And so it comes to pass - the saga of missing dividend from Bank of Ireland, and the taxpayers are left holding the bag... The background to the story is here. Karl Whelan's post here gives the relevant links to the documents. And my analysis is as following:
Following the conversion of dividend due (€250 million) from the Bank of Ireland preference shares owned by the state to ordinary shares on 22 of February, the state will emerge as an almost 16% owner of the bank equity.
The relevant ISE document stipulates that:
"As a consequence of this and, in accordance with Bye Law 6(I)(4), the Directors of the Bank of Ireland announce that on 22 February 2010 it will issue and allot to the NPRFC 184,394,378 units of Ordinary Stock being the number of units equal to the aggregate cash amount of the 2010 dividend of €250.4m divided by 100% of the average price per unit of ordinary stock in the 30 trading days prior to and including today's date. Application will be made in due course for the listing of these units of stock. This increases the units of Ordinary Stock of Bank of Ireland in issue to 1,188,611,367. As a result the NPRFC will own 15.73 per cent of the issued Ordinary Stock (excluding the NPRFC Warrant Instrument)"
Which means a massive shareholder dilution and a significant set back to the BofI ability to raise equity. Recall that the BofI was planning for a €1 billion rights issue which would have meant roughly a 38.6% dilution of existent shareholder rights. Now, with a preemptive 16% dilution by the state, a rights issue planned will mean a 44% dilution post-rights should the price of the shares remain constant at Monday. And this is before we factor in 25% option on ordinary shares that is held within the preference shares we already have.
Of course it won't. A rational valuation model of shareprice will require that the price declines roughly 15% on Friday close post State dilution. Which means that market cap of the BofI will fall, at current average to €1,353 million, implying the post-right dilution of 48%.
In a way, Government taking the stake in BofI prior to rights issue at current valuation means the taxpayer is buying an asset that is likely to drop in value almost 50% within months after the State takes its stake. With one sweep of the pen, Minister Lenihan just signed off on an investment - using our cash - that will be worth 1/2 of its current value once BofI goes into equity raising.
Of, course, a much grimmer reality beckons should the State move tonight spell the end to the BofI equity issue prospects. In this case, today's announcement forces the Government to fully recapitalise the bank out of taxpayers funds, leading to a 90% plus State ownership and a massive liability to the taxpayers.
Irony of all ironies - the Government will end up transferring bad assets from its own bank to its own holding entity - Nama. What can possibly go wrong?
PS: In their September 3, 2009 note titled "Irish Banking - Crossing the Rubicon", Bloxham Stockbrokers said: "There is already a €825 million benefit to taxpayers from recovery in the market value of Allied Irish Bank and Bank of Ireland: Holding options worth a 25% stake in both AIB and Bank of Ireland, the taxpayer has benefited by €825 million as a result of the shareholding. This is apart from the benefit of the annual 8% yield from the €7 billion injection into the two main banks, which adds a further €560 million to the return per annum."
Run this by us, please, Bloxham - €825 million? Again? Crossing the Rubicon it was.
Wanna see some more fantasy estimates from the brokers? Davy:
"19 June 2009 17:26 Bank of Ireland could raise €1.5 billion in September and pay off some of the €3.5 billion in Government preference shares, according to stockbrokers Davy. ...In a report on Bank of Ireland today, Davy Research says the effect of a rights issue, in which the bank would issue more shares, could be used to pay funds back to the State and potentially leave the Government with a stake of 7%. "
7%? Run this by us, please, Davy Research - 7% state ownership? Right.
Friday, February 19, 2010
Thursday, February 18, 2010
Economics 18/02/2010: Ryanair are releasing actual evidence
Another chapter in 500 jobs saga at Dublin Airport: remember that claim that RTE aired that Ryanair could have been planning to use Hangar 6 as a monopoly-busting Terminal 3?
Earlier today Ryanair released its letter to IDA, dated July 2, 2009 - which commits Ryanair to the specific, narrow use of Hangar 6 and suggests DAA can impose a clause that would restrict Ryanair use of Hangar 6 only to heavy maintenance work. Here is the letter:
At the very least, one has to be fair to Ryanair - they are the only party to the entire debacle who are backing their claims with real evidence. DETE or DAA might want to follow the lead... I am certainly going to give them space on this blog, if they need one.
Earlier today Ryanair released its letter to IDA, dated July 2, 2009 - which commits Ryanair to the specific, narrow use of Hangar 6 and suggests DAA can impose a clause that would restrict Ryanair use of Hangar 6 only to heavy maintenance work. Here is the letter:
At the very least, one has to be fair to Ryanair - they are the only party to the entire debacle who are backing their claims with real evidence. DETE or DAA might want to follow the lead... I am certainly going to give them space on this blog, if they need one.
Wednesday, February 17, 2010
Economics 17/02/2010: Baltic Dry Index & trade recovery
Some interesting reading from the BDI – Baltic Dry Index – that tells us the cost of hiring a bulk commodity shipping cargo. The BDI is a good indicator of concurrent trade and industrial activities globally – rising BDI means tighter supply of shipping capacity and thus increased shipping volumes – spot. Back in 2008 is was at a record high of 11,793.
Now, January 2009 saw BDI falling to 772 low, it then recovered with some tremendous volatility through the year before setting annual 2009 average of 2658. As of today it is at 2598 – below the 2009 average and at only 22% of the 2008 peak.
Not much of a sign of a global recovery here.
Now, January 2009 saw BDI falling to 772 low, it then recovered with some tremendous volatility through the year before setting annual 2009 average of 2658. As of today it is at 2598 – below the 2009 average and at only 22% of the 2008 peak.
Not much of a sign of a global recovery here.
Economics 17/02/2010: The Saga of 500 jobs
The story of 500 jobs at Ryanair maintenance facility continues with this:
Tuesday, February 16, 2010
Economics 16/02/2010: Aircarft Servicing Investment Letters
UPDATE below
Here are actual letters between Michael O'Leary and Mary Coughlan, TD that have made so much press recently.
Nothing else to add here.
Except an update:
This is from Ryanair:
Here are actual letters between Michael O'Leary and Mary Coughlan, TD that have made so much press recently.
15th February 2010
Mr. Michael O'Leary
Chief Executive Officer
Ryanair Limited
Dublin Airport
County Dublin
Dear Michael,
Thank you for your letter of 10th February 2010 which was received in my office by post today.
Needless to say I was very disappointed to learn of the decision of Ryanair to locate its new investment in Prestwick despite our best efforts, through IDA Ireland, to secure the investment for
You will recall that there were two obstacles to progressing this matter. Firstly, your reluctance to talk to the DAA which owns Hangar 6 and secondly the fact that Hangar 6 was being occupied by another party. A number of options for developing facilities at
I can assure you that the Government is most anxious to secure further investment from Ryanair at
It has been possible in the very recent past to secure new investment in aircraft maintenance facilities at
Yours sincerely
Mary Coughlan T.D.
Tánaiste and Minister for
Nothing else to add here.
Except an update:
This is from Ryanair:
Ryanair, today (16 Feb 10) released photographs of what Hangar 6 is being used for today – precisely nothing. These photographs were taken at approx. 9am this morning and show no heavy maintenance work going on in the hangar, at a time of year when it should be full of aircraft undergoing heavy maintenance. This is why 800 SRT engineers are on the dole today.
Ryanair today made the point that Aer Lingus have a long-term heavy maintenance contract for their entire fleet of 35 aircraft in France and therefore has no requirement for the Hangar 6 facility. Ryanair believes that the DAA lease to Aer Lingus was designed solely to block Ryanair’s request for this facility which was submitted to the Tánaiste last September at a time when Ryanair was offering to create 500 maintenance jobs at Dublin Airport.
Ryanair also today released an extract from its DAA lease agreement for Hangar 1, which contains a standard clause in all DAA lease agreements allowing the DAA to terminate leases and relocate licensees (such as Aer Lingus in Hangar 6) should the DAA require the facility.
Ryanair’s Stephen McNamara said: “We are releasing these photographs and this extract from a DAA licence agreement to demonstrate two things:
1. that Hangar 6 is unused and Aer Lingus’ line engineers have no use for this large heavy maintenance building and,
2. to prove that the DAA has lied again when they claimed that Aer Lingus has a 20 year lease over Hangar 6 and cannot be moved.
“These photographs and this information proves yet again that the DAA has lied to the Govt and the public and has, we believe, misled the Tánaiste last September and again recently when they claimed that they had other parties interested in using the Hangar 6 facility for heavy maintenance. These false claims show why Ryanair cannot and will not deal with the DAA”.
Ends
Economics 16/02/2010: Daft.ie and rental markets
- There is seasonality issue – explained below – which suggests that January rise might be just a dead cat bounce;
- There is demand issue – also elaborated upon below – which suggests that there is no fundamentals-based explanation for January rise; and
- There is a momentum issue – again, more below – which implies that after 24 months of straight downward trajectory, a small correction is long over due and that this will not necessarily establish an upward trend.
So let us take a look at the 3 possible factors listed above.
The first chart shows Daft rental index, marking in red circles all the cases where January posted an improvement on December (table below brings this out in numbers in terms of m-o-m changes in the index). Only one occasion – end of 2005 – was the case where this local peaking took place one month before the normal January peak. So this January is no exception here.
Some have argued that this January is different because it is the first reversal of the established trend. True, if we take the trend to mean 2007 peak to today. But if you look at the chart above, you notice that January shows exactly the same performance relative to preceding months and following months on the upward trend and on the downward trend. So I do not buy this argument that because we were falling before, a bounce today means a change in trend.Now take a look at daft own chart (I have no data for transactions from them, so can’t really do any analysis).
Notice the V-shaped segments? Aha, they too take place on end of 2007 to the beginning of 2008, end of 2008 to the beginning of 2009, and end of 2009 to, you’ve guessed it the ‘Great Improvement Month’ of January 2010. But here is more worrying thing: take a look at within-year trend lines for 2007, 2008 and 2009:- Numbers of properties inflowing and exiting (rented, withdrawn, sold, demolished and soon also Namacised) trend up in 2007 and 2008 almost at the same trend line and intercept.
- Number of properties inflowing and exiting trend still up in 2009, but with higher intercept than before and flattening slope.
- Number of properties listed overall is down, true, but this simply means we have soaked up some of the overbuild into rentals. How much of it? 2007-2010 differential is about 15,000 units. Surely this is about 1/6th of the supply out there in terms of new-built, plus another 20,000 units vacated by the leaving immigrants and emigrants. Good luck if anyone thinks that we are bottoming out in terms of supply. We are just pausing.
So what does this tell us about 2010? Little, but… if this continues, numbers of transactions will flatten more, with greater overall average volume (higher intercept and positive slope) in 2010 than in 2009. Does this mean we are out of the woods and that supply is finally catching up (downward) with demand? I don’t know this. Why? Because I do not know anything about the drivers of supply and I know something about the drivers of demand.
On supply side, 2009 saw no new built properties hitting the market.
And it saw some reductions in supply as banks took possessions of some properties that might have been on the market for renting, but never rented. Absent actual contracts for rent, banks have no incentive to go into the expensive rental market themselves. They would rather rent wholesale to the local authorities and may be sign up with rental agents. Rental agents will list in bulk, so one listing on daft might mean a large number of actual apartments behind it. Statistics show improved (reduced) supply, but reality shows increased supply.
Other contractions took place in estates that are now completely frozen. In anticipation of continued work, half-finished estates might have seen developers listing some properties there for rent. Now that estates are abandoned – in court proceedings or simply frozen by cash-strapped developers – the listings ‘exited’ (green line went up in the chart above). Happy times? I doubt it.
But what is even more concerning in my view is the demand side. We know that there is no growth in demand out there – demographics is slow moving, so expectations based on kids finishing college and renting their first apartment are static. Foreigners are not flooding into
Daft really should do some analysis here to see if this is true. But it looks plausible. If this is happening, then we can expect to see: number of exits improving, while number of listings growing slower (lags in re-listing cheaper properties, etc). This is why the green line above is trending up faster than the blue line.
But the implication of this being true – if it is true, that is – is that within a month or so, once contracts are shifted to new and better quality properties, the cheaper, smaller apartments market will implode. And it will also drag down the more expensive market with a lag of, say 3-6 months.
In short, I simply do not buy the idea that the rental markets are signaling improvement. It will take 3-4 months of continued up-trending for me to buy the story.
Monday, February 15, 2010
Economics 15/02/2010: Bank of Ireland ethical dilemma
So here we are folks, the state has run into a bit of a trouble.
Remember those dividends that our (taxpayer-bought) preference shares in the BofI and AIB were supposed to generate? Ok, there is a problem here.
On February 22, BofI is supposed to pay out some €240 million to us (the taxpayers, in case if you wondering) in dividends on these shares. Alas, if you recall, the EU has imposed severe restrictions on the banks dividends. This means that we are now in a no-man's land when it comes to getting paid on that €3.5 billion we put into BofI. The Government has an option to circumvent the EU rules and ask for shares to be paid in instead of cash, but this surely will open claims from the bondholders who are not being paid their coupons. And, of course, if shares are issued in the way of payment, there will be dilution. At current price, €240 million worht of BofI shares will be, ahem, 24% of the expected €1,000 million rights issue or 19.1% of the market capi of the bank. Some serious dilution, unless the EU grants an exemption to the State.
But an exemption for the Government is an ethically dubious move for several reasons:
Remember those dividends that our (taxpayer-bought) preference shares in the BofI and AIB were supposed to generate? Ok, there is a problem here.
On February 22, BofI is supposed to pay out some €240 million to us (the taxpayers, in case if you wondering) in dividends on these shares. Alas, if you recall, the EU has imposed severe restrictions on the banks dividends. This means that we are now in a no-man's land when it comes to getting paid on that €3.5 billion we put into BofI. The Government has an option to circumvent the EU rules and ask for shares to be paid in instead of cash, but this surely will open claims from the bondholders who are not being paid their coupons. And, of course, if shares are issued in the way of payment, there will be dilution. At current price, €240 million worht of BofI shares will be, ahem, 24% of the expected €1,000 million rights issue or 19.1% of the market capi of the bank. Some serious dilution, unless the EU grants an exemption to the State.
But an exemption for the Government is an ethically dubious move for several reasons:
- In all other bank support schemes, the EU did not lift restrictions on dividends/interest/coupon payments for sovereigns. Should it do so for Ireland, what's next?
- Payments to other bondholders who have identical rights to the state (on paper) will not be made, opening up the entire process to legal challenges.
Economics 15/02/2010: Ireland and the Euro
Sunday Times, February 14, 2010.
Like a namesake of Federico Fellini’s 1983 classic, E la nave va (And the ship sails on), the Greek debt saga continues its course toward the increasingly inevitable default. Another week, another impenetrable web of announcements, and no real solutions. At this stage, the EU’s ability to resolve the crisis is no longer a matter of markets trust and the reputational costs for the euro are becoming more than evident.
So much so that conservative and forward-looking ECB is starting to think of contingency planning. A source close to Frankfurt has told me earlier in the week that some ECB economists are contemplating the likely run on the euro leading to a 20-25% devaluation of the currency to bring it virtually to parity with the dollar. If that happens, an interest rates hike of 50 basis points or more will be a strong possibility sometime before the end of Q3 2010. A derailment of the nascent economic recovery in the core euro zone countries will be virtually assured.
The plan, currently under discussion at the EU level, involves a guarantee on Greek debt, plus a package of subsidised loans both underwritten by other euro zone countries (re: Germany). The problem is that this is unlikely to be enough.
Greek problems are not cyclical and will not go away once the markets calm down. Country structural deficit, in line with Ireland’s is around 60-70 percent of the overall exchequer annual shortfall. And unlike Ireland, Greece is facing an acute problem refinancing its gargantuan public debt. Worse than that, the latest revelations concerning the complex derivative contracts used by the Greek authorities to hide a significant share of its deficit over the recent years clearly show that the country will have to be much more aggressive in scaling back its annual deficits in order to be able to issue new bonds. The EU latest plan does not facilitate any of these measures. Neither does it have a credible enforcement mechanism. Should Greece decide at any point in the future to renege on its obligations under the rescue package, the entire crisis will be replayed tenfold. And the threat of this gives the Greeks a trump card against the EU Commission under collective guarantees.
Thus, currently, there are only three economically feasible structural solutions to the ongoing crisis in the euro area.
The best option would be a massive injection of liquidity across the common currency area. Minting a fresh batch of euros worth around €1-1.5 trillion and disbursing the currency to the national Governments on a per-capita basis would allow the PIIGS some breathing room in dealing with their deficit and debt problems. At the same time, countries like Germany, with more fiscally sound public spending habits, would be able to use this money to stimulate domestic demand and savings through tax credits and investment.
The drawback of such a plan is that it can reignite inflationary pressures within the euro area. This risk, in my view, is misplaced. Given structural weakness in consumer demand and continued cyclical weakness in new business investment, it is unlikely that much of the freshly-minted cash will go anywhere other than savings. Incidentally, with most the money flowing back into the banking sector, the ECB can then use this increase in deposits to close down some of the asset-backed lending positions that euro area banks have built up with Frankfurt.
Two other solutions involve introduction of a parallel ‘weak’ euro for PIIGS, or an outright bailout of Greece, Portugal, and possibly Spain and Ireland, through a partial pay-down of these countries debts. Both would have dire consequences for the euro itself.
The logistics of running two parallel currencies within a block of countries under a single-handed management of the ECB will produce more than confusion in the markets. The monetary policy required for the ‘weak’ euro state would entail interest rates at roughly triple those in the ‘strong’ euro countries, with the resultant potential for an explosion of carry trades unfolding within a single monetary union.
In addition, there is no mechanism by which either Greece or any other country can be compelled to switch to a ‘weak’ euro. In Ireland’s case, being forced into a ‘weak’ euro will be a disaster for the longer term prospects of maintaining strong presence of the US and UK multinationals here who rely on out full membership in the common currency club to drive their transfer pricing.
An outright paydown of the PIIGS debts – no matter how tough the EU Commission gets in terms of talking up ‘conditional lending’ and ‘direct supervision’ provisos of such an action – will result in an unenforceable lending from Germany to the PIIGS.
From Ireland’s point of view, however, the inevitable outcome of all possible alternatives for dealing with Greece will be devaluation of the euro close to parity with the US dollar. And here may lie the best news Irish exporting firms have heard since the beginning of this recession.
Given the dynamics of our exports-producing sectors, Ireland desperately needs a shot in the arm to stay alive as economy through 2010.
Per CSO, our MNCs-dominated modern manufacturing – the source of most of our goods exports – has managed to post a spectacular 14.5% seasonally-adjusted drop in production in Q4 2009. Pharmaceuticals output declined a 7.5% in the last quarter, while computer, electronic and optical equipment sector – another pillar of our exporting activities was down 14.9% in December 2009. It all points to growing weakness in exports-driven high value added segment of our manufacturing. In short, Ireland can use a serious devaluation of the euro on the exporting side.
But a silver lining never comes without some cumulus clouds in tow.
A devaluation – while a boom for exporters – will act to reduce consumer spending and, through higher cost of imports, will further reduce income available for domestic savings and investment. Given the already abysmally low levels of personal consumption, it is highly likely that this will trigger more household defaults on debt and mortgages.
Furthermore, a devaluation can trigger rising inflation across the euro area which, once imported into Ireland, will undermine the gains in competitiveness achieved during the current crisis. For comparison, consider the case of Ireland v Greece. In his recent note, NIB’s Chief Economist, Ronnie O’Toole highlighted the fact that between mid 2008 and the end of 2009, Irish consumer prices have fallen some 4.6%. In contrast, Greece saw its prices rise some 2.3% over the same period. Of course, falling price levels imply that it is much easier for companies and governments to cut nominal wages. A new bout of inflation induced by the EU solutions to the Greek crisis can wipe out this advantage.
Alas, no one so far has noticed that in both, Ireland and Greece, a cut in nominal wages in line with inflation will do two things. One – it will leave real wages – the stuff that private sector producers really care about – intact. And it will be a magnitude of 3-4 times too little for repairing the Exchequer balance sheet. With both countries facing a 2010 deficit of 10-11% of GDP, a 5% cut in public sector wages is equivalent to applying Bandaid to a shark bite.
And a rise in euro area inflation will have an adverse impact on Irish exporters. Despite devaluation, many of our MNCs and indigenous exporting companies buy large quantities of raw and intermediate inputs from abroad. The rise in the cost of imports bill will partially cancel out the gains in final prices achieved due to devaluation. This is especially significant for the companies trading in modern higher value-added sectors, where geographically diversified multinationals use Ireland as a later stage production base with intermediate inputs coming from other EU countries and the US.
Lastly, a devaluation of the euro close to the dollar parity is likely to trigger monetary tightening by the ECB, with interest rates rising by 50 basis points in the next six months. Coupled with reduced provision of new liquidity by Frankfurt, the resulting credit crunch on the Irish banks will trigger a massive jump in the burden of mortgages here. Needless to say, even with booming exports, Ireland Inc will be in deep trouble as trade credits, corporate funding and personal loans will be pushed deep into red by rising costs of borrowing.
At this stage, we really are caught between a rock and a hard place.
Like a namesake of Federico Fellini’s 1983 classic, E la nave va (And the ship sails on), the Greek debt saga continues its course toward the increasingly inevitable default. Another week, another impenetrable web of announcements, and no real solutions. At this stage, the EU’s ability to resolve the crisis is no longer a matter of markets trust and the reputational costs for the euro are becoming more than evident.
So much so that conservative and forward-looking ECB is starting to think of contingency planning. A source close to Frankfurt has told me earlier in the week that some ECB economists are contemplating the likely run on the euro leading to a 20-25% devaluation of the currency to bring it virtually to parity with the dollar. If that happens, an interest rates hike of 50 basis points or more will be a strong possibility sometime before the end of Q3 2010. A derailment of the nascent economic recovery in the core euro zone countries will be virtually assured.
The plan, currently under discussion at the EU level, involves a guarantee on Greek debt, plus a package of subsidised loans both underwritten by other euro zone countries (re: Germany). The problem is that this is unlikely to be enough.
Greek problems are not cyclical and will not go away once the markets calm down. Country structural deficit, in line with Ireland’s is around 60-70 percent of the overall exchequer annual shortfall. And unlike Ireland, Greece is facing an acute problem refinancing its gargantuan public debt. Worse than that, the latest revelations concerning the complex derivative contracts used by the Greek authorities to hide a significant share of its deficit over the recent years clearly show that the country will have to be much more aggressive in scaling back its annual deficits in order to be able to issue new bonds. The EU latest plan does not facilitate any of these measures. Neither does it have a credible enforcement mechanism. Should Greece decide at any point in the future to renege on its obligations under the rescue package, the entire crisis will be replayed tenfold. And the threat of this gives the Greeks a trump card against the EU Commission under collective guarantees.
Thus, currently, there are only three economically feasible structural solutions to the ongoing crisis in the euro area.
The best option would be a massive injection of liquidity across the common currency area. Minting a fresh batch of euros worth around €1-1.5 trillion and disbursing the currency to the national Governments on a per-capita basis would allow the PIIGS some breathing room in dealing with their deficit and debt problems. At the same time, countries like Germany, with more fiscally sound public spending habits, would be able to use this money to stimulate domestic demand and savings through tax credits and investment.
The drawback of such a plan is that it can reignite inflationary pressures within the euro area. This risk, in my view, is misplaced. Given structural weakness in consumer demand and continued cyclical weakness in new business investment, it is unlikely that much of the freshly-minted cash will go anywhere other than savings. Incidentally, with most the money flowing back into the banking sector, the ECB can then use this increase in deposits to close down some of the asset-backed lending positions that euro area banks have built up with Frankfurt.
Two other solutions involve introduction of a parallel ‘weak’ euro for PIIGS, or an outright bailout of Greece, Portugal, and possibly Spain and Ireland, through a partial pay-down of these countries debts. Both would have dire consequences for the euro itself.
The logistics of running two parallel currencies within a block of countries under a single-handed management of the ECB will produce more than confusion in the markets. The monetary policy required for the ‘weak’ euro state would entail interest rates at roughly triple those in the ‘strong’ euro countries, with the resultant potential for an explosion of carry trades unfolding within a single monetary union.
In addition, there is no mechanism by which either Greece or any other country can be compelled to switch to a ‘weak’ euro. In Ireland’s case, being forced into a ‘weak’ euro will be a disaster for the longer term prospects of maintaining strong presence of the US and UK multinationals here who rely on out full membership in the common currency club to drive their transfer pricing.
An outright paydown of the PIIGS debts – no matter how tough the EU Commission gets in terms of talking up ‘conditional lending’ and ‘direct supervision’ provisos of such an action – will result in an unenforceable lending from Germany to the PIIGS.
From Ireland’s point of view, however, the inevitable outcome of all possible alternatives for dealing with Greece will be devaluation of the euro close to parity with the US dollar. And here may lie the best news Irish exporting firms have heard since the beginning of this recession.
Given the dynamics of our exports-producing sectors, Ireland desperately needs a shot in the arm to stay alive as economy through 2010.
Per CSO, our MNCs-dominated modern manufacturing – the source of most of our goods exports – has managed to post a spectacular 14.5% seasonally-adjusted drop in production in Q4 2009. Pharmaceuticals output declined a 7.5% in the last quarter, while computer, electronic and optical equipment sector – another pillar of our exporting activities was down 14.9% in December 2009. It all points to growing weakness in exports-driven high value added segment of our manufacturing. In short, Ireland can use a serious devaluation of the euro on the exporting side.
But a silver lining never comes without some cumulus clouds in tow.
A devaluation – while a boom for exporters – will act to reduce consumer spending and, through higher cost of imports, will further reduce income available for domestic savings and investment. Given the already abysmally low levels of personal consumption, it is highly likely that this will trigger more household defaults on debt and mortgages.
Furthermore, a devaluation can trigger rising inflation across the euro area which, once imported into Ireland, will undermine the gains in competitiveness achieved during the current crisis. For comparison, consider the case of Ireland v Greece. In his recent note, NIB’s Chief Economist, Ronnie O’Toole highlighted the fact that between mid 2008 and the end of 2009, Irish consumer prices have fallen some 4.6%. In contrast, Greece saw its prices rise some 2.3% over the same period. Of course, falling price levels imply that it is much easier for companies and governments to cut nominal wages. A new bout of inflation induced by the EU solutions to the Greek crisis can wipe out this advantage.
Alas, no one so far has noticed that in both, Ireland and Greece, a cut in nominal wages in line with inflation will do two things. One – it will leave real wages – the stuff that private sector producers really care about – intact. And it will be a magnitude of 3-4 times too little for repairing the Exchequer balance sheet. With both countries facing a 2010 deficit of 10-11% of GDP, a 5% cut in public sector wages is equivalent to applying Bandaid to a shark bite.
And a rise in euro area inflation will have an adverse impact on Irish exporters. Despite devaluation, many of our MNCs and indigenous exporting companies buy large quantities of raw and intermediate inputs from abroad. The rise in the cost of imports bill will partially cancel out the gains in final prices achieved due to devaluation. This is especially significant for the companies trading in modern higher value-added sectors, where geographically diversified multinationals use Ireland as a later stage production base with intermediate inputs coming from other EU countries and the US.
Lastly, a devaluation of the euro close to the dollar parity is likely to trigger monetary tightening by the ECB, with interest rates rising by 50 basis points in the next six months. Coupled with reduced provision of new liquidity by Frankfurt, the resulting credit crunch on the Irish banks will trigger a massive jump in the burden of mortgages here. Needless to say, even with booming exports, Ireland Inc will be in deep trouble as trade credits, corporate funding and personal loans will be pushed deep into red by rising costs of borrowing.
At this stage, we really are caught between a rock and a hard place.
Saturday, February 13, 2010
Economics 13/02/2010: On benefits of marriage to investment
Feeling marital around the Valentine's Day? Well, how about investing in some stocks?
A paper just published in The Review of Financial Studies (2010, 23(1) pages 385-432) titled: “The Effect of Marital Status and Children on Savings and Portfolio Choice" by David A. Love (not kidding there) looked at the impact of marital status on optimal decisions about saving, life insurance, and asset allocation. It turns out, quite predictably I must add, that changes in marital-status and the number of children can have “important effects on optimal household decisions”:
In addition to wealth-to-income ratio, divorce and portfolio choice are linked through changes in financial background risk as “the former spouses move from living on a combined income to each relying on a potentially more volatile single stream. …Uninsurable background risk, arising, for example, from labor income, business income, and housing, can have a quantitatively large impact on optimal portfolio decisions.”
A final way that the divorce might influence optimal portfolio choice is through its effect on savings “as the former spouses update their desired consumption of housing, food, transportation, and childcare.” Divorcees from a single car household buy a new car. They also increase childcare expenditure in most cases, unless large divorce settlements induce one parent exit from the labour force. Food consumption expenditure and volume rise, as all other consumption of both durables and non-durables.
Contrast the economic implications of divorce for the two-child couple with those of a childless couple. Members of the childless couple will still experience a change in wealth and income in the event of a divorce, “but there will be no additional shock to resources due to child support, college expenses, or differences in scale economies related to the assignment of custody. Given this differential impact on resources, it is reasonable to expect that the childless couple will respond differently to divorce in terms of saving and portfolio choice. In addition, children may also alter households' responses to widowhood. For example, depending on the strength of the bequest motive, surviving spouses with children will tend to have larger amounts of wealth relative to income compared to those without children, leaving them more exposed to market risk.”
All of these conjectures are supported by evidence, but there are some surprises in findings as well:
“This trajectory of wealth accumulation is mirrored, in part, by the evolution of portfolio shares. Earlier in the life cycle, households with children hold riskier portfolio shares (by about 10 percentage points) than households without children, but the relationship reverses in retirement.” So no, risk aversion is lower for married couples probably because their dual incomes act as hedges against single income volatility.
Instead – it is bequest motive that drives them to become more conservative in older age. “…a riskier allocation for these younger households is optimal because their consumption streams are less dependent on the performance of financial markets. In retirement, however, children provide an incentive to maintain wealth for bequests, and the resulting increase in the wealth-to-income ratio makes households increasingly sensitive to stock market volatility.”
Hmmm, this brings us to taxes, then. A rise in inheritance tax during the wealth accumulation period of household life cycle implies a reduced incentive to save for bequest. This, should then result in lower risk aversion for older age households. And that, in turn, will lead to greater volatility of investment and also to higher cost of borrowing by the sovereigns. How so? Because if older households become less risk averse, their share of government bonds in total investment portfolio will drop. This means lower demand for bonds and higher yields on new issuance. Cost of sovereign borrowing goes up and the benefits of higher taxes to Government revenues are cancelled out, at least in part.
Imagine that – some say there is no such thing as Laffer Curve… not even at 100% marginal tax rate?
A paper just published in The Review of Financial Studies (2010, 23(1) pages 385-432) titled: “The Effect of Marital Status and Children on Savings and Portfolio Choice" by David A. Love (not kidding there) looked at the impact of marital status on optimal decisions about saving, life insurance, and asset allocation. It turns out, quite predictably I must add, that changes in marital-status and the number of children can have “important effects on optimal household decisions”:
- Widowhood induces sharp reductions in the portfolio shares in stock, and the impact is largest for women and individuals with children.
- Divorce causes men and women to reallocate their portfolios in different directions; men choose much riskier allocations, while women opt for safer ones.
- Children play a fundamental role in the optimal portfolio decisions. Men with children, for example, increase their shares in response to divorce by less than half as much as men without children.
In addition to wealth-to-income ratio, divorce and portfolio choice are linked through changes in financial background risk as “the former spouses move from living on a combined income to each relying on a potentially more volatile single stream. …Uninsurable background risk, arising, for example, from labor income, business income, and housing, can have a quantitatively large impact on optimal portfolio decisions.”
A final way that the divorce might influence optimal portfolio choice is through its effect on savings “as the former spouses update their desired consumption of housing, food, transportation, and childcare.” Divorcees from a single car household buy a new car. They also increase childcare expenditure in most cases, unless large divorce settlements induce one parent exit from the labour force. Food consumption expenditure and volume rise, as all other consumption of both durables and non-durables.
Contrast the economic implications of divorce for the two-child couple with those of a childless couple. Members of the childless couple will still experience a change in wealth and income in the event of a divorce, “but there will be no additional shock to resources due to child support, college expenses, or differences in scale economies related to the assignment of custody. Given this differential impact on resources, it is reasonable to expect that the childless couple will respond differently to divorce in terms of saving and portfolio choice. In addition, children may also alter households' responses to widowhood. For example, depending on the strength of the bequest motive, surviving spouses with children will tend to have larger amounts of wealth relative to income compared to those without children, leaving them more exposed to market risk.”
All of these conjectures are supported by evidence, but there are some surprises in findings as well:
“This trajectory of wealth accumulation is mirrored, in part, by the evolution of portfolio shares. Earlier in the life cycle, households with children hold riskier portfolio shares (by about 10 percentage points) than households without children, but the relationship reverses in retirement.” So no, risk aversion is lower for married couples probably because their dual incomes act as hedges against single income volatility.
Instead – it is bequest motive that drives them to become more conservative in older age. “…a riskier allocation for these younger households is optimal because their consumption streams are less dependent on the performance of financial markets. In retirement, however, children provide an incentive to maintain wealth for bequests, and the resulting increase in the wealth-to-income ratio makes households increasingly sensitive to stock market volatility.”
Hmmm, this brings us to taxes, then. A rise in inheritance tax during the wealth accumulation period of household life cycle implies a reduced incentive to save for bequest. This, should then result in lower risk aversion for older age households. And that, in turn, will lead to greater volatility of investment and also to higher cost of borrowing by the sovereigns. How so? Because if older households become less risk averse, their share of government bonds in total investment portfolio will drop. This means lower demand for bonds and higher yields on new issuance. Cost of sovereign borrowing goes up and the benefits of higher taxes to Government revenues are cancelled out, at least in part.
Imagine that – some say there is no such thing as Laffer Curve… not even at 100% marginal tax rate?
Economics 13/02/2010: Inflation targets and What's in a name?
One interesting observation – Oliver Blanchard in yesterday interview with Wall Street Journal suggests (here) that “If I were to choose inflation target today, I’d strongly argue for 4%. But we have started with 2%, so going from 2% to 4% would raise issues of credibility. We should have a discussion about it.”
I have argued for some time now that a combination of
Good to see serious heavy hitter in policy economics, like Oliver Blanchard, also thinking the same.
Now, to more ‘fun’ economics.
Remember Shakespeare’s “What’s in a name? / That which we call a rose by any other name would smell as sweet.” (Romeo and Juliet).
In the world where information moves much faster and where uncertainty is much higher – in other words, in the world we inhabit today – this view is no longer true, for what is in the name does tell us much about what is in the name bearer.
A recent paper by Aura, Saku and Hess, Gregory D., What’s in a Name?, Economic Inquiry, Vol. 48, Issue 1, pp. 214-227, January 2010 (link here) shows exactly this.
“Expectant parents lie awake at night, consult books, and some even hire a consultant to choose their new child’s name. Is it similar to the process that manufacturers undertake when branding a new product? Viagara pretty much speaks for itself, but to what extent does Gregory, Saku or even Jamaal convey information and/or meaning.”
The study attempts to answer two main questions:
…More specifically, we investigate the extent to which a respondent’s first name features affect his or her years of formal education, self reported financial relative position as well as social class, to have a child before 25, and occupational prestige. …we can examine the gender differences between lifetime outcomes and first name features.”
There are broadly speaking three main findings:
First, names indicate a great deal of information on
It turns out that when this is controlled for,
“There is the further possibility that these quasi economic outcomes may also be correlated with labor productivity: simply unhappy workers and those that feel that they are lower class (or even upper class) may have differential labor productivities. Based on the findings… controlling for a myriad of exogenous family background characteristics, a first name’s popularity and/or ‘blackness’ appear to have an impact on intermediate economic outcomes that are likely correlated with labor productivity but not on actual economic outcomes. It would thus appear that …the ‘blackness’ of a name is correlated with factors that can affect labor productivity which could in turn be reflected in discrimination at the resume level [but not at face-to-face level]. As we demonstrate, however, this potential channel of discrimination does not have an impact on pure economic outcomes in our sample.”
In general, this explains why past immigrants to the US – from Europe and elsewhere – tended to automatically adopt most popular local names for their children to ‘assimilate’ into the American mainstream.
It also shows that, for example in the case of Ireland, one would expect past emigrants to be selected on the basis of those with more common names experiencing more favorable in outcomes. Furthermore, currently, within the country, Irish first names might provide for better outcomes - as they serve as more acceptable norms here, while at the same time placing children at relative disadvantage to their peers if they should emigrate out of Ireland.
Lastly, when looking at the trends in names, since the onset of recession, more mainstream names have moved up the popularity chain in Ireland with more Gaelic-derived names becoming less popular. This too might be explained by the findings - when times are tough, implicitly, parents tend to focus more on real economic and social outcomes than on the feeling of being in tune with Eamon O Cuiv's 'national culture'.
Overall, instead of the Shakespeare’s idea that it is the inherent subject characteristic that matters, not the name, is no longer true. Instead, modern relationship between the name and the person is probably better described by a different quote – from Johnny Cash’s (1969), A Boy Named Sue: “So I give ya that name and I said goodbye / I knew you’d have to get tough or die / And it’s that name that helped to make you strong”.
I have argued for some time now that a combination of
- continued tightness in the credit markets,
- long-term stickiness of European unemployment and
- massive national deficits and debt issuance since 2008 imply the need for inflationary reductions in debt levels accumulated by the euro area states, especially those members of the APIIGS club
Good to see serious heavy hitter in policy economics, like Oliver Blanchard, also thinking the same.
Now, to more ‘fun’ economics.
Remember Shakespeare’s “What’s in a name? / That which we call a rose by any other name would smell as sweet.” (Romeo and Juliet).
In the world where information moves much faster and where uncertainty is much higher – in other words, in the world we inhabit today – this view is no longer true, for what is in the name does tell us much about what is in the name bearer.
A recent paper by Aura, Saku and Hess, Gregory D., What’s in a Name?, Economic Inquiry, Vol. 48, Issue 1, pp. 214-227, January 2010 (link here) shows exactly this.
“Expectant parents lie awake at night, consult books, and some even hire a consultant to choose their new child’s name. Is it similar to the process that manufacturers undertake when branding a new product? Viagara pretty much speaks for itself, but to what extent does Gregory, Saku or even Jamaal convey information and/or meaning.”
The study attempts to answer two main questions:
- does a person’s name convey information about their background?
- does a person’s name have an impact on the person’s long run economic outcomes, such as income, education, fertility, social standing, happiness or prestige?”
…More specifically, we investigate the extent to which a respondent’s first name features affect his or her years of formal education, self reported financial relative position as well as social class, to have a child before 25, and occupational prestige. …we can examine the gender differences between lifetime outcomes and first name features.”
There are broadly speaking three main findings:
- there is a strong empirical relationship between an individual’s first name and their background;
- there is a weaker (but still significant) empirical relationship between an individual’s lifetime outcomes and their first names. Taken together, these first two findings imply that names do convey information about an individual’s labor market productivity. A rose is not quite a rose by any other name.
- both non-black non-whites with ‘blacker’ names as well as blacks with more popular (i.e. predominantly ‘whiter’) names have significantly worse financial outcomes. “This last piece of evidence can be interpreted in light of a subtle form of discrimination: namely, while black names come with discrimination and identity costs and benefits for black individuals, non-black non-whites with ‘blacker’ names face the costs of such names though not the benefits. A similar identity/discrimination channel would also hold for blacks with more popular (i.e. whiter) names, …though it does not provide conclusive proof of discrimination.”
First, names indicate a great deal of information on
- gender (and this conclusion is not based on linguistic gender of the name, but on standard phonetic characteristics);
- the year when one was born,
- a respondent’s higher parental education background "can be partially inferred from higher popularity, fewer syllables, more standard spellings, fewer ‘oh’ endings, not starting with a vowel, ending with a consonant and having a lower Blackness Index (the extent to which a given name is race-specific). This latter result …is actually quite large: moving from a purely non-black name to a fully black name is associated with a Father having 2 fewer years of formal education and a Mother having 1 year less.”
- more popular names are associated with better lifetime outcomes: that is, more education, occupational prestige and income, and a reduced likelihood of having a child before
- names with higher values for Blackness Index are “associated with poorer lifetime outcomes: that is, less education, occupational prestige, happiness, social class and income, and an increased likelihood of having a child before 25".
- ‘ah’ and ‘oh’ ending sounds in a name are also related to poorer lifetime outcomes, though popularity is related to better lifetime outcomes.
It turns out that when this is controlled for,
- Name popularity remains a significant explanatory variable in education outcomes, but not in financial outcomes;
- Blackness Index is statistically significant again in the class determination, and whether or not a person has higher happiness quotient in the future, as well as in educational attainment: “Higher values for BIND lead to a lower assessment of social class, happiness and an increased chance of having children before 25. However, as with POPULARITY, BIND is now no longer statistically significant in the income responses. Again, the role of education and labor market experience is clearly soaking up the role that POPULARITY and BIND played in the income response” in earlier analysis.
“There is the further possibility that these quasi economic outcomes may also be correlated with labor productivity: simply unhappy workers and those that feel that they are lower class (or even upper class) may have differential labor productivities. Based on the findings… controlling for a myriad of exogenous family background characteristics, a first name’s popularity and/or ‘blackness’ appear to have an impact on intermediate economic outcomes that are likely correlated with labor productivity but not on actual economic outcomes. It would thus appear that …the ‘blackness’ of a name is correlated with factors that can affect labor productivity which could in turn be reflected in discrimination at the resume level [but not at face-to-face level]. As we demonstrate, however, this potential channel of discrimination does not have an impact on pure economic outcomes in our sample.”
In general, this explains why past immigrants to the US – from Europe and elsewhere – tended to automatically adopt most popular local names for their children to ‘assimilate’ into the American mainstream.
It also shows that, for example in the case of Ireland, one would expect past emigrants to be selected on the basis of those with more common names experiencing more favorable in outcomes. Furthermore, currently, within the country, Irish first names might provide for better outcomes - as they serve as more acceptable norms here, while at the same time placing children at relative disadvantage to their peers if they should emigrate out of Ireland.
Lastly, when looking at the trends in names, since the onset of recession, more mainstream names have moved up the popularity chain in Ireland with more Gaelic-derived names becoming less popular. This too might be explained by the findings - when times are tough, implicitly, parents tend to focus more on real economic and social outcomes than on the feeling of being in tune with Eamon O Cuiv's 'national culture'.
Overall, instead of the Shakespeare’s idea that it is the inherent subject characteristic that matters, not the name, is no longer true. Instead, modern relationship between the name and the person is probably better described by a different quote – from Johnny Cash’s (1969), A Boy Named Sue: “So I give ya that name and I said goodbye / I knew you’d have to get tough or die / And it’s that name that helped to make you strong”.
Friday, February 12, 2010
Economics 12/02/2010: Crisis pressures in broader debt markets
And so the Greek saga continues, with yesterday’s announcement that the EU has a worked-out rescue package for the country now turning out to be yet another wishful thinking piece of poorly prepared PR. No package details, and the markets are not impressed.
But forget Greece for a moment. The good news is that just as in Autumn 2008, the last couple of months have been the case of “bad news = good news”. The markets have finally started to turn their attention to the completely reckless ways in which majority of Governments around the world have been managing their finances, both before the crisis and during it.
The new line of fire is now directed at Turkey and Japan.
Japan, pushing for well over 200% of GDP ratio of debt is in a league of its own. And the current Government is hell-bent on raising the debt limits higher with aggressive spending targets and Napoleonic plans for shifting even more public expenditure into largely unproductive investment (for a country with already extensive public capital stock, the diminishing marginal returns on new public investment have set in some time ago). Debt ratio to working age population is now well above USD100,000 and is rising at accelerating pace. Savings rate has fallen to below 4% while the fiscal deficits are now much higher than they were back in the days when the savings rate was around 18%. Current account balance has declined from the peak of 5% in 2007 to under 1.5% today and is set to fall further. With these dynamics in mind, Japan is going to account for roughly 11% of the total global expected issuance of new bonds in 2010.
Turkey is a serious basket case, although it might not appear to be such from the simple debt levels comparisons. Like Ireland, Turkey has low debt to GDP ratio (45% as opposed to Greece with 113%, Portugal with 77%, Spain with 54%), It is in line with Ireland current 46.2% debt levels (although in Ireland’s case, a GNP base would work much better, bringing out true public debt to a much more formidable 57% of GNP). But it is not the level of debt that is worrisome. The awesome rate of debt increase, along with hidden debts that the public sector underwrites are the real concerns here.
An interesting chart from Turkey Data Monitor:
shows just how bad Turkish debt dynamics are. In the environment where it is currently yielding over 8% with an average maturity being around 2 years, the problem for Turkey is the following:
So dynamics matter. And they matter for Ireland. Which got me thinking – just how bad is our debt position going to get and what costs will this impose on the economy. Here are few charts:
Start with gross debt as percentage of GDP and GNP. Above chart shows figures for the official debt estimates from Stability Plan Update, December 2009, issued by the Department of Finance. Additional lines show the ratio of debt to GNP and also extension of debt figures to include Nama's €59 billion allocation, plus expected €12 billion in post-Nama capital injections into the banks. Finally, the last line shows the above, accounting for a lower growth rate in GNP scenario than the one forecast by the DofF for 2012-2014 period. The important issue here is that our debt to GNP (the real measure of our economy) is going to breach 100% even under DofF own rosy assumptions.
Next, consider the growth rate in our debt:
Pretty dramatic, especially when you compare the rate of growth in 2009-2012 against the tiny rates of decline predicted for 2013-2014. The rates of decline in fact will be about half the rate of interest we will be paying on this debt.
So expect no respite in terms of the cost of debt financing in sight:
The above are pretty big annual numbers - up to €14 billion going to feed the debt monster annually! Crazy stuff for an economy worth around €130 billion in terms of its GNP. Alternatively, €14 billion is roughly 30% of the total Government expenditure that this country can afford if we were to stay on structurally balanced fiscal path!
And thus, cost of debt financing as percentage of our economy is going to be excruciating - up to 9.5% of the annual economic output at the peak (under the most pessimistic scenario). Which means the total cost of the current fiscal crisis is also going to be astronomical:
By the end of 2014, thus, we are looking to have wasted between €50 billion and €80 billion in total on sustaining that which is simply unsustainable - our gargantuan public sector overspending.
Incidentally, this pretty much explains why I do not believe that marginal reforms of the public sector, such as 'productivity improvements', 'reduced spending on external consultants' and 'staff re-allocations' will be enough to address the issue. In real world we inhabit, we need a massive cut in terms of overall spending on public sector and this can only be achieved by slashing numbers employed in the public sector and cutting pensions and wage expenditure on the remaining staff.
PS 1: given chronic lack of skills, aptitude and capabilities present in many areas of the public sector, an idea of using internal expertise to reduce reliance on external consultants advice and expertise, while hoping for improved efficiency is simply absurd.
PS2: A year ago, myself and Brian Lucey wrote an article for the Irish Times about the massive debt overhang in the Irish economy. Using IMF statistics we established that Irish economy stands out as the second most indebted economy in the world in terms of ratio of debts to GDP, the most indebted economy in the world when it comes to applying our real measure of economic activity - GNP, and one of the most indebted economies in absolute terms.
In response to the article, we were told by the Irish officials that 'total debts do not matter, only public debt does'.
In the real world, total debts of economy do matter because they show structural composition of economy itself, revealing the extent to which economic growth is being financed by reckless borrowing.
This month, Hayman Advisors weighted in on our side:
The above debts cover public debt, plus 5 top banks per country, with Iceland figure showing pre-crisis conditions. Forbes magazine reproduced this chart in their cover story for February 8 edition with a tag line saying "It's the Total Debt, Stupid".
I agree.
But forget Greece for a moment. The good news is that just as in Autumn 2008, the last couple of months have been the case of “bad news = good news”. The markets have finally started to turn their attention to the completely reckless ways in which majority of Governments around the world have been managing their finances, both before the crisis and during it.
The new line of fire is now directed at Turkey and Japan.
Japan, pushing for well over 200% of GDP ratio of debt is in a league of its own. And the current Government is hell-bent on raising the debt limits higher with aggressive spending targets and Napoleonic plans for shifting even more public expenditure into largely unproductive investment (for a country with already extensive public capital stock, the diminishing marginal returns on new public investment have set in some time ago). Debt ratio to working age population is now well above USD100,000 and is rising at accelerating pace. Savings rate has fallen to below 4% while the fiscal deficits are now much higher than they were back in the days when the savings rate was around 18%. Current account balance has declined from the peak of 5% in 2007 to under 1.5% today and is set to fall further. With these dynamics in mind, Japan is going to account for roughly 11% of the total global expected issuance of new bonds in 2010.
Turkey is a serious basket case, although it might not appear to be such from the simple debt levels comparisons. Like Ireland, Turkey has low debt to GDP ratio (45% as opposed to Greece with 113%, Portugal with 77%, Spain with 54%), It is in line with Ireland current 46.2% debt levels (although in Ireland’s case, a GNP base would work much better, bringing out true public debt to a much more formidable 57% of GNP). But it is not the level of debt that is worrisome. The awesome rate of debt increase, along with hidden debts that the public sector underwrites are the real concerns here.
An interesting chart from Turkey Data Monitor:
shows just how bad Turkish debt dynamics are. In the environment where it is currently yielding over 8% with an average maturity being around 2 years, the problem for Turkey is the following:
- Can a country with history of past debt problems and rising deficits really roll-over some USD125 billion worth of debt? and
- Can such a country do this in the environment where worldwide, national governments are expected to issue some USD4.5 trillion worth of bonds in 2010 - three times the normal volume of global debt issuance?
So dynamics matter. And they matter for Ireland. Which got me thinking – just how bad is our debt position going to get and what costs will this impose on the economy. Here are few charts:
Start with gross debt as percentage of GDP and GNP. Above chart shows figures for the official debt estimates from Stability Plan Update, December 2009, issued by the Department of Finance. Additional lines show the ratio of debt to GNP and also extension of debt figures to include Nama's €59 billion allocation, plus expected €12 billion in post-Nama capital injections into the banks. Finally, the last line shows the above, accounting for a lower growth rate in GNP scenario than the one forecast by the DofF for 2012-2014 period. The important issue here is that our debt to GNP (the real measure of our economy) is going to breach 100% even under DofF own rosy assumptions.
Next, consider the growth rate in our debt:
Pretty dramatic, especially when you compare the rate of growth in 2009-2012 against the tiny rates of decline predicted for 2013-2014. The rates of decline in fact will be about half the rate of interest we will be paying on this debt.
So expect no respite in terms of the cost of debt financing in sight:
The above are pretty big annual numbers - up to €14 billion going to feed the debt monster annually! Crazy stuff for an economy worth around €130 billion in terms of its GNP. Alternatively, €14 billion is roughly 30% of the total Government expenditure that this country can afford if we were to stay on structurally balanced fiscal path!
And thus, cost of debt financing as percentage of our economy is going to be excruciating - up to 9.5% of the annual economic output at the peak (under the most pessimistic scenario). Which means the total cost of the current fiscal crisis is also going to be astronomical:
By the end of 2014, thus, we are looking to have wasted between €50 billion and €80 billion in total on sustaining that which is simply unsustainable - our gargantuan public sector overspending.
Incidentally, this pretty much explains why I do not believe that marginal reforms of the public sector, such as 'productivity improvements', 'reduced spending on external consultants' and 'staff re-allocations' will be enough to address the issue. In real world we inhabit, we need a massive cut in terms of overall spending on public sector and this can only be achieved by slashing numbers employed in the public sector and cutting pensions and wage expenditure on the remaining staff.
PS 1: given chronic lack of skills, aptitude and capabilities present in many areas of the public sector, an idea of using internal expertise to reduce reliance on external consultants advice and expertise, while hoping for improved efficiency is simply absurd.
PS2: A year ago, myself and Brian Lucey wrote an article for the Irish Times about the massive debt overhang in the Irish economy. Using IMF statistics we established that Irish economy stands out as the second most indebted economy in the world in terms of ratio of debts to GDP, the most indebted economy in the world when it comes to applying our real measure of economic activity - GNP, and one of the most indebted economies in absolute terms.
In response to the article, we were told by the Irish officials that 'total debts do not matter, only public debt does'.
In the real world, total debts of economy do matter because they show structural composition of economy itself, revealing the extent to which economic growth is being financed by reckless borrowing.
This month, Hayman Advisors weighted in on our side:
The above debts cover public debt, plus 5 top banks per country, with Iceland figure showing pre-crisis conditions. Forbes magazine reproduced this chart in their cover story for February 8 edition with a tag line saying "It's the Total Debt, Stupid".
I agree.
Wednesday, February 10, 2010
Economics 10/02/2010: Can Labour Party lead?
Does a coalition involving any party in partnership with Labour makes sense?
Unfortunately, despite Labour Party having in its ranks some very talented and economically literate senior politicians (Joan Burton and Ruairi Quinn come to mind), there is a legacy of the LP being largely captured by the Trade Unionist movement. In times of economic expansion, this risks the party pre-committing itself to the policy platforms that:
For example, consider the current situation with public sector wages and non-wage earnings clearly being out of line with private sector and with the reality of economic crisis on the ground. Two past policy dimensions, each one sufficient enough to rule out Labour's ability to impose fiscal discipline on the state, that come to mind:
There is also a strange belief, on behalf of Labour party that extending a place in a university to everyone who applies (see here), regardless of their merit or ability, is a jobs-supporting policy as well. In following this, Labour commits two cardinal errors:
So there you have it - despite having some very good people in its ranks, Labour party is simply not a credible contender for economic crisis management.
Unfortunately, despite Labour Party having in its ranks some very talented and economically literate senior politicians (Joan Burton and Ruairi Quinn come to mind), there is a legacy of the LP being largely captured by the Trade Unionist movement. In times of economic expansion, this risks the party pre-committing itself to the policy platforms that:
- expand public sector beyond economically efficient levels;
- make the above expansions permanent in nature (i.e. irreversible); and
- commit the state to correcting any potential funding shortfalls out of tax revenue increases.
For example, consider the current situation with public sector wages and non-wage earnings clearly being out of line with private sector and with the reality of economic crisis on the ground. Two past policy dimensions, each one sufficient enough to rule out Labour's ability to impose fiscal discipline on the state, that come to mind:
- Labour consistently supported increases in the lower tier wages, thus advocating a compression of wage distribution from the left tail. In current environment, Labour could cut upper tier public sector wages, further compressing the distribution, this time from the right tail. But it cannot commit to shifting the entire distribution left. And this means that any savings achieved will be poultry and will not go far enough to address the existent wages gap between public and private workers to the left of the median wage.
- Labour also persistently advocated minimum wage increases. A cut in a minimum wage, therefore, is not an option for Labour. But absent cuts in minimum wages, what policy can promote jobs creation at the bottom of the skills distribution? A cut in the cost of employing workers - aka a cut in employer PRSI - is also out of question for Labour. Training and state subsidised employment simply cannot deliver sustained jobs for this category of unemployed.
There is also a strange belief, on behalf of Labour party that extending a place in a university to everyone who applies (see here), regardless of their merit or ability, is a jobs-supporting policy as well. In following this, Labour commits two cardinal errors:
- It implicitly beliefs that getting a college degree improves ones ability to gain employment; and
- It explicitly assumes that providing tertiary education for all is necessarily net-additive economic and social activity.
So there you have it - despite having some very good people in its ranks, Labour party is simply not a credible contender for economic crisis management.
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