12/11/2011: Russian economy - Summary 2011

Summary of the Russian economy in the light of the removal of the final barriers to the country accession to the WTO (see the related note here). To see the slides, click on the individual frame to enlarge

12/11/2011: Russia's accession to the WTO - opportunities for Irish exports & investment

This week, finally, with much delay, there is a full agreement for Russia accession to WTO, clearing the few issues that remained the stumbling block to the country membership. It is now expected that Russia’s membership will be approved at the WTO Council meeting on December 15-17. The decision is expected to go for ratification to the Duma some time in early 2012. Following the ratification, Russia will be formally admitted to the WTO within 30 days after the vote.

Under the core conditions for entry, import tariffs will be reduced from the average of 10% to 7.8% with at least 1/3 of all tariffs reductions to take place on the date of formal accession. 25% of the rest of tariffs reductions will take place after 3 years of transition. The balance will take effect after 7 years of transition (these focusing in the 'sensitive' areas of car manufacturing and aircraft manufacturing) and 8 years for some agricultural tariffs (e.g. poultry).

One core achievement will be in the area of customs clearance, with maximum customs fee to be reduced from the current Rb90,000 - or ca USD2,900 to Rb30,000.

Another core development is that the previously-announced major privatisations programme will be subject of reporting to the WTO

More specifically, in the areas of importance for irish exporters:

• Agricultural imports will see average tariffs falling from 13.2% current to 10.8% post-adjustment period. Cereals tariffs will declined from 15.15% to 10% and dairy tariffs will fall from 19.8% to 14.9%. Domestic agricultural supports - subsidies - will be reduced from USD9bn in 2011-2012 to USD4.4bn in 2018. 
• Russia will privatise 100% shareholding in the United Grain Company in 2012, as well 50%+1 share of the Rosagrolizing (by 2013).
• Overall, agricultural measures can be expected to drive significant change in the sector in Russia post-2020, with some expected capex growth in advance of these as domestic enterprises re-tool to enhance competitiveness.
• Manufacturing tariffs are to fall from 9.5% average to 7.3%. While automotive manufacturing imports tariffs are to declined from 15.5% to 12% over 7 years period. 
• In chemicals sector, average tariffs are to decline from 6.5% current to 5.2%.
• In telecoms sector, by the end of 2016 there will be lifting of the restriction on foreign ownership from the current 49% to allow full ownership of enterprises.
• Similarly, there will be no restriction on full foreign ownership of banks. However, foreign banks combined market share of the Russian market will remain capped at a maximum of 50%. In addition, by 2021 foreign insurance companies will be allowed to open fully-owned subsidiaries and branches in Russia.
• In transport sector, there will be equalization of treatment of foreign-made aircraft to that of the Russian-made aircraft in terms of leasing, eliminating current preferential treatment of Russian manufactured aircraft. By mid 2013, Russian railways will phase out price differentials for shipments of Russian-made and foreign-made goods.
• In services, the restriction on share ownership for wholesale, retail and franchise companies will be lifted immediately after the accession.

It is unlikely, however, that the accession will have an immediate impact on Russian trade and investment relations with the rest of the world, as compliance period relating to the accession is long, especially in the more 'sensitive' areas, such as car industry, transport industry, agriculture etc. However, we can expect an improved drive toward domestic (Russian) enterprises increasing their competitiveness and the Russian Government to accelerate efforts to improve institutional frameworks and enhance institutional capital. More active Government drive to secure key internal markets reforms is expected and this is likely to shape forthcoming Presidential elections.

On the net, I expect significant changes in the markets for Irish exporters into Russia and a long-term process of reforms and investment growth for Russian markets as the result of the accession. This is hugely positive development. The market potential for Irish trade with Russia is in the region of €1.3-1.5 billion or roughly double the current levels of exports.  The market potential for Irish investment into Russia is in the region of €1 billion per annum, although achieving this potential requires significant changes in the supply of auxiliary services to Irish investors (access to functional banking and investment advice).

Lastly, there is also a huge potential for Russian investment into Ireland. In recent years, Russian investments into EU have been increasing from about €3 billion annually in 2008 to the expected volume of €4.1 billion in 2011. But Ireland remains off the map for Russian investors with just two Russian-owned companies being clients of the IDA.

Note: Russia is currently the largest economy in the world outside the WTO, with GDP in excess of USD1.9 trillion expected in 2011. The World Bank estimates that joining WTO will add 3.7% to the country GDP between 2012 and 2016 and 11% within 2012-2021. See a follow up note summarizing the Russian economy.

11/11/2011: Ireland's Consumer Prices: October

Irish CPI and HICP figures for October show continued pattern of public sector-controlled costs inflation and continued pressures on prices in the domestic economy. Here are the details.

Per chart above, Irish CPI rose from 104.4 in September to 104.7 in October compared to December 2006 when it stood at 100. Re-based to December 2001, October CPI was at 123.6, up on 126.2 in September. Mom CPI rose 0.3% and 3mo change is 0.8%. Annualized rate of change is now 2.8% - the highest since April 2011. All items CPI rose from 2.6% in September to 2.8% in October. 3mo MA is now at 2.53% and 6mo MA is at 2.62%.

Harmonized Index of Consumer Prices also increased 0.3% mom to 107.1 in October from 106.8 in September. A year ago, index reading was 105.5, so controlling for rounding yoy HICP rose 1.5% in october, up on 1.3% in September and 1% increases in July and August.

 CPI by household budget components was also worrying:

• Food and non-alcoholic beverages prices inflation remained at 1.4% for the third month in a row, with 6mo MA of 1.17% and 3mo MA of 1.4%. In 3mo through October, average price inflation rose 50% on 3mo period through July.
• Alcoholic beverages & tobacco remained in deflation of -0.5% for the fourth month running. 3mo MA is -0.5% and 6mo MA is -0.3, which means we are witnessing slightly accelerating deflation.
• Clothing & footwear posted -0.3% CPI in October, same as in September, down from -1.2% deflation in August. 3mo MA is -0.6% and 6mo MA is -1.2%, so we are seeing some slowdown in deflation.
• Housing, water, electricity, gas and other fuels posted another double-digit price increase of 10.2% in October, up on CPI of 8.9% in September. 3mo MA CPI is now at 8.77% and 6mo MA CPI is at 9.07%. Largest yoy increases in this category were: 20.5% increase in natural gas prices, 20.3% hike in liquid fuels prices, 18.1% increase in mortgage interest costs, 11.5% rise in electricity prices, and 6.9% price increase for bottled gas.
• Deflation continued to build up in Furnishings, household equipment and maintenance category with CPI of -2.2% in October against -2.3% in August and September. 3mo MA is now at -2.27% and 6mo MA is at -2.37%.
• As far as state-controlled sectors go, Health had another bumper crop year with price increases of 2.3% in October, against CPI of 3.4% in June-September. 3mo MA is at 3.03% and 6mo MA is at 3.42%. Hospital services drove inflation here with annual rate of price change of 9.8%. In contrast, pharmaceutical products prices are down 3.3% yoy in October.
• Transport - another heavily state-controlled or dominated sector also posted robust inflation of 3.6% in October against 4.2% in September. CPI for the sector is now at 3mo MA of 3.67% and 6mo MA of 3.52%. Costs of purchasing vehicles have fallen 4.3% yoy through October, but costs of fuels and lubricants rose 14.5%. Rail transport costs are up 1.8%, Bus fares are up 10.0%, Air transport costs up 5.6% and Sea transport costs up 6.4%.
• Communications CPI in October stood at 1%, same as in previous 2 months. 6mo MA is now at 2.08%.
• Recreation & culture CPI posted -0.8% growth in October, more deflationary that -0.5% in September. 3mo MA is at -0.7% and 6mo MA at -0.65%.
• Education CPI showed the buoyancy of the Celtic Tiger era with 6.5% increase in October on the foot of 12 previous months posting deflation. 3mo MA is now at 1.1% and 6mo MA at -0.1%. THe swing in CPI was a massive 8.1 percentage points. Virtually all inflation in the sector was accounted for by the third level education costs - up 13.4% yoy in October (+13.5% mom). Education costs now run +21.9% ahead of December 2006 level for primary education, +22.7% for second level education, +50.1% for third level education and only +4.7% for Other education & training.
• Restaurants and hotels CPI came in at -0.9% in October from -0.8% in September. 3mo MA is at -0.8% and 6mo MA is at -0.65%. Accommodation services posted the largest deflation of -3.8% mom and -3.0% yoy, with Restaurants, cafes & fast-food posting deflation of -0.2% mom and -1.9% yoy.
• In Miscellaneous Goods and Services category, the only notable changes were: 12.7% yoy increase in insurance costs, broken down into a massive 23.8% yoy rise in Health insurance costs, and 4.2% rise in Transport Insurance costs. Overall, this category costs rose 6.4% yoy in October and 0.5% mom

State-controlled sectors and prices inflation is now running at 1.15% in October, up on 1.03% in September. 3mo MA and 6mo MA for the series are both at 1.0%. In contrast, private sectors prices are rising at 0.51% in October down from 0.55% in September. 3mo MA for these prices increases is 0.50% and 6mo MA is at 0.56%

Cumulative gap between state-controlled sectors prices and private sectors prices from December 2007 through today now stands at 140.51%, up from 139.62% in September.

11/11/2011: Some interesting recent links

Few links worth saving and reading - on diverse topics:

• Two Economist articles on our ability to access others' thoughts (here) and a related piece (here). 
• And excellent piece from the Irish Times on the role of data storage in changing the ways we think (here).
• Irish Times piece on electricity pricing and our state plans to export renewable energy: are we going to subsidise foreign consumers (here).
• Krugman's comment on Roubini's summary of the effects of 'internal devaluations' (here).
• Thomas Begley's piece on losses in Irish third level education competitiveness (here).
• My interview with Max Keiser from kilkenomics on the global financial crisis and the role of the markets and governments (here).
• A good graphic on latest ECB purchases of Italian bonds (here).
• An excellent set of graphics that provide visualization of euro area cross debt holdings (here).

11/11/2011: Industrial Production & Turnover - September

Industrial production and turnover figures for September provide some interesting reading. Monthly figures are significantly volatile, so some comparisons are tenuous at best, but overall, despite some downward pressures, the figures are encouraging. Here's why.

Industrial production index for manufacturing has declined from 116.4 in August to 113 in September - monthly drop of 2.92%. Year on year, September 2011 is still up 0.18% although index is down on September 2007 some 0.1%. The average of the 3mo through September 2011 was 2.2% ahead of the average for 3mo through June 2011 and 2.1% ahead of the 3mo average through September 2010. September 2011 reading is ahead of 6mo MA of 112.3 and 12mo MA of 111.7.

All of the above suggests the slowdown in activity in September was not as sharp as we might have expected given the adverse news flow from the rest of the Euro area.

All industries index has fallen from 115.2 in August to 111.2 in September, registering a yoy decline of 0.1% and mom drop of 3.47%. The index is down 1.67% on September 2007. Just as with Manufacturing index, All industries index 3mo average through September 2011 was up 2.59% on previous 3mo period and also up 1.82% on 3mo period through September 2010. The index was also above its 6mo MA of 110.7 and 12mo MA of 110.2. Again, this suggests that the slowdown is still shallow and there is some robustness in the series.

Both indices are still ahead of their readings in July and June. In fact, Manufacturing sub-index is resting at the second highest level since January 2011. The same holds for All Industries index.

Modern Sectors sub-index fell from 130.2 in August to 128.4 in September (-1.38%mom) but is up 1.18% yoy and 11.3% ahead of the reading for September 2007. 3mo average through September is 3.1% ahead of the 3mo average through June 2011 and is 1.8% ahead of the 3mo average through September 2010. The sub-index is ahead of its 6mo MA of 127.3 and its 12mo MA of 126.2. Modern Sector production activity remains at the second highest level since July 2010.

Per chart above, traditional sector production sub-index has fallen to 89.8 in September from 98.5 in August. The overall trend in the sub-sector is uncertain. Massive break out from the long term decline trend in August - with index posting the strongest performance since November 2008 is now followed by a contraction of 8.8% yoy and 1.8% mom in September. However, September reading still rests comfortably above the long term trend line and ahead of 6mo MA of 89.3 and 12mo MA of 89.1. This is the second strongest reading for the sub-index since September 2010.

Having shrunk to 31.7% in August, the gap between Modern and Traditional sectors has widened once again to 38.6%.

In terms of turnover, Manufacturing industries saw a significant decline in overall turnover activity from 104.3 in August to 100.5 in September. The index is now down 0.4% yoy and 3.64% mom. The index is also down 6.8% on September 2007. However, 3mo average through September is up 3.5% on 3mo average through June 2011 and also up 1.2% on 3mo average through September 2010. The good news is that September was the third consecutive month with turnover index at or above 100, which means that September reading is ahead of 6mo MA of 99.9 and 12mo MA of 99.5. But the gap is extremely small.

Transportable goods industries turnover also declined in September 2011 from 103.8 in August to 100.1. Mom, yoy and relative to September 2007 dynamics are virtually identical to those for Manufacturing sector. Similarities persist in comparatives for 3mo averages and for 6m and 12mo MA.

Hence, overall, turnover data is less encouraging than volume data, which is expected during the overall build up of pressures in global trade flows.

Also per chart above, new orders index came in at disappointing 99.6 in September down from 102.1 in August (decline of 1.09% yoy and -2.45% mom). Compared to September 2007 the index is now off 8.93%. 3mo average through September 2011 is 2.1% ahead of the 3mo average through June 2011, but is only 0.1% ahead of the 3mo average through September 2010. Current reading is very close to 6mo MA of 99.52 and to 12mo MA of 99.18.

So on the net, I am reading the numbers coming out for September as rather positive developments, signaling some resilience in Irish manufacturing and industrial production in the face of challenges across the euro area and other core trading partners. Of course, this data requires some confirmation in months ahead before we can pop that celebratory cork...

10/1/2011: Some simple Italian Auction maths

Italy's latest auction of 12mo t-bills came in at:

• Allocation: €5bln 
• Average yield 6.087% vs 3.57%  in last month's auction
• bid to cover ratio 1.989  vs 1.88 last month

The auction proves that

1. Italy is now insolvent (reminder - Italy is heading for 120% debt/GDP ratio with average real growth rate 1990-2010 of under 1% pa, implying that as ECB bound for inflation, Italy's annual expected growth over the next 20 years is unlikely to cover 1/2 of Italy's funding costs for its debt)
2. Italy is now illiquid (see chart below for funding requirements forward, courtesy of the ZeroHedge)
3. EFSF is now blown out of the water, with Italy's funding needs over 2012-2015 alone accounting for more than 1/2 of the entire enlarged EFSF pool of liquidity (good luck raising that, folks)
4. Italy's banking system is now insolvent as well, with Intesa's exposure at €60.2bn, UniCredit exposure of €49.1bn, Banca Monte at €32.5bn
5. Euro area top banks are now also insolvent with BNP Paribas exposure of €28bn, Dexia (aha, that one again) exposure of €15.8bn, Credit Agricole exposure of €10.8bn, Soc Gen exposure of €8.8bn, Deutsche Bank exposure of €7.7bn
6. A 30% haircut on Italy, in addition to 75% haircut on Greece requiring a direct hit on banks capital in Europe of some €315bn (that's on top of EFSF exposure to shore up Italian sovereign alone)

07/11/2011: Don't blame 'Johnny the Foreigner' for Western markets collapse

Global current account imbalances have been at the forefront of policy blame game going on across the EU and the US. In particular, the argument goes, savings glut in net exporting (mostly Asian) economies was the driving force behind low cost of investment flows around the world, producing a credit creation bubble via low interest rates. The deficit countries - the US, EU etc - have thus seen easing of lending conditions and world interest rates fell. The credit boom, therefore, was fueled by these savings surpluses, increasing risk loading on investment books of banks and other lenders and investors in the advanced economies.

Much of this orthodoxy is rarely challenged, so convenient is the premise that it is the Chinese and Indians, etc are to be blamed for what has transpired in the West. The mechanics of the process appear to be straight forward with current account imbalances going the same way as the causality argument - from surpluses in the East to deficits in the West.

A recent paper from the Bank for International Settlements, authored by Claudio Borio and Piti Disyatat and titled "Global imbalances and the financial crisis: Link or no link?" (BIS WP 346, May 2011), however, presents a very robust counter point to the orthodox view.

According to authors, "The central theme of the Excess Savings (ES) story hinges on two hypotheses: 

(i) net capital flows from current account surplus countries to deficit ones helped to finance credit booms in the latter; and 

(ii) a rise in ex ante global saving relative to ex ante investment in surplus countries depressed world interest rates, particularly those on US dollar assets, in which much of the surpluses are seen to have been invested. 

Authors' objection to the first hypothesis is that "by construction, current accounts and net capital flows reveal little about financing. They capture changes in net claims on a country arising from trade in real goods and services and hence net resource flows. But they exclude the underlying changes in gross flows and their contributions to existing stocks, including all the transactions involving only trade in financial assets, which make up the bulk of cross-border financial activity. As such, current accounts tell us little about the role a country plays in international borrowing, lending and financial intermediation, about the degree to which its real investments are financed from abroad, and about the impact of cross-border capital flows on domestic financial conditions." In other words, looking at current account deficits and surpluses, tell us little, in authors' view, about the financial flows that are allegedly being caused by these very current account imbalances.

This kinda makes sense. Imagine a MNC producing goods in country A, selling them to country B. Current account will record surplus to A and deficit to B. But the MNC might invest proceedings in country C via a fourth location, country D. Net current account position becomes indeterminate by these flows. Thus, per authors, "in assessing global financing patterns, it is sometimes helpful to move away from the residency principle, which underlies the balance- of-payments statistics, to a perspective that consolidates operations of individual firms across borders. By looking at gross capital flows and at the salient trends in international banking activity, we document how financial vulnerabilities were largely unrelated to – or, at the least, not captured by – global current account imbalances."

The problem arises because in traditional economics framework, savings (income or output not consumed in the economy) is investment. But in the real world, investment is not saving, but rather financing - a "cash flow concept… including through borrowing". Thus, per authors', "the financial crisis reflected disruptions in financing channels, in borrowing and lending patterns, about which saving and investment flows are largely silent." So ignoring the difference between the savings and investment financing, the current account hypothesis ignores the very nature of imbalances it is trying to model.

With respect to the second hypothesis, "the balance between ex ante saving and ex ante investment is best regarded as determining the natural, not the market, interest rate. The interest rate that prevails in the market at any given point in time is fundamentally a monetary phenomenon. It reflects the interplay between the policy rate set by central banks, market expectations about future policy rates and risk premia, as affected by the relative supply of financial assets and the risk perceptions and preferences of economic agents. It is thus closely related to the markets where financing, borrowing and lending take place. By contrast, the natural interest rate is an unobservable variable commonly assumed to reflect only real factors, including the balance between ex ante saving and ex ante investment, and to deliver equilibrium in the goods market. Saving and investment affect the market interest rate only indirectly, through the interplay between central bank policies and economic agents’ portfolio choices. While it is still possible for that interplay to guide the market rate towards the natural rate over any given period, we argue that this was not the case before the financial crisis. We see the unsustainable expansion in credit and asset prices (“financial imbalances”) that preceded the crisis as a sign of a significant and persistent gap between the two rates. Moreover, since by definition the natural rate is an equilibrium phenomenon, it is hard to see how market rates roughly in line with it could have been at the origin of the financial crisis."

In other words, the second hypothesis above confuses the observed market cost of capital - interest rates charged in the market - for the equilibrium natural rates that prevail in theory of balanced goods and services flows. The latter do not really exist in the market and cannot be referenced in investment decisions, but are useful only as benchmarks for long term analysis. Natural rates are "better suited to barter economies with frictionless trades" while the market rates are best suited to analyzing "a monetary economy, especially one in which credit creation takes place". And the market rates are driven by largely domestic (investment domicile) regulation, monetary policies, market structure, etc. In other words, market rates are caused by the US, EU etc policies and environments and not by Chinese trade surpluses.

The main conclusion from the study is that while current accounts do matter in economic sustainability analysis, "in promoting global financial stability, policies to address current account imbalances cannot be the priority. Addressing directly weaknesses in the international monetary and financial system is more important. The roots of the recent financial crisis can be traced to a global credit and asset price boom on the back of aggressive risk-taking. Our key hypothesis is that the international monetary and financial system lacks sufficiently strong anchors to prevent such unsustainable booms, resulting in what we call “excess elasticity”."

The former means, frankly speaking, that bashing China et al is not a good path to achieving investment markets stability and sustainability. The latter means that hammering out a new, more robust risk pricing infrastructure back at home, in the advanced economies, is a good path to delivering more resilient investment markets in the future. No easy "Johnny the Foreigner made me do it" way out for the West, folks.

07/11/2011: Sunday Times, Nov 06, 2011

This an unedited version of my article for Sunday Times, Nov 06, 2011 edition.

In a recent research paper titled “The real effects of debt” Bank for International Settlements researchers, S. Cecchetti, M. Mohanty and F. Zampolli provide analysis of the long-term effects of debt on future growth. The authors use a sample of 18 OECD countries, not including Ireland, for the period of 1980-2010 and conclude that “for government debt, the threshold [beyond which public debt becomes damaging to the economy] is in the range of 80 to 100% of GDP”. The implication is that “countries with high debt must act quickly and decisively to address their fiscal problems.” Furthermore, “when corporate debt goes beyond 90% of GDP, [the] results suggest that it becomes a drag on growth. And for household debt, … a threshold [is] around 85% of GDP.”

Thus, combined private non-financial and public debt in excess of ca 255% of GDP exerts a long-term drag on future growth even in the benign environment of the Age of Great Moderation, the period from the mid-1990s through 2007, when low inflation and cost of capital have spurred above-average global growth.

The period under consideration in the study, was also the period when Baby Boom generation was at its prime productive age, when rapid expansion of ICT drove productivity in manufacturing and services, and innovations in logistics revolutionized retailing (the so-called Wal-Mart effects).

And yet, despite all the positive push forces lifting the growth rates the negative pull force of building debt overhang was still visible. Euro area economies have posted average growth rates of 2.0% per annum in 1991-2007, well below less indebted group of smaller advanced economies that posted average annual growth of over 4.2%.

From the Irish perspective, these impacts of debt overhang on long-term growth present a clear warning. Ireland’s robust growth in the 1990s and through 2007 represent not a long-term norm, but a delayed catching up with the rest of the advanced economies. In other words, even disregarding the negative effects of the severe debt overhang we experience today, Ireland’s average growth rates in the foreseeable future will be close to the average growth for smaller open economies in the euro area. That rate, according to the IMF latest forecasts, is unlikely to be significantly above 2.0%.

But Ireland’s debt overhang, when it comes to debt that matters – i.e. debt analyzed by Cecchetti, Mohanty and Zampolli – is beyond severe. It is outright extreme. Across the 18 advanced economies, average real economic debts weighted by the economies’ size stood at 307% of GDP at the end of 2010 and are expected to rise to ca 310-312% of GDP or GNP. Ireland’s real economy debt to GDP ratio is likely to reach above 415% of GDP and, more importantly, 490% of GNP. (Chart below)

According to the Bank for International Settlements econometric model, the above overhang can be expected to reduce Irish GDP growth by ca 0.7 percentage points over the long run, implying that our long term potential growth rate rests somewhere closer to 1.3-1.4% per annum on average.

At these rates of growth, our Government debt repayments, even if the entire pool of Irish bonds were financed at the lowest currently available rates – the EFSF 3.3% – Ireland nation debt financing will be consuming the entire surplus generated by economic growth.

This issue frames the entire discourse about the ‘green shoots’ allegedly emerging on Ireland’s economy landscape.

In October, according to the NCB Purchasing Index Irish manufacturing sector moved back into growth territory. The headline index, however, came in at an anaemic 50.1 (index above 50 mark signaling growth). Crucially, jobs prospects continued to deteriorate with sub-index for employment standing at 47.1. New exports orders – the leading indicator of our exports-led ‘recovery’ still underwater at 49.8. Profit margins for Irish manufacturing firms continued to contract for the 32^nd consecutive month.

Even our much celebrated trade data is starting to flash warning signs. In August – the latest period for which trade statistics are available – seasonally-adjusted trade surplus was a hefty €3,699 million. This figure represents a year-on-year decrease of 1.3%. Given this trend, in annual terms, for eight months through August 2011, Irish trade surplus is running at 0.5% below 2010 result.

Per latest IMF projections, in 2012-2016, Irish current account surpluses are expected to average 1.38% of GDP per annum. Despite unprecedented collapse in imports, fuelling trade growth does require new debt financing and imports of inputs. Small open economies’ average forecast for the euro area is 1.94% over the same period. In other words, less indebted countries of the euro area are expected to generate greater current external surpluses than more indebted Ireland. Get the point? Debt overhang can hold back even exports-led recoveries.

The debt overhang is now also exposing the underlying weaknesses in the Exchequer fiscal adjustments. Lack of consumer demand, investment, and the resultant implosion of domestic economy are now driving the state finances deeper into the red despite massive capital spending cuts and sizeable tax increases over the last three years. The latest tax receipts show that in 10 months through October 2011, income tax receipts are behind the budgetary target by 1.2%, VAT -4.5%, corporation tax -4.2%. Adjusting for the hit-and-run pensions levy, year on year tax Exchequer deficit is down just €155 million. Fuelled by stubbornly high unemployment and lack of any real reforms in public finances, voted current exchequer expenditure is up from €33,662 million in 10 months to October 2010 to €34,450 million for the same period this year.

All indications so far are that the second half 2011 growth will once again post a nominal GNP contraction and quite possibly the same for nominal GDP.

Courtesy of overburdened households and companies, Irish economy is now stuck in a quick sand of a balance sheet recession, which risks becoming a full-blown decades-long stagnation. Even our greatest hope – improving competitiveness – is being threatened by debt. Again, referring to the latest data, despite the past gains, Ireland remains the least competitive 'old' euro area economy. Ireland has competitiveness gap of 34.7% compared to Germany and 14.7% compared to euro area as measured by differences between our harmonized competitiveness indicators. This gap will be virtually impossible to close, as the gains in competitiveness to-date have been driven primarily by jobs destruction and earnings declines. Cutting even deeper into earnings by raising taxes and/or reducing employment costs will either risk destabilizing even more our sick banking sector or will require cuts in taxes to compensate for disposable income losses.

To summarize, there is no hope of growing out of the debt crisis we face when the expected growth this economy can achieve in the next decade or so is roughly ten times smaller than the debt repayments we have to finance for the combined public and private non-financial debt. Once we rule out sovereign debt restructuring, the only solution to our crisis will require reducing the private sector debt overhang.

Box-out:

This week, European Financial Stabilization Fund postponed placement of €3 billion new bonds that were earmarked to provide new funding for Ireland under the Troika agreement. The funds are critical to our repayment of the €4.39 billion in Government bonds maturing November 11. While no one expects the Government to fall short on bonds redemption, the delay in raising EFSF funds is worrisome from the broader Euro area perspective. The hopes of leveraging the EFSF from its current €440 billion lending capacity to €1 trillion or more have hit a number of snags in recent days with all BRIC countries, the G20, the UK and Japan all suggesting that they will be unwilling to invest in EFSF leveraging on the basis of the terms implied by the current arrangements. The suspension of the latest issue, coming on foot of the original plans for 3.3% coupon pricing of the new and much smaller debt further extends concerns about the EFSF ability to leverage up. The EFSF leveraging is designed to provide cover for sovereign bonds of Italy and Spain, as well as for some limited capital supports to the euro area banking sector. If the EFSF cannot issue unlevered bonds at 3.3%, the implied commercial rates for levered EFSF issuance can be somewhere North of 5.25%. Costs and even the shallowest of the margins will push the effective lending rate to the member states to above 5.5%. Yet, at these rates, Italy’s sovereign financial imbalances cannot be sustained, regardless of whether the country deficit is 5% or 2%. Ditto for Portugal, and Greece, and Ireland. In other words, there’s not a snowball’s chance in hell the latest EU proposal for leveraging EFSF will work, given this week’s fiasco.

07/11/2011: US Mint sales for October

In recent weeks there was some long-expected noises coming out of the gold 'bears' quick to pounce on the allegedly 'collapsing' sales of gold coins by the US mint. I resisted the temptation to make premature conclusions until the full monthly sales data for October is in. At last, we now can make some analytical observations.

The thesis advanced by the 'bears' is that October sales declines (for US Mint sales of new coins) are:

1. Profoundly deep
2. Consistent with 'gold bubble is bursting at last' environment and
3. Significantly out of line with previous trends, and
4. Changes are reflective of buyers exiting the market on the back of high gold prices

Let's take a look at the data:

First - sales. 

In absolute terms, number of coins sold by the US Mint in October has fallen to 65,000 from 115,500 in September. Mom, thus, volume of sales, measured in the number of coins is down 43.7% and yoy change is -45.6%. Significant declines. Latest sales are running below the historical trend and 6mo MA has hit the long term historical trendline. 

This suggests reversion to historical mean, as predicted by my previous note on this matter and is, in my view, a welcome sign of some 'froth' reduction in the speculative component of the market. The trend remains on the upside, and 6mo MA is still running ahead of pre-crisis averages. Historical average is at 98,329 coins with a massive standard deviation of 112,309. Crisis period average is 128,967 and smaller (but still substantial) standard deviation of 110,323. Now, for 10 months of 2011 so far, the average is 130,400 coins sold, but the standard deviation (imprecise estimate, of course) of 41,934 or roughly 1/3 of the volatility over entire history.

Thus, if anything, monthly movements along the elevated average trend for crisis period are now looking less volatile than in pre-crisis period, which suggests that gold is acting as a hedge during the crisis against prolonged risks in other asset classes and that this property is so far being reinforced by reduced volatility as well.

Chart above shows that when it comes to gold coinage sales in volume (oz) of gold content, October sales (50,000 oz) are well below September sales (91,000 oz) and are 46.8% behind October 2010 sales. Worried 'bears' are onto something here? Well, not exactly. As with coinage, volatility of the series historically runs at 52,985 against historical average sales of 55,768 oz. Crisis-period volatility is at 44,726 against crisis-period average sales of 95,859 oz. 10mo through october 2011 volatility is at 26,514 (1/2 of historical volatility) and average sales are 89,350 oz - below crisis period average. Again, there seems to be more stability in sales in terms of oz volume than before, which, surely, should be a good thing for a hedge instrument. The 6mo MA trend is on decline here since March-May 2011 and, again, this is not a bad thing, as it signals continued reversion to 'normal' trading conditions - i.e. potential reduction in speculative buying.

Next little thingy, volume of gold per coin sold on average now stands at 0.769 oz/coin in October, virtually bang on with September 0.788 oz/coin. Which too is a good thing. Average historical volume of gold per coin sold is 0.587 oz/coin (stdev of 0.2) and crisis-period average is 0.816 oz/coin (stdev of 0.191). Latest 10 months period average is 0.703 oz/coin (note - we are still well ahead of that in October) and stdev for the period is 0.126 - well below historical volatility. 

So no drama - in fact, much less drama - in October data. Upward trends remain, reversion to trend is ongoing nicely, volatility falling. I never make predictions about bubbles timing, but as far as 'bursting' explosions and profound changes - I don't really see them. At least not yet.

What about the fourth 'argument' listed above? Are buyers fleeing gold coins markets because prices are too high? Well, I don't know what buyers think, but correlation between price of gold and volume of gold sold via coins by the US Mint is evolving as follows:

Thus, in October, 12mo dynamic correlation has fallen to -0.24 from -0.06 in September. This looks dramatic, until we consider historical trends. Average historical correlation is at -0.09 with stdev of 0.397. Crisis period correlation averages at -0.151 with a standard deviation of 0.377. For the period of January 2011-October 2011, average correlation is at -0.205 and stdev at 0.151.

The above implies that while current negative correlation is not dramatic, the trend in 2011 is so far distinctly for deeper negative correlations between gold price and coins sales and for more stability along this trend line.

Is this a good thing? Nope. The opposite is true in my opinion. More negative correlation implies stronger reduction in speculative buying, leaving gold coins demand more dependent on long term hedging objectives and as the tool for preservation of wealth. In other words, less speculation, more long term demand. This is not what we should see in a bubble 'bursting' stages.

Once again, caution is due - I am not arguing if there is a bubble in gold markets overall. This is just analysis of the coins sales. I am simply suggesting that we are seeing a well-predicted reversion to the mean along upward trend in demand. We are also seeing, in my opinion, gold coins doing exactly what gold in general is expected to do - providing long term hedge instrument against risks associated with other asset classes.

Disclosure: I serve as non-executive member of the Investment Committee of GoldCore and I am long gold with stable unchanged allocation over the last 3 years. All of the above views are solely my own. 

07/11/2011: Economic Sentiment in EU27, Euro area and the Big 4

In previous two posts I covered Consumer Confidence and Business Confidence indices for EU27, Euro area and the Big 4 economies. Here's the latests composite indicator for Economic Sentiment.

Overall EU27-wide economic sentiment continued to point South in October with a reading of 93.8 (below 100) coming on foot of 93.9 in September. 3mo MA for the indicator is now at 95.0 against 6mo MA of 98.4, signaling downward trend. The index is now below 100 for three months in a row.

Historical average for the series is at 101.1 against pre-Euro introduction period average of 102.1. Since introduction of the Euro, the index averaged 99.5, well below pre-Euro era average reading.

Euro area own economic sentiment also deteriorated in October to 94.8 against 95.0 in September. The index is now below 100 for three months in a row. 3mo MA at 96.1 below 6mo MA of 99.3 showing downward trend.

Historical average for the index is at 100.8 with the reading of 102.1 for the period prior to Euro introduction and 98.8 for the period since Euro introduction.

Per charts above:

• Economic Sentiment declined in Germany from 104.9 in September to 104.1 in October, with 3mo MA at 105.3 running behind 108.6 reading for 6mo MA. Before Euro introduction, German Economic Sentiment averaged 103.9 and since Euro introduction the average is at 98.1.
• Economic Sentiment fell (slightly) in Spain from 90.9 in September to 90.8 in October, remaining below 100 for every month since August 2007. 3mo MA is at 91.5 against 6mo MA of 92.6, so contraction in the sentiment continues to accelerate. Pre-euro period average for Spain is at 101.9 and since introduction of the Euro the index averaged only 98.6.
• Economic Sentiment bounced back to slower rate of decline in France rising from 96.0 in September to 97.2 in October. The index remains below 100 for 3 consecutive months. 3mo MA is now at 97.6 against 6mo MA of 101.2. France is the only country which saw improvement in the Economic Sentiment since introduction of the Euro. Pre-euro period average is at 99.4 against Euro period average of 101.8.
• Italian economic Sentiment has bounced slightly from 89.0 in September to 89.3 in October showing a slowdown in the overall rate of decline. 3m MA is at 90.8 and 6mo MA is at 93.3, with 6 consecutive months of sub-100 readings. Prior to introduction of the Euro, the index averaged 101.5 and since introduction of the Euro, the average is 99.3.

As shown in the chart below, shallow positive trend in the Economic Sentiment index during the years prior to Euro introduction has been replaced by a negative trend since introduction of the common currency.

Furthermore, the rate of decline in the averages between pre-Euro and post-Euro introduction periods is steeper in the Euro area than in the overall EU27, suggesting that the Euro was not conducive to improvements in overall Economic Sentiment.

07/11/2011: Producer Confidence in EU27, Euro area and Euro area Big 4

In the previous post we looked at the historical (and latest) data for Consumer Confidence in EU27 and the Euro area. This post updates data for Producer Confidence (Industrial Producers segment).

Business Confidence indicator fell from -5.7 in September 2011 to -6.8 in October for EU27. The decline marks continued downward trend with index below zero for the third month in a row. 3mo MA is now at -5.0 against 6mo MA of -2.4. Historical average is at -6.1 against pre-Euro period average of -5.6 and Euro period average of -6.8.

The indicator slipped to -6.6 in October, down from -5.9 in September for Euro area sub-sample. This too was the third consecutive month of index reading below zero. 3mo MA is at -5.1 against 6mo MA of -2.2. Pre-euro period average is -5.6 against post-euro introduction average of -6.2.

The index deteriorated mom in Germany (+1.4 in September to -0.7 in October), and Italy (-9.8 to -10.3) and on both countries 3mo MA is now below 6mo MA. France (-8.3 to -7.6) and Spain (-16.0 to -13.8) saw a slowdown in the rate of decrease in confidence. Both countries also show deeper contractions over 3mo MA than over 6mo MA.

As chart below shows, as with Consumer Confidence, Business Confidence has moved from up-trend over time in the period before the introduction of the Euro to a negative trend since the introduction of the Euro. This effect, however, can be explained by the changes in the economic environments across the entire EU, not just within the Euro area. 

Comparatives for historical averages show that pre-euro period averages were above those attained post-euro introduction in Germany and Italy, virtually unchanged in France and lower in Spain. This is consistent with the long term effects of the construction sector bubble in Spain.

06/11/2011: Consumer Confidence - Euro area and Big 4

Ignored in the hula-balloo of the euro crisis, the real side of the euro area economy is clearly not firing on all cylinders. In particular, the confidence indicators continue to signal underlying structural weaknesses both on the producer and consumer sides.

Here are the latest indices for consumer and producer confidence across the EU and euro area. The present post deals with Consumer Confidence, with subsequent two posts discussing October data for Producer Sentiment and Economic Sentiment.

Overall Consumer Confidence for EU27 has declined from -19.1 in September to -20.2 in October. 3mo MA is now running at -18.7 which is significantly below the 6mo MA of -15.9. Year ago, the index stood at -11.5 against the historical average of -11.1, pre-Euro average of -10.7 and Euro-era average of -11.8.

Euro area Consumer Confidence index stood at -19.9 in October, down from -19.1 in September. 3mo MA in October was -18.5 against 6mo MA of -15.3, so the underlying trend in recent months is down. Historical average ins -12.2 and pre-Euro era average is -11.3 against Euro era average of -13.2.

It is worth noting that the declines between pre-Euro era and Euro era averages in deeper for Euro area countries, strongly suggesting that the introduction of the Euro overall has been associated with an average decline in the consumer sentiment in the Euro area members states that cannot be explained by the variation in consumer sentiment within the overall EU.

Further, per charts above, German Consumer Confidence has fallen from -1.9 in September to -3.3 in October, remaining below zero for the second month in a row. German Consumer Confidence 3mo MA was -1.7 in October against 6 mo MA of +2.6. Historical average is -8.1. Pre-euro era average for Germany is -7.6 against the average of -8.8 for the period following the introduction of the euro. Once again, the swing downward from pre-euro period to post-euro period is larger for Germany than for EU27.

Spanish Consumer Confidence has fallen from -17.0 in September to -19.6 in October, with 3mo MA of -17.9 against the 6mo MA of -15.8. As with Germany, pre-euro period average index reading was -10.9 and post-euro introduction the average is -16.0, showing clearly that introduction of the euro in Spain was not associated with an improvement in consumer sentiment.

France’s Consumer Confidence index continued to signal contraction in demand, albeit at slower pace. October reading came in at -24.3 against -28.4 in September. 3mo MA stands at -26.3 against the 6mo MA of -23.0. France was the only country of the large euro area economies that saw an improvement in consumer sentiment since introduction of the euro: pre-euro period average reading for France was -19.4 against post-euro introduction the average index reading is -17.1.

Italy’s Consumer Confidence had posted a decline from already abysmal -31.1 in September to -33.9 in October. 3mo MA is now at -31.3 against the 6mo MA of -29.0. Just as Spain and Germany, Italy shows signs of decline in consumer confidence since introduction of the euro. Pre-euro period average index reading is -12.9 against a statistically significantly lower post-euro introduction average of -17.1. Of the Euro Big-4 economies, Italian consumers showed the greatest adverse impact of the euro introduction.

Oh, and the thing is… on average, across the Euro area itself, the same problem remains:

As shown above, the trend in consumer confidence over time was up pre-euro introduction. With euro introduction, the trend has been down.