Economics 07/06/2010: Moving to the next stage in Euro crisis

Last Friday, speaking at the CPA annual conference (will be posting the highlights of the speech here later) I referred to a new 'beast' of the sickly-prickly Eurostates: the BAN-PIIGS. The new bit - 'BAN' - referred to Belgium, Austria and the Netherlands.

Fast forward two days, getting off the trans-Atlantic flight in hot and humid New York guess what hits my news feed? Belgium and France taking in water on the back of Hungary's woes (see earlier post here) and Ukraine is putting some new pressures on Euro area banks. French and Belgian CDS are moving up, while Austria is also back in the spotlight.

Brian Lenihan's announcement that Irish banks will be rolling over €74.2bn of guaranteed loans, bonds, and other systemic support papers before October 1 guarantee is scheduled to run out is not helping the markets either. As Morgan Kelly, Karl Whelan and couple other analysts estimated - once again well ahead of our gallant DofF 'forecasters' - everyone dependent on the Irish government guarantees will be pushing their re-scheduling/roll-overs before October hits.

Surprised? You see - we used to have one main crisis back in 2008-2009: insolvency of banks balancesheets. It should have been resolved directly through recapitalization of the banks via equity take overs by the taxpayers and restructuring of the banks debts. Foolishly, we chose a different path:

• We facilitated banks rolling over debt - as if changing maturity date on the bonds that cannot be serviced changes the level of debt impacting the banks;
• We then proceeded to allow banks to name their capital requirements by allowing them to spread their losses over longer time horizon, as if changing the date of repayments start on a defaulting loan can make the loan perform;
• Following this, we pumped the banks with steroids of ECB facilitated lending - as if swapping few private bonds for ECB loans resolves the problem of balance sheet overhang;
• We created Nama to take bad loans off the banks balancesheets, but, realising the futility of the undertaking, went on to impose unrealistically low haircuts that simply sped up some of the very process of losses recognition in the second bullet point above. Given the levels of real impairments on the loans, Nama only bought banks more time to spread their losses, thus avoiding recognizing the problem of weak balance sheets and amplifying the problem of insolvency;
• Amidst all of this, banks became liquidity traps - sucking up vast amounts of funding. This was not fully satisfied by the ECB, so the banks engaged in predatory re-pricing of performing loans (mortgages etc) in a futile effort to get some more cash flowing;
• The insolvency crisis blew up into a liquidity crisis.
  

So now we have both. And no real way of resolving either or both.

We could have sustained this game, teetering on the brink between full insolvency and a credit crunch, if and only if the euro bonds markets were at the very least stable and the ECB was capable of parking collateral garbage it collected in exchange for banks loans for a long time. Alas, two things are currently under way.

First, the French bonds have slid off their 'safe heaven' pedestal over the last couple of weeks, with spreads over the German bund going up eight-fold since the end of 2009. French bonds are now posing massive liquidity risk to institutionals holding them. French Prime Minister declared last week that: “I only see good news in parity between euro and dollar”. In effect, the French are now openly inviting massive devaluation of the euro - something that is bound to disappoint Germany.

Second, there is no room for more Quantitative Easing, as the ECB has been exposed as an institution that has run out of reserves cover for its own operations. Last week, ECB balancesheet had more than 150% ratio of immediate liabilities to assets held. And that was only for liabilities vis-a-vis Greek rescue package.

Something will have to give, folks. Just as Ireland has precipitated its own implosion by pushing the liquidity crisis on top of our already formidable insolvency crisis, so the ECB and the entire euro zone is now working hard to achieve the same. We are now well behind that point of no return in monetary policy where promises to act with support for the sovereign bonds will be sufficient to stave off a run on the bond yields. Instead, the ECB's rhetoric will be tested, leaving it only one option - start running printing presses.

Now, those of you who followed my writings on the issue will say 'Good, we need a massive - €3-5 trillion - issuance of cash, don't we?' The problem is that while the answer is 'yes, we do', this emission cannot simply involve purchasing of more Government bonds. We need a direct, un-levered injection of new money into the system and it must be broadly based - going not just to the public coffers, but to private economies of the Euro area as well. ECB printing cash to buy Government debt will not reduce the debt levels for the Eurozone sovereigns (which means insolvency problem will remain and will actually increase), nor will it resolve the problem of liquidity crunch in the block (giving money to the Governments to finance roll over of existent debt is about as liquidity-enhancing as burning this cash in a fireplace).

The end game, in my view, can be only across three major disruptions in the euro assets:

• Collapse of the euro below parity of the US dollar; followed by
• Debt restructuring through offers to the bondholders to take a haircut (possible ranges: 35-50% for Greece and Portugal, 25-30% for Spain, 20% for Ireland and Italy, 15-20% for Austria, Belgium... and so on). These will be attempted first privately - via larger institutional consortia, with both sticks (threat of default) and carrots (some sort of delayed tax incentives?) being deployed to get larger institutional holders to accepts a drastic shave off; and once this is underway, the inevitable conclusion to the crisis will be:
• Imposing haircuts on banks bondholders, with the ECB standing by to hose the banks with cash, should liquidity dry up during the haircut imposition.
  

Finale: euro's credibility gone, euro/usd rate below parity persists, inflation will be running ahead of economic recovery and Europe will slide into a Japan-styled long-term depression.

In the mean time, before the end game, expect more bans on trading in various instruments (the French have finally agreed to the German-style ban on naked shorts) and more fiery rhetoric about speculators, destabilizing market forces and other gibberish from the dear leaders of Europe.


PS: All of this reminds me of a conversation I had with one very senior stocks analyst/strategist back in the middle of 2008 meltdown in the markets. I was concerned that the ways in which fiscal and monetary authorities were throwing cash at the banks were going to lead to both running out of policy space to continue accelerated supports for the sector and economy at large. "Charged by the bear, make sure you don't run out of all bullets early on. You might miss," I insisted. In response I was given a complete assurance that resolute actions on large scale (equivalent to unloading the entire magazine of ammunition at the shadow of the problem before actually having an idea as to what the problem really is) will mean that the 'Bear won't be charging for long'. I wish I was wrong... He still writes daily, weekly and monthly missives about the investment strategy for clients.

Economics 05/06/2010: Exchequer returns May 2010

May tax revenues are behind Budget plan, as talk about recovery is intensifying.

Recall, April was the month of allegedly improved (aka above the plan) tax revenues. May came in, bringing about a double whammy:

1. cyclical components were trending tax revenue down. As normal and forecasted by the DofF;
2. non-cyclical trend was also down, which was not predicted by DofF.
   

Oops. Tax revenue came up to €3.11bn in May or €141mln behind the target. This brought the annual (to-date) position on revenue side to some €148mln below target. Annualized rate of revenue decline is down to 10.4% (massive, still) from 10.8%. Budget assumes that tax revenue for 2010 will be 6% behind 2009 - €31.05bn instead of €33.04bn collected for 2009. I don’t want to venture a forecast here, but we are clearly in the uncharted waters of volatile bottom bouncing.

Here are my charts, per usual:
Chart above highlights seasonal cyclicality: Tax revenue up in May – just as it done in 2008 and 2009, but the swing is shallower than in previous 2 years. Total revenue uptick in May is better than in 2008 (when there was actual slight decline in the series), but the same as in 2009. Total expenditure is down, just as it did in May 2008 and 2009, although decline in 2008 was stronger. So we are somewhere in-between in terms of dynamics – neither 2008 with its calmer Exchequer conditions due to lags on revenue side, and the extremely disastrous 2009.

To-date, 2010 is shaping out to be on a slightly better local trend than the linear trend line for 2008-present, when it comes to tax receipts, although the local trend is still downward. Ditto for the upward trend in expenditure. Notice that we undershot expenditure trend by about as much as in 2008 and there is a significant improvement on 2009.

In short, there is no dramatic change between previous years and today. The crisis is still in full bloom, folks.

Some annual comparisons due:
You can clearly see how in comparative terms, monthly receipts so far been coming in at below 2009 levels except in March. Was that a boost due to scrappage scheme and the combined effect of 2010 license plates luring in the silly vanity buyers (we still do have folks who think a lower range car with 2010 plates beats a higher range one with 2007 ones – the Celtic Hamsters, as I would call them: stripes and all, but clearly short of Tigers. Also, notice that May 2009 uplift in receipts brought the monthly figure closer to May 2008 than current uplift shifted us toward May 2009.

Here is a crude comparative to the ‘target line’ – drawn based on the basis of -6% deviation in receipts. Now, these are monthly receipts, so it is not exactly coincident with the ‘real’ DofF target line (which, frankly, I can’t be bothered to trace as it is irrelevant, as long as the annual target is set at 6%). If you assume that there will be a pick up in revenue (outside the seasonality factors) in the second half of the year, hold your hopes for the annual figure to come on-target. However, my ‘target’ line is telling:
We are clearly underperforming the ‘target’ so far, although we are moving close to it. Another interesting feature is the comparative between the ‘target line’ and 2008 revenue, clearly showing that we are in for another shocker of a deficit even if we hit the target. The reason is simple – our current expenditure is not really declining significantly relative to 2008. Which means that unless revenue surprise in H2 2010 will be a massive one, the deficit is going nowhere compared to the 7-9% objective set out by our counterparts in the PIIGS.

Chart above shows another set of comparatives. This time on the expenditure side and deficit. On the expenditure side, we are running much closer to 2008 figure this year than in 2009. But we are still above the 2008 level. On deficit side, we are better off than in 2009 since March, but still worse than in 2008, although the gap is closing in May relative to January-March. One wonders what will happens once the latest Live Register changes hit the unemployment rolls and their income taxes stop flowing in, over months ahead. Remember, there are lags here as some of the redundancy payments are taxable.

Now, look at cumulative receipts to date:It is clear just how resilient our underperformance, relative to 2009 and 2008 is over the 5 months of 2010. Take a look next at total receipts, with the aforementioned ‘target line’ in:
Again, underperformance is evident. What is dramatic, however, is that after rounds upon rounds of various tax increases, charges, duties etc rises, we are still nowhere near seeing an uplift in tax revenues. A Laffer curve? Perhaps. Alternatively – collapse of the tax base? May be both. It is, nonetheless clear that following the Unions-suggested path of ‘tax em, don’t cut spending’ is not an option.

Total expenditure comparatives. There has been much said – domestically and internationally – about dramatic cuts in public spending. Really, folks?
Tell me if I am not seeing something, but the yellow line is not showing any really dramatic cuts – not the ones you’d expect for a country with 14% deficits.

Suppose we decided to cut half of our deficit out of expenditure side alone (presuming the other half comes out of increased revenue – despite this being unrealistic, entertain such a possibility). Let’s call this scenario ‘½ target line’. Alternatively, suppose the entire adjustment to 3% deficit was to be carried out of expenditure side – call this scenario ‘full target line’. The following will be consistent with an expenditure target, relative to 2009:
So we are doing no too poorly in terms of ‘half-target’ line, implying that the Government is aiming to either dramatically raise taxes (and hope that it will result in a significant revenue uptake), or they are hoping to discover some sort of precious metals deposits somewhere in the bogs, perhaps at the end of a rainbow. Otherwise, we are not on track to any fiscal recovery, just to a moderate decrease in the deficit.

To Government’s credit, however, let us note that spending is down 8.9% yoy over the first 5 months. Then, of course, to their discredit – most of this decline came out of cuts to capital spending. Note also, reductions in spending are running on 2009 figures. That means that yoy we are currently saving some €1.7 billion (over 5 months) – a sizable chunk. Capital side of spending accounts for €890mln of that. Sounds like pretty fair? Well, not really – capital spending last year was held back until later in the year. Which means that in real terms, capital spending in the first 5 months of 2010 is a whooping 36% down on the same period in 2009 and is running at roughly 20% below 2009 annualized rate of spend. And the source of these capital savings? Oh – DofTransport and DofEnvironment – the two account for some 70% of the cumulative 5-months shortfall.

So the strategy might be: cut spending on roads and transport, charge people more for poor quality commute (‘carbon’ tax and fuel excises) and replenish the coffers… In other words, don’t dare call it a tax on income, but the twin contraction in investments in improving transport and expansion of taxes on commute are in the end exactly that. Unless, of course, you are in the Dail or Seanad – in which case, it’s Alice in Wonderland life for you, courtesy of commuting subsidies.

Current spending is only 5% below last year’s, generating savings of €850mln – bang-on with expectations. This masks two sub-trends:

• There has been 10.5% drop in overall current spending outside the Dof Social Welfare/Protection; and
• DofSocial Protection is running up 13.1% on current expenditure. Wait, as I’ve said before, until the latest additions to Live Register kick in and before a significant wave of long-term unemployed start getting into much more extensive social welfare benefits.
  

Final comparatives, therefore:
Yes, the deficit is improving on cumulative basis and on 2009. But we are far off the deficit figures for 2008 and our dynamics are pointing to no convergence toward 2008. Now, recall that in order to return back to 2008 deficits we need to also take into account that since 2008, Irish economy has contracted significantly. In other words, the task of restoring 2008 deficit levels (not spectacular either) will take even more cuts out of us today than we are so far willing to deliver.

Economics 05/06/2010: Economics of Fiscal Stimulus

This is an unedited version of my article for June-July issue of the Village Magazine.

Weeks into a new round of ‘talks’ over the public sector reforms and Ireland’s Policy Kindergarten squad is getting more agitated by the issue of cuts in the Government expenditure. The logic of their arguments, led by the likes of Tasc, the Irish Times, and an army of Unions-employed ‘economists’, is perverse: “In order to get the economy back on track, we need to borrow more and spend on public services and wages.”

There are three basic arguments why stimulating Irish economy though increased public spending won’t work in the current conditions even in theory, let alone in practice. These are: the structural nature of the fiscal crisis we face, the size of the debt we face, and the lack of evidence that stimulus can work in a country like Ireland.

Structural deficits

Economists distinguish two types of deficits: cyclical and structural. The first type of deficits occurs when a temporary economic slowdown leads to an unforeseen decline in revenue and acceleration of certain components of spending (e.g. unemployment insurance and social welfare). By its definition, the cyclical deficit will be automatically corrected once economy returns to its long term growth path.

In contrast, structural deficits are those that arise independently of the short term changes in economic growth. They are the outcome of unsustainable increases in permanent spending and/or decline in the long term growth potential that might arise from a severe crisis.

In the case of Ireland, both of the latter factors are at play. Various estimates of the extent of structural deficits carried out by the likes of IMF, OECD, the European Commission, ESRI and independent analysts range between one half and two thirds of the 2009 General Government deficit, or 7-9.5% of GDP.

Reckless expansion of Government spending in the period of 2001-2007 is the greatest cause of these – not the collapse of our tax revenue. In the mean time, our economy’s long-term growth rate has declined from the debt-and-housing-fueled 4.5% per annum to a Belgium-like 1.8% per annum.

In 2000, General Government Structural Balance stood at roughly -0.5% of GDP. By 2008 this has fallen to almost -11% courtesy of a massive build up in permanent staff increases in the public sector, rises in welfare rates, explosion in health spending and creation of a gargantuan army of quangoes and supervisory organizations.

Forget, for a second, that majority of these expenditures represented pure waste, delivering nothing more than top jobs for friends of the ruling class, plus scores of jobs for public and quasi-public sector workers. Between 1981 and today Ireland has recorded not a single year in which Government structural balance was positive. Windfall stamps, VAT and capital gains tax receipts over 2001-2007 have masked this reality, as Goldman Sachs structured derivatives masked the reality of Greek deficits.

We are not getting any better

Over the recent months, the Government has been eager to ‘talk up’ our major selling points. Ireland, it goes, is a country with stabilized public finances and low debt to GDP ratio.

Last month, Eurostat exposed the lie behind the ‘stabilized public finances’ story. It turns out our Government has decided to sweep under the carpet billions of cash it borrowed in 2009 to recapitalize Anglo. Courtesy of this, our deficit for 2009 was revised to a whooping 14.3% of GDP – topping that of Greece.

But Irish General Government deficit this year is expected to come in between 11.7% and over 12% of GDP, depending on who is doing the forecasting – Department of Finance or ESRI. And this is before we factor in March 2010 statement by the Minister for Finance, promising over €10 billion for the banks this year. This means that, as the rest of the world is coming out of the recession, our fiscal deficit for 2010 is expected to either match or exceed the revised level achieved in 2009. Some stabilization.

Irish Government debt is expected to reach 78-82% of GDP by the end of 2010 – on par with Eurozone’s second sickest economy, Portugal. With Nama and banks recapitalizations factored in, Irish taxpayers will be in a debt hole equal to between 117% and 122% of GDP by 2011 and to 137% by 2014. At the point of the Greek debt crisis implosion last year, Greece had second highest debt to GDP ratio in the EU at 117%, after Italy with a massive 119%.

In totality, current crisis management approach by the Irish State is going to cost every Irish taxpayer in excess of €117,000 in added tax liability. Neither Iceland nor Greece come close.

Economy on steroids

Still think that we should be stimulating this economy through more borrowing?

Take a look at the private sector debts. In terms of external debt liabilities, Ireland is in the league of its own amongst the advanced economies. Our overall debts currently are in excess of the critically high liabilities of the HIPCs to which we are sending intergovernmental aid. And rising: in Q3 2009, our external debt liabilities stood at a whooping USD 2.4 trillion, up 10.8% on Q3 2007. Of these, roughly 45% accrue to the domestic economy – more than 6 times our annual national income.

Ireland’s share of the world debt is greater than that of Japan and more than double that of all BRICs combined, once IFSC companies are included. Over the next 5 years, the entire Irish economy will be paying out around €206,000 per each taxpayer in interest on this debt. Adding more debt to this pile is simply unimaginable at any stage, let alone when the cost of borrowing is high and rising.

These figures show that the main cause of the current crisis is not the lack of liquidity in the system, but an old-fashioned problem of insolvency.

This problem is directly related to the actions of the Irish state. Over the last decade, there was a nearly 90% correlation between the average increases in the Irish tax revenues plus the rate of economic growth and the expenditure growth on capital and current spending sides. In effect, courtesy of the ‘Boom is getting boomier’ Ahearn/Cowen team Ireland had two bubbles inflating next to each other – a private sector borrowing bubble and a public sector spending one. Government’s exuberant optimism, cheered on by the Social Partners – the direct beneficiaries of this ‘fiscal policy on steroids’ approach – explains why during Brian Cowen’s tenure in the Department of Finance, Irish structural deficit doubled on his predecessor’s already hefty increases.

But what went on behind the glossy Exchequer reports was the old-fashioned pyramid scheme. Some got rich. Temporarily, we had an army of politically connected developers and bankers stalking the halls of premier cars dealerships and property auction rooms.

Permanently, an entire class of public employees reaped massive dividends in terms of shares in privatized enterprises that cumulated in their pension plans. Current claims that because the values of some of these payoffs have declined over time (often due to the intransigent nature of the unions in the semi-state companies, staunchly resisting change and productivity enhancing reforms) is irrelevant here. Prior to their privatization, these companies were called 'public' assets. Creation of any, no matter small or large, private gains to their employees out of the companies' privatizations or securititization through pensions funds liabilities of their assets in favor of employees, therefore, is nothing more than an arbitrary, unions-imposed grab of the public asset.

Benchmarking, lavish pensions and jobs security – also paid out of the economy leverage (just think of the NPRF - explicitly created to by-pass the illegal, under the EU rules, taxation of economy for provisioning for future public sector pensions liabilities) – was a cherry on top of the cake. Public companies management got dramatically increased pay and a permanent indemnity against competition through a regulatory system that was all but a client of their semi-state companies.

From our hospital consultants to our lawyers, academics and other professionals – a large army of state-protected, often non-competitive internationally professional elites collected state-subsidised pay so much in excess of their real productivity that we became the subject of diplomats’ jokes.

Our state’s response to this was telling. Just as the country was borrowing its way into insolvency, our Government gave billions to aid developing nations. That was the price our leaders chose to pay to feel themselves adequate standing next to Angela Merkel and Nicolas Sarkozy at the EU summits. Incidentally, as the country today is borrowing heavily to cover its basic bills, Brian Cowen still sends hundreds of millions of our cash to aid foreign states and has recently decided to commit over €1,000 million – full year worth of the money he clawed out of the ordinary families through income levies – to the Greek bailout package.

Economics on Steroids

Still think more state-centred economy is the solution to our problem? Irish economists, primarily those affiliated with the Unions are keen on talking about the ‘positive multiplier’ effect of deficit-financed stimulus. Sadly for them, there is no conclusive evidence that borrowing at 5 percent amidst double-digit deficits and ‘investing’ in public services does any good for the economy.

Firstly, one has to disregard any evidence on fiscal stimulus efficiency coming out of the larger states, like the US, where imports component of public and private expenditure is much smaller than in Ireland. The US estimates of the fiscal stimulus multiplier also reflect a substantially lower cost of borrowing. Even if Ireland were to replicate US-estimated fiscal stimulus effects, higher cost of our borrowing will mean that the net stimulus to Irish economy will be zero on average.

Second, international evidence shows that for a small open economy, like Ireland, the total fiscal multiplier effect starts with a negative -0.05% effect on economic growth at the moment of stimulus and in the long run (over 6 years) reaches a negative -0.07-0.31%. Add the cost of financing to this and the long-term effect of deficit financed stimulus for Ireland will be around -2.3% annually.

Third, no one on the Left has a faintest idea what the new spending should be used for. Simply giving borrowed cash to pay the wage bill in the public sector would be unacceptable by any ethical standards. Any investment that is bound to make sense would have to focus on our business centre – Dublin, where infrastructure deficit is acute and potential demand is present. Alas, this will not resolve the problem of collapsed regional economies. Pumping more cash into the ‘knowledge economy’ absent actual knowledge infrastructure of entrepreneurship, private finance, skills and without a proven track record of exporting potential, is adventurist even at the times of plenty.

In short, the idea that expanded deficit financing will support any sort of real recovery in the economy is equivalent to arguing that pumping steroids into a heart attack patient can help him run a marathon.


Ireland needs severe rethinking and reforms of the grossly inefficient and ethically non-sustainable spending and management practices of our public sectors. It should start with significant rationalization of expenditure first and then progress to a more deeply rooted revision of the public sector objectives and ethos.

Ireland also needs a significant deleveraging of what is a basically insolvent economic structure. This too requires, amongst other things, a significant reduction in overall public spending. Far from ‘borrow to spend’ policies advocated by the Left, we need ‘cut to save’ policies that can, with time, yield a permanent increase in the national savings rate, productive private investment and improved returns on education and skills. Otherwise, we might as well give our college graduates a one-way ticket out of Ireland with their degrees, courtesy of Tasc and the Unions.

Economics 04/06/2010: Bond markets are still jittery

For all the EU efforts:

• Throwing hundreds of billions into the markets in bonds supports;
• Banning 'speculative' transactions;
• Talking tough on reforms;
• Bashing rating agencies into a quasi-submission; and
  
• Proposing a 'markets calming' [more like 'markets killing'] financial transactions taxes

There has been preciously little change in the way the bond markets are pricing sovereign debt of the PIIGS. More ominously, the crisis is not only far from containment, it is spreading. Following PIIGS, the attention is now shifting onto BAN countries - Belgium, Austria and Netherlands. And in the case of Austria, the unhappy return of the Eastern European woes is now seemingly on the cards.

How so? Look no further than Hungary. The country had taken IMF bailout money, promising to deliver severe austerity measures. It now faces a new round of pressures due to once again accelerating deficits. It looks like the cuts enacted were not structural in nature, amounting to chopping capital expenditure programmes rather than current spending... Sounds familiar? so here we go again (courtesy of Calculated Risk blog): spreads are rising (Ireland's position as the second sickest country by this metric remains unchallenged) and CDS rates are rising as well (Ireland's still in number 3 spot).
As Calculated Risk points: "After declining early last week, sovereign debt spreads have begun widening for peripheral euro area countries. As of June 1, the 10-year bond spread stands at 503 basis points (bps) for Greece, 219 bps for Ireland, 195 bps for Portugal, and 162 bps for Spain."

Let's get back to Hungary, though: yesterday, Hungarian officials said that instead of 3.8% of GDP deficit target, 2010 is likely to see the deficit widening to 7-7.5% of GDP. Who's to blame? Well, per Reuters report: '"fiscal skeletons" left by the previous Socialist administration'.

Economics 02/06/2010: Regional variations in labour markets

While working on a project relating to economic policies in Ireland, I was compiling data on regional variations in various series. Here is a set of interesting graphs detailing the labour force differences across the main regions.

Each data set reflects the latest available QNHS data through Q3 2009 and each is presented in two charts - full history and a snapshot of the crisis dynamics since 2007.

First the unemployment rates
Notice that since time memorial Dublin runs at or below average in terms of unemployment rates. This pattern is no persistently broken, with Dublin unemployment performing remarkably better in this crisis. Also note that the top tier of unemployment black spots in the country also remains relatively resilient over time. This has to put to test any assertion that state policies to deal with longer term unemployment are working.

Take a look at a closer time frame, relating to the current crisis:
You hear a lot about the MNCs and exporting companies holding our line from a total collapse of economy. Well, say the same for Dublin, South-West and Mid-East. Of course, the latter is largely, hmmm, Greater Dublin, really.

The chart above also hints at something more disturbing here. Recall that early rounds of layoffs impacted predominantly construction sector and associated services. Well, look at Midlands and South-East. It does appear that the two regions were experiencing significantly faster rates of jobs losses in the early parts of the crisis than any other region.

One wonders what is the exact distribution of jobs in the country relative to places of residence. This, of course, is a long running question that CSO is refusing to ask on QNHS. What trouble can there be, folks, in asking a recipient to state where they physically work. It would tell us a lot about people's commuting patterns (helping to better plan transport systems) and about where people are actually employed (helping us to better plan associated business services provisions). But no - CSO staunchly refuses to ask. Why? Because the state is most likely unwilling to admit that the National Spatial Strategy and the IDA/EI mandates to produce jobs for regions is failing. Ireland has natural hubs of jobs and jobs creation potential - Greater Dublin area, Cork area, Galway-Limerick area. This is where jobs concentrate and where companies want to be. So how about a challenge to CSO - ask an important question, will you? Have some gumption...

Back to data: labour force participation rates next
What the charts above show is the precipitous decline in labour force participation rates since the peak of H2 2007. And these declines are worrisome, for we normally tend to ascribe the destructive effects of the economic crises to unemployment, forgetting about those who leave the work force altogether. Well - take a look at charts above.

Another disturbing realization on the foot of the above charts is that regions with lowest participation rates also tend to be regions with higher unemployment. This is important because it signals that even in a small country like Ireland, mobility between residential location and work location is still restricted (by distance, lack of proper roads, transport shortages etc). It also suggests that in the long run, areas with higher unemployment tend to become traps for non-participation in labour force. The vicious spiral of being jobless in an area with no jobs creation leads to becoming disillusioned and dropping out of the work force for good.

And this implies higher rates of overall dependency. Remember - these are numbers for able bodied adults. So if we take the rate of unemployed and add to it the rate of those who are not in the labour force, we get a proportion of population that needs someone else to work for them to sustain themselves. Now, a caveat here - of course some of those who are not in labour force are gainfully engaged in work at homes - non-market activities that are productive and include, among other very important ones, like carrying for the elderly or ill, raising children etc. These, however, are not the majority in these numbers. Nor are they likely to be distributed predominantly into higher dependency areas of the country. So conclusions presented below stand:
Predictably, the lowest dependency ratios are in high work regions: Mid-East and Dublin. And although these ratios rose in these two regions through the crisis, they are still well below the national average and leagues below the dependency ratios for the likes of Border and South-East regions. Here's a closer look:
Of course, what these trends mean is that throughout the entire series duration (from 1998) Dublin and Mid-East have acted as a subsidy generating regions for the rest of the country. Someone had to pay for the higher dependency rates in regions that are above country average (since the welfare rates are not varied geographically).

Economics 02/06/2010: Live Register - no longer flatlining

Liver Register numbers are out today, erasing much of the optimism that might have been building up about unemployment figures over the last couple of months. Here are the updated charts:
Unemployment rate is now rising again, reaching 13.7% after staying flat for the last four months at 13.4%. My forecast in January was that we will hit 13.5% in May. I was wrong. Well, not as wrong as some of our 'official' forecasters who were saying that we are turning the corner on unemployment...

Let's put today's news into perspective:
Notice 'missing' bubbles before May? That is because we had no growth in LR figures (they were actually shrinking) in February-April. Since the beginning of the year, mom, LR increased by 5,800 in January, fell by 2,300 in February, rose by 600 in March and contracted by 500 in April. With May increase of 6,600, we now have a net addition to the LR over the first 5 months of the year of 10,200. The Exchequer cost of these will be around €325 million per annum. In fact it will be probably higher as contractions in employment most likely have taken place in higher value added sectors, given that construction sector has virtually no jobs left to lose.

Taking a slower snapshot of the LR:
You can clearly see an uptick in the series in May. Given how relatively 'sticky' (trend-driven) LR is, this suggests that we might be heading for a new acceleration.

Next consider average weekly series. These are not seasonally adjusted:
However, taking seasonally adjusted data and extracting monthly series shows that we are firmly above the 'stabilization' line of zero change in the LR mom:
So here you have it - labour markets beg to differ from the Government's official line that 'all indicators point to a recovery'...

Economics 02/06/2010: Central bank data analysis

Latest monthly data from the CB is out and here are a couple of updates on series I've been covering before.

First harmonized competitiveness indicators (EU-wide data update coming soon):
Notice some serious progression on competitiveness front is finally starting to take place. This is good. The trend is also good - strong downward trajectory in the series since November 2009. Accelerating again since March. Data lags should not be this significant, so I will be keeping a watch on earnings data from the CSO.

For all the good news, so far we are still in the zone of low competitiveness, down to March 2006 level and well above the period when Ireland Inc was performing at much stronger rates in the 1990s. Remember, these are real indicators, so price levels changes since the 1990s are factored in already.

Private sector credit. First the totals:
We are back to August 2007 levels and the fall rate is slowing down. Year on year change, subsequently, is flat at -9.3% same as in March. Too early to call it a recovery or even a full stabilization, as seasonality suggests that we might see some trend reversal in the short run. Remember, these are declines on already bottom-hitting 2009!

Next: mortgages.
Levels are down to July 2008 and the rate of decline is -1.6% yoy, compared to -1.4% in March. This, however, can be due to a significant declines in mortgages due to write-offs of defaulting loans. In addition, this deterioration rate might be also masking the fact that pretty much anyone in distress who could have done so has already re-negotiated their mortgages in 2009. Thus, only the really tough cases are still sitting out there.

The data on actual new borrowing is below. At the aggregate levels, there is no turn around in household investment, which, of course, is the main leading indicator of recoveries. Also worrisome is the fact that there is no deleveraging of mortgages debt.

Private sector credit outside mortgages is dynamically virtually identical to the total private sector credit figure reported above. Year-on-year changes seem to be reflective of some seasonal effects, with improved rate of contraction in April. General trend is for flatter rates of decline overall since about January. This means little, however, as we need a term structure decomposition of credit in order to tell if this is really a flattening of the downward trajectory or simply restructuring of non-performing lines of credit.

Now, let's take a look at actual changes in rates and volumes in PS credit. First, new loans:
Notice that both for corporates and households, longer term rates are moving up, while shorter term rates are moving down. This likely reflects banks' and interbank credit markets' expectation for a steepening in the interest rate curve, plus some easing in wholesale cost of credit in March. Also note that mortgage rates for new, and especially for fixed rates, mortgages are rising. Hardly a robust support for the housing market.

On corporate investment side, sizable declines for short term maturity loans - operating capital, and reasonably improving environment for larger investment-suitable loans with longer term fixes.

On volumes side, there is a worrisome increase in all shorter term loans - a sign that both companies and households are reliant increasingly on short bank finance for operational and short-term credit. This might mean two things:

1. These increases might reflect increase in supply against a pinned up demand; or
2. These increases might be consistent with increased cash flow pressure on companies (if non-payment and defaults by clients is rising) and households (if arrears are building up on the side of unemployed and underemployed after the households have gone through their savings and redundancies).

We can't tell which one of these forces is operative here. But it does not look to me like operational demand is rising naturally. Remember, so far we only have strong exports performance across the economy. This means you would expect an increase in trade credits (short-term). Most of trade finance in Ireland is actually not done via Irish banks, but through MNCs-own global arrangements. Apart from exports, it is hard to see where organic demand for short term loans would come from.

An even more interesting picture is emerging when we look at existing clients:
Notice how all of the rates changes (except for 5 year plus maturity corporate loans) are trending up? Are the banks ripping off their existent client base to beef up their margins? Well, lets put these changes side by side:
Notice that the above table comparisons are really only loose approximations. But there is a remarkable regularity with which existent loans holders are being loaded with the almost opposite type of changes in rates charged as compared with new clients.

Economics 1/6/2010: Numbers game at Anglo

Last night, I sat down to run through possible scenarios for the Anglo's 'The Bad and the Ugly' Banks division. You see, something was telling me right off the start that the idea of a 'Good' Bank just doesn't really square off with our knowledge of the bank's operations to date.

So I posited to myself the following question: given Nama transfers and rumored split off of €12-15bn worth of loans into a 'good' bank, can the resulting entity be viable? Like a scientist in a lab, I donned on a white coat (well, really my favorite UofChicago sweatshirt), pulled out a Petri dish (my Excel) and started observing the split of that outright not-so-beautiful and very toxic (to the taxpayers) bacteria, called Anglo...

Here are the results, first in numbers and then in plain English:

Step 1: recall we have pumped €10.3 billion worth of promisory notes into the bank alone. Relying on my yesterday's analysis (see details here), I reproduced the demand that a 'Good' Anglo will generate for funding these promisory notes. Now, a reminder - these numbers (penultimate column) correspond to interest only charge on Anglo from the promisory notes. They exclude principal repayment and other recapitalization funding already in the bank.
Bah, I said, the thing in the Petri dish of mine looks pretty ugly. Ugly as in unable to cover the taxpayers-due interest on capital it receives at the first glance.

Ok, I said to myself, but may be were the new 'Good' bank to grow over time, it will become relatively viable with time? Suppose the 'Good' bank generates no impairments going forward (unrealistic assumption, but suppose it does), suppose that 'Good' Anglo grows its book at 5% (generating no new impairments). Further suppose that there's some value in the 'Bad' bank - so assume 20% of the loans transferred to it perform in the future (an extremely optimistic assumption, but what the h***ll, not much out of line with the general assumptions the Government has been making all through its management of the crisis).

The question I asked then was: with all these rosy assumptions in place, what amount of interest payments annually can Anglo afford?

To compute this, I took several scenarios:

1. I allowed 'Good' Anglo to take €12 or €15 billion in loans on board;
2. I assumed that it generates 2% of the loan book annually (another optimistic assumption - as it corresponds to an efficiently operating bank in terms of costs, book of business and funding costs - all of which are not exactly characteristic of the Anglo)
3. I then assumed three different potential burden levels on interest (recall, no principal) repayment at 30% of the total annual return by the bank, 25% and 20%. Let me explain here that a 30% number is utterly unrealistic, implying that almost a third of the entire operating revenue of the bank will be used to pay interest on a small share of its capital funding. This will, in effect, leave no surplus to pay bonuses (of any kind) and dividends (of any kind) as well as to finance bank's insurance etc. 25% mark is also unrealistic, while 20% is back-breaking for a bank, but can be probably sustained over a couple of years.

Table below shows the results by stating the amount of interest repayment that the bank can generate across both its 'Good' and 'Bad' divisions. Blue-bold numbers mark the first time that the annual interest funding requirement gets met.
All of this is fine, I said to myself next, but before the interest requirement is first met on the annual basis, there are years of the bank not covering the interest bills. These will cumulate.

My next question, therefore was: How soon can the bank break into the 'black' vis-a-vis interest repayment alone?
Table above shows the cumulated interest arrears from the €10.3 billion in promisory notes. It clearly shows that under all scenarios, save one (the most optimistic scenario) the entire Anglo operation cannot be expected to generate enough cash to cover even the portion of its interest bill. In fact, under the more realistic scenario (last two columns), Anglo - 'Bad' and 'Good' combined - will continue to accumulate interest arrears on the taxpayers funds (ex €4 billion in direct capital it received) through 2020.

There is no principal repayment charge in the above, nor is there a chance of receiving anything close to the interest bill, even assuming that we do not roll up interest on the cash we put in. In simple words - the entire Anglo operation is so fundamentally bust, that the taxpayer is likely to never receive even a few cents on the euro of the money we've put into it.

The only thing that grew in my Petri dish was a voracious bacteria capable of hoovering taxpayers money at a speed unimaginable to any other bank.

One wonders if that is what Mr Alan Dukes and our Government mean when they are saying that proceeding with keeping Anglo on a respirator amounts to minimizing the cost to the taxpayers.

Economics 31/05/2010: Anglo's latest cash call

This just in - the Government has decided to give Anglo, yes, that very Anglo which is Ireland's real zombie bank with no prospect - even theoretical one - a fresh capital injection of €2 billion (here). This brings taxpayers' capital injected into the bank to €14.3 billion to-date.

The official information by DofF claims that because the injection comes in a form of a promisory note, payable over 10-15 years, there will be lesser impact on the taxpayers today. However, although the official announcement does not say so, this term structure of payments means that our future deficits will be front loaded (pre-committed to the amount announced today), implying that for Ireland to reach required 3% deficit/GDP limit by 2015, we will have to face an increased funding requirement for Anglo over time.

This requirement must be provisioned today, since the notes work in the following way:

• At any point in time between today and 10-15 years from now, Anglo can waltz into DofF's offices and ask for any share - between 0.00001% and 100% of the amount issued on the promisory note.
• At that moment, the Government will have to come up with cash pronto, which means - no time to issue separate bonds.
• Which implies that the very second Mr Dukes asks for cash, our deficit goes up by that exact amount.

Now, prudentially, we should have set an escrow account and provided for this funding. In practice, as is clear from the DofF release, no provisions will be made. The entire, and I repeat, the entire risk of the drawdown therefore is leveled on the shoulders of taxpayers. The DofF in effect is praying to the forces of fortune that Anglo won't come in with a request for funds tomorrow, and/or that any request will not be for the entire sum of the promisiory note.

Now, let us revert back to the 'bank' called Anglo. The State has now committed €10.3 billion in promisory notes. These carry interest rate of... well, I am not sure... but suppose it is 5% to cover the cost of borrowing for these funds in the market, once the funds are disbursed. Assume that 10% of that (actually below a normal charge for a letter of credit for an insolvent company) is outstanding annually until a drawdown. Make a further assumption: assume that Anglo will draw the entire amount in equal annual installments over 5 years - an assumption that is also extremely conservative.

At 5% per annum, Anglo's liabilities to the taxpayers are:
Let me quickly and briefly explain the last 2 columns above. The penultimate column shows the sum of interest charges (at 5% on drawn funds), plus underwriting charge (at 0.5% for undrawn promisory note funds remaining) that Anglo should be paying over the next 10 years, assuming draw down is evenly spread over 5 years on both tranches. The last column then states the amount of loans that are performing that Anglo needs to have on its books in each year to cover the loans interest, not the principal, but interest, assuming that Anglo uses 0.5% of the loans to cover its interest rate, which would roughly amount to 25-30% of its entire interest income on the loans (note - that is really a severe case of the credit squeeze on a bank, but hey, suppose they manage without breaking the back).

How do I come up with this 25-30% estimate? In a normal year, one can expect a fully efficient bank to make ca 2% of their loans volume in revenue. If it pays 0.5% of that amount to cover costs of promisory note, it will be swallowing 25% of the revenue base.

Now, Anglo is transferring to Nama some €35 bn worth of loans, leaving it with ca €30 billion in remaining loans on its books. Of these, roughly 60% is expected to go into the 'bad' bank - in other words, roughly €18 billion worth of loans won't b performing. This leaves it with roughly 40% of loans or €12 billion on the side available for revenue generation. It needs ca €28 billion to cover the cost of the prmisory notes alone...

Get the picture? Even if you dispute my assumptions and half all the costs of the promisory note carry, you still can't get Anglo balance sheet to cover the cost (not the principal) of what it is borrowing from the taxpayers. This puts into perspective the DofF claim that: "As the Minister stated last March the overriding objective of the Government is to minimise the cost to the taxpayer of the restructuring of Anglo Irish Bank".

Economics 31/05/2010: How much more evidence do we need?

In the spirit of my earlier posts on the matter - here is today's press release from Ryanair. Let me add, uncontroversially, that I fully subscribe to Ryanair view that our travel tax (defacto assigned in the Irish Times op ed to Gurdgiev-Ryanair [campaign against the] tax, but since then spreading to include on the opposition side all main airlines based in Dublin) has been hurting tourism in Ireland, while imposing an arbitrary, unnecessary and unjustifiable burden on ordinary families here.

RYANAIR BELIEVES IRISH GOVT HAS CAUSED OUR TOURISM COLLAPSE AS GROWTH RETURNS TO OTHER EU COUNTRIES

INDEPENDENT REPORT SHOWS THAT ONLY COUNTRIES WITH TOURIST TAXES CONTINUE TO DECLINE

Ryanair, Ireland’s largest airline, today (31^st May) published irrefutable evidence that the Irish Govt is responsible for the collapse in Irish tourism as new (independent) statistics show traffic growth has returned to those EU countries that do not impose tourist taxes. These statistics disprove Minister Dempsey’s claims that the fall in traffic and tourism is ‘an international phenomenon’ and proves that Irish tourism is being devastated by the Govt’s €10 tourist tax.

The RDC Aviation report (attached) highlights that Irish seat capacity (which drives passenger numbers) collapsed by over 140,000 in April and by over 700,000 so far in 2010. Seat capacity continues to decline in Ireland, the UK and France - the only European countries which continue to impose tourist taxes. By contrast, growth has returned to countries which have scrapped tourist taxes (Belgium and Holland) or reduced airport charges, in some cases to zero, (Spain) to stimulate tourism growth.

Ryanair warned that this downward trend at Irish airports will worsen throughout 2010 as the DAA makes Ireland even more uncompetitive with a 40% increase in the airport charges to pay for its €1.2bn T2 white elephant.

RDC Aviation: Irish Airport Capacity Jan-Apr

Year	Seats
2009	5,021,727
2010	4,321,433
Decline	– 700,294

Ryanair’s Stephen McNamara said:

“The RDC Aviation report shows that those countries, like Ireland, which impose tourist taxes continue to decline and disproves the Dept of Transport’s claims that the continuing record collapse in traffic at Dublin Airport is ‘an international phenomenon’. The Irish Govt’s €10 tourist tax and high charges at the DAA Monopoly have made Dublin an uncompetitive, expensive destination. Growth has returned throughout Europe except in Ireland, the UK and France which are the only major European countries to tax tourists instead of welcoming them.

“Ireland’s traffic and tourism decline will increase when charges at the DAA Monopoly rocket by over 40% in October as the Dept of Transport rewards the DAA for its traffic decline and the €1.2bn white elephant, T2. Unfortunately 2010 will be even worse than 2009 in terms of lost visitors, jobs and tourism revenues in Ireland. It is time to axe this stupid €10 tourist tax and slash the DAA’s high fees”.

Economics 30/05/2010: A gargantuan task ahead

As the Government continues to insist that the worst is over for Ireland Inc, let us consider some headline numbers on the structure of our public spending.

The figures reported below refer to 2008 comparisons, so they omit most of the horrific fall-out from the current economic crisis. as such, these comparisons relate more to the structural imbalances our state is running, not to the recessionary effects. This is worth keeping in mind, for it means that the differences between Ireland and other states reported below, as well as the adjustments required for us to reach sustainable long term equilibrium on spending and taxation sides will have to be put in place no matter what happens to our economy in years to come. It is also worth keeping in mind because the figures reported below underestimate the extent of our post-2008 imbalances compared to other countries that had experienced much less pronounced crisis over 2009.

All data is taken from the publicly available sources - the IMF and CSO - so the Government and our tax-and-spend crowd of Unions-led economists are fully aware of these. Plausible deniability does not apply, therefore, when it comes to our Government pronouncements about its policies and the current position of the Irish economy on international competitiveness scale.

Chart above plots Ireland's position vis-a-vis its peers in the developed world in terms of the overall size of the primary (non-capital) share of public expenditure in the economy. Two facts worth highlighting here:

• Ireland's Government spending as a share of our real economic income (GNP) is the second highest of all countries in the group, and is well in excess of the average for small open market economies (SOME). It is in excess of Germany (Berlin) and well ahead of the US (Boston).
  
• By this metric, Ireland simply does not qualify as a 'market' economy, as domestic private sector accounts here for less than 47% of GNP! In the USSR of the 1980's, private economy (black market) accounted for around 40% of the total GNP. Get the comparison?

Chart above shows that Irish public sector is clearly one of the most lavishly paid one in the entire developed world. In fact, our public sector wages and earnings swallow over 14.4% of our national income, making Ireland's PS workers the 5th highest paid (on aggregate) in the advanced world. The gap between Irish public sector earnings bill and that for the average SOME is a massive 4.47% of our GNP. Roughly speaking Irish public sector wages bill contains a roughly speaking 48% premium relative to the PS counterparts in similar economies around the world. Clearly, even the reductions in overall take home pay imposed on PS in Budgets 2009-2010 has not erased this premium, especially when one recognizes that since 2008 our GNP has contracted almost in line with the decline in PS pay.

Chart above maps Ireland relative to the US (Boston) and Germany (Berlin) to show just how absurd the whole notion of Ireland Inc being positioned between Boston and Berlin is in the real world. In reality, just one parameter - Social Benefits as a share of GDP/GNP - marks our relative position as being between Boston and Berlin. In every other parameter, we are a basket case of excessive public spending and taxation relative to both the US and Germany.

With the above data in mind, what adjustments in the budgetary positions will be required to bring Ireland into the exact position of being between US and Germany to reflect our stated competitive benefit of being an economy that can facilitate trade and investment flows between the two giants - the EU and US?
To restore our competitive balance we need:

• A cut of €23 billion in gross annual primary spending by the state (current expenditure) - some 14.7% of our GNP. Not €3bn as Brian Lenihan is doing, or €3.5bn as An Bord Snip Nua was suggesting. A whooping €23 billion, folks!
• The cut above cannot come from the capital budget side - where most of the cuts so far took place. It has to be cut from the current expenditure. The reason for this is simple - capital spending is one-off item of expenditure and it is associated, in theory, with a net positive return on investment. Current spending is permanent and yields no financial return.
  
• The cuts must include at the very least a €9.3bn reduction in the wages and pensions bill in the public sector (5.9% of GNP or almost 44% cut in the total PS wages bill, achievable through both reductions in numbers employed and wages paid and pensions benefits entitlements).
• Social benefits, at least in the long run, actually are in line with us being smack between Boston and Berlin, so no adjustment is needed here in the short term (given further deterioration in the fiscal position in Ireland since 2008, I would actually recommend a temporary cut here. Also, longer term reforms, to change the structure of welfare benefits and state pensions must be enacted, but for the reasons different from the budgetary considerations).
• Instead of raising tax revenue, Irish Government should engage in a dramatic reduction of tax burden on the economy. Generally, total tax take in the Irish economy exceeds the average Boston-Berlin position by 6.5% of GNP, requiring a reduction in overall tax burden of €10.3bn on 2008 numbers.
• This reduction in the tax burden should include a cut in personal income tax, CGT and personal gains/profits taxes of 2.1% of GNP or €3.3bn.

There is absolutely no ground for our Government and policy leaders' claims that Ireland is strongly positioned between the low(er) tax US and high(er) tax Germany as a competitive destination for exports and investment arbitrage. In fact, due to the Government-own policies, fiscal and tax imbalances created in this economy mean that we are, at a macroeconomic level, grossly uncompetitive relative to

• both the EU and the US,
  
• as well as relative to our main competitors world wide - the small open market economies.