24/09/2011: Projected trends in economic growth for 2011

In the previous post I covered the current results for Q2 2011 QNA for Ireland. As promised, here, I will focus on forward-looking signals emerging from H1 2011 data.

Please note, though I do use the term 'forecast' below, the results shown here are really more projections than formal forecasts. The difference is very important. I use data through Q2 2011 to estimate what the economy performance is likely to be, assuming no change on the trends established in H1 2011. Of course, this is subject to significant risks (identified below).


Based on Q2 2011 (preliminary - and I stress this) data, chart below shows my forecast for 2011 growth:
Using simple forward forecast based on Q1 20003 - Q2 2011 data, we can now expect:

• Agriculture, Forestry and Fishing sector real output to grow by ca 5.5-5.6% this year, well in excess of 2010 growth of 0.7%, lifting sector output closer to €3.2bn in 2011 or 3.2% ahead of 2007 (the peak year for GDP and GNP).
  
• Industry, including construction, is expected to expand by 5.0-5.1% this year, slightly below 5.2% growth rate achieved in 2009. This will put sector output in real terms 2,9% ahead of the pre-crisis peak of 2007.
• However, industry performance will come against continued double digit contraction in Building & Construction sub-sector, which is expected to shrink 17-18.5% in 2011, compounding an astonishing 30.1% decline in 2010. Bu the end of this year, the sub-sector output can be 61.3% below the level of pre-crisis peak year of 2007. Note, the peak for the sub-sector was back in 2004 and if things continue on trend, 2011 output will be a whooping 74% below that.
• Distribution, transport & communications sector is likely to post another decline this year - shrinking by some 1.1-1.2% against a decline of 2% in 2010. Relative to economy's pre-crisis peak the sector is likely to be down 16.3% in 2011.
  
• Public administration & defence sector will contract 2.4-2.5% in 2011, based on data through Q2 2011, compounding a 2.7% decline in 2010. The sector is likely to fall compounded 4.9% on 2007 and 9% on peak sector contribution in 2008.
• Other services (including rents) - the sector accounting for 51% of our overall economic acitivity (GNP) is likely to post another contraction of -0.6-0.8% this year, compounding a 2.3% fall in 2010 and down 6.6% on 2007 peak.

Hence, GDP is expected to expand by 1.5-1.6% this year on the constant factor basis if we are to use the data from H1 2011, following 0.1% contraction in 2010. This will put our GDP somewhere around 5.6-5.7% below 2007 peak levels.

Taxes, net of subsidies are continuing to fall with 3.5-3.7% decline in 2010 now expected to be followed by 1.8% contraction in 2011. The end of 2011 taxes net of subsidies will likely come in at 32-33% below 2007 levels. This, of course, is driven by the twin forces of rising social welfare costs and continued presence of other substantial transfers, plus a reduced tax take.

With this, overall GDP (in constant market prices) can be expected to rise ca 1.1-1.3% in 2011, based on preliminary data through Q2 2011 (subject to revisions and also reflective of much more robust global economic conditions pre-July 2011 amplification of the crises). This will follow on a 0.4% decrease in 2010, leaving the gross real income 9% below 2007 levels.

Net factor income outflows to the rest of the world are likely to continue rising in 2011, growing 2.4-2.6% in 2011 (assuming amplified crisis conditions do not trigger signifcant withdrawals of retained profits), leaving factor outflows up 4.3% on 2007 levels.

With that, we can expect GNP to rise 0.8-1.0% in 2011, following on 0.3% growth in 2010 and national income will be 11.2% below 2007 peak levels.

Sectoral decomposition of national income by source, so far, stands at:

• Agriculture, forestry and fishing - the flagship sector by subsidies received and attention paid to it (remember, RTE and Irish Times are so keen covering ploughing championships) - contribution to GNP will be a whooping 2.4% in 2011 a 'massive' jump on 2.3% in 2008 and 2009, but still below 2.8% average annual contribution in 2003-2005.
• Industry (including Building & Construction) will be contributing 34.9% on GNP, up on 33.5% in 2010. If this materialises, 2011 will be the best year for Industry since 2003, which, incidentally, shows just how significant the growth in MNCs-led exports-oriented manufacturing was over recent years. As Building & Construction subsector contribution shrank from 9.9% at the peak in 2004 to 2.6% in 2011, manufacturing picked up the slack, pushing Industry overall contribution from 34.1% in 2004 to 34.9% - a swing of 8.1 percentage points.
• Distribution, transport & communications sector contribution is currently running at 15.7%, behind 16.0% in 2010, and at the lowest levels since 2005.
• Public administration and defence contribution to GNP is running at 4.2%, down from 4.4% in 2010, but still ahead of 3.9% in 2006 and 2007 and ahead of 4.0% annual average for 2003-2005. In 2003-2007 sector contribution average was also 4.0%, so our austerity so far is, in relative terms, seeing an increase in spending on public administration and defence as the share of the total economic pie. Now, these two functions are not front-line vital services, last time I checked, so you would expect a rational policy would be to shrink these sub-sectors at least at the speed of reduction in GNP. So far, this is not happening. Another alternative would be to reduce them at least at the rate of decline in taxes importance in the economy. This too is not happening, as shown below.
  
• Other services are likely to contract in their importance in the economy in 2011 (to ca 51.1% of GNP) following a contraction from 53.5% in 2009 to 52.1% in 2010. Large share of these services are exportables, which highlights the fact that not all of our exporting activities are booming.
• Taxes net of subsidies are likely to come in at 11.3% of GNP in 2011, down from 11.6% in 2010 and reaching the lowest level on the record since 2003. 2003-2007 average here is 14.5%, 2008-2010 average is 12.4%, so current state of taxes net of subsidies is worse than any recorded sub-period.
  

Again, to stress, one metric for sustainability of public spending would be to have public administration and defence spending contracting faster than the rate of contraction in taxes. And again, this is simply not happening. Since 2007 taxes have fallen from 15.0% of domestic economy to 11.3%. In the same period, public administration & defence contributions have increased from 3.9% to 4.2%.

Again, to stress, these 'forecasts' or rather 'projections' are based solely on preliminary figures for H1 2011. They are not strictly speaking forecasts, but rather annualized reflections of performance between January 2011 and June 2011. The risks to these are to the downside:

• Decreasing rate of growth in the US and the euro area materialising since May-June 2011 is not reflected in the projections above
• Signs of significant slowdown in broad leading economic indicators (PMIs, investment etc) are not reflected in the projections above, and
• Preliminary data can see significant revisions in time - in Q1 2011, preliminary estimate for GNP decline was estimated at 4.3% and it was revised to 3.0% decline in the current release, so the swings can be quite significant.
  

23/09/2011: QNA for Q2 2011: decent growth=welcome news

Second quarter national accounts were published today and came in with a surprise (in my case) on the upside across both GDP and GNP. Here are the details:

In terms of constant prices (real variables):

• Irish Q2 GDP came in at €41,080mln - a rise of €829mln qoq or 2.1% - strong showing. Last time GDP stood at above €41bn was in Q4 2008. YOY real GDP is up €936mln or 2.3% - another strong figure. However, we are still €3.158bn below Q2 2007 levels (-7.1%). This is a benchmark to reach since it represents the pre-crisis peak.
• GNP came in at €32.683bn in Q2 2011, up €354mln (+1.1%) qoq - growth, but anemic given previous quarter sharp fall-off. YOY GNP is also up 1.1% (+€368mln), but relative to Q2 2007 we are still down 11.7%.

Due to slower growth in GNP, the GNP/GDP gap has widened in Q2 2011 from 19.7% in Q1 to 20.4% in Q2. We are now at the largest gap point since Q1 2003. Importantly, the gap widening - due to higher outflows of profits expatriated by the MNCs - did not push GNP into negative growth this quarter. This reflects positive activity in non-exporting sectors. Income from the ROW - the category that captures profits expatriation - went from -€7.922bn in Q1 2011 to -€8.397bn in Q2 2011, reaching the highest level since Q1 2003.

Index of sectoral activity shows that:

• Consumption activity declined from 98.5 in Q1 2011 to 97.8 in Q2 2011. Index of consumption activity stood at 100.2 in Q2 2010. Q2 2011 marks the second quarter of index falling below 100 (which marks Q1 2005 level of activity). Prior to the last two quarters, index never dipped below 100 in the series since Q1 2005. In constant prices, Consumption has dropped from Q1 2011 reading of €20.336bn to €20.19bn in Q2 2011. This reflects an 0.7% decline qoq and 2.4% drop yoy. Compared to Q2 2007 we are now spending €4.199bn less on Consumption (-10.7%).
  
• Net Government Expenditure has dropped from €6.708bn in Q1 to €6.484bn in Q2 2011 (-3.3% qoq). Government spending is now 3.3% behind Q2 2010 and 10.7% below Q2 2007 levels. Notice that Government consumption decreases are now catching up with those in private consumption. To see this, consider index movements. Recall that in Q1 2005 the index stood at 100. Current index for Government expenditure reading is 104.3, down from 107.9 in Q1, but still above Q1 2005 levels.
  
• Fixed capital formation improved slightly, in terms of index, rising from 46.5 in Q1 2011 to 46.7 in Q2 2011. However this is the fourth consecutive month that the index is below 50. In absolute terms, Gross fixed capital formation was €4.665bn in Q2 2011, up 0.4% on Q1 2011. Capital investment is, however, still 14.3% below the levels in Q2 2010 and a massive 51% below Q2 2007 levels. My recent research, presented last week at a conference in UCC shows that we are now close to failing to cover amortization and depreciation on existent stock of both private and public capital.
• One of the largest positive contributions to growth in Q2 2011 came from the increases in the value of physical changes in stocks, which rose €760mln qoq and €782mln yoy.
• Exports are booming - as we know, and imports rose much less dramatically than exports Q2 2011, so net trade grew, yielding a net positive contribution to GDP. Exports are now up 5.8% qoq against imports rising 3.4%, while yoy exports are up 4.9% against imports rising just 0.1%. This clearly suggests that we are not running 8%+ growth in exports and also shows that transfer pricing is one of the core drivers of our exports as inputs imports are not exactly dramatic. The 8% growth in exports is what underlies much of the DofF rosy projections for 2011 made back in the Budget 2011 (of course, since then DofF has revised its growth projections down to 0.8% annual rate for 2011 GDP).
  

I will post on detailed breakdown by sectors and annual forecasts for QNA series in my next post.

So to conclude & summarise: we have some good news here - both GDP and GNP expanded, against the backdrop of continued growth in MNCs profits outflows, implying that despite sluggish GNP growth, domestic activity (if only carried out by exporting sectors) is growing. These numbers are, of course, subject to significant uncertainty as preliminary data tends to be revised and sometimes substantially, while overall quarterly series tend to show high volatility. Lastly, there is an ongoing slowdown in all leading indicators for Q3 growth both domestically and internationally. And longer-term view is still bleak - with continued domestic and international crises, dead banking sector, prospect of state-sponsored duopoly in the banking sector in the foreseeable future, forthcoming increases in taxation and further cuts in investment, and importantly, the prospect of rising pressures post-crisis on the interest rates expectations.

Nonetheless, for our battered economy of the last 3 years, we can have a light smile tonight.

21/09/2011: ESRB warns of contagion across euro area financial systems

The General Board of the European Systemic Risk Board (ESRB) held its third regular meeting today on September 21st, and here are the highlights.

In terms of assessing the current situation, the ESRB stated that "since the previous ESRB General Board meeting on 22 June 2011, risks to the stability of the EU financial system have increased considerably. Key risks stem from potential further adverse feedback effects between sovereign risks, funding vulnerabilities within the EU banking sector, and a weakening of growth outlooks both at global and EU levels."

So what ESRB is saying here is that the crisis has completed full circle: if in 2008-2009 transmission of risks worked from insolvent banking sector to insolvent sovereigns and (technically always solvent) monetary authorities via liquidity supports & recapitalization schemes, since 2010 through today the risks have flown the other way - from insolvent sovereigns to insolvent banks via bust bond valuations. The only question that remains now, is where the vicious spiral swing next. In my view - at least in anti-taxpayer, anti-competition Europe it will force taxpayers to directly recapitalize the banks (see IMF's latest calls and the rumor that France is about to go this way) to protect incumbent banking license holders from bankruptcy, receiverships and competition from healthier and new banks.

"Over the last months, sovereign stress has moved from smaller economies to some of the larger EU countries. Signs of stress are evident in many European government bond markets, while the high volatility in equity markets indicates that tensions have spread across capital markets around the world. The situation has been aggravated by the progressive drying-up of bank term funding markets, and availability of US dollar funding to EU banks had also decreased significantly. In that context, central banks have decided on coordinated US dollar liquidity-providing operations with longer maturities."

Nothing new in the above, but it is nice to see an honest admission of the ongoing liquidity crisis. Now, recall that I have said on numerous occasions that bank runs start with a run on the bank by its funders. This is what we term a liquidity crunch - interbank markets freeze, banks bonds funding streams dry out. Only after that can the depositor run develop, usually starting with corporate depositors. Funny enough - the ESRB wouldn't say it out-loud, but in effect it already called in the above statement a bank run in funding markets. Worse, we also know - from the likes of Siemens transaction reported here (http://trueeconomics.blogspot.com/2011/09/20092011-eu-banks-losing-corporate.html ) - that to some extent (unknown) corporate deposits run might be taking place as well. Next?

"The high interconnectedness in the EU financial system has led to a rapidly rising risk of significant contagion. This threatens financial stability in the EU as a whole and adversely impacts the real economy in Europe and beyond."
Boom!

So, per ESRB:
"Decisive and swift action is required from all authorities. In the immediate future this includes:
* implementing, fully and rapidly, the measures agreed upon at the 21 July meeting of the Heads of State or Government of the euro area;
* adopting sustainable fiscal policies and growth-enhancing structural measures so as to achieve or maintain credibility of sovereign signatures in global markets; and
* enhancing the coordination and consistency of communication.
Now, I am not a fan of July 21 decisions, primarily because they do not address the core issue of the crisis - too much debt in the system and too little growth. EFSF purchasing sovereign bonds and lending to insolvent states is not going to reduce the debt pile accumulated by European Governments. Nor will extending maturity and lowering interest rates on its loans help improve economic situation in PIIGS and beyond. So I would disagree with ESRB on the first bullet point.

Calling for adoption of sustainable fiscal policies and growth enhancing measures is like telling a person sinking in a bog to pull harder on his hair. Fiscal sustainability is not being delivered in any of the PIIGS so far, and there is absolutely no appetite for any Government in Europe to take properly drastic measures required to get their finances on sustainable path. Even the very definition of sustainability used by EU is a mad one (let alone not a single state actually adhered to it so far with exception of Finland). A deficit of 3% pa means that you get to 100% debt/GDP ratio in longer time than with a deficit of 5% pa. But you will still get there, folks. Debt to GDP ratio of 60% is only sustainable if, in the environment of 3% 10-year yields your economy expands by more than 1.8% pa (assuming no population growth and no amortization and depreciation under balanced budget). That has not happened in the euro zone in any single 10 year period since we have full data for its members.

Growth-enhancing measures adoption is another case of pure 'wishful' thinking. In most of the Euro area and indeed in the EU Commission, this usually means more subsidies and more state spending. In parts of Central and Eastern Europe it usually means promoting real private sector competition and investment. Of course, we know who weathered the storm best in the last two recessions. But, hey, ESRB wouldn't make a call as to what it means by this "adopting... growth-enhancing measures" despite the fact that much of "growth enhancements" unleashed on euro area economies in recent past is precisely what got us into the current sovereign debt mess in the first place.

As per its last bullet point, one starts to wonder if ESRB is going down the slippery line of 'rhetoric ahead of action'. What does "enhancing the coordination and consistency of communication" mean? All of the EU policymakers 'speaking with one voice'? Curtailing or otherwise minimizing dissent? Controlling information flows? What the hell, pardon my French here, does it really mean, folks?

On a beefy ending, ESRB prescribes that: "Supervisors should coordinate efforts to strengthen bank capital, including having recourse to backstop facilities, taking also into account the need for transparent and consistent valuation of sovereign exposures. If necessary, this could benefit from the possibility for the European Financial Stability Facility to lend to governments in order to recapitalise banks, including in non-programme countries."

I am sorry to say this, but if anyone reading this is going to vote in the Dail on the European Financial Stability Facility and Euro Area Loan Facility (Amendment) Bill 2011 you really have to understand this statement. In effect, ESRB here welcomes loading of the risks of insolvent banking systems - including in non-programme countries - into one single facility, the EFSF, which will have preventative powers to intervene in the markets to buy distressed debts of banks and sovereigns. In a sense, EFSF will become a super-dump - a motherload of super toxic financial refuse from both radioactively insolvent sovereigns and biochemically toxic banks. You wouldn't want THIS anywhere near your local constituency.

21/09/2011: Risk focus swings?

What gives, folks:

Tables below show the swing in risk assessments away from PIIGS to net contributors to the EFSF/EFSM/ESM alphabet soup concocted by the EU to powder over the gaping wounds left by the earlier stages of sovereign debt crisis. Why?

Absent long-term trend we can only speculate, but can it be the ever-widening liability being loaded on Finland, Austria and Netherlands under the current euro area 'burden-sharing' arrangements? Or are the markets re-assessing the prospects for the euro bonds?

21/09/2011: Ireland's External Trade for July 2011

Trade stats for Ireland for July are out today and as predicted, trade balance has shrunk somewhat off its historic high attained in June. Here are the details:

• Seasonally adjusted exports fell 11.74% to €7,027.2mln in July down from €7,961.9mln in June. Year on year exports are down €763.4mln or 9.80%. Relative to July 2009 levels, exports are down €32.3mln or 0.46%.
• To remind you, H1 2011 exports stood at robust €46,450.4mln well ahead (+6%) on €43,821.9mln in H1 2010 - a difference of €2,628.5mln.
  
• Imports, seasonally-adjusted, increased in July to €3,876.6mln - a rise of 2.57% mom and 2.40% yoy. Compared to same month in 2009, imports are up 4.14%.
• H1 2011 imports stood at €24,929.2mln up 8.44% on same period of 2010.

As the result, trade balance fell 24.67% mom to €3,150.5mln, with annual rate of decline standing at 21.34% and relative to same period in 2009, trade balance is down 5.59%. Much of this seems to be accounted for by a combination of an increase in imports from the Chemicals & Related Products and decreases in the same sector exports, although current release does not provide sectoral data breakdown for July (data is supplied with 1 month lag).
Terms of trade remained subdued at the lower end of export prices
Terms of trade in June were up to 78.2 (higher ratio of export prices to import prices) from 76.9 in May 2011, but year on year terms of trade are still down by 11.5% and relative to June 2009 terms of trade are now also lower by some 10.73%. as highlighted below:
Imports intensity of exports also fell - perhaps in part due to rebuilding of supply stocks (higher imports) in core exporting sectors, such as Chemicals:
Imports intensity of Irish exports (ratio of exports value to imports) now stands at 181.3% in July 2011, down from a record-breaking 210.7%. This reflects a normal pattern of supplies inventories exhaustion followed by subsequent rebuilding. Two interesting trend, however emerge from the above chart:

• Overall imports intensity of Irish exports rose during the period of the current crisis due to two factors - the catastrophic collapse of consumer good imports and increased incentive to engage in transfer pricing for the MNCs
• Imports intensity of our exports also became much more volatile in the current crisis, again due to removal of the stabilizing factor of domestic consumption imports and due to possible reduction in the willingness of the MNCs to hold longer stocks of inputs (possibly reflecting generally elevated uncertainty of global demand).
  

Again, as a reminder of previous robust performance, and to correct for embedded monthly volatility in the trade data, the figures for H1 2011 compared with H1 2010 show that:

• Exports increased by 7% to €47,114mln
• Exports of Medical and pharmaceutical products increased by 14% or €1,754mln
  
• Exports of Organic chemicals rose by 13% or €1,194mln
• Exports of Computer equipment fell by 7% or €142mln
  
• Exports of Telecommunications and sound equipment decreased by 25% or €107mln
• Exports to the USA increased by 14% or €1,337m while exports to Spain fell by 16% or €276mln
• In the H1 2011, 23% of Ireland’s exports went to the USA, with Belgium (16% - as an enter-port) and Great Britain (13%) being the other dominant markets
• Imports increased by 9% to €24,992mln
• Imports of Petroleum increased by 24% or €496mln
• Imports of Medical and pharmaceutical products rose 24% or €419mln
  
• Exports of Organic chemicals increased by 26% or €279mln
  
• Imports from Great Britain rose by 19% or €1,191mln and from Germany by 16% or €256mln
• Over half (53%) of Ireland’s imports came from Great Britain, the USA and Germany in the first half of 2011

On the net, July figures can prove to be a temporary correction and should be taken less as a signal of real weakness, and more as a temporary downshift along the continuously rising trend line.

However, so far, January-July 2011 data suggests the annual rate of growth in imports of just under 8%, in exports of just over 3.6% and the trade surplus decline of just under 1%. P{ut differently, January-July cumulated imports now stand at €28.8bn against €26.77bn in the same period of 2010. Meanwhile, exports are at €53.48bn against €51.61bn. This means January-July 2011 trade surplus is running at a cumulative €24.67bn against same period 2010 trade surplus of €24.84bn. Sorry to say it, I am not seeing 6-8% trade expansion here, at least not for the first seven months of the year.

21/09/2011: Fed's QE3 and why it will fail

Markets catalysts for today (barring unexpected news from the euro area) will be the US Fed statement expected at 19.15. Following the FOMC two-day meeting consensus expectation is for the FED to announce new, but relatively modest - compared against QE1-2, easing measures labeled in the media Operation Twist.

These will attempt to boost consumer and corporate borrowing and spending, as well as ease longer-term debt constraint for the Feds and local authorities (states and municipalities). The Fed is likely to attempt flattening the longer-term yield curve in a hope that restarting borrowing will cut US elevated 9.1% unemployment rate.

To do this, the Fed will probably sell short-term debt (Treasuries) to buy out longer term debt - in effect the cost of borrowing will rise in the short run, while longer term financing costs will decline. Short-term consumer credit will take a hit, as will less liquid financial services providers. Operating capital for businesses is also likely to become more expensive. Just how exactly this is going to help US economy - anyone's guess, but it will provide some breathing space for the US Government, put pressure on the Republican opposition to debt ceiling hikes (pressing the argument forward that short-term financing is getting relatively more expensive) and will encourage banks to load up on maturity mismatch risk via incentivising shorter bonds loading).

Simultaneous selling of short term maturities and buying of longer term debt will in effect sterilize Fed intervention when it comes to its balance sheet, but it will also encourage cutting back the entire maturity profile of banks asset books.

The core problem, of course, is that these measures are likely to fail to deliver anything meaningful to the economy. The cause of stalled consumer and producer demand for credit is not the cost of financing - especially in the short run, since mortgage rates are currently at historically low levels. The real cause is the fact that the US is suffering from debt overhang.

Back in 1980, US Household, Corporate and Government debt as percentage of nominal GDP amounted to 151% - 3rd lowest in G7. By 1990 this rose to 200% - 4th lowest. With Bill Clinton's (or rather Republican Congress) heroic efforts to cut that, 2000 level of debt was 198% - the lowest in G7. In 2010, the US combined public and private non-financial debt was 268% - the second lowest in G7.

Meanwhile, household debt rose from 52% of GDP in 1980 to 95% of GDP in 2010. Thus US households have gone from being 4th most indebted in G7 back in 1980 to being second most indebted in 2010. In the mean time, corporate debt remained relatively low, compared to G7 states - rising from 53% in 1980 (3rd lowest) to 76% of GDP in 2010 (lowest in G7).

Public sector debt rose from 46% of GDP (3rd lowest in G7) in 1980 to 71% of GDP in 1990 (3rd highest in G7), declined to 58% of GDP in 2000 (second lowest) and rose to 97% of GDP in 2010 (3rd lowest in G7).

In a recent paper, presented at Jackson Hole, WY meeting this year, S. G. Cecchetti, M. S. Mohanty and F. Zampolli (paper titled "The real effects of debt") reported that thresholds for debt levels that are damaging to economic growth (under the baseline case that covers presence of the financial crisis) are:

• 96% for Government debt to GDP ratio (US was already at 97% in 2010)
• 73% for Corporate debt to GDP ratio (US was at 76% in 2010) and
• 84% for Household debt to GDP ratio (US was at 95% in 2010)

Spot the problem, folks, for Ben clearly can't see it. (Hint: of all three debt heads, household debt is further out of trigger range).

Thus, the only meaningful stimulus the US Government can put forward is the set of measures to deliver meaningful reductions in household debt. About the only tool for that is a broad-based middle and upper-middle classes income tax cut.

Everything else, including Ben's financial re-engineering of the yield curve, is not much different from what the EU is doing with Greece. Kicking the can down the road is not the proverbial elephant the Fed is ignoring. The can itself - household debt - is.

20/09/2011: EU banks losing corporate deposits & 'stress tests' scam

In a testament that the world continues to lose confidence in Euro area banking system, Europe's largest engineering firm, Siemens reportedly withdrew large amounts of deposits from the commercial banking system and deposited them with the ECB. The details of this transaction were reported in today's FT (link here) and other media outlets.

In the mean time, WSJ reported that documents distributed at the meeting of the euro area finance ministers in Wroclaw last weekend out to question the validity of the European banking stress tests carried out this summer.


Siemens withdrawal amounted, reportedly to €500 million and impacted "a large French bank", motivated by "concerns about the future financial health of the bank and partly to benefit from higher interest rates paid by the ECB". Again, per reports, Siemens now holds €4-6bn at the ECB, mostly in one-week deposits.

Siemens set up a banking arm almost a year ago to insure itself against adverse risks to liquidity flows in the context of the global financial crisis, enabling it "to tap the central bank for liquidity and deposit cash at the ECB"Siemens does not only use the ECB as a haven; it also gets paid a slightly higher interest rate than it would get from a commercial bank.

ECB, currently amidst sterilized bonds purchasing programme, uses deposit facilities to cut down on money supply increases created by it buying PIIGS bonds. To do this, ECB attracts deposits from commercial banks by offering 15bps margin on its deposits over 0.95% average interest rate for overnight deposits with euro are banks.

In effect, Siemens move kills two birds with one stone - the company achieves greater security of deposits (eliminating counter-party risks) and benefits from 0.15% spread on deposits - a nice sum amounting to €6-9mln per annum, which most likely covers its 'banking' operations costs.

In the severely distorted world of euro area banking, thus, smart corporates can have a decent free lunch, courtesy of ECB's continued insistence on protecting failed sovereigns and banks.


Per WSJ report (link here) EU banks stress tests carried out in July 2011 were based on archaic macroeconomic scenarios that did not cover the latest developments in sovereign credit markets. "The tests did not manage to restore market confidence,"reports WSJ based on the document discussed by finance ministers.

One specific macroeconomic assumption criticised relates to the scenario under which stress is applied to sovereign bond holdings of the banks - the core point of the entire exercise - "a scenario which was clearly taken over by events as months passed by."

So here we have it, folks, our ministers have now admitted what most of us knew all along - the stress tests in 2011 were as shambolic as those in 2010 despite being carried out under the watchful eye of EBA - the 'new' authority that is supposed to make the banks more transparent and better managed post-crisis.

I bet folks at Siemens Bank are glad they didn;t put much faith with euro area banks regulators...

20/09/2011: Wholesale Prices - more margins pressure

Wholesale Price Index for Ireland is out today - monthly series (note - these are highly volatile series in general) and the results are not too good for profit margins in Irish manufacturing.

Monthly factory gate prices declined 0.4% in August 2011 against an increase of 0.2% in August 2010, implying annual rate of contraction of 1.0%. In July 2011, annual rate of decrease stood at 0.4%.

Overall price index for manufacturing industries (NACE 10-33) stands at 97.2 in August 2011, down from 97.6 in July and 98.2 in August 2010. We are now in the third monthly decline in a row.

Stripping out effects of food, beverages & tobacco sector, manufacturing price index fell to 92.2 in August 2011, down from 92.5 in July and 94.2 in August 2010. Year on year index is now down 2.1% against annual decline of 1.5% in July.


In the month, the price index for export sales was down 0.5% while the index for
home sales (domestic sales) increased by 0.1%. In the year there was a decrease of 2.2% in the price index for export sales (this can be influenced by currency fluctuations, as CSO correctly points out). In July 2011 annual rate of decline was 1.6%. However, CSO fails to point out that deflation has been affecting severely our largest exporting sectors - pharma and ICT (see below on this). In August 2010, annualized rate of change in export prices was +0.2%.

There was an increase of 4.7% in respect of the price index for home sales (this can be influenced by state-controlled producers ripping-off domestic consumers, but hey, no mention of that in CSO release). In July 2011 there was a 4.9% increase yoy in same prices. And in fact, domestic sales prices have been rising every month since December 2009, implying increasing pressures on retail sector here and domestic consumers.

So the two-tier economy is well supported by price changes as well as production volumes: our exports are getting cheaper (last increases in exports prices yoy were recorded in January 2011), while our domestic sales are getting more expensive and fast. The last time changes in prices in domestic sector fell behind changes in prices (in same direction) in exports sectors was July 2010. And not a peep from either our policymakers or the CSO about these facts.

What CSO does highlight is that: "Contributing to the annual change were increases in Dairy products (+10.1%), Meat and meat products (+8.1%) and Other Manufacturing including Medical and Dental Instruments and Supplies (+3.2%), while there were decreases in Computer, electronic and optical products (-6.4%), Basic pharmaceutical products and pharmaceutical preparations (-3.6%) and Other food products including bread and confectionary (-1.1%)."
Now, recall that pharma accounts for 90% of our trade surplus. Basic pharma sector wholesale prices have now fallen to 87.4 in August 2011, down from 90.7 in August 2010 and from the local peak of 106 attained in November 2008.

CSO does report that "The price of Energy products increased by 3.3% in the year since August
2010, while Petroleum fuels increased by 9.1%. In August 2011, the monthly price index for Energy products decreased by 1.4%, while Petroleum fuels decreased by 3.7%." I would add that electricity remained unchanged at 115.2 year on year and most of price increases in this sector are due to Petrol and Autodiesel (both +9% yoy), Gas oil (+10.3%) and Fuel oil (+8.8%).

Year on year, the price of Capital Goods decreased by 5% in August, to 82.5 and it was down 4.3% in July. The index now stands at 82.5, down from 83 in July 2011 and 86.8 a year ago. Intermediate goods ex-energy price index rose 2% in August (yoy) against yoy rise of 2.7% in July. This index remain in the positive territory since November 2011.

19/09/2011: Highly Leveraged Banks' real impact on economy

An interesting paper from CEPR sheds some (largely theoretical) light on the real side of the current global financial crisis.

CEPR DP8576 titled "Financial-Friction Macroeconomics with Highly Leveraged Financial Institutions" by Sheung Kan Luk and David Vines (September 2011: available here) models the current crisis by adding "a highly-leveraged financial sector to the Ramsey model of economic growth". The paper shows that the presence of high leverage in financial sector "causes the economy to behave in a highly volatile manner" and thus exacerbate the macroeconomic effects of aggregate productivity shocks.

The model is based on the mainstream financial accelerator approach of Bernanke, Gertler and Gilchrist (BGG). The core BGG model assumes leveraged goods-producers are subjected to idiosyncratic productivity shocks, inducing them to borrow from a competitive financial sector.

Luk and Vines, by contrast, assume that "it is the financial institutions which are leveraged and subject to idiosyncratic productivity shocks." As the result of this, leveraged financial institutions "can only obtain their funds by paying an interest rate above the risk-free rate, and this risk premium is anti-cyclical [ in other words the premium is higher at the time of adverse productivity shock, i.e. during the recession], and so augments the effects of shocks."

Luk and Vines parameterise the model to US data under the assumption that "the leverage of the financial sector is two and a half times that of the goods-producers in the BGG model". The assumption is relatively robust for the current environment in the US. It is probably less robust in the case of the EU where financial sector leverage is likely to be higher in a number of countries due to:

1. Traditional over-reliance on debt financing of the banking sector
2. Lower rates of deleveraging in the banking sector than in the US, and
   
3. Greater deposits attrition during the crisis.
   

The study finds that the presence of leveraged financial institutions "causes a much more significant augmentation of aggregate productivity shocks than that which is found in the [traditional] BGG model."

In the nutshell, this provides a plausible explanation as to the channels through which financial sector funding and operational strategy risks (leading to higher leverage) transmit through to real economy. It also links more directly monetary policy to the real economy as well. Ben, keep that printing press running... nothing can possibly go wrong with negative interest rates, mate.

17/09/2011: QNHS 2Q 2011 - public sector v private sector trends

This is the second post on the data from QNHS for 2Q 2011.

Table below summarises data from QNHS results, showing changes for specific sectors of the economy as well as core figures for overall employment, labor force and unemployment.
Using the data from core QNHS we can compute decomposition of employment pool into three broadly defined subsectors, as shown below. The core trends here are the following:
Ratio of private sector employees to those employed in public sector now stands at ca 2.76 private sector workers per 1 public sector employee. Sacred yet? That ratio rose from 2.73 in (an improvement, in fact) qoq between 1Q 2011 and 2Q 2011, but is down from 2.78 in 2Q 2010 and 3.00 in 2Q 2009. In other words, there are fewer private sector employees now per each public sector employee than in either 2010 or 2009 or indeed in 2008 and so on.

The same is true across the specific sectors. There are more people in employment in education per private sector worker now than 2007-2010, there are more people employed in public administration per private sector worker now than in 2007-2010, there are more people employed in healthcare per person employed in private sector today than in any moment since 1Q 2004. This, after the allegedly savage cuts in numbers in public sector employment.

QNHS also now reports EHECS-based public sector employment estimates. Table 1.1 below (reproduced from QNHS release) shows the estimates of public sector employment broken down by the different high level areas within the public sector. I've added the red line below showing proportional allocation of employment - the number of private sector workers per each public sector worker. This only slightly differs from the same metric I derived above based solely on QNHS. Again, there are, broadly speaking, 2.82 persons working in private sector per each 1 person in public sector. A year ago, there were 2.86, 2 years ago, there were 2.85... savage cuts folks? Not exactly. Looks more like continued steady burden on private sector from supporting public sector employment.
That's a tough thing to swallow, folks. Per CSO: "The number of employees in the public sector showed no change over the year to Q2 2011. However, the employment figures for this quarter include 5,300 additional temporary Census field staff who were employed during the periods covering Q1 and Q2 2011. When these staff are excluded there was a fall of 1.3% in employment over the year to Q2 2011." Give it a thought, folks - a fall of 1.3% when unemployment rose 3.93% and underemployment went up 20.89% and employment fell 2.1% and private sector employment declined 2.4%.

"The number of employees in the public sector has continued to fall over the last three years with a total decrease of 24,600 up to Q2 2011 when excluding census field staff." Drama unfolds? Let's check that table above. Since 4Q 2008 through 2Q 2011:

• Private sector employment is down 12.9%
• Civil service employment is down 7.5%
• Semi-states employment is down 8.5%
• Total public sector ex-semi-states employment is down 5.5%
• Total public sector employment is down 5.9%
  

Draw your own conclusions as to whether the Croke Park is delivering or not.

16/09/2011: QNHS 2Q 2011 - things are getting frighteningly worse less rapidly

This is the first of two posts on QNHS 2Q 2011 data released yesterday.

Yesterday's QNHS results for 2Q 2011 confirmed the continuation in the trend weaknesses in Irish labour markets, with some moderation in the rate of deterioration qoq.

Per CSO: "There was an annual decrease in employment of 2.0% or 37,800 in the year to the second quarter of 2011, bringing total employment to 1,821,300. This compares with an annual decrease in employment of 2.9% in the previous quarter and a decrease of 4.1% in the year to the second quarter of 2010."

Other core stats and changes are:

• The annual decrease in employment of 2.0% is the lowest annual decline since 3Q 2008.
• On a seasonally adjusted basis, employment fell by 3,200 (-0.2%) in the quarter. This follows on from a seasonally adjusted fall in employment of 7,200 (-0.4%) in Q1 2011. The 2Q 2011 fall in employment is the lowest quarterly decrease recorded in the seasonally adjusted series since 1Q 2008.
• The largest decrease in employment over the year was recorded for the 25-34 year age group (-27,500 or -5.0%). A reduction of 21,100 was also recorded for the 20-24 age group (-15.0%). Numbers in employment are now down 324,900 on the peak attained in 4Q 2007.
  

The total number of persons in the labour force in 2Q 2011 was 2,125,900, representing a decrease of 26,800 (-1.2%) over the year. This compares with an annual labour force decrease of 50,400 (-2.3%) in Q2 2010. This marks a decrease of 128,500 on the peak reached back in 1Q 2008.

Unemployment rose 10,900 (+3.7%) in the year to 2Q 2011 with 304,500 now unemployed (male unemployment increasing by 5,600 (+2.8%) to 205,700 and female unemployment increasing by 5,200 (+5.6%) to 98,800). The unemployment rate increased from 13.6% to 14.3% yoy in 2Q 2011.

The long-term unemployment rate increased from 5.9% to 7.7% over the year to Q2 2011. Long-term unemployment accounted for 53.9% of total unemployment in Q2 2011 compared with 43.3% a year earlier and 21.7% in the second quarter of 2009.

The seasonally adjusted unemployment rate increased from 13.9% to 14.2% over the quarter.
Full-time employment fell by 53,000 (-3.7%) yoy with declines in both male (-33,700) and female (-19,300) full-time employment. Per CSO: "This decline in full-time employment was partially offset by an increase in the number of part-time workers where the numbers increased by 15,200 (+3.7%) over the year. Part-time employment now accounts for 23.4% of total employment. This had been as low as 16.7% in Q3 2006." Full-time employment is now down 367,600 on peak (4Q 2007) and part-time employment is now at its new peak at 426,800 - up 40,800 on 4Q 2007.


Part-time underemployment (a form of unemployment, really) increased by 23,000 (+20.9%) from 110,100 to 133,100 over the year. Part-time underemployment now represents just under one-third (31.3%) of total part-time employment, up from 26.8% a year earlier. Among males, part-time underemployment is close to half of total part-time employment (46.7%), up from approximately 42% a year earlier. For females the comparative proportion is one quarter (25.0%), but as with males this proportion has been increasing over time.

Now to the frightening number: combined unemployed and underemployed part-timers now stand at a frightening 434,700 or 20.5% of the labor force. This number is up from 400,300 a year ago (+8.6%).

So, on the net we have:

• flattening out of the unemployment increases curve, but continued increases, nonetheless
• flattening out of labor force decreases rate, but continued declines in labor force
• increasing share of employment taken up by part-time employed
• increasing share of long-term unemployed and underemployed in the labor force.
  

And LR confirms this diagnosis:
It's not exactly 'turning the corner' moment, is it?

15/09/2011: Some observations on NTMA & NAMA statements to the Oireachtas Committee

I was going over the statements issued by NTMA and NAMA to the Oireachtas Committee last week and was struck by some rather interesting bits...

Let's start with the Statement by John Corrigan, Chief Executive NTMA, to the Joint Committee on Finance, Public Expenditure and Reform, 9 September 2011:

"The banking stress tests carried out by the Central Bank in the first quarter of 2011 quantified the additional capital support required by the banking sector at €24 billion. The NTMA Banking Unit has worked very hard to minimise the amount of this additional capital to be provided by the taxpayer. Through initiatives like burden sharing with the junior bondholders and the sourcing of private capital for Bank of Ireland, the net amount of this capital provided by the State is now expected to be around €16.5 billion. The savings generated can be redirected to funding the day-to-day operation of the country."

Can Mr Corrigan explain this: as of August 1, 2011, the State has injected (under PCAR/PLAR allocations) €17.292bn (here) according to DofF note. That €792mln difference is not exactly a pittance...

Oh, and while we are on the issue of being accurate - PCAR/PLAR capital allocations are designed to deliver capital & liquidity cushions for the period 2011-2013. Not a trivial issue, mind you, especially since Mr Corrigan repeatedly relies on PCAR/PLAR recapitalization exercise as a definitive (aka permanent) line in the sand on banking crisis.

Now, as to the "savings can be redirected to funding the day-to-day operation of the country" - that is pure rhetoric, sir, isn't it? Mr Corrigan himself shows that it is (see marked with italics next quote below).

"In order to stabilise our debt/GDP ratio Ireland needs to get back to running a primary budget surplus (the budget balance excluding interest payments) as soon as possible. Indeed in the context of debt sustainability, this metric is far more important than the absolute level of debt per se. Ireland still has the biggest primary deficit of any eurozone country, a fact not lost on investors..."

So, wait a sec, Mr Corrigan. You said "savings [from PCAR/PLAR recaps] can be redirected to funding the day-to-day operation of the country". You also said that we need to run a primary surplus. You can't have your cake, Mr Corrigan, and eat it.

"The objective of the [banks] deleveraging process is to achieve a more prudent loan to deposit ratio for the institutions concerned through a reduction of their balance sheet assets of some €70 billion while avoiding sales at prices which absorb excessive capital."

Was Mr Corrigan trying to say that we need to deleverage the banks while minimizing the calls on the banks' capital for losses incurred in the process of deleveraging? Ok, that would imply selling good - aka performing - assets first. What would that do to the banks balancesheets, Mr Corrigan? It will undermine banks balancesheets, leaving them with poorer quality average assets. Is that Mr Corrigan's idea of restoring banking system to health? And is that covered by PCAR/PLAR definitive line in the sand? You know, Mr Corrigan, that it is not.



There was also Mr McDonagh speaking on the day...

Opening Statement by Mr. Brendan McDonagh, Chief Executive of NAMA, to the Joint Committee on Finance, Public Expenditure and Reform Friday, 9th September 2011"

"We have now recruited over 190 staff with the specialist skills and experience required to manage a portfolio of property loans with balances in excess of €72 billion."

So NAMA chief thinks it is a great achievement of NAMA that it managed to hire 190 people. Boy, Mr McDonagh would do well in public sector where the metrics of spending are more important than those of earning...

But what is this about €72 billion portflio balances? NAMA valued the portoflio it purchased at €30.5bn gross (inclusive of the LTEV uplift). Banks, who sold NAMA that portfolio wrote down the losses realized, implying that NAMA end valuation in their view was a reasonable reflection of the value of portfolio NAMA bought. So is Mr McDonagh deploying Eugene Sheehy's approach to claiming balances on loans to be assets under management and refusing to write down the actual loans values to the publicly disclosed valuations that NAMA itself prepared?

And is Mr McDonagh conveniently forgetting that the book value of these assets has fallen since that LTEV was assessed and assets were valued? May be Mr McDonagh should consult his own annual report to see his organization taking charge against that loss?

Of course, Mr McDonagh is just pumping up NAMA's (aka his own) importance. NAMA, you see, is not managing €30.5 billion-valued undertaking, or an odd €25 billion actual undertaking (once we factor in at least some of the value losses on NAMA's portfolio), but a €72 billion portfolio. In a way, Mr McDonagh is like Montgomery Burns checking his old ticker for the price of his Federated Slaves Holdings plc...

I love Mr McDonagh's next statement:
"There is a third, small group of debtors ... with whom we could work but who are not co-operating adequately with the process and who appear to believe that, after all that has happened, the taxpayer somehow still owes them a living. We have been as fair, reasonable and patient with these people as any court could possibly expect us to be but, in the circumstances, it is likely that we will be left with no option but to instigate additional enforcement actions before the year is out. Above all else, ...the self-indulgent behaviour of a few has no place in resolving the national crisis with which, collectively, we are grappling."

Now, close your eyes, imagine a summer night, chirping of birds in the distance. From an open window dark woods staring into the room. Armchair. The house owner, with mustache, in military tunic, pipe in hand, explaining in deep Georgina accent to two smaller (in evident statue) men the rationale for dealing resolutely with a small group of dissidents who refuse to cooperate, betraying self-indulgent decadent behavior amidst the national crisis... Mr McDonagh's rhetoric is permeated with Joe Stalinesque tonalities, innuendos, juxtaposing reasonable (NAMA) against the decadent and asocial (developers), the 'few' against the 'many'. Himself positioned in a high priest fashion at the head of the judgment table, burdened with the duty of carrying NAMA's burden of justice to the few unwise dissenters. Why not visit Lubyanka Museum in Moscow on your next corporate outing, my dear NAMAnoids?

There's more of the same, pardon me self-indulgent and arrogant stuff in relation to the public allegedly asking politicians uninformed questions and some people (unknown to us) making uninformed statements about NAMA. "The accusation that NAMA is bureaucratic and slow in dealing with these approvals is unfair and unwarranted but, unfortunately, in the current environment, when it comes to NAMA, many seem to feel that they have no obligation to check the facts before making the accusation."

Ok, Mr McDonagh. I would like to make an informed observation. Where do I get the facts? From you? From NAMA? Who can assure me that the facts you &/or NAMA present are full, correct and not mis-represented?

Let's try the 'trust your NAMA' thingy. Here you say: "There has been much interest from the public (over 100,000 downloads) [in relation to NAMA list of properties under receivership] and in particular from younger people who are keen to use the current correction in property prices to purchase their own homes."

How do you know these are young people? I downloaded the list without any registration. Are you tracking my IP address and accessing, unbeknown to me my details? Are you acting legally in doing this? Or are you simply making a claim that cannot be verified? So much for 'trust your NAMA' proposition then.

And now to the conclusion: "It is our intention that NAMA will be a creative and dynamic force in the property market and, more generally, that it will contribute significantly to the economic resurgence of Ireland in the years ahead." Sorry, Mr McDonagh, but you are not getting it. NAMA has a defined - according to your own chairman and legislation establishing NAMA - mandate. That mandate does not envision NAMA becoming either 'creative' or 'dynamic', nor does it envision 'NAMA contributing to the economic resurgence of Ireland'. Your mandate is to:

1. Recover taxpayers' funds, and
2. Close the shop after doing so.

In case you weren't paying attention on September 9th, Mr Frank Daly said in his statement - made alongside your own: "...the objective that has been set for us by the legislature, under Section 10 of the NAMA Act, is to recover, at a minimum, that amount plus whatever additional funds we need to advance as working or development capital for projects." Mr Daly repeats this objective (in slightly different wording) twice in his statement. Mr Daly does refer to NAMA being "creative and flexible", but unlike Mr McDonagh, he limits this to the reference to properties that NAMA is working with, not to the entire property market and not to the economic resurgence of the whole country.

“Ἀπόδοτε οὖν τὰ Καίσαρος Καίσαρι καὶ τὰ τοῦ Θεοῦ τῷ Θεῷ” (Matthew 22:21), Mr McDonagh. And please, extinguish that pipe and change the tunic... Being Uncle Joe is not only uncool, it is also, fortunately, infeasible for you.