sectors in advanced economies through changes in interest income and ...expense."
• "By the end of 2012, governments in the US, the UK, and the Eurozone had collectively benefited by $1.6 trillion, through both reduced debt service costs and increased profits remitted from central banks."
• "Meanwhile, households in these countries together lost $630 billion in net interest income, with variations in the impact among demographic groups. Younger households that are net borrowers have benefited, while older households with significant interest-bearing assets have lost income."
• "Non-financial corporations across these countries benefited by $710 billion through lower debt service costs."

It is worth noting that the McKinsey study does not account for the effects of reduced unemployment and shallower recessions that were attributed to the deployment of the monetary policies. Neither does the study account for the effects of higher taxation levied by the Governments on households.

Banking sector effects identified in the study are:

• "The era of ultra-low interest rates has eroded the profitability of banks in the Eurozone. Effective net interest margins for Eurozone banks have declined significantly, and their cumulative loss of net interest income totaled $230 billion between 2007 and 2012."
• "...Banks in the US have experienced an increase in effective net interest margins as interest paid on deposits and other liabilities has declined more than interest received on loans and other assets. From 2007 to 2012, the net interest income of US banks increased cumulatively by $150 billion."
• "Over this period, therefore, there has been a divergence in the competitive positions of US and European banks."
• "The experience of UK banks falls between these two extremes."

Financial companies and assets:

• "Life insurance companies, particularly in several European countries, are being squeezed by ultra-low interest rates. Those insurers that offer customers guaranteed-rate products are finding that government bond yields are below the rates being paid to customers."
• Obviously, not a word about the vast financial repression sweeping across the financial sector, especially in the euro area, which is seeing assets seized for 'tax raising' etc.
• But a stern warning: "If the low interest-rate environment were to continue for several more years, many of these insurers would find their survival threatened."
• And, not stated but on everyone's mind: if the low interest-rate environment were to come to an end, wholesale bankruptcy of household and corporate financial balance sheets will do miracles to the economies too...
• Per McKinsey: "The impact of ultra-low rate monetary policies on financial asset prices is ambiguous. Bond prices rise as interest rates decline, and, between 2007 and 2012, the value of sovereign and corporate bonds in the United States, the United Kingdom, and the Eurozone increased by $16 trillion."
• "But we found little conclusive evidence that ultra-low interest rates have boosted equity markets. Although announcements about changes to ultra-low rate policies do spark short-term market movements in equity prices, these movements do not persist in the long term. Moreover, there is little evidence of a large-scale shift into equities as part of a search for yield. Price-earnings ratios and price-book ratios in stock markets are no higher than long-term averages."

Households:

• "Ultra-low interest rates are likely to have bolstered house prices, although the impact in the United States has been dampened by structural factors in the market. At the end of 2012, house prices may have been as much as 15 percent higher in the United States and the United Kingdom than they otherwise would have been without ultra-low interest rates, as these rates reduce the cost of borrowing."
• "If one accepts that house prices and bond prices are higher today than they otherwise would have been as a result of ultra-low interest rates, the increase in household wealth and possible additional consumption it has enabled would far outweigh the income lost to households. However, while the net interest income effect is a tangible influence on household cash flows, additional consumption that comes from rising wealth is less certain, particularly since asset prices remain below their peak in most markets. It is also difficult today for households to borrow against the increase in wealth that came through rising asset prices."

Summary of the effects:

27/10/2013: Financial Repression, Economic Suppression & Budget 2014

This is an unedited version of my Sunday Times article for October 20, 2013.


With fanfare of media appearances and fireworks of Dail statements, Budget 2014 was pushed off the dry dock and into the turbulent waters of reality. Full of political sparkle on the outside, overloaded with hidden taxes and charges and yet-to-be-fully-detailed painful cuts on the inside, it sailed off into the future. It will take at least 9-12 months from now to see what adjustments will have to be made in 2015 to compensate for the 'savings' on cuts delivered this week. It will take us longer to find out if the Budget 2014 will have a positive or negative effect on our ability to fund our deficits in the markets.

Yet, one thing is beyond the doubt: Budget 2014 was a significant gamble by the Government that could have done better by avoiding taking any gambles at all. Minister Noonan has decided to buy some political capital in the Budget. This capital came in the form of reduced rate of overall budgetary adjustment, compensated for by the hope-based increases in public sector efficiencies, plus some symbolic handouts to middle class families. Majority, such as the free GP visits for children under the age of 5, were poorly targeted and economically inefficient – extending scarce resources not to where they are needed most (such as, for example, long-term care provision or means-tested provision of health services) but to where political expediency leads. Many fail the core Budget objectives of making our fiscal policies more robust to adverse shocks that may occur in the near-term future.

In the end, Budget 2014 delivered virtually no real departures from the past Budgets. Predictably, there were no 'new' taxes. Instead the Budget put forward a list of new 'revenue raising measures'. The State will claw out of the banks EUR150 million in levies. Given that our banking sector is being reduced to a Three Pillars oligopoly, the levies will come straight from charging customers more for the same services. Pensions funds levy - a form of expropriation of private property - is to raise additional EUR135 million. This is a tax on present income, and in the case of pensions funds levy a tax on current wealth, plus a tax on future incomes foregone due to reduced levels of pensions funds. EUR140 million will be pumped out of the banks’ customers by taxing interest on savings. All in – financial sector will take a hit of EUR425 million on a full year basis, reducing its ability to lend, invest in the economy and to deal with mortgages distress. The measures will also weaken the quality of Irish banks' deposits base by reducing incentives to save. Carmen Reinhart and Kenneth Rogoff aptly termed such measures ‘financial repression’. De facto, we are bailing in ordinary banks customers and savers to pay for the past sins of the banks. Cyprus redux, anyone?

Cuts side of the Budget was also predictable. At the aggregate level, departmental expenditure as the share of GDP continues to run above 1990-2007 average. Instead of real cost reductions in Health we got some EUR250-300 million worth of new charges to be levied on services to insurance holders. And reduced insurance deductibility on the revenues side should do even more to reduce insurance coverage in the market. Net effect will most likely be falling transfers from private patients to public services, and higher demand for public health.

From businesses perspective, whatever the State added on one side of the budgetary equation, the state took out on the other. Thus, for all incentives for construction and building trade, overall capital spending by the Government in 2014 is projected to fall by some EUR100 million. As we stand, in 2013, capital spending by the Government barely covers amortization and depreciation of the total stock of public capital. Next year, things are going to get worse.

Much of the business stimulus schemes are geared toward supports for the property markets, including the incentives for foreign investors to put money into Irish REITs. Aside from the property-related measures, other business stimulus polices are either extensions of the already existent ones or more promise of doing something in the future. One example is the issue of Trade Finance supports. We are now five years into talking about the need to help smaller exporters with the cost of and access to trade insurance and credit.  Still, there is no tangible delivery on this.


However, the real question, left unanswered by Budget 2014 is: what's next for Ireland? The Government is rhetorically focused on our 'exit' from the Troika-led funding programme. This objective is a policy epicycle designed to ease public attention off the realities of bad domestic governance during the crisis. Exit from the bailout, financially, fiscally and economically, means a public recognition that Ireland has run out of funds we can borrow from the IMF and the EU. It also puts forward a commitment that, unlike Greece, we will not be asking for another bailout. Being not Greece does not make us Iceland, however, since Iceland repaid its bailout loans. In contrast, we will be carrying our debts to Troika for years to come.

The Government is promising that once we exit the bailout, we will regain our control over fiscal policies. This is a gross over-exaggeration. Having ratified the Fiscal Compact, Ireland is now subjected to heavy EU oversight as long as our fiscal performance falls short of the targets set in the treaty. It will be long time before we meet all of the conditions.

The scrutiny of our targets will increase, while our performance will remain under serious pressures arising from the crisis. Most recent IMF forecasts assume full EUR5.6 billion adjustments taken over 2014-2015 period, and economic growth averaging over 2.1 percent per annum (almost 6 times the average growth in 2012-2013 period). These forecasts imply that in 2014-2015 Ireland will still face the third highest cumulative deficits in the euro area ‘periphery’. And the debt levels of Irish state are set to continue rising. In 2013, the Department of Finance projects the level of Irish Government debt to be at EUR205.9 billion. By 2018 this is projected to rise to EUR211.6 billion.

And here's another kicker. The Fiscal Compact sets the target for long-term structural deficits (in other words deficits that would prevail were the economy running at its long run sustainable growth potential) at 0.5 percent of GDP. IMF projections out through 2018 put Irish structural deficits declining from 5.1 percent of potential GDP in 2013 to 2.0 percent in 2018. In other words, in 2018 Ireland is expected to be the worst performing 'peripheral' state in terms of structural deficits and operate well outside the criteria set in the Fiscal Compact.

Worse, comes December 15, we will lose a strong supporter of our efforts to restructure legacy banking debts and the only member of the Troika that promotes structurally more important economic and markets reforms.

On foot of our weak fiscal position, the politicisation of the Irish economy is already building up, driven primarily by our European partners and – until December 15 – resisted by the IMF.

The pressure is rising on Ireland's corporate taxation regime. The Government admitted as much by promising to close the loophole that allows some MNCs to nearly completely avoid paying Irish corporate taxes.

The pressure is also growing on blocking Ireland’s chances to restructure legacy banks debts. Germany, the ECB and the Eurogroup are angling to block Ireland's potential access to the European funds set up to deal with the future banking crises.

We are going into 2014 self-funding mode with all the costs of the bailout in place, including the Dvoika (Troika less one) oversight and substantial deficit and debt overhangs. It now appears that there will be no credit line to cover any increases in the cost of borrowing that might arise in the future. There will be no precautionary fund to cushion against any risk to market demand for Irish Government bonds. There will be no system in place to deal with any future banking problems or with the legacy debts should such arise. The ECB, the IMF and our forecasters are all warning us that we still face potentially significant downside risks to growth and banks stability. The IMF has been for months raising the issues of the SMEs insolvencies and poor quality of banks capital.

In other words, we are boxing ourselves into a high-risk game with little to show for this in terms of a positive return from our 'exit' from the bailout.

History suggests that prudence, not pride should be our guide. Back in 2010 we pre-borrowed aggressively in the markets prior to the state finances collapsing under the poorly structured banks bailouts. Now, we are gunning for the 'exit' without having secured any support from our 'partners' once again. The hope is that this time it will be different: the markets will lend us at decreasing costs, while growth lifts the entire domestic economy out of stagnation. This might not be an equivalent of playing Russian roulette, but it is certainly a game of chance with high stakes on the losses side and little tabled on the potential winnings side.

Box-out:
The latest OECD research on basic skills across the advanced economies puts to a serious test our claims to having a highly educated workforce. Ireland ranked eighth in terms of the proportion of younger adults with tertiary education. In terms of problem solving proficiency, both our college graduates and adults with only secondary education rank below their respective OECD averages. In problem solving in a technology-rich environment – a proxy for skills related to internationally-traded services, the sole driver of our economy today – Ireland ranks 18th in the OECD. Our younger workers score below their OECD peers in basic literacy and in numeracy. When it comes to introduction of new processes and technologies in the workplace Ireland is ranked between such premier divisions of the global innovation league as Cyprus and Belgium. Given our poor performance in digital economy-specific skills, exposed in October 2012 report by the OECD and covered in these pages before, it is high time for us to get serious about reforming our education and training systems.

16/8/2012: Financial Repression - Round 2

Financial repression continues to gain speed in Ireland: link here.

Basic idea: having raided actual pensions funds, the Irish Government is to issue special annuities (priced accordingly to reflect State's 'grudging acceptance' for now of the pensions tax break) for insurance and pensions providers.

The good part of the idea is, as Fitch points in the note, added funding stream for the Government.

The bad parts are, as Fitch does not bother to note:

• Deleveraging economy means that funds will be taken out of the already diminished private investment stream, should the annuities be successful in raising such funds;
• Risks of claims exposure to Ireland for Ireland-based providers will now be amplified by more assets tied to Ireland (de-diversification);
• The new funding is debt, priced more expensively than what we can avail of from the Troika programme and subsequently from the ESM (at least access to and the cheapness of the ESM funds was the Government-own rationale for convincing the voters to back the Fiscal Compact earlier this year - something that the rating agencies have confirmed, as I recall);
• The new funding is still debt, which means that the new 'source' is not going to help restoring Irish public finances to sustainability path;
• Payments on these annuities will be subject to the same seepage out to imports (consumption of recipient households) as any other income and thus will have lower impact on our GDP, and an even worse impact on our GNP, than were the annuities structured using foreign governments' bonds;
• Share of the Irish state liabilities held by domestic investors will rise, which automatically implies riskier profile for both: Exchequer future funding and pensions;
• The latter (pensions funding risk profile deterioration) will also induce higher expected value of future unfunded liabilities (basically, as risk of pensions funding rises, probability of claims on state in the future to fund public pensions rises as well), and so on.

But, hey, why would the Irish State bother with any of these concerns when they've found another quick fix to €3-5 billion of our cash?

And on a more macro level, financial repression is back on the EU agenda too. The latest spike in French rhetoric about the need for 'own-funding' of the EU operations (link here) is just that, have no doubt. The idea is to give EU some central taxation powers so, as claim goes, it reduces the 'burden' on national governments. So far so good? Not exactly. Neither the French, nor any other Government in Europe at this stage is planning to 'rebate' (or reduce) internal tax burdens to compensate for EU new tax burden. In other words, the Governments ill simply pocket the 'savings'. Which, to put it simply, means the new 'powers' will simply be new taxes for the already heavily over-taxed and recession-weakened economies of Europe.

All in the name of deleveraging the State at the expense of the real economy. And that is exactly what the financial repression is all about.

Updated: And just in case we need more 'creative' thinking, here's an example of financial suppression: It turns out Nama (Irish State Bad Bank - don't argue that SPV thingy, please) should use public purse to suppress normal price discovery processes in Irish property markets. Right... you really can't make this up. Irish elites are now so desperate for relevance, they are fishing that Confidence Genie anytime anyone is feigning some attention to what they have to say.

29/7/2012: Financial Markets Repression

In my recent conversation with Carmen Reinhart, we discussed at length various forms of financial repression to be unleashed onto the public with the coming systemic deleveraging in the US, EU and elsewhere. One of the most prominent topics in our discussion were potential capital controls. And we both agreed that most likely, it will be Eurozone that will be first in the races to impose such. Of course, there are signs of softer version of capital controls within the banking system already present. So much so that Mario Draghi had to identify national regulations as barriers to single market in banking under current conditions.

Never mind. The US Fed is not about to fall behind the curve. And in the latest suggestion for policymakers, the Federal Reserve Bank of New York (Staff Report No. 564, July 2012, linked here) puts forward an idea that "for money market fund (MMF) reform [to] mitigate systemic risks arising from these funds by protecting shareholders, such as retail  investors, who do not redeem quickly from distressed funds... a small fraction of each MMF investor’s recent balances, called the “minimum 

balance at risk” (MBR), be demarcated to absorb losses if the fund is liquidated."

Wait, does this mean that fund investors can face some small share loss imposed onto them because they might be quicker than other investors in exiting or more foresightful enough to spot the fund running into trouble ahead of other investors? Yep, that's right.

"The MBR would be a small fraction (for example, 5 percent)  of each shareholder’s recent balances that could be redeemed only with a delay.  The delay would ensure that redeeming investors remain partially invested in the fund long enough (we suggest 30 days) to share in any imminent portfolio losses or costs of their redemptions.  However, as long as an investor’s balance exceeds her MBR, the rule would have no effect on her transactions, and no portion of any redemption would be delayed if her remaining shares exceed her minimum balance."

And the rationale: "to reduce the vulnerability of MMFs to runs and protect investors who do not redeem quickly in crises."


That, folks, is a hell of a capital control proposal.