17/5/15: Public Debt, Private Debt… Someone Thinks There Might Be Consequences

Remember last year vigorous debate about whether debt (in particular real economic debt - as I call it, or non-financial debt - as officialdom calls it) matters when it comes to growth? Well, the debate hasn't die out… at least not yet. And some heavy hitters are getting into the fight. Òscar Jordà, Moritz HP. Schularick and Alan M. Taylor paper, "Sovereigns versus Banks: Credit, Crises and Consequences", Working Paper No. 3: http://ssrn.com/abstract=2585696

Ok, so some key preliminaries: "Two separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies." The problem is that the two 'narratives' "…may interact in important and understudied ways", most notably via debt and debt overhangs.

The authors examine "the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt."

Time for Krugmanites to pop some champagne? Err, not too fast: "However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression."

Wait, what? A state indebted to the point of losing its shirt (or rather default on pay awards to trade unionised workers and retirees) imposes cost on private sector that can be detrimental during private sector own deleveraging? Yeah, you betcha. It is called power of taxation. Just as during the current crisis the Governments world wide gave no damn as to whether you and I can pay kids schools fees, health insurance and mortgages, so it was thus before.

"We uncover three key facts based on our analysis of around 150 recessions and recoveries since 1870:

1. in a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; 
2. the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and 
3. the path of recovery is worse still when a credit-fuelled crisis coincides with elevated public debt levels. Recent experience in the advanced economies provides a useful out-of-sample comparison, and meshes closely with these historical patterns. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now."

Now, take a more in-depth tour of the changes in fiscal and private non-financial debt across 17 advanced economies since 1870s:

Oh, yeah… 1950s and 1960s public deleveraging was done by leveraging up the real economy. And it didn't stop there. It got much much worse… instead of deleveraging one side of the economy, both public and private sides continued to binge on debt. Through the present crisis.

So "what does the long-run historical evidence say about the prevalence and effects of private and public debt booms and overhangs? Do high levels of public debt affect business cycle dynamics, as the public debt overhang literature argues? Are the effects of either variety of debt overhang more pronounced after financial crisis recessions?"

So here are the results:

So the results provide "…a first look at over 100 years of the inter-relationships of private credit and sovereign debt. We end with five main conclusions":

1. "…while public debt has grown in most countries in recent decades, the extraordinary growth of private sector debt (bank loans) is chiefly responsible for the strong increase of total liabilities in Western economies. About two thirds of the increase in total economy debt originated in the private sector. ...Sovereign and bank debts have generally been inversely correlated over the long run, but have increased jointly since the 1970s. In modern times, the Bretton-Woods period stands out as the only period of sustained public debt reduction, both in expansions and recessions."
2. "…in advanced economies financial stability risks originate primarily in the private sector rather than in the public sector. To understand the driving forces of financial crises one has to study private borrowing and its problems. In the very long run, if we run a horse race between the impact of changes or run-ups in private credit (bank loans) and sovereign debt as a predictor of financial crisis and its associated distress, private credit is the more significant predictor; sovereign debt adds little predictive information. This fits with the events of 2008 well: with the exception of fiscal malfeasance in Greece most other advanced countries did not have obvious public debt problems ex ante. Of course, ex post, the fierce financial crisis recession would wreak havoc on public finances via crashing revenues and rising cyclical expenditures."
3. "…with a broader and longer sample we confirm that private debt overhangs are a regular feature of the modern business cycle. We find that once a country does enter a recession, whether it is an ordinary type or a financial-crisis type of recession, if it carries the legacy of a large private credit boom then the post-recession output path of the economy is typically adversely affected with slower growth."
4. "…our new data also allow us to see the distinct contribution of public debt overhangs. We find evidence that high levels of public debt matter for the path of economies out of recessions, confirming the results of Reinhart et al. (2012). But the negative effects of high public debt on the performance of the economy arise specifically after financial crises and in particular when private borrowing also ran high. While high levels of public debt make little difference in normal times, entering a financial crisis recession with an elevated level of public debt exacerbates the effects of private sector deleveraging and typically leads to a prolonged period of sub-par economic performance." In other words, not too fast on that champagne, Krugmanites… 
5. "…from a macroeconomic policy standpoint these findings could inform ongoing efforts to devise better guides to monetary, fiscal, and financial policies going forward…" blah… blah… blah… we can stop here.

Funny how no one can get the right idea, though - the reason public debt matters is because the state always has a first call on all resources. As the result, the state faces a choice at any point of deleveraging cycle:

• (A) leverage up the State to allow deleveraging of the real economy; or
• (B) tax there real economy to deleverage the State.

In the US, the choice has been (A) in 2008-2014. In Europe, it has been (B). The thing is: both Europe and US are soon going to face another set of fine choices:

• (Y) reduce profligacy in the long run to deleverage the State; or
• (Z) get the feeding trough of pork barrel politics rocking again.

No prizes for guessing which one they both will make… after all, they did so from 1970s on, and there are elections to win and seats to occupy...

29/4/15: China's Debt Pile is Frightening & Getting Worse

Just catching up on some interesting data on China, courtesy of @AmbroseEP, showing debt to GDP ratios for China's real economy:

Now, note that the comparatives are all advanced economies that can carry, normally, higher debt levels. Which makes China's 282% estimated total debt pile rather large.

The chart references as a source data presented in this (see scone chart) http://trueeconomics.blogspot.ie/2015/03/5315-troika-tale-of-irish-debt.html but adjusted to reflect RBS estimates. which pushes McKinsey point for China horizontally to the levels close to Greece.

As someone else pointed out, nominal GDP growth in China is apparently now lower than interest on debt.

Meanwhile number of stock market accounts has gone exponential in recent days - using borrowed money (Chinese residents borrowed over Yuan 1 trillion or Euro150 billion worth of cash to pump into stock markets):

Economy is clearly slowing down in China, with conflicting reports and estimates of 1Q 2015 growth suggesting possible contraction in the real economy and domestic demand. (See http://www.irishtimes.com/business/economy/china-equity-markets-boom-while-economic-growth-stutters-1.2182547).

At the top of debt chain are local authorities: latest official data shows borrowings by the local authorities were up by almost 50% since the start of H2 2013 to c. 16 trillion yuan. Local authorities debt growth accounts for a quarter of changes in overall domestic debt since 2008. Recently, the IMF warned China that the country overall economic debt is expanding at a faster pace than debt in Japan, South Korea and the U.S. grew before the onset of the Global Financial Crisis.

My view: when this pile of Chinese debt blows, things will get spectacularly ugly, globally.

13/3/15: Emerging Markets Corporate Debt Maturity Squeeze

H/T to @RobinWigg for the following chart summing up Emerging Markets exposure to the USD-denominated corporate debt redemptions calls over 2015-2025. The peak at 2017 and 2018 and relatively high levels for exemptions coming up in 2016, 2019-2020 signal sizeable pressure on the EM corporates that coincides with expected tightening in the US interest rates cycle - a twin shock that is likely to have adverse impact on EMs' capex in years to come. With rolling over 2017-on debt becoming a more expensive proposition, given the USD FX rates and interest rates outlook, the EMs-based corporate sector will come under severe pressure to use organic revenue generation to redeem maturing debt. Which means less investment, less hiring and less growth.

The impossible monetary policy trilemma that I have been warning about for some years now is starting to play out, with delay on my expectations, but just as expected - in the weaker and more vulnerable markets first.

4/2/15: Debt Overhang and Sluggish Growth

Debt overhang and its impact on growth has been a rather controversial topic over the recent years. One of the key contributors to the debate is Kenneth Rogoff. Rogoff has a new paper out on the topic, together with Stephanie Lo, titled "Secular stagnation, debt overhang and other rationales for sluggish growth, six years on" published by the Bank for International Settlements (http://www.bis.org/publ/work482.pdf).

In the paper, Rogoff and Lo state that "there is considerable controversy over why sluggish economic growth persists across many advanced economies six years after the onset of the financial crisis. Theories include a secular deficiency in aggregate demand, slowing innovation, adverse demographics, lingering policy uncertainty, post-crisis political fractionalisation, debt overhang, insufficient fiscal stimulus, excessive financial regulation, and some mix of all of the above." Rogoff and Lo survey "the alternative viewpoints" on the causes of slow growth. The authors argue that "until significant pockets of private, external and public debt overhang further abate, the potential role of other headwinds to economic growth will be difficult to quantify."

Rogoff and Lo focus strongly on the effects of debt overhang on growth. "In our view, the leading candidate as an explanation for why growth has taken so long to normalise is that pockets of the global economy are still experiencing the typical sluggish aftermath of a financial crisis… The experience in advanced countries is certainly consistent with a great deal of evidence on leverage cycles, for example the empirical work of Schularick and Taylor (2012), who examine data for a cross-section of advanced countries going back to the late 1800s and find that the last half-century has brought an unprecedented era of financial vulnerability and potentially destabilising leverage cycles. Moreover, focusing on more recent events, Mian and Sufi’s (2014) estimates suggest that the effects of US household leverage might be large enough to explain the entire decline in both house prices and durable consumption."

Still, their conclusion is very cautious. Instead of assigning direct causality from debt to growth, they suggest increased indeterminacy of the relationship between other variables and growth in the presence of high debt overhangs. They do reinforce the point that the argument about debt overhang relates to the total real economic debt (governments, households and non-financial corporations), not solely to government debt alone.

23/8/2014: That Pesky Problem of Real Debt...

Again, revisiting IMF's Article 4 consultation paper for Euro Area, published in July 2014, here is a summary of the Euro area 'peripheral' countries debt overhang.

First real economic debt (debt of non-financial companies, households and public sector):

 Points of note:

1. Ireland's debt overhang is severe. More severe than of any other 'peripheral' country. Bet you forgot that little bit with all the 'best-in-class' growth performance droning in the media. Ah, and worse, remember, not the level alone, but the rate of debt increases over time, also matters. And by this metric, we too are the worst in the group, both for debt increases on 2003 levels and debt increases on 2008 levels.
2. Ireland's households' debt has declined over 2008-2013, more so than in Portugal and Spain. But it remains second highest after the Netherlands' and this decline masks true extent of debt problem because 2013 figure no longer counts household debts issued by banks that left Ireland and books of loans sold to investment funds. This also excludes some securitised debt.
3. Ireland's corporate debt problem is potentially overstating true extent of real debt in the economy, as it includes a small share of MNCs debt - debt issued by Irish institutions. This is likely to be relatively minor, in my view, as MNCs largely do not do debt intermediation via Irish domestic institutions. 

Now on to our household debt deleveraging in more detail:

Good news is, when it comes to our households, we are aggressively deleveraging compared to pre-crisis debt peak. As aggressively (in rate terms) as the U.S. Caveats mentioned above apply.

But there is a problem with all the debt legacy:

In the above 'PS' stands for private sector, not public sector. So private sector debt legacy is associated with negative subsequent economic growth, in general. But as above shows, for the peripheral countries, including the basket case outside Troika capture, Slovenia, and the rarely mentioned case of Finland (see chart below) it is also compounding structurally weak fundamentals other than debt alone.

So a timely reminder: that debt problem - it has not gone away. Not by any measure and most certainly not for Ireland.

Note: to see the problem in Finland consider the following chart:

1/12/2013: The Age of Great Stagnation: Sunday Times, 24/11/2013

This is an unedited version of my Sunday Times column from November 24, 2013.


In recent months, the hope-filled choir of Irish politicians raised to a crescendo the catchy tune of the return of our economic fortunes. Their views are often echoed by some European leaders, themselves eager to declare the euro crisis to be over. Earlier this year, as the euro area remained mired in official recession, the perpetually optimistic Economics Commissioner, Olli Rehn, summarised the economic environment as follows: “…we have disappointing hard data from the end of last year, some more encouraging soft data in the recent past and growing investor confidence in the future.”

Since then, we had ever-disappointing hard data through September this year, un-interpretable volatile soft data, and an ever-booming confidence in the future. This pattern of rising expectations amidst non-improving reality has been with us for over two years.

Which raises two questions. Firstly, is the fabled recovery we are allegedly experiencing sustainable? Second, are we betting our economic house on a right horse in the long run?


In our leaders’ imagination, this country’s prospects for a recovery remain tied to those of the euro area. The official theory suggests that growth in our major trading partners will trickle down to our exports, which, in turn, will drive domestic economy via improving investment and consumer spending. This theory rest on the fundamental belief that things have hit their bottom in Ireland and the only way from here is up.

These are the two core theories behind the short-term projections that underpinned Budget 2014. And, taken with risk caveats highlighted this week by the Fiscal Council assessment of the Department of Finance projections, the views from the Merrion Street represent a rather optimistic, but reasonably feasible forecast for 2014.

Alas, in the longer run, a lot is amiss with the above two theories. The most obvious point of contention is that we've heard them before. And so far, both turned out to be wrong.

Over 2009-2013, cumulative real GDP across the euro area shrunk by 2.1 percent, and expanded by 3.5 percent across the G7 countries. In Ireland, over the same period, GDP fell by 4.7 percent. The tail of Ireland was wagging the dog of the EU on the way down into the Great Recession.

The converse is true on the way up. Unlike in the early 1990s, the improving economic fortunes abroad are not doing much good for Ireland’s exports either. Over the last four years, volumes of imports of goods by the euro area countries grew by almost 15 percent and for G7 these went up 21 percent. Irish exports of goods over the same period of time rose just 2.2 percent. Global trade, having shrunk in 2008 and 2009 has been growing since then. Again, Ireland missed that momentum.

Over the crisis period, growth in our exports of goods and services did not translate into strong growth in our GDP and was completely irrelevant to the dynamics of our GNP or national income. The reason for this paradox is that our goods exports have shrunk 3.57 percent in 2012, having posted declining rate of growth 2011 compared to 2010. The rate of their decline is now accelerating. In January-September this year our exports of goods fell 6.7 percent compared to the same period a year ago. Goods trade is the core employer of Irish workers amongst all exporting sectors and the main contributor to the economy at large.

Instead of goods trade, our external balance expansion became dependent solely on ICT services and a massive collapse in imports.

Much of the former represent transfer pricing and have little real effect on the ground. As the result, our exports growth came with virtually zero growth in employment, domestic demand or investment. We don't need to dig deep into the statistics to see this: over the period of our fabled exports-led recovery, Irish private sector prices and domestic demand both followed a downward path.

The latter, however, presents a serious risk to the sustainability of our debts. To fund our liabilities, we need long-term current account surpluses to average above 4 percent of GDP over the next decade or so. We also need economic growth of some 3-3.5 percent in GDP and GNP terms to start reducing massive unemployment and reversing emigration. Yet, to drive real growth in the economy we need domestic investment and demand uplifts. These require an increase in imports of real capital and consumption goods. Should our exports of goods continue down the current trajectory, any sustained improvement in the domestic economy will be associated with rising imports and, as a corollary, deterioration in our trade balance.

This, in turn, will put pressures on our economy’s capacity to fund debt servicing. And given the levels of debt we carry, the tipping point is not that far off the radar.

In H1 2013 Ireland's external real debt (excluding monetary authorities, banks and FDI) stood at almost USD1.32 trillion - the highest level ever recorded in history. Large share of this debt is down to the IFSC and MNCs sector. However, overall debt levels in the Irish system are still sky high. More importantly, the debt levels are not declining, despite the claims to the aggressive deleveraging of our households and banks. At the end of H1 2013, total real economic debt in Ireland - debt of Irish Government, excluding Nama, Irish-resident corporates and households - stood at over EUR492 billion - down just EUR8.5 billion on absolute peak attained in H3 2012. In other words, our current debt levels are basically flat on the peak and are above the highs attained before the crisis.


With all the talk about positive forecasts for the economy and the world around us, we are desperately seeking to escape three basic truths. One: we are facing the risk that neither exports growth nor the reversals of our foreign trade partners' fortunes are likely to do much for our real economy. Two: the real break on our growth is the gargantuan burden of combined household, government and corporate debts. And three: we have no plan to deal with either the former risk or the latter reality.

Instead of charting our own course toward achieving sustainable long-term competitiveness in our economy, we remain attached at the hip to the slowest horse in the pack of global economies – the euro area. This engine of Irish growth is now seized by a Japanese-styled long-term stagnation with no growth in new investment and consumption, and glacially moving deleveraging of its banks and sovereigns.

Governments across the EU are pursuing cost-cutting and re-orienting their purchasing of goods and services toward domestic suppliers. In this zero-sum competition, small players like Ireland are risking being crushed by the weight of financial repressions and domestic protectionism in the larger economies.

These forces are not going to disappear overnight even if growth returns to Europe. According to the global survey by Markit, released this week, one third of companies worldwide expect their business to rise over the next 12 months. By itself - a low number, but a slight rise on 30 percent at the end of Q2 2013. Crucially, however, improving sentiment does not translate into improving economic conditions: only 14 percent of companies expect to add new employees in 2014.

As per financial repression, euro area banks remain sick with as much as EUR 1 trillion in required deleveraging yet to take place and some EUR350-400 billion worth of assets to be written down. Should the banks stress tests uncover any big problems there is no designated funding to plug the shortfalls. According to the Standard Bank analysts' research note, published this week: "Increasingly, European governments are resorting to tricks to resolve the problems of their banking systems, including inadequate stress tests, overly optimistic growth and asset price forecasts, and some unusual accounting stratagems."

Which foreign government or private economy is going to start importing Irish goods and services or investing here at an increasing rate when their own populations are struggling to find jobs and their banks are fighting for survival.


Meanwhile, we remain on a slow path to entering new markets, despite having spent good part of the last 6 years talking about the need to 'break' into BRICS and the emerging and middle-income economies. In January-September 2012, Irish exports to BRICS totaled EUR2.78 billion. A year later, these are down EUR240 million. Controlling for exchange rates valuations, our exports to the key developing and middle-income markets around the world are flat since 2010.

We are also missing the most crucial element of the growth puzzle: structural reforms that can make us competitive not just in terms of crude unit labor costs, but across the entire economic system. Since 2008 there has been virtually no changes made to the way we do business domestically, especially when it comes to protected professions and state-controlled sectors. Legal reforms, restructuring of semi-state companies’ and the sectors where they play dominant roles, such as health, transport and energy, changes to the costs and efficiencies in our financial services – these are just a handful of areas where promised reforms have not been delivered.

Political cycle is now turning against the prospect of accelerating such reforms with European and local elections on the horizon. Reforms fatigue sets in. The relative calm of the last 9-12 months has pushed all euro area governments into a false sense of security.

The good news is that the collapse phase of the Great Recession is over. The bad news is that with growth of around 1.5 percent per annum on GDP we are nowhere near the moment when the economy starts returning to long-term health. I warned about this scenario playing out over the next decade in these very pages back in 2008-2009. Given the latest projections from the Department of Finance and the IMF, we are firmly on the course to deliver on my prediction.

Welcome to the age of the Great Stagnation.

Box-out:

Recent research paper from the European Commission, titled The Gap between Public and Private Wages: New Evidence for the EU assessed the differences between public sector and private sector earnings across the 27 member states over the period of 2006-2010. The findings are far from encouraging for Ireland. In 2010, Irish public wages were found to be some 21.2 percent higher than the comparable wages paid in the private sector. The study controlled for a number of factors impacting wages differentials, including gender, age, tenure in the job, education and job grades. Strikingly, the study found that wages premium in the public sector was higher for women, for younger workers and for less skilled employees. A positive public wage premium was also observed at all levels of educational attainment with the largest premium paid to workers with low education and the lowest to workers with medium levels of education. If in 2006 Irish public sector wage premium stood on average at 20.5 percent, making our public sector wage premium second highest in the EU27, by 2010 we had the highest premium at 21.2 percent. It is worth noting that in all Nordic countries of Europe, the wage premium to public sector workers was found to be negative in 2010.

10/10/2013: IMF's GFSR October 2013: Focus on Corporate Debt Overhang

I'll be blogging out today some interesting charts from the IMF's GFSR October 2013... these will appear in no particular order, with brief summaries...

Here's a start: non-financial corporate sector debt crises in the euro periphery. I always noted that the important issue in the current crisis is not just a traditional sovereign debt crunch, but the debt overhang over what I call the total real economic debt: household, non-financial corporate and government debts.

In the above that Irish banks offer lower rates, based on the bank capital and reserves ratio to NPLs than other banks, including Portugal, Italy and Spain. Also note that 5 years into the crisis and after massive recapitalisations Irish banks buffers are lower than for any other economy, save Cyprus and Greece. That is the cost of delaying resolution of the loans.

Note: my latest article on European and Irish banking systems is available here: http://trueeconomics.blogspot.ie/2013/10/9102013-leveraged-and-sick-euro-area.html

The next four charts show that quality of loans to non-financial corporate sector is deteriorating and remaining poor for firms in the periphery, while improving for German and French firms.

Most worrying is the Italian situation where quality of loans is continuing to deteriorate and the rate of deterioration is accelerating, while Spanish situation remains exceptionally weak:

Things are desperate-to-dire in Greece and Portugal too:

More to come, so stay tuned...

16/9/2013: A Liquidity Slush or an Equity Switch?

Three more charts from BIS Quarterly (http://www.bis.org/publ/qtrpdf/r_qt1309a.pdf), showing the switch of liquidity out of the Emerging Markets into Advanced Economies...

 And then from the Advanced Economies bonds into Advanced Economies equities with a small bounce up on Emerging Markets equities side too...

Two thoughts:

1. There is no yield-driven bounce anymore, so pricing is not a huge help in this process; and
2. Is this the end of the debt bubble and the start of the equities rise (structural, not nominal rise, driven by shift in corporate funding models) or is this a temporary slush of liquidity?

10/4/2013: EU Commission on debt-overhang in Europe

A new paper on the effects of debt and deleveraging in Europe was published by the EU Commission. The paper can be accessed here.

Some nice charts summarising the debt overhang in the real economy (households and non-financial corporates):

Gross level relative to GDP, Irish households are 3rd most indebted in the euro area by 2011 measure. However, adjusting for GDP/GNP gap puts us at the top position, well ahead of Cyprus and even ahead of the EU27 'leader' - Denmark.

Now, much is usually being said about Irish net debts being lower due to immense wealth accumulated by the households. Table above shows that, actually, that is not true. We rank second from the top. Interest burden has declined, but it remains the third highest in the euro area.

Now to non-financial corporations:

 Irish corporates are second most indebted (after Luxembourg) in the EU and adjusting for GDP/GNP gap, the difference to the third most-indebted country is even more dramatic than the chart above indicates. Irish corporates debt rose in 2008-2011, rather dramatically - marking the highest increase in the euro area.

Detailed decomposition:

Again, adjusting for GDP/GNP gap, Irish economy is the most indebted in the euro area and the EU when measured relative to overall economy size (note: Luxembourg comparatives are wholly meaningless due to massive presence of brass-plates operations in the economy).

More fun charts:

Again, Ireland is in top first (corporates ex-Luxembourg) or second (households) positions.

Deleveraging household debt overhang will be extremely painful for Ireland:

And although asset valuations suggest the pain will be milder, in reality, one has to consider the fact that Irish household assets valuations are not exactly (a) fully reflective of real extent of price contractions in the housing sector, and (b) liquid.

 Here's EU Commission view:
"as regards households capacity to repay (figure 12), Ireland, Spain, Estonia, the Netherlands, Latvia, Denmark, the United Kingdom and, to some extent, Cyprus are amongst those that experienced a rapid increase in household indebtedness before the crisis. Despite the varying starting position in terms of household debt, the information content of the level dimension also points to the same set of countries as potentially prone to suffer from deleveraging pressures, on top of Portugal and Sweden. Ireland, Latvia and Estonia also appear as subject to high  pressures when considering actual leverage as well as its build-up (figure 13)".

And on non-financial corporates deleveraging:
"on the firms' side, there is also a clear positive relationship between the  accumulation and the level factors when considering the capacity to repay (figure 14). Countries like Belgium, Ireland, Spain, Cyprus, Portugal and Bulgaria stand out as presenting vulnerabilities related to their firm's indebtedness. This snapshot is highly nuanced when looking at firm's asset side (see figure 15). Belgium and Cyprus present a healthier picture while firms in countries like Greece, Italy, Slovenia and Latvia appear as subject to higher pressures. As a robustness check, this exercise was also run with consolidated data and the results are consistent but for the case of Belgium, where the relevance of intra-company loans calls for further qualifications when assessing non-financial corporates debt sustainability"

Using more sophisticated analysis, the Commission paper concludes that:
"The following countries can be identified as more prone to face deleveraging pressures in the household and non-financial corporation sectors: Cyprus, Denmark, Spain, Ireland, the Netherlands, Portugal, Estonia, Latvia, Slovakia, Sweden and the United Kingdom on the household side and Belgium, Bulgaria, Cyprus, Greece, Spain, Hungary, Ireland,  Italy, Portugal, Estonia, Latvia, Slovenia, Sweden and the United Kingdom on the corporate side."

Of all countries listed above only Ireland, Cyprus, Spain, Portugal, Estonia, Latvia, Sweden and the UK fall into both groups, but only Ireland falls into extreme scenarios of debt sustainability in both categories:

In EU Commission calculations (see link above), Ireland has the greatest gap to sustainability (35.2%) when it comes to debt overhang in the entire euro area, and second highest in the EU.

13/10/2012: Euro area debt crisis and fake targets

My article for the Globe & Mail on euro area debt targets (link here).

10/10/2012: Irish Real Economic Debt - Busting Records

Last night I came across the latest data from the IMF on the overall levels of indebtedness and leverage across a number of countries. Here's the original data:

Much can be taken out of the above. For the purpose of discussion below, I define real economic debt as a sum of household, non-financial corporate and government debts, excluding financial firms' debts. This real economic debt is liability of the Irish economy: households, private enterprises and public sector providers of goods and services.

First up, total debt levels:

Ireland's total real economic debt runs at a staggering 524% of our GDP and 650% of our GNP. In fact, I use 24% GDP/GNP gap as a basis for adjustment which is significantly less than the current gap, but is consistent with 2011-2012 (to-date) average. Put into perspective:

• Our economy's overall indebtedness is 1.73 time higher than the euro area levels in GDP terms and if GNP is used as a basis it is 2.14 times higher
• Our real economic debt is 14.4% ahead of that of Japan (second most indebted country on the list) if GDP is used and is 41.9% ahead of Japanese debt if GNP is used.

Our real economic debt can be decomposed into the following three components contributions:

In other words, the above chart clearly shows that Ireland's core debt overhang arises not from the Government finances, but from accumulation of liabilities on the side of the companies. More than that:

• Ireland's Government debt levels are 25.5% ahead of the euro area
• Ireland's Household debt levels are 64.8% above the euro area
• Ireland's corporate debt levels are at 209% of the euro area levels.

Thus, with the Government policy firmly focused on taxing households to save own balancesheet, we have a perverse situation that the economy is dealing with debt overhang in Government debt that is more benign than the debt overhangs in the sectors the Government is obliterating. Households faced with increased taxation to pay for Government debts and deficits implies lower spending on goods and services and lower ability to repay household debt. Thus higher taxes on households (direct and indirect, including aggressive extraction of income via semi-states' charges) imply growing burden of the debt overhang in the private sectors (firms and households).

Adding financial debts to the overall real economic debt in the economy forces Ireland into a truly unprecedented position vis-a-vis other countries in the sample. (Note - adjustment for IFSC is mine).

Using the bounds for debt of 90% (consistent with upper range for Checchetti, Mohanty and Zampolli (2011) and Reinhart, Reinhart & Rogoff (2012)), the levels of cumulated real economy debts that are consistent with reducing future long-term potential growth in the economy are taken to be 270% of GDP. Hence:

and

In the above, the larger the size of the bubble, the greater is the drag on future economic growth from debt. The further to the right on the chart the bubble is located, the greater is the problem associated with Government debt (as opposed to other forms of debt). What the above shows is that Ireland's debt crisis is truly unique in size, but it also shows that the most acute crisis is not in the Government debt, but in private sectors debt.

Now, at 4.5% per annum cost of funding overall debt, irish economy interest rate bill on the above levels of real economic indebtedness runs at ca 29.2% of our GNP. Do the comparative here - interest rate bill equivalent to the total annual output of the Irish Industry (that's right - all of our Industrial output in 2011 amounted to less than 29.3% of our GNP. This is deemed to be 'long-term sustainable'... right...


Note: In my presentation at a private dinner event yesterday I referenced by earlier estimate of the total economic debt in Ireland at 420% of GDP. My 2011 estimate was ca 400% GDP. These figures have been published by me in the Sunday Times and also correspond closely to the 2010 figures cited by Minister Noonan in the Dail and made public here on this blog. They also were confirmed by Peter Mathews TD. My estimates were based on publicly available data which is less complete than data available to the IMF.