Economics 22/04/2010: Ireland's deficit tops Greece

Updated below

Breaking news: Eurostat just revised Irish General Government Deficit figures from 11.7% officially reported in Budget 2010 to a whooping 14.3%, raising our deficit above revised Greek figure. Here is the link to the note.

Excerpt: "Ireland had its budget deficit revised even more [than Greece] -- to 14.3 percent from the initially reported 11.7 percent. Irish Finance Minister Brian Lenihan said this was a result of a technical reclassification associated with government support provided to the banking sector. "It is important to note that the underlying 2009 general government deficit for Ireland is 11.8 percent of GDP, which is broadly similar to that projected in December's budget," he said. "There is no additional borrowing associated with this technical reclassification. This is a once-off impact, and will not affect the government's stated budgetary aim of reducing the deficit to below 3 percent of GDP by 2014," Lenihan said."

That would be putting a brave face on what now amounts to the most deficit-ridden country in the EU!

One question remains to be answered - given that all 2009 recapitalization funds for banking sector came from NPRF, what 'technical reclassification' yielded this massive upward revision?

Update: There has been a lot of talk in the blogosphere about the 'silver lining' to today's news. In particular, one argument is making rounds that goes as follows: "Since our deficit has increased for 2009 to 14.3%, then the reduction to 10.6% envisioned in the Budget 2010 will be even more impressive to the markets".

Here is why this argument is fallacious:

1. Today's revision of deficit for 2009 represents a reflection by Eurostat that cash injected into the Anglo Irish Bank by the state was borrowed via general spending fund in the open markets and as the result constitutes deficit financing. If so, where do you think this year's banks recapitalization will come from? Uncle Sam? or may be Angela Merkel? These recapitalizations are not, repeat not factored in the Government Budgetary projections per Budget 2010. The Eurostat rulling means that should the Government borrow the €10-12 billion to recapitalize the banks in the markets this year, this too will be reflected in our deficit. Now do the math - Government budget allows for €18.7 billion in General Government Deficit or 11.6% of GDP in 2010. If we add to this the lower bound of recapitalization estimates, our deficit rises to over €28 billion or a whooping 17.4% of GDP. Even if the Government wrestles out of the NPRF more cash to plug the banks balancesheet black hole, and assuming that our borrowing for banks purposes goes up by just half of the announced requirement, our Gen Gov Deficit will reach 14.7% of GDP. At which point we can all shout 'Eat our shorts, Greece!' once again.
2. Today's revision clearly shows that the Government has been caught red-handed in attempting to avoid labeling our true General Government liabilities as such. This is about as reputation-destroying as Greece's use of financial derivatives in the past.
   
3. An argument of a 'silver lining' assumes that as a one-off increase, this deficit revision does not matter going forward. This, in effect, is equivalent to saying that no cyclical deficit matters, no matter how big it is. Of course, such an argument is absolutely devoid of any anchoring in finance or economics. Cyclical deficits add up to total deficits. Total deficits - cyclical or not - add up to the total debt. This is exactly how Greece got itself into the bin!
   

Economics 21/04/2010: De-capitalizing Credit Unions

Per latest leaks from the financial regulators: In order to allow credit unions greater flexibility in re-scheduling loans, Section 35 of the Credit Union Act 1997 is amended to increase the proportion of the loan book of individual credit unions comprising loans of greater than five years duration, subject to appropriate liquidity provision and accounting transparency.

This, in effect, is the plan for de-shoring up capital reserves at the Credit Unions, which so far have the lowest level of financial transparency in operations amongst all financial institutions licensed to conduct retail business in the country. Whatever hides underneath that iceberg, one can only wonder. However, it is now clear that our regulators are concerned with the unions' ability to re-negotiate non-performing loans and to, thereby, avoid calling in loans on ordinary households.

Credit unions under this provision will be allowed to extend loans maturity, providing relief to the households who cannot repay their debts. However, unless householders' problems leading to delinquency on loans are temporary and short-term in nature, this measure will simply dig a deeper debt hole for already financially distressed families.

And the news have implications for the banks. Recall that in theory credit unions should have been the most conservative lenders in the nation. If they are now experiencing significant pressures on their consumer loans, what can be said about the banks who hold jumbo mortgages, top-up mortgages and car loans leveraged up to 6-8 times peak 2007 income?

How long can this charade last?

Economics 20/04/2010: IMF report on global financial stability

IMF's GFSR report for Q1 2010 is out today, and makes a fantastic, albeit technical reading of the global financial system health. Ireland features prominently.

First, Ireland, alongside with Austria, the Netherlands and Belgium are the four leading countries responsible for contagion of markets shocks to the rest of the Euro area. Own fundamentals drove, per IMF team, Irish sovereign bond spreads more than those for any other country in the common currency area, dispelling the Government-propagated myth that our crisis was caused by the US and the global financial markets collapse. Chart below - from the report - illustrates:
Between October 2008 and March 2009, Ireland's contribution to cross-Euro contagion was 12.3% of the total Euro area distress probability - second highest after Austria (16.7%). For the period of October 2009 - February 2010, the picture changed. Greece came in first in terms of distress contagion risk - at 21.4%, Portugal second with 18.0%. Ireland's role declined to 8.1% - placing us 6th in the list of the worst contagion risk countries. A positive achievement, beyond any doubt. But again, IMF attributes the entire probability of the risk of contagion from Ireland to the Euro zone down to domestic fundamentals, not external crisis conditions.

This progression has not been all that rosy for the sovereign bonds:
Notice that Ireland's term structure of CDS rates has barely changed in Q4 2009-Q1 2010. Why is that so? Despite the Budget 2010 being unveiled in between, the markets still perceive the probability of Ireland defaulting on sovereign debt in 5 years times relative to 1 year from now as pretty much unchanged. This would suggest that the markets do not buy into the Government promise to deliver a significantly (dramatically and radically) improved debt and deficit positions by 2015! In other words, the Budget 2010 has not swayed the markets away from their previous position, leaving Ireland CDS's term structure curve much less improved than that of the other PIIGS.

Here is another nice piece of evidence. Guess who's been hoovering up ECB lending?
And if you want to see just why Irish banks will be raising mortgage rates regardless of what ECB is doing, look no further than this:
The chart above, of course, covers 2008 - the year when Anglo posted spectacular results and AIB raised dividend. Imagine what this would look like if we are to update the figure to today. Also notice that in terms of return on equity, Irish banks were doing just fine with low margins back in 2008 and before. The reason for this is that our lending model allowed for that anomaly: banks were literally sucking out tens of billions of Euro area cheap interbank loans and hosing down a tiny economy with cash. As long as the boom went on, it didn't matter whether the bankers actually had any idea why and to whom they were lending. Now, the tide has gone out, and guess who's been swimming naked?

Interesting note on the equity markets. looking at historic P/E ratios, the IMF staff concludes that back in February 2010 "For advanced economies, equity valuations are within historical norms". Except for Ireland, which deserves its own note: "Forward-looking price-to-earnings ratios of Ireland appear elevated due largely to sharp downward revisions in earnings projections."

So, read this carefully: Irish stocks were overvalued - based on forecast forward P/Es - back in the time of the paper preparation. Using z-scores (deviation of the latest measure from either the historical average or the forward forecast based on IMF model) for Irish equities are: +2.1 for shorter horizon (a simplified 96% chance of a downward correction) and +0.9 for longer term forecasts (roughly 63% chance of downward adjustment). In other words, the market is overpriced both in the short term and in the long run. Worse than that, we have the highest short and long term horizon over pricing in the world!

In housing markets, our price/rent ratio z-score is +1.1 (74% probability of deterioration), which means we are somewhat close to the bottoming out but are not quite there. How big is the 'somewhat' the IMF wont tell, but it looks like we are still 1.1 standard deviations above the equilibrium price. Price to income ratio - the affordability metric is at +0.8 stdevs, so prices might still have to fall further to catch up with fallen incomes (57% probability).

Economics 19/04/2010: INBS - Titanic hits the ocean floor...

INBS has reported a €2.49bn loss for FY 2009 on the loan book just under €11bn, with roughly €8.5bn of this attributable to development and investment in property markets. Provisions amounted to €2.8bn, so in other words, the Kingdom of Irish Local Finance has managed to pile up an impressive 25.5% impairment charge on the book that has already taken a hit in 2008. Between 2008 and 2009, INBS has managed to post impairments of 30%.

Actually, here is a better view: 96% of all losses are on commercial development books, which means INBS has been lending money to folks whose default rates are currently running at more than 33% yoy! These are recognized default rates, which conceal the fact that many of the INBS' loans (just as in the case of other banks) would really be deep in red, were they not re-negotiated and switched into 'interest holiday' loans back in 2008-2009. Now, remember the numbers released by Nama? 2/3rds of the loans not paying interest. Apply that to the INBS books - the expected impairment charge for 2010-2012 will be around €5.7bn. And that's only for the non-householders' loans...

The numbers are truly outstanding by all possible measures.

INBS's administration expenses rose to €46mln from €45mln in 2008, and the bank has managed to accumulate €7 million in professional fees as one-off expenses, presumably relating to the management efforts to shore up the hull of a sinking boat.

Per Irish Times report, CEO Gerry McGinn said the greatest management challenges were in relation to the commercial loan portfolio. "The society has manifestly been seriously under-resourced in many areas of its business activities and support functions, but most especially in commercial lending," he siad.

Under-resourced? As if throwing more cash at staff and consultants would have prevented them from issuing so absurdly poorly priced and analyzed loans?

At this stage, especially given Mr McGinn's denial of the reality (that the INBS is a burnt-out force with not a modicum of decorum to pretend that it can act as a functional lender) any more taxpayers cash directed to the INBS would be a pure and gratuitous waste!

Economics 20/04/2010: Fas training for ex-Dell workers

Last week, media report (Silicon Republic, 16/04/10, 300 out of 1,900 former Dell workers received FAS training) provided some evidence that was supposed to show us just how effective Fas training systems can be.

"The Steering Committee responsible for advising on the implementation of the European Globalisation Adjustment Fund (EGF) for the 1,900 former Dell workers in Limerick has revealed that 300 have received FAS training so far... The committee ...is chaired by Oliver Egan, assistant director general in FAS. Another meeting is scheduled for towards the end of this month."

So hold on - so far, we know, there were meetings. And more meetings will happen.

"The Minister for Labour Affairs, Dara Calleary TD, commented: “There is a lot which has been done already and is being done with EGF support in the mid-west and which is perhaps only now starting to become visible”."

What is Minister on about here? (italics are mine): "In relation to concrete measures the Minister highlighted:

• The guidance service FAS provided to more than 1,900 former workers to date with some 300 persons receiving training in 2009 [note: this is a standard practice for large scale layoffs. How many of these 'graduates' actually found a job?]
• That in the first quarter of 2010, training and educational activity has increased with more than 200 EGF clients currently enrolled in evening classes, more than 250 EGF clients are registered with the Limerick City Adult Education Service [is that registration a pre-condition for some additional unemployment or other financial support?];
• That both Limerick Institute of Technology and University of Limerick have implemented a broad range of educational programmes for EGF clients [how many are enrolled? what types of programmes? what is the expected completion date?];
• That more than 150 clients having availed of EGF training support grant administered by FAS to date [so we have 1,900 workers laid off enrolled total, 300 completed Fas training, 150 are receiving a special subsidy, 100 more are 'registered'];
• That Fas runs a community-based initiative for more than 100 EGF clients [community-based initiatives rarely lead to gainful employment];
• That some 225 clients are registered with the City and County Enterprise Boards and are undertaking start-your-own-business programmes [Who administers these programmes? What are graduation rates and what are the success rates for new entrepreneurs?];
• The commencement of a dedicated EGF internship programme in partnership with the medical devices sector which will see more than 80 clients attending a series of workshops in April with successful candidates progressing into the full internship programme in June 2010 [This is perhaps the closest that Fas would ever come to giving these workers real hope of a gainful employment].

So, over 6 months after the layoffs, there are absolutely no hard numbers Minister Calleary can supply to show any success in progressing the former Dell workers into gainful employment. Surely, this is disturbing, given that Fas work does not come cheap and given that Minister has managed to set up a score of various schemes and taskforces - none of which are free to the taxpayers.

"I have committed to reviewing the overall programme in June to ensure that we are maximising the reach of the programme and to identify any additional or innovative measures that might be further considered,” Mr Calleary said. Really? So far, there are no indications that the review is going to be effective in assessing Fas' effectiveness in designing, administering and deploying these programmes.

Economics 16/04/2010: The incoming train II

It is a good feeling to be ahead of the curve, especially when the curve is drawn by the likes of FT. Per today's FT Deutschland report: the ECB is warning about a new crisis, a return of global imbalances in the coming years. In its monthly report the ECB warns: “At the current juncture, global imbalances continue to pose a key risk to global macroeconomic and financial stability . . . The stakes are high to prevent a disorderly adjustment in the future that would be costly to all economies.” Jurgen Stark is predicting that we have entered a new stage in the financial crisis – a sovereign debt crisis which means that “dealing with [the resulting severe macroeconomic imbalances] will represent one of the most daunting challenges for policymakers in modern history.”

My own take on the same topic was published here.

Another issue, also raised repeatedly on this blog, is discussed in Joachim Fels' (Morgan Stanley) piece on FT Alphaville (here). Fels makes a claim that countries with a high degree of inflation aversion (Germany) might have an incentive to quit. Fels suggests three warning points for the crisis to develop:

• First, any signs of moral hazard emerging in the fiscal policies in the euro area
• Second, ECB failure to raise interest rates on time to cut inflationary pressures, and
  
• Third, the political pressure rising against the Euro in Germany.

Hell, by these metrics, we are already in the midst of the euro collapse by 2 out of three measures (first and third). Alas, the second metric is a bogus one. There is plenty of evidence to show that ECB has not been an 'inflation hawk', acting often pro-cyclically before and targeting the likes of PMIs instead of hard inflation and monetary parameters. So the real question here is: What's the potential trigger for an exit?

Greece asking for the pledged money won't do. If you think in terms of game theory, once that happens in earnest (and it might be today or over the weekend), Germany will face the following two options:

1. Grant request for assistance in full and thus pre-commit itself to the common currency at the sunken cost of an exit of ca 10-12 billion euro that it will commit to Greek deficits financing;
2. Exit now, saving the aforementioned money, but destroying its political capital within the EU.

The problem is that the net cost of (1) is much smaller than the net cost of (2). And this means there has to be another - non-Greek - trigger. Italy or Spain?

Economics 15/04/2010: Greece problems back to the frontline

So, as I have predicted in the interview with BBC World Service (excerpt here), the markets have little faith in the Greeks and, indeed, in the EU’s ability to effectively underwrite Greek crisis.

Greek bond yields are now rising again on the investors’ view that German, French and Irish legislators might veto the deal. And in Germany there is a growing movement to challenge the Greek deal in a constitutional court, as being an illegal subsidy. The yield on Greek two-year bonds jumped 66bps yesterday reaching 6.99% and 5-year CDS rose 56bps to 436bps.

And FT’s Daniel Gros argues that the EU package is unlikely to solve anything, as the country needs about €30-50bn annually, depending on the future deficits path assumptions. Either way, 3-year package of up to €45bn won’t cut it. And the interest bill savings are also too thin – under the EU proposed deal, Greece will be facing an interest rate of ca 5%, which will provide the country with only €900mln in annual savings relative to market rates. Going lower to 4% - something opposed by Germany – will raise savings to ca €1,350 million per annum – still short of what is needed. Per Gros: the Greek problem is not one of liquidity but of insolvency.

And the IMF is severely constrained in what it can do in Greece by the fact that it can only lend 10-12 times the reserves position that Greece holds with IMF. And this means, at a maximum €15 billion.

So here we go – for all who thought the story is over, the most likely thing is that the actual story is just beginning.

Economics 13/04/2010: As bad as Northern Rock back in 2008?

So we have some more clarity on the state of our credit flows, courtesy of the latest monthly report from the Central Bank. And boy are we sick. At the height of the financial crisis, Northern Rock had 303% loans to deposits ratio. Ireland Inc? 269% absent risk adjustments on short-term deposits, and 323% once short term deposits risk of call-in is set at 10%.

Ouch! Irish financial system doesn’t resemble Quinn Insurance – it resembles Anglo!

Economics 13/04/2010: Retail sales

Retail sales are out today for February – some singing of good news hymns is being heard. And the headlines do appear to be touchy: “The volume of retail sales (i.e. excluding price effects) increased by 3.0% in February 2010 compared to February 2009 and there was a monthly increase of 14.9%.” This was the first monthly increase in the volume in 25 months.

But, “the year on year increase is primarily explained by the 30.5% year on year growth recorded in Motor Trades in February 2010.” Tax breaks still work, folks, even in the economy mired in a recession. So much for all those Lefties who so ardently argued that taxes don’t change behavior. Apparently they do. Here is an interesting point - may be someone can document it later – a rebate of 1,500 on a tax bill is seemingly doing more to Motor trade than the steep price declines passed directly onto the purchase price itself. Why? Perhaps it is a behavioral issue.

The trouble is – motor purchases tend to be one-offs – we don’t exactly shop for a new car a month or a year after we purchased one. So motor trade pick up cannot be expected to continue into the second half of 2010. Once the Motor Trades are excluded “the volume of retail sales decreased by 3.1% in February 2010 compared to February 2009 and the monthly change was +1.2%.” Ok, still a monthly rise, but remember – 12 months to February 2010 things were bad.

And no they are actually even worse. The impact of the yearly drop – indiscernible directly in monthly figures is that:

• the volumes are down;
• the value of sales is down; and
• the retail price inflation is negative.

In other words, actual sales – as translated into revenue of retail sector businesses – are still going down.

There were, however some sectors with yoy volume increases:

• Department Stores up 10.9%
• Pharmaceuticals Medical & Cosmetic Articles up 1.2%
• Clothing, Footwear & Textiles up 1.8%
• Electrical Goods up 3.5%
• Other Retail Sales up 2.8%

But the largest sector Non Specialised stores, inc. supermarkets, shows a year on year decrease of 1.7% and a month on month decline of 1.9%.

Much overlooked, the actual true indicator of health of the retail sector is the value of total sales achieved. In other words, we might book massive increases in the volume of sales, if we were to start giving stuff away for free. But that won’t restore any jobs lost in the sector. It is, really, the value of sales that we are after. And this has fallen (e-Motors) by 7.4% and the monthly change was only +0.1%.

With the exception of the Motors and Fuel sectors (where the Government collects lions share of the final price in taxes and charges) “most sectors continue to show year on year decreases in the value of retail sales however a number of sectors show monthly increases in the value of retail sales in comparison to January 2010.”

Not exactly a sign of a revival that we might be cheerful about.

Economics 13/04/2010: ESRI's latest forecasts for Ireland

ESRI's latest quarterly commentary is coming out today. Here are the core numbers:

• 2010, "expect GNP to be essentially unchanged from its 2009 volume; the corresponding figure for GDP is ½ per cent less than in 2009".
• 2011, "expect GNP to grow by 2¾ per cent and GDP to grow by 2½ per cent. While this return to growth is to be welcomed, it should be seen as a modest pace of growth."

My double take:

• 2910 figures are fine for GDP, a bit optimistic for GNP
• 2011 figures would be above my forecasts of 1.7-1.9% GNP, 2.0-2.2% GDP.

"In spite of the stability in the numbers employed, we expect unemployment to fall between 2010 and 2011, averaging 13¾ per cent in 2010 and 13 per cent in 2011. This expected fall in the rate of unemployment is related in part to expected migratory outflows – 60,000 in the year ending April 2010 and 40,000 in the year ending April 2011. We also expect to see on-going falls in labour force participation."

My view - if we are to have 60K outward migrants in 2010, what would hold the others back in 2011? There will be no prospects for new employment (and ESRI agree) and there will be improved jobs offers abroad (IMF agrees), so why not 80K in 2011 to follow 60K outflowing in 2010?

"In our analysis, we assume that the Government will implement its indicated budgetary package for 2011 where spending cuts and tax increases will amount to €3 billion. When combined with a return to modest growth and the consequent impact on revenues, we expect to see the General Government Deficit falling to 10¾ per cent of GDP in 2011, down from 12 per cent in 2010."

Putting aside the issue of whether this Government has ability to implement planned cuts, 10.75% deficit in 2011 certainly implies that there is no chance of Ireland meeting its obligations to reduce deficit to below 3% of GDP by 2014.

"We note that the recapitalisation needs of the Irish banks are now likely to be at least €33 billion, assuming that the State investment in Anglo Irish Bank ultimately amounts to €22 billion. In terms of net cost to the State, a figure of €25 billion is possible."

Great, folks, €22-27 billion was my estimate of the eventual cost of Nama produced back in the H1 2009. ESRI finally converged to this forecast of mine. Good to note.

Economics 12/04/2010: The next incoming train has left its first station

My current article on the longer term prospects for global economy, published in the current issue of Business & Finance magazine. This is an unedited version.

Forget the circus of the Euro zone Government’s bickering about Greece’s bailout package and the escapist idea of setting up the EU-own EMF. The real crisis in the Euroland is now quietly unfolding behind he scenes.

Finally, after nearly 15 years of denial, courtesy of the severe pain inflicted by the bonds markets, Brussels and the core member states are forced to face the music of their own making. The current crisis affecting Euro area economy is, in the end, the outcome of a severely unbalanced economic development model that rests on the assumption that exports-led economic expansions in some countries can be financed through a continued massive build up in financial liabilities by their importing partners.

Put more simply, the problem for the world going forward is that in order to sustain this economic Ponzi game, net importers must continue to finance their purchases of goods and services from net exporters by issuing new debt. The debt that eventually settles in the accounts of the net exporters.

One does not have to be versed in the fine arts of macroeconomics to see that something is wrong with this picture. And one does not have to be a forecasting genius to understand that after some 40 years of rising debts on the balance sheet of importing nations, the game is finally up. I wrote for years about the sick nature of the EU economy - aggregate and individual countries alike.

Last week, Lombard Street Research's Charles Dumas offered yet another clear x-ray of of the problem.


Source: Lombard Street Research, March 2010

As Dumas' chart shows, core Euro area economies are sick. More importantly, this sickness is structural. With exception of the bubble-driven catch-up kids, like Spain, Ireland and Greece, the Euro area has managed to miss the growth boat since the beginning of the last expansion cycle.

The three global leaders in exports-led growth: Germany, Japan and Italy have been stuck in a quagmire of excessive savings and static growth. Forget about jobs creation – were these economies populations expanding, not shrinking, the last 10 years would have seen the overall wealth of these nations sinking in per capita terms. Only the Malthusian dream of childless households can allow these export engines of the world to stay afloat. And even then, the demographic decline will have to be sustained through disposal of accumulated national assets. So much for the great hope of the exports-led growth pulling us out of a recession. It couldn’t even get us through the last expansion!

Over the last decade, the Sick Man of Europe, Italy has managed to post no growth at all, crushed, as Dumas’ put it, by the weight of the overvalued and mismanaged common currency. The Sick Man of the World, Japan has managed to expand by less than 0.8% annually despite running up massive trade surpluses. Germany’s ‘pathetic advance over eight years’ adds up to a sickly 3½% in total, or just over 0.3% a year. France, and the UK, have managed roughly 0.98% annualized growth over the same time. Comparing this to the US at 1.27% puts the exports-led growth fallacy into a clear perspective.

I wrote in these pages before that the real global divergence over the last 10 years has been driven not by the emerging economies decoupling from the US, but by Europe and Japan decoupling from the rest of the world. The chart above shows this, as the gap between European 'social' economies wealth and income and the US is still growing. But the chart also shows that Europe is having, once again, a much more pronounced recession than the US.

Europe's failure to keep up with the US during the last cycle is made even more spectacular by the political realities of the block. Unlike any other developed democracy in the world, EU has manged to produce numerous centralized plans for growth. Since the late 1990s, aping Nikita Khruschev's 'We will bury you!' address to the US, Brussels has managed to publish weighty tomes of lofty programmes - all explicitly aimed at overtaking the US in economic performance.

These invariably promised some new 'alternative' ways to growth nirvana. The Lisbon Agenda hodge-podge of “exporting out of the long stagnation” ideas was followed by the Social Economy theory that pushed the view that somehow, if Europeans ‘invest’ money they did not have on things that make life nicer and more pleasant for their ageing populations growth will happen. Brussels folks forgot to notice that ageing population doesn’t want more work, it wants more ‘free’ stuff like healthcare, public transport, social benefits, clean streets, museums and theatres. All the nice things that actually work only when the real economy is working to pay for them.

As if driven by the idea that economic development can be totally divorced from real businesses, investors and entrepreneurs, the wise men of Europe replaced the unworkable idea of Social Economy with an artificial construct labelled ‘Knowledge Economy’. This promised an exports-led growth fuelled by sales of goods and services in which we, the Europeans, are supposedly still competitive compared to our younger counterparts elsewhere around the world. No one in Brussels has bothered to check: are we really that good at knowledge to compete globally? We simply assumed that Asians, Americans, Latin Americans and the rest of the world are inferior to us in generating, commercializing, and monetizing knowledge. Exactly where we got this idea, remains unclear to me and to the majority of economists around the world.

The latest instalment in this mad carousel of economic programmes is this year's Agenda 2020 – a mash of all three previous strategies that failed individually and are now being served as an economically noxious cocktail of policy confusion, apathy and sloganeering.

But numbers do not lie. The real source of Euro area's crisis is a deeply rooted structural collapse of growth in real human capital and Total Factor productivities. And this collapse was triggered by decades of high taxation of productive economy to pay for various follies that have left European growth engines nearly completely dependent on exports. No amount of waterboarding of the real economy with cheap ECB cash, state bailouts and public deficits financing will get us out of this corner.

The real problem, of course, is bigger than the Eurozone itself. Exports-led economies can sustain long-run expansions only on the back of a borrowing boom in their trading partners. It is that simple, folks. Every time a Mercedes leaves Germany, somewhere else around the world, someone who intends to buy it will either have to draw down their savings or get a loan against future savings. Up until now, the two were inexorably linked through the global debt markets: as American consumers took out loans to buy German-made goods, Chinese savers bought US debt to gain security of their savings.

This debt-for-imports game is now on the verge of collapse. Not because the credit crunch dried out the supply of debt, but because the global debt mountain has now reached unsustainably high levels. The demand for more debt is no longer holding up. Global economic imbalances remain at unsustainable levels even through this crisis and even with the aggressive deleveraging in the banking systems outside the EU.

Take a look at the global debt situation as highlighted by the latest data on global debt levels. The first chart below shows the ratio of net importing countries’ gross external debt liabilities (combining all debts accumulated in public and private sectors, including financial institutions and monetary authorities) to that of their net exporting counterparts. The sample covers 20 largest importers and the same number of largest exporters.

Source: IMF/BIS/World Bank joint data base and author own calculations

As this figure illustrates, since mid-point of the last bubble at the end of 2005, the total external debt burden carried by the world’s importing countries has remained remarkably stable. In fact, as of Q3 2009, this ratio is just 0.3 percentage points below where it stood in the end of 2005. Compared to the peak of the bubble, the entire process of global deleveraging has cut the relative debt burden of the importing states by just 9.8%.

To put this number into perspective, while assets base of the world’s leading economies has fallen by approximately 35% during the crisis, their liabilities side has declined by less than 10%. If 2007 marked the moment when the world finally caved in under the weight of unsustainable debt piled on during the last credit boom, then at the end of 2009 the global economy looked only sicker in terms of long-run sustainability.

The picture is more mixed for the world’s most indebted economies.
Plotting the same ratio for the US and UK clearly shows that Obamanomics is not working – the US economy, despite massive writedowns of financial assets and spectacular bankruptcies of the last two years remains leveraged to the breaking point. The UK is fairing only marginally better.

Of course, Ireland is in the league of its own, as the country has managed to actually increase its overall share of global financial debt during this crisis courtesy of an out-of-control public expenditure and the lack of private sector deleveraging. Take an alternative look at the same data. Ireland’s gross external debt (liabilities) stood at a whooping USD 2.397 trillion in Q3 2009, up 10.8% on Q3 2007. Of these, roughly 45% accrue to the domestic economy (ex-IFSC), implying that Irish debt mountain stands at around USD 1.1 trillion or more than 6 times the amount of our annual national income.

Chart below shows gross external debt of a number of countries as a share of the world’s total debt mountain.
Source: IMF/BIS/World Bank joint data base and author own calculations

And this brings us to the singularly most unfavourable forecast this column has ever made in its 7 years-long history. Far from showing the signs of abating, the global crisis is now appearing to be at or near a new acceleration point. Given the long-running and deepening imbalances between growth-less net exporting states, like Germany, Japan and Italy and the net importers, like the US, we are now facing a distinct possibility of a worldwide economic depression, triggered by massive debt build up worldwide. No amount of competitive devaluations and cost deflation will get us out of this quagmire. And neither a Social Economy, nor Knowledge Economics are of any help here.

Paraphraisng Cypher in the original Matrix: “It means fasten your seat belt, Dorothy, ‘cause Kansas of debt-financed global trade flows is going bye-bye”.

Economics 12/04/2010: Nama's economic distorionism

An interesting quote from the just-published paper (Claessens, Stijn, Dell’Ariccia, Giovanni, Igan, Deniz and Laeven, Luc A., Cross-Country Experiences and Policy Implications from the Global Financial Crisis. Economic Policy, Vol. 25, Issue 62, pp. 267-293, April 2010). I reported on this paper last year at length, when it was still an IMF Working Paper.

“An example of distortions between financial institutions and the fiscal conditions is the extension of guarantees in the case of Ireland to the largest banks. Prior to the extension of guarantees, the CDS-spreads for the large Irish commercial banks were very high. Post guarantees, bank CDS-spreads declined sharply, while the sovereign spread increased. Measures like these, now numerous in many advanced countries today, distort asset prices and financial flows.”

This goes hand-in-hand with the EU assessment of Nama as a market distorting mechanism, which, as reported last week by Irish Independent, was concealed from the public when our Minister for Finance issued a press release claiming that Nama was fully supported by the EU Commission.

Further per Claessens et al: “Guarantees on deposits and other liabilities issued by individual countries have led to beggar thy neighbor effects as, starting with Ireland, they forced other countries to follow with similar measures.”

This statement in effect condemns Irish Government claim that our Guarantee was a success because it was copied by other countries. Instead, as Claessens et al confirm, the Guarantee forced risk from Ireland onto our trade and investment partners. Not exactly a high moral ground.

“The rapid spread of guarantees led to further financial turmoil in other markets. Many emerging markets not able to match guarantees suffered from capital outflows as depositors and other creditors sought the safe havens. Distribution of risks sharply changed over time and across circumstances."

More importantly, both – the revealed note from the EU and the above academic assessment – provide a significant warning in terms of the future of the banking and property sectors in Ireland. Given the systemic nature of distortions, subsequent exits and scaling back of foreign banks presence in the country, the lack of transparency and fairness in the property markets, it is now virtually assured that post-crisis interventions Irish banks and property markets will remain in their zombie state. Japan-styled recession is a looming threat for Ireland Inc.


Of course, you wouldn’t notice this, if you were listening to some of our heroic stock brokers – especially those folks like Bloxham who back in mid 2008 ‘forecast’ that ‘markets do come back’. In their latest strategy statement, issued last Friday, the Bloxham’s boys have managed to outperform themselves in terms of Green-jerseying (emphasis is mine):

“Ireland is undergoing some of the heaviest self imposed penalties for the fiscal over exuberance of the 2000s of any EU economy since the global credit crisis began in 2008. From budgetary austerity measures to public sector wage cuts, from crushing additional taxes both personal and indirect, to a mega-costing banking recovery plan; all in the name of stabalisation and repositioning as a viable economy. As Ireland passes through the next major set of hurdles (the transfer of assets to NAMA and the recap of the banking system), the market reaction so far has been favourable.”

Any evidence of this?

“10-year sovereign Irish bonds are still trading at 146 basis points above German bonds, compared with 280 basis points at the worst point for the Irish system in March 2009. Compared with Portugal at 126 bps over Germany, Irish spreads still have strong progress to make.”

The more the things improve in the wake of all the measures passed by the Government, the more the spreads stay the same? Indeed: “Irish sovereign debt costs have remained static in the past week, while Greek debt costs balloon by 100 bps. In relative terms, Ireland sovereign performance has been exceptionally good since the “Super Tuesday” announcements from the National Asset Management Agency (NAMA), the Financial Regulator and the Minister for Finance.”

But hold on to your seats for a wild ride into the land of bizarre logic: “A falling Irish debt cost is largely unappreciated domestically but is a very hansom reward for the pain taken in Ireland thus far.”

I am now thoroughly confused, folks – if the spreads stayed the same, what falling Irish debt costs do the Bloxham folks have in mind? Am I missing something in their vernacular? Or are they missing in the faculty of trivial maths – falling costs mean declining spreads, yet the spreads ‘remained static’ and debt costs did the same.


A real pearl of the note is in its conclusions: “We would expect that the wider Irish stock market will also benefit strongly over the next 6 months, as re-cap plans proceed and the export sector resilience is maintained. Ireland could be finally coming back on the international investor map.”

Indeed it might. Or it might not. I wouldn’t venture a prediction here, but Bloxham guys – having been so right on so many occasions in the past (including that brilliant note from them back in July 2008 (see the note here) surely would know better. Except, hmmm, what does Ireland’s exporting performance have to do with Irish stock prices? Not much – more than 80% of our goods exports and over 90% of our services exports are accounted for by the MNCs – none of which are listed on Irish Stock Exchange. So unless Bloxham guys know something about Fortune 500 companies plans to relocate their listings to Dublin…