04/08/2011: Safe Haven within a small open economy

Some interesting news flow on the Swiss Franc side today with the Swiss National Bank announcing that it will intervene in the markets across not just one instrument, but three, simultaneously. CHF had seen dramatic appreciation against the Euro and the USD in recent months (see charts below), with current valuations of CHF, according to SNB: "threatening the development of the economy and increasing the downside risks to price stability in Switzerland."

In line with this, SNB announced that it will (1) move target 3-mo Libor rates closer to the range of between 0% and 0.25%, down from the current range of 0% to 0.75%, (2) will "very significantly increase" the supply of CHF, and (3) will hike required deposits for Swiss banks from CHF30 billion to CHF80 billion.

Funny thing, folks, shortly after the announcement, CHF fell against the Euro by 1.8% to CHF1.1061/Euro, and against the dollar +1.4% to CHF0.7761/USD. Yet, with the latest rumors from the US - about QE3 - the USD promptly fell back against the CHF to 0.7701/USD and erased most of the euro gains to CHF1.1054/Euro.

The problem, of course, is that for all the firepower deployed, SNB has little power to shift the prevalent investor sentiment that, at the time of expected QE3 and continued uncertainty about the Euro area sovereigns, CHF - alongside other small currencies - represents, in the minds of investors, a safe haven. This, of course, is the dilemma of the Swiss franc - a safe haven within an small and open economy: too well-run to join the basket cases across its borders, too small to defend...

And so to end with some good background on what's going on with CHF recently - read this.

03/08/2011: US ISM & Irish PMIs (Manufacturing)

On August 1, US Institute of Supply management monthly manufacturing activity index for July posted the worst performance since July 2009, falling 4.4 points to 50.9 (barely above 50 mark of zero growth). The new orders sub-index dropped into contractionary territory and employment index suffered significant drop. Factory gate prices also contracted signaling a decline in profit margins going forward.

Meanwhile, Irish manufacturing PMIs (published by NCB) for July similarly came in with disappointment. Here are the updated numbers:

• Overall Manufacturing sector PMI declined to 48.2 in July (below 50, signaling contraction of activity), down from 49.8 in June and marking the second consecutive month of contracting sector activity.
• 12-mo average for PMI is now at 52.3, while 3mo average is at 49.9 against previous 3mo average of 56.1.
• In 3-mo to July 2010 PMI stood at 56.1.
• The July reading is the worst since January 2010

• On seasonally adjusted basis, output sub-index also posted second consecutive month of contracting activity with July reading of 49.8, slightly up on June 49.3
• New orders activity was also contracting at 47.9 in July, down from also contractionary 48.7 in June. New orders 12-mo average is now at 53.1 and 3 mo average at 49.8, while previous 3 months average was 58.1.
• New export orders activity continued to grow at a slowing pace, down to 51.3 in July from 51.5 in June and 58.7 in May. 3mo average through July now stands at 53.8 against 3mo average through April at 59.9.

Other sub-indicators:

• Backlogs of work contracted at faster pace of 41.1 in July down from 41.8 in June - the worst reading since August 2009. Sharp decrease in July was mainly reflective of a strong drop in new orders
• Stocks of purchases and suppliers delivery times were all signaling contracting activity
• Stocks of finished goods also signaled tighter manufacturing activity
• Per NCB note: "Attempts by firms to improve cash flow led to a marked reduction in stocks of purchases in July, with the rate of depletion the fastest since August 2010. Stocks of finished goods also fell, although the rate of decline was only slight. Post- production inventories have reduced in each month since May 2008."
  

On profit margins side:

• Again per NCB note: Increased oil and commodity prices led to a further rise in input prices. Despite easing for the fourth month running, the rate of cost inflation remained sharp, and faster than the long-run series average." Specifically: input prices sub-index stood at 59.3 in July, down from 63.5 in June. 3mo average through July now stands at 63.9, while 3mo average through April was 75.1 - an improvement in the rate of inputs costs growth, but these continue on the upward trajectory.
• As NCB note: "In response to higher input prices, manufacturers raised their output charges. However, strong competition and weakening demand meant that the rate of inflation was only slight." Again, output prices sub-index fell to 50.4 in July, from 53.2 in June and 12mo average now stands at 52.8, while 3 mo average is at virtually identical 52.6. This is down from the previous 3moo period (through April 2011) which was 57.4.
• So profit margins are continuing to deteriorate (second chart below).
  

Per chart above last, employment conditions continued to deteriorate in Manufacturing, with sub-index for employment moderating contractionary signal to 49.1 in July from 48.3 in June. This marked third consecutive month of employment sub-index below 50. While 12mo average stands at 50.2, 3mo average through July is now at 49.1, contrasted robustly by 3mo average through April 2011 at 54.0. Same period (3mo through July) of 2010 averaged 49.5 reading.

This, of course is disheartening. The chart below updates the pace of 'recovery' in Manufacturing for July data:

Please note: data is sourced from NCB publication, while all charts and statistical details as well as analysis are supplied by me.

01/08/2011: Should President Obama play a harder ball with the Republicans?

In the wake of the US debt 'deal' pre-announcement, I have been seeing comments, including that from Paul Krugman in the NYT today (here) which appear to suggest that President Obama's agreement to accept parts of the Republican's proposals represents a surrender of the presidential authority and, more improtantly, such a limit on presidential authority is somehow a bad signla concerning consistency of macroeconomic policy in the US.

In particula, Prof Krugman states: "In fact, if I were an investor I would be reassured, not dismayed, by a demonstration that the president is willing and able to stand up to blackmail on the part of right-wing extremists. Instead, he has chosen to demonstrate the opposite."

Now, this argument would be fine, if Mr Obama had a record worth taking a stand on. He does not. Here are two charts on US debt based on IMF WEO database.

So both in terms of debt to GDP ratio and absolute current dollar denominated debt levels, Mr Obama might do well running away from his previously established record. Whether he did this via the latest debt deal or not is a separate issue altogether, but Mr Krugman's statement that President Obama should have exhibited more intransigence as the means for encouraging investors confidence in his administrative abilities is bizarre, to put it mildly. Mr Obama has no record worth defending. He has a record worth abandoning.

30/07/2011: US debt woes - some cool grpahics from NY Times

Several people asked about some of the assumptions I used in my post on US debt after the debt-ceiling increases.

While I outlined all of the assumptions in the original post, some of them are motivated by the following excellent infographic on US debt problems presented by the NY Times - link here. The subsequent post will show some comparatives for the US debt crisis.

These are reproduced here, with some commentary.

Note that in the entire debate about the US debt limits, I am of the view that the issue at hand is not the ceiling itself, by the level of the US overall indebtedness. In other words, if the US raises debt ceiling, in my opinion, it avoids immediate crisis, but loads the 'spring' of unsustainable debt levels even more.
Again, the above is irrelevant from my point of view. The US can simply print money or issue IOUs to cover its own debts in the short term. In reality, however, any more debt piled onto the US economy is going to be unsustainable and warrants a downgrade.

Clearly, the argument that the Republican presidencies are more fiscally conservative does not hold. Since Ronald Regan (who at the very least delivered on the stated objective of facing up to the USSR), US Republican presidents have accumulated $7.6 trillion worth of debt, or $633 billion worth of new debt per annum, on average, with George Bush, Sr at $375 billion annually, while his son - George W Bush, Jr at $625.5 billion per annum on average. Ronald Reagan accumulated new debt at ca $237.5 billion per annum on average.

In contrast, 2 Democratic administrations have managed to rake up $3.8 trillion worth of new debt, averaging $175 billion per annum on average for Bill Clinton and $800 billion per annum for Barak Obama.

Hence, Obama now holds an absolute record in fiscal profligacy, followed by George W. Bush (Jr), then by George Bush, Sr and Ronald Reagan. Bill Clinton is the least profligate of all US presidents since 1981.
Lastly, take a look at the source for my assumptions on the yields used in the post linked above:
So my assumptions of 3.5-4% post-debt deal are pretty close to what we can expect on the back of a 1 notch downgrade for the US debt.

Please see the following post on more comparatives for the US debt and economic dynamics.

30/07/2011: Detailed analysis of Retail Sales figures for June 2011

The volume of retail sales rose +0.2% in June 2011 compared with June 2010 and +1.1% mom. The 3mo average for the volume index is now at 93.07, while the 6 mo average is 92.3. Both below the current monthly reading. June reading marks the second consecutive monthly increase in the index. 2010 average is 93.3, while 2011 average to-date is 92.3, behind that of 2010.

The value of retail sales rose +0.4% in June 2011 when compared with June 2010 and there was a month-on-month increase of +0.7%. The value index now stands at 89.4 (marking the second consecutive month of increases) against 3mo average of 88.7 and 6mo average of 88.3. Compared to 2010 average of 88.9, the 2011 average to-date is now at 88.3.


Thus, the volume of retail sales in June 2011 stood at 94.1 down 16.73% relative to the peak. Current monthly reading for the value index is 23.59% below the peak for the series.
Couple of charts for quarterly changes:

Of course, the problem with the above data is that it is distorted by the motor sales volumes and values, especially pronounced due to the expiry of the Government incentive scheme for new motors purchases in June 2011. Hence, ex-motors data paints a dramatically different picture of continued deterioration in retail sales.

Excluding Motor Trades, the volume of retail sales fell 4.2% in June 2011 when compared with June 2010, while there was a monthly decrease of 0.1%. Thus, June marked a 5th consecutive month of declines in the colume of retail sales ex-motors. The index is now at 98.2, below 3mo average of 98.5 and 6mo average of 99.45 and well below 2010 average of 102.2.

Ex-Motor Trades there was an annual decrease of 3.2% in the value of retail sales and a
monthly decrease of 0.5%. Index reading of 94.6 in June 2011 stands below 3mo average of 95.3 and 6mo average of 96.2 as well as 2010 annual average of 97.6. The index has now declined (mom) for 3 months in a row.

In year on year terms, volume index retail sales ex-motors are now down 14 moths in a row and in terms of value index for 36 months in a row. In 2010, index of volume of retail sales ex-motors posted an average monthly decline of 0.28%, while in 2011 to-date the same figure is 0.03, while the latest 3mo average is 0.67% decline. For value of sales ex-motors, the average monthly decline was 0.24% in 2010, against 0.08% average monthly decline in 2011 to-date and 0.8% decline in 3 months to-date. So clearly, last 3 months suggest increased rate of deterioration on both 2010 and H1 2011 averages.


Relative to peak, the volume of retail sales ex-motors has now fallen 13.33%, while the value of retail sales ex-motors is down 19.42%. Both series continue their downward trajectory.


So overall, in June 2011, Motor Trades were up +21.9% yoy in volume. Alongside motor sales, sales of Electrical Goods (+5.2%) and Furniture & Lighting (+2.6%) were the only three categories that showed year-on-year increases in the volume of retail sales this month. Fuel (-12.0%), Hardware Paints & Glass (-10.4%) and Other Retail Sales (-8.1%) were amongst the ten categories out of 14 total that showed year-on-year decreases in the volume of retail sales this month.

In terms of value of retail sales, Motor Trades posted an annual increase of 18.3% - the only category of sales that posted an annual increase in value. Hardware & Paints (-10.9% yoy), Other Retail Sales (-6.0%), Bars (-5.8%) were the categories with largest (above 5%) declines in the value. Overall, 13 categories out of total 14 have posted yoy declines in value of retail sales.

My previous analysis of the Consumer Confidence indicator from the ESRI and high level dynamics in retail sales (see link here) shows that these trends toward continued pressures in the retail sector are expected to continue over coming months.

30/07/2011: High level data on Retail Sales & Consumer Confidence

Let's update the latest stats on retail sales in Ireland and consumer confidence - a separate, more detailed post will look on the specifics of the retail sales data.

The volume of retail sales rose 0.2% in June 2011 yoy and +1.1% mom. However, all of the increases were accounted for by motor sales.

The value of retail sales rose +0.4% in June 2011 yoy and +0.7% mom. Again, all effects are due to motor sales increases.

Provisional estimates for Q2 2011 show the volume of retail sales fell by 1.7% yoy and rose 1.8% qoq. Once again, the figures were dramatically improved by motor sales.

Consumer confidence, measured by the ESRI index have posted a dramatic drop in June from 59.4 in May to 56.3. Index is now 5.38% down qoq, 5.219% down mom and 17.084% down yoy.

So while overall retail sales indices signal some slight improvements in conditions, consumer confidence indicator shows that in months ahead there is likely to be renewed pressure on retail sales. In fact, of course, there is no divergence between the two sets of indicators, as retail sales continue to fall when taken on ex-motors basis.

Longer-term averages also suggest further softening in the retails sales
Three months moving averages are now:

• Index of Value of retail sales up 0.49% qoq, 0.189% up mom and 1.743% down yoy
• Index of Volume of retail sales up 1.276% qoq, 0.253% up mom and 2.218% down yoy
• Consumer confidence is up 23.291% qoq, 5.426% up mom and 8.299% down yoy.
  

30/07/2011: Some uncomfortable US debt arithmetic

In the light of the Senate vote yesterday, it is worth examining the extent of changes in the US debt and interest costs within the context of the Republican's-agreed plan (debt ceiling increase of $2,500-3,000 billion in exchange for 10-year deficit reductions of €917 billion).

There are a number of assumptions that we must make about the proposals, since it appears at this time that no clear picture is emerging as to what the specific details of spending and cuts might be.

Let us assume the following scenarios:

Scenario 1: Debt ceiling is increased by $2,500 billion to $16,800 billion
Scenario 2: Debt ceiling is increased by $3,000 billion to $17,300 billion

Assume that over the next 10 years there are no further increases in the debt ceiling.

Now, let us make some assumptions about the post-deal yields:

• Scenario A: assume that the current yields on US Treasuries - ca 3% - prevail over the next 10 years (this is extremely optimistic, since (1) it is likely that debt ceiling increase can lead to AAA downgrade one-two notches, (2) it is highly likely that US Fed is going to raise interest rates at least in some point in time between now and 2020. In this case, 10-year compounded interest charges on just the increase in the debt ceiling will be 34.39%.
  
• Scenario B: assume that average US Treasury yield rises to 3.5% post-deal. In this case, 10-year compounded interest charges on just the increase in the debt ceiling will be 41.06%.
• Scenario C: assume that average US Treasury yield rises to 4.0% post-deal. In this case, 10-year compounded interest charges on just the increase in the debt ceiling will be 48.02%.

Next, it is crucial to identify just how the 'savings' will be delivered and to what amounts cumulative to 2020. Let us make some assumptions on that:

• Republican plan of achieving savings of $917 billion by 2020, distributed:

1. Uniformly over 10 years in $91.7 billion increments
2. Front-loaded as follows: 175% of 91.7 billion in years 1 and 2, each, followed by 125% of that in years 3 and 4 each, followed by 100% in years 5 and 6 each and 50% in years 7-10 each, implying that through year 2 annual savings will be $91.7 billion plus $183.4 billion. By year 4 the savings will be running at $366.8 billion, by year 6 - at $550.5 billion and so on.
   

• Alternative plan (more like Democrats' plan) of achieving 1/2 of the Republican plan savings of ca $460 billion over 10 years, distributed:

1. Uniformly over 10 years in $46.0 billion increments
2. Front-loaded as follows: 175% of $46 billion in years 1 and 2, each, followed by 125% of that in years 3 and 4 each, followed by 100% in years 5 and 6 each and 50% in years 7-10 each, implying that through year 2 annual savings will be $161 billion. By year 4 the savings will be running at $276 billion, by year 6 - at $322 billion and so on.

Table below summarizes net savings (reductions - where positive) on the debt levels as the result of the proposed deal. These do not account for interest charges on the existent pre-debt deal debt level of $14,300 billion, nor for the costs of old debt financing that might rise in the wake of the debt ceiling hike.
In bold in the table above, I outline the more likely scenarios. Now, to arrive at the total debt ceiling hike impact we need to subtract from the above values the expected increase in the cost of Federal debt financing on the current $14,300 billion worth of debt. These are approximately $715 billion in the case of Scenario B and $1,430 billion in the case of Scenario C.

Thus, overall, in the most likely scenarios,

• The Republicans-proposed plan will achieve a reduction in the overall 2020 debt levels of just $802-1,994 billion in the most benign scenario or a reduction of $365 billion to an increase in debt of $827 billion in the more adverse case
• The Alternative plan will achieve increases in total debt burden for the US of between $573 and $1,171 billion in the more benign case and increases in total debt of $2,273 billion to $3,341 billion in the more adverse case.

In summary - neither potential outcome represents a significant departure for the US from the current massive debt levels. To achieve meaningful savings on the current debt, the US will require severe front loading of Republicans-proposed cuts and convincing the markets that its AAA rating must remain intact. However, even in this case, more likely effect will be to reduce debt levels by some €1,990 billion, or just 14%...

29/07/2011: Euro area leading economic indicators - July 2011

The new Euro area leading growth indicator - eurocoin - published by CEPR and Banca d'Italia is out for July, showing signficant slowdown in economic activity in the Euro area ahead. Headline numbers are:

• Euro-coin fell in July for the second month in a row, declining from 0.62 in May to 0.52 in June and to 0.45 in July.
  
• 3 months average through June was 0.58 and 6 months average through June was 0.56. In July these declined to 0.53 and 0.555 respectively.
• Year on year June 2011 reading was 13.04 higher. July 2011 reading was 12.5% above that for July 2010.
• With historical standard deviation for eurocoin at 0.4594 > current July 2011 reading, this month reading is statistically insignificantly different from zero. The same is confirmed by looking at the crisis period standard deviation from January 2008 through current reading, which stands at 0.6288.

• The latest eurocoin implies Euro area growth rate of 1.81% pa, down from 2.24% pa growth predicted by the 6mo moving average.
• Core drivers of slowdown are: falling business confidence, stock market performance and widening spreads between long and short-term interest rates (cost of capital rising).
  

Updating figures for ECB rate policy determinants:

The above still support my view that equilibrium repo rate consistent with ECB's medium term inflation target is around 3.0-3.25%, well ahead of the current rate.

Latest industrial production (through May 2011) shows downward turn in growth in Germany, France and Spain, with Spain posting contraction in output, while France virtually reaching zero growth point. Italy is the only country of the Euro area Big 4 still showing accelerating growth in industrial production. Hence, overall for the Euro area, industrial output was nearly at zero growth line in May 2011, having posted 4 consecutive months of declining growth.

PMI composite for Euro area business confidence is now for the second month in a row firmly in the contraction zone. Consumer confidence is now at zero expansion in July, having declined over the last 2 months, with Italy, Spain and France all showing persistent declines in consumer confidence.
Chart source (here).

Lastly, exports show falling rates of growth over a number of consecutive months through May 2011 in France, Italy and Spain.

26/07/2011: Greek deal will increase Greek debt

Eurointelligence.com today reports that (emphasis is mine):

"Hugo Dixon, at Reuters Breakingviews, did the math on the Greek package, and concludes that the calculation by the European Council and the IIF regarding the projected rate of debt reduction is wrong. He said that Nicolas Sarkozy’s calculation of a 24 percentage point fall in the Greek debt-to-GDP ratio ignores the effect of credit enhancement, which is going to be massive.

Once you include the efforts Greece has to make to secure the rollover deal, the debt-to-GDP ratio rise by 14% to 179% of GDP.

As part of the deal with the IIF, Greece will need to secure some of the rolled over bonds with zero coupon bonds. The four options have different implications for the extent of the credit enhancement. But on the IIF’s own assumptions, the costs of the exercise would be €42bn for Greece to finance credit enhancements for the €135bn of bonds in the IIF’s scheme."

You can read the entire proposal by IIF here. And, by the way - I run through their proposal figures. The massive savings for Greece stated in this are referencing the future payouts that are being saved assuming Greece were to pay full set of coupon payments and principal on its bonds over their history. This is slightly misleading, as the markets have been pricing significant (40%+) discounts on much of Greek bonds for over 1 year now.

Aside from that, the IIF calculations assume 9% discount rate through 2030. This is a strange assumption, given that the deal replaces / writes down bonds with an average coupon yield of ca 4.5% and Greece can borrow from EFSF/EFSM at ca 5% effective rate.

Adjusting for these, my 'back of the envelope' calculations suggest that the actual value of the Greek programme is closer to €26-32 billion instead of €37 billion when it comes to net private sector contribution.

In addition, rollovers to longer maturity, in my opinion, are reducing peak debt levels, but extend payments burden over time, implying that adverse impact of debt on growth and economic performance in Greece are simply extended into the future. In other words, extended maturities do not do much to improve Greek situation. They can be effective if the Greek debt spike were a 'one-off' event. But since debt overhang in Greece is structural (see chart below - showing Greek debt becoming a structural problem around 1993) and underpinned by long term (endemic since at least 1987) current account deficits, extending maturity of debt simply increases life-time cycle of debt overhang.

In summary, there is no substitute to a full default by Greece. The latest 'deal' simply, potentially, pushes this default into 2016-2020 period, and that with optimistic forecasts for growth at hand.

Another can meets the EU boot, and... fails to roll far down the proverbial road.

25/07/2011: Comprative analysis of Euro Area and Euro Big 4

There’s a lively debate going on in parts of Europe about the longer-term fall out from last week’s ‘Deal for Greece +”. Most notably – in Germany (see here). In light of this, it is worth looking into some facts about economic performance of the Euro area Big 4 economies: is Germany right about protecting its fiscal conservativism from collectivization of risks envisioned by the ‘Deal’?

Let us plough through some data and IMF forecasts for the following set of countries & country-groups: France, Germany, Italy and Spain (the Big 4) against the Euro area as a whole, plus Advanced Economies and Major Advanced Economies (G7). Please note that the IMF forecasts are not exactly in agreement with my view of where some of these economies are heading, but for the reasons of comparative simplicity and transparency, I will rely on IMF data here.

In the end, what I am after here is some (crude – so be warned) metric of risks – disaggregated across countries and groups.

Starting from the top: chart below shows annual growth rates in GDP expressed in constant prices.

Economies, 2000-2007 growth rates averaged 2.61%, while the crisis years growth fell on average 0.06% annually. The projected growth for post-crisis period 2011-2016 IMF forecasts growth of 2.46%. In all of these periods, Advanced Economies group leads the league table of our sample countries/regions.

Area managed to achieve average annual growth of 2.16% in pre-crisis period, but suffered 0.63% annual average contraction during the crisis. Post-crisis, Euro area economies are expected to grow 1.76% which is the third slowest rate of growth in our sample.

G7 economies grew 2.27% on average annually in pre-crisis period and faced a relatively mild average crisis-period contraction of output of 0.36%. These economies are expected to grow at 2.29% per annum on average in 2011-2016.

France recorded average annual growth of 2.12% in 2000-2007 and subsequently posted relatively mild contraction of 0.32% (annual average) in 2008-2010. The country is expected to grow its economy at an average annual rate of 1.94%.

German economy grew on average at an annual rate of 1.58% during the pre-crisis years – posting second slowest growth in the sample. During the crisis, the economy contracted 0.15% per annum on average (second best performance in the sample), while it is expected to grow at 1.84% average rate in 2011-2016 – not a blistering growth forecast, but above Euro area as a whole.

Italy posted slowest average annual growth in the sample during the pre-crisis period (1.46%), the deepest average annual contraction in the sample during the crisis (-1.75%) and is expected to continue slowest growth performance with 1.32% average annual growth rate in 2011-2016.

Spain recorded the fastest real growth in the sample for the pre-crisis period (3.62% average annual rate), followed by the second magnitude of contraction (-1.0% per annum on average) in the crisis period. Spanish economy is expected to grow at 1.62% on average in 2011-2016 – second slowest in the sample.

In terms of GDP per capita (chart below):

Germany was the first in our sample to reach pre-crisis peak level of GDP per capita between 2009 and 2010, followed by the Advanced Economies and the Euro area. G7 group of countries recovered from the crisis in terms of GDP per capita by the end of 2010, while France’s recovery will take it into 2011. Spain is expected to recover from the declines in GDP per capita around 2011-2012, while Italy will take the longest to reach pre-crisis peak – some time between 2012 and 2013.

In terms of investment as a share of GDP (chart below):

Advanced economies investment averaged 21.05% in the period prior to the crisis, falling to 19.08% during the crisis before recovering somewhat to 20.08% in the period 2011-2016. No data is available for the Euro area and G7 countries.

France invested 20.2% of its GDP on average during 2000-2007 period, recording a marginal decline to 20.11% in the crisis years and is expected to recover to 20.60% of GDP in 2011-2016.

Germany was the weakest country in the sample in terms of investment with investment ratio to GDP of 18.24% in the pre-crisis years, followed by 17.50% during the crisis and by expected 17.81% in the post-crisis period.

Italian economy investment as a share of GDP was 21.01% in pre-2008 period, followed by 20.11% during the crisis. IMF expects Italian investment to rise to 20.54% of GDP in the post-crisis period.

Spain’s investment to GDP ratio was 28.30% in 2000-2007 period, followed by 25.5% in 2008-2010 and 22.98% projected for 2011-2016.

So in terms of investment as a share of GDP, Germany is clearly a laggard here, which is of course explained by two core factors: (1) aging population and (2) already extensive stock of capital.

Unemployment rates are shown in the chart below:

During pre-crisis period, Spain psoted the highest rate of unemployment, averaging 10.54%, followed by Germany (8.93%) and France (same as Germany). Euro area as a whole averaged 8.45% unemployment rate during the pre-crisis period, followed by Italy at 8.11%. This poor performance by European part of out sample is contrasted by the pre-crisis unemployment of 6.11% for the group of Advanced Economies and 6.05% for G7 group.

During the crisis, Spanish unemployment rose to 16.47%, followed by France (9.02%) and Euro area (9.0%). G7 economies posted 7.35% average rate of unemployment while Advanced economies came in at 7.34%. Germany shows the best unemployment rate for the period at 7.22%.

Post-crisis, IMF forecasts for Spain to remain worst performing country in our sample with 16.91% average unemployment rate, followed by Euro area at 9.03% and France at 8.57%. In contrast, Italy’s unemployment is projected to settle at 7.87% average, with Advanced economies coming in at 6.77% and G7 economies at 6.54%.

So what about employment – in other words, jobs creation:

The chart clearly shows that Germany, G7 group and France are the weaker performers in the sample in terms of longer-term trends in jobs creation. Now, see the following chart on population changes. Of course the problem here is that while German population is shrinking (so jobs creation is not exactly high on their agenda, especially with low unemployment), for France (with expanding population) slow jobs creation is a major draw back (hence high unemployment as well).

By 2015, based on IMF projections, German population will shrink by 1.284 million relative to 2000, while Italian population will grow by 4.638 million, French by 5.352 million and Spanish population will expand by 6.304 million.

In terms of fiscal performance, consider the following two charts plotting general government revenue as % of GDP and the general government expenditure as % of GDP:

The following chart shows general government deficits:

Based on three charts above, consider the fiscal adjustments required to deliver on the deficit targets to 2016:

Of all countries in the sample, France represents the steepest required fiscal adjustment in terms of deficit reductions, totaling 4.475% of GDP between 2011 and 2016, followed by the G7 group of countries with 4.063% and Advanced economies at 3.567%. Euro area projected adjustments are 2.519%, while German projected adjustment is 2.326%. The weakest – fiscally – performing countries – Italy and Spain – have the lowest fiscal adjustments planned at 1.439% and 1.679% respectively.

Mapping these adjustments alongside the absolute measure of fiscal performance (Gross Debt) and taking into account the economies growth potential, chart below shows two groups of countries. The first group (no shading) is the group of economies facing the moderate adjustment on deficits side, against stronger targets on debt reductions. This group includes Germany, Italy and Euro area. The second group of countries represents a group facing steeper adjustments on fiscal deficits side and/or significant deterioration in debt positions. This group covers Spain, Advanced economies, G7 and France. It is worth noting that this group of countries faces stronger growth prospects, but Spain and France represent two weaker economies in this group.

Chart below provides an illustration of the debt challenges faced by the sample economies. General Government debt rose 48% in Spain form an average of 47.62% of GDP in 2000-2007 to 70.5% of GDP projected average for 2011-2016. In France, the same increase was 43.6% from 61.83% of GDP pre-crisis to 88.76% average in post-crisis period. At the same time in Germany, gross government debt to GDP ratio rose from 63.64% of GDP pre-crisis to 76.48% of GDP in post-crisis period – the second slowest rate of increase in the sample after Italy.

Overall, for the period of 2011-2016, average gross government debt levels are expected to range from 121.93% of GDP for the G7 economies, to 119.32% of GDP for Italy, 105.33% of GDP for Advanced economies, 88.76% of GDP in France, 87.55% of GDP for the Euro area, 76.48% of GDP in Germany and 70.49% of GDP in Spain.

Lastly, let’s take a look at the current account positions.

As chart above shows, cumulative 2011-2016 expected current account positions as the share of GDP are: Germany +25.9% of GDP, Euro area +0.67% of GDP, Advanced Economies -1.92% of GDP, G7 economies -7.13% of GDP, France -14.6% of GDP, Italy -17.4% and Spain -24.5% of GDP.


Now, let us pool the information contained in the above data to derive the overall riskiness of each economy/group in the sample. To do this, I assign to each country/group a score out of 1-14 based on their performance relative to the top performing economy. So top performer in each category of score below gets 14, the with the next performer getting 12 or less, with distribution of scores within each category/heading following the underlying data. The higher raw scores reflect stronger economic performance and / or lower risk. So the final risk scores are based on inverting the raw scores. Summing these up across categories/criteria produces the total risk score reported in the penultimate column of the table. These are ranked in the last column with 1=highest risk country.


The results are consistent with statistical distribution and are robust to several checks, namely:
1) Removal of the GDP per capita recovery statistics
2) Removal of the Employment index
3) Removal of the Government Expenditure metric

The core results are:

1. Germany clearly represents the most sustainable country in the sample of all Big 4. In fact, its fiscal and macroeconomic position would be significantly undermined if it were to move to Euro area harmonized position
2. Spain and Italy are the two weakest economies in the sample with very high risk rating
3. France is statistically closer to Spain and Italy than to Euro area harmonized economy and is clearly the least sustainable economy in the sample after Spain and Italy.
   

23/07/2011: Internet Age and Social Capital

We have heard on many occasions various arguments that Internet and the culture of new media and exchanges it has created are responsible for dumbing-down of society, reduced imagination, increased propensity to violence, contracting attention spans and a host of other evils.

My personal view on this – not scientifically proven, mind you – is that Internet is yet another medium for developing, visualizing and delivering information. I do not see it as intrinsically transformative of the way we interact with the world around us, but as a tool for amplifying the speed of our interactions. Hence, any dumbing-down – if it takes place at all – is, to me, not the outcome of the Internet Age, but of something in our human nature, in our ways of relating to the world.

At last, there is some evidence appearing – academic, not market research-led (again, not that there is any intrinsic reason to mistrust the latter or to trust the former) – that Internet might not be all that bad for us as ‘Social Beings’.

A recent study "Surfing Alone? The Internet and Social Capital: Evidence from an Unforeseeable Technological Mistake" by Stefan Bauernschuster, Oliver Falck and Ludger Woessmann, published by CESIfo (Working Paper 3469, May 2011) uses some wide-cover German data to attempt to answer whether the Internet undermines social capital or facilitates inter-personal and civic engagement in the real world.

The study “exploits a quasi-experiment in East Germany created by a mistaken technology choice of the state-owned telecommunication provider in the 1990s that still hinders broadband Internet access for many households.” In other words, the study uses East German data as control group for reduced exposure to Internet to see if such limitation yielded profound difference in social interactions compared against the groups with full access to broadband Internet.

The study finds “no evidence that the Internet reduces social capital. For some measures including children’s social activities, [the study] even find[s] significant positive effects.”

Per authors’ conclusions, “in virtually all specifications and for virtually all social capital indicators, both the value-added models and the instrumental-variable (IV) models yield positive point estimates on having broadband Internet access at home. …results indicate significant positive effects of broadband Internet access on the frequency of visiting theaters, the opera, and exhibitions and, …on the frequency of meeting friends. Exploring a relatively small sample of children aged 7 to 16 living in the sampled households, we further find evidence that having a broadband Internet subscription at home increases the number of children’s out-of-school social activities, such as doing sports or ballet, taking music or painting lessons, or joining a youth club. Broadband Internet access also does not crowd out children’s extra-curricular school activities, which include such areas as sports, music, arts, and drama.”

Crucially, “several tests of validity and robustness support a causal interpretation of our results”.

20/07/2011: EU's Banks Levy is a dangerous idea that will impede reforms in the sector

The latest calls for introduction of the banks levy within the EU (see here) as:

• the means for financing some of the banks rescue measures and
• the means for reducing the probability of the future crises
  

represents nothing more than a cynical and/or largely economically illiterate attempts by the EU lawmakers to dress up new revenue raising measures as ‘reforms’.

The core problems with this proposals are:

1. With current market structure & declining competition in Euro area banking sector, this levy represents another hidden tax on European households & companies. The current environment in banking sectors in many EU countries lends itself to the incumbent banks being able to pass the levy on to their customers without incurring any, whatsoever, direct moderation either on their own leverage levels or stabilization of their funding streams.
2. xWith declined competition in the sector, the new levy will act to further reduce Returns on Equity for any new entrant into the market, thus effectively acting as a barrier to entry and the means for protecting European zombie banks from competition from non-legacy banking institutions.
3. A levy will do absolutely nothing to resolve the problem if Europe’s zombie banks unable to exist as functional banking institutions, but sapping vital deposits and savings out of investment stream, thus starving the European economies of capital. European banks require some €250-500 billion worth of funds to cut their dependence on public funding and ECB/CB emergency assistance for funding and capital. Raising €10 billion annually through the proposed banks levy is simply too little to address the above gap.
4. In many cases, this levy will in effect result in a transfer of taxpayers’ own or guaranteed funds from the banks balance sheets (where these funds are now being deposited to support capital and funding activities of the zombie banks) to the EU collecting body.
   

A recent (June 2011) IMF Working Paper /11/146, titled “Recent Developments in European Bank Competition” by Yu Sun clearly finds that introduction of the common currency and the current financial crises have led to repeated reductions in overall degree of competition within the European banking sector, compared before and after EMU (1995–2000), post-EMU (2001–07) and post-crisis (2008-09)."

"Columns (3) and (4) in the table below report the H-statistic (higher H-stat reflects higher degree of competition in the banking sector) and standard error before EMU for each country or region, columns (5) and (6) after EMU. Column (9) displays the changes in the H-statistics from pre to post EMU period."

Thus, “the overall competition level in euro area dropped slightly after EMU, from 0.699 to 0.518 while competition levels across member countries converged [the standard deviation of H-statistics of euro member countries drops from 0.17 before EMU to 0.12 after EMU]."

“The finding that large and financially integrated countries or regions tend to exhibit less competitive behavior than smaller sectors is in line with others studies, including Bikker and Spierdijk (2008), who also find some deterioration in competitive behavior over time for Europe’s banks. They argue that banks in large and integrated financial markets are pushed by rising capital market competition and tend to shift from traditional intermediation to more sophisticated and complex products associated with less price competition."

“While the small decline in the level of bank competition for the euro area is statistically significant, it is somewhat smaller than the estimates reported by Bikker et al. (2008) using an un-scaled revenue function. For Austria and Germany, a slight increase in the competition level of their banking systems is estimated; however, the increase is not statistically significant. The H-statistics in Finland, France, Greece, Italy and Netherlands dropped after EMU. At the same time, Spain, the U.K. and the U.S. experienced some small but statistically significant improvement in the competition level of their banking systems."

Before and after the recent financial crisis: “The recent financial crisis and possibly corresponding policies seem to have left a strong mark on bank competition in many countries, as indicated by the competition indicators before and after the crisis for the sample…. Columns (7) and (8) of Table 3 show the H-statistics after the financial crisis. In the U.S., Italy, Germany, Spain and the euro area, bank competition seems to have declined following the financial crisis; however the declines in Germany, Italy and euro area are trivial.”

Bank competition among large (top 50) and small banks (bottom 50): “For some countries, like U.S. and U.K., small banks compete more intensively, while larger banks in Austria, France, Italy, Portugal and Spain are more competitive before EMU. In other countries, the competition indicators of larger banks are not statistically different from those of smaller banks before EMU”. Competition within small and large banks: “The euro area, France, Greece, Italy and Netherlands have experienced a significant drop in competition in both small and large banks, while both banks in the U.S. and U.K. showed a noticeable increase."

So overall, “the euro area experienced a significant but small decline in bank competition after EMU and the financial crisis. Some studies with similar findings have attributed the decline in competition to the process of consolidation, and the movement of bank activities from traditional financial business to off-balance sheet activities [both anti-competitive processes have accelerated under regulatory blessings of many Governments since the crisis]. More importantly, competition levels in euro countries seem to have converged after EMU, not just at the average national market level, but also between different bank types and ownership [so that less competitive markets became more competitive with euro creation, while more competitive ones became less so]. Finally, following the financial crisis, competition fell in many countries, and especially in some countries where large credit and housing booms took place."

In this environment, in my view, introducing a banking levy will simply reinforce the existent market structure and further prevent markets-led corrective adjustments in the sector. At the same time, the levy will exert new costs and pressures on banks clients.