3/4/2012: Sunday Times 1/4/2012 - Deep Reforms, not Exports-led Recovery, are needed

This is an unedited version of my Sunday Times article from 1/4/2012.

After four years of the crisis, there are four empirical regularities to be learned from Ireland’s economic performance. The first one is that the idea of internal devaluation, aka prices and wages deflation, as the only mechanism to attain debt deleveraging, is not working. The second is that the conventional hypothesis of a V-shaped recovery from the structural crisis, manifested in economic growth collapse, debt overhang and assets bust, is a false one. The third fact is that Troika confidence in our ability to meet ‘targets’ has little to do with the real economic performance. And the fourth is that exports-led recovery is a pipe dream for an economy in which exports growth is driven by FDI.

Restoring growth requires structural change that can facilitate private companies and entrepreneurs search for new catalysts for investment and consumption, jobs creation and exports.

For anyone with any capacity to comprehend economic reality, Quarterly National Accounts (QNA) results for Q4 2011, showing the second consecutive quarterly contraction in GDP and GNP, should have come as no surprise. In these very pages, months ago I stated that all real indicators – Purchasing Managers indices, retail sales, consumer and producer prices, property prices, industrial turnover figures, banking sector activity, and even our external trade statistics – point South. Yet, the Government continues to believe in Troika reports and statistical aberrations produced by superficial policy and methodological changes.

The longer-range facts about Ireland’s ‘successes’ in managing the crisis, revealed by the QNA, are outright horrifying. In real (inflation-adjusted) terms, in 2011, every sector of Irish economy remains below the pre-crisis peak levels. Agriculture, forestry and fishing is down almost 22%, Industry is down 3%, Distribution, Transport and Communications down 17%, Public Administration and Defence down 6%, Other Services (accounting for over half of our GDP) are down 8%. In Q4 2011, Personal Consumption was 12% below Q4 2007 levels, Gross Domestic Fixed Capital Formation was 57% down on 2007. The only positive side to Irish economic performance compared to pre-crisis levels was Exports of goods and services, which were just 1.2% ahead of Q4 2007 level.

Meanwhile, factor income outflows out of Ireland – profits transfers by the MNCs – were up 19% relative to pre-crisis levels. Despite a rise of 0.7% year on year, Irish GDP expressed in constant prices is still 9.5% below 2007 levels. Our GNP, having contracted 2.53% year on year in 2011, is down an incredible 14.3% on the peak. All in, Irish economy has already lost nine years of growth in this crisis, once inflation is controlled for.

We are now three years into an exports boom and the recovery remains wanting. Here’s why. Between 2007 and 2011 exports of goods rose €2.5 billion or just 3%, while imports of goods fell 31.3% - a decline of €19.6 billion. Over the same period, exports of services rose €5 billion, while imports of services increased €5.5 billion. All in, rising exports of goods and services accounted for just 35% of the increase in Ireland’s trade surplus. Almost two thirds of our trade surplus gains since 2007 are accounted for by collapse in imports. Taken on its own, the dramatic fall-off in imports of goods amounts to 91% of the total change in trade surplus in Ireland.

Both the Government and the Troika should be seriously concerned. Taken in combination with accelerating profits transfers out of Ireland by the MNCs, these numbers mean that Irish economy is struggling with mountains of private and public debts that exports cannot deflate.

Remember all the noises made by the external and domestic experts about Ireland’s current account surpluses being the driver of our debt sustainability? Last week, the CSO also published our balance of payments statistics for 2011. In 2010, Irish current account surplus stood at a relatively minor €761 million. In 2011, current account surplus fell to €127 million. If the entire current account surplus were to be diverted to Government debt repayments, it will take Ireland 579 years to bring our debt to GDP ratio to the Fiscal Pact bound of 60%.

The immediate lesson for Ireland is that we need serious changes in the economic fundamentals and we need them fast.

First, Ireland needs debt restructuring. We must shed banks-related debts off the households and the Exchequer. In doing this, we need drastic restructuring of the banking sector. Simultaneously, an equally dramatic reform of taxation and spending systems is required to put more incentives and resources into human capital formation and investment. Income tax hikes must be reversed, replaced by a tax on fixed and less productive capital – particularly land. All land, including agricultural. Entrepreneurship-retarding USC system must be altered into a functional unemployment insurance system.

Policy supports should shift on breaking the systemic barriers to domestic firms exporting and restructuring dysfunctional internal services markets that are holding companies back. Public procurement changes and markets reforms in core services – energy, water, transport, public administration, etc – must focus on prioritising facilitation of inward and domestic investment, entrepreneurship and jobs creation.

Delivery of health services must be separated from payment for these services, with Government providing the latter for those who cannot afford their own insurance. Private for-profit and non-profit sector should take over delivery of services. Exports-focused private innovation, such as for example International Health Services Centre proposal for remote medicine and ICT-related R&D, should be prioritized.

In education, we need a system of competing universities, colleges and secondary education providers. A combination of open tuition fees plus merit and needs-based grants for domestic students will help. We should incentivise US universities to locate their European campuses here, and shift more of the revenue generation in the third level onto exports. In the secondary education, we need vouchers that will encourage schools competition for students. In post-tertiary education we need to incentivise MNCs to develop their own corporate training programmes and services here.

This will simultaneously expand our skills-intensive exports and provide for better linkages between formal education and, sectoral and business training – something the current system is incapable of delivering.

One core metric we have been sliding on is sector-specific skills. This fact is best illustrated by what is defined as internationally traded services sector, but more broadly incorporates ICT services, creative industries and associated support services.

Eurostat survey of computer skills in the EU27 published this week, ranked Ireland tenth in the EU in terms of the percentage of computing graduates amongst all tertiary graduates. Both, amongst the 16-24 years olds and across the entire adult population we score below the average for the old Euro Area member states in all sub-categories of computer literacy. Only 13% of Irish 16-24 year olds have ever written a computer programme – against 21% Euro area average. Over all survey criteria, taking in the data for 16-24 year old age group, Ireland ranks fourth from the bottom just ahead of Romania, Bulgaria and Italy in terms of our ICT-related skills.

Not surprisingly, at last week’s Digital Ireland Forum 2012 the two core complaints of the new media and ICT services sector leaders were: lack of skills training domestically and draconian restrictions placed on companies ability to import key skills from abroad.

The Irish economy and our society are screaming for real change, not compliance with Troika targets and ego-stoking back-slapping ministerial foreign trips.

Box-out:

On the foot of my last week’s questions concerning the role of securitizations and covered bonds issuance by the Irish banks in restricting banks’ ability to control the loans assets they hold on their balancesheets, this week’s move by Moody’s Investors Services to downgrade the ratings of RMBS (Residential Mortgage-Backed Securities) notes issued by two of the largest securities pools in the country come as an additional warning. On March 26^th, Moody’s reduced ratings on RMBS notes issued by Emerald Mortgages and Kildare Securities on the back of “continued rapid deterioration of the transactions, Moody’s outlook for Irish RMBS sector; and credit quality of key parties to the transactions [re: Irish banks] as well as structural features in place such as amount of available credit enhancement.” The last bit of this statement directly references the concerns with over-collateralization raised in my last week’s note. Although Moody’s do not highlight explicitly the issue of declining pools of collateral further available to shore up security of the asset pools used to back RMBS notes, the language of the note is crystal clear – Irish banks are at risk of running out of assets that can be pledged as collateral. This, of course, perfectly correlates with the lack of suitable collateral for LTRO-2 borrowings from the ECB by the Irish banks, other than the Bank of Ireland last month. As rated by Moody’s, half of the covered RMBS notes were downgraded to ‘very high credit risk’ or below and all the rest, excluding just one, were deemed to deteriorate to ‘high credit risk’ status. Surprisingly, the Central Bank’s Macro-Financial Review published this week makes no mention of either the RMBS, covered bonds or the impact of securitization vehicles on banks’ balance sheets. See no evil, hear no evil?

2/4/2012: Q1 2012 US Mint Gold coins sales

Time to update the data for Q1 2012 US Mint gold coins sales - something I have been doing as a sort of an ongoing project.

As before, there is much volatility sloshing around, and as before, there is less drama when one takes a closer look at the data.

Q1 2012 volume of sales (oz) of US Mint coins fell 29.7% year on year, and 22.3% on 2010. The demand is also down 38.5% on 2009. Total volume of sales stood at 210,500 oz in Q1 2012, 17% below the average demand for Q1 over 2008-2011 period, but much stronger (+89%) on pre-crisis average for 2000-2007.

Much of the downside to the demand was driven by February sales, which run 21,000 oz against March sales of 62,500 oz.

Chart below illustrates:

Note that stabilization of the price trend along the flat line above US$1,660/oz since H2 2011 is not associated with establishment of a similarly flat trend for volume of US Mint sales. More on this below, but in basic terms this confirms that the demand for gold coins has little to do with the price in general. In other words, no hysteria and no bubble here. Something other than price movements drives demand for coins. 

It is worth noting, that, as consistent with the above observations 6mo MA for volume demand is now at 95,083 oz which is below the March demand of 99,500. Again, no drama - rather mean reversion in the short run.

On the side of coinage sold, demand for coins fell 20.6% in Q1 2012 compared to Q1 2011, but it up 41.3% on Q1 2010 and 12.0% on Q1 2009. Total demand was 383,000 coins in Q1 2012 of which 256,500 came in January. Compared to this, 2000-2007 Q1 average is 216,929 and 2008-present Q1 average is 313,000. So current first quarter is well ahead of the historical averages, but on a moderate side compared to 2011.

 Looking at the two charts above, it is clear that while volume demand is following a pronounced down-sloping trend, coinage demand is relatively flat. Which is consistent with a decrease in average gold content per coin sold. In Q1 2012, average oz/coin sold fell to 0.63 from 0.82 average for Q1 2008-2011. Average weight per coin is down 0.1% in Q1 2012 year on year, and down 37% on Q1 2010 and Q1 2009 (in both of these years, average oz/coin content of US Mint coins sold was 1.0). However, this decline has itself been mean-reverting as the chart below clearly shows.

One point to be made in addition to the above is the increased volatility in the series since the mid-2007 through 2010 that is now abating since the beginning of 2011. This reinforces the general historical trend established since 1987.

As mentioned above, correlations between price and volume of gold demanded (via US Mint coinage sales) are now running consistently below the historical trend for some time - primarily since H2 2010. This continues today. The 12mo rolling correlation is negative on-average since July 2010 and this remains the case for Q1 2012. However, Q1 2012 negative correlation is moderate - averaging just -0.05, which is statistically indistinguishable from the Q1 2011 (+0.1) and more moderate than -0.4 correlation for Q1 2010. The average for 12mo rolling correlations for Q1 period over 2000-2007 was +0.18 and during the crisis period it fell to +0.03. With standard deviation of 0.36 none of these correlations suggest any dramatic departures in price-demand relationship from a stable long-term zero correlation trend. Chart below illustrates:

The point that the above adata suggests is best glimpsed by directly relating the levels and the rates of change in gold price and the overall demand for gold via US Mint coins. Both exercises are illustrated below:

And guess what: historically - that is since 1987 - gold price has virtually nothing to do with demand for US Mint coins (in terms of volume of gold sold via coins) neither in terms of levels of price effect on levels of demand for gold, nor in terms of rate of change in price effect on rates of change in demand.

Which means that at least in the case of the US Mint sales, there is no hype, and no madness. What there is instead, is a rather volatile demand with gentle upward slope imposed against a robustly positive exponential relationship in gold price:

The fact that in recent months demand for gold has been oscillating around the historic trend (as opposed to resting above that trend in August 2008-August 2011 period) is the good news - the current levels of demand are historically sustainable, trend reversion-consistent and show neither hype, nor panic buying.

As I have noted in January post (here): "Welcome back to ‘normalcy’ in US Mint sales." Yep, still holds.




Disclaimer:

1) I am a non-executive member of the GoldCore Investment Committee
2) I am a Director and Head of Research with St.Columbanus AG, where we do not invest in any specific individual commodity
3) I am long gold in fixed amount over at least the last 5 years with my allocation being extremely moderate. I hold no assets linked to gold mining or processing companies.
4) I have done and am continuing doing academic work on gold as an asset class, but also on other asset classes. You can see my research on my ssrn page the link to which is provided on this blog front page.

5) Yes, you can find points (1)-(3) disclosed properly and permanently on my public profiles. 

6) I receive no compensation for anything that appears on this blog. Never did and not planning to start now either. Everything your read here is my own personal opinion and not the opinion of any of my employers, current, past or future.

2/4/2012: Impact of the middle class on economic, social and political institutions

A fascinatingly interesting study of the effects the middle class has on economic, social and political institutions.

The World Bank Policy Research Working Paper 6015: "Do Middle Classes Bring Institutional Reforms?" by Norman Loayza Jamele Rigolini Gonzalo Llorente (link here - emphasis mine) "examines the link between poverty, the middle class and institutional outcomes using a new cross-country panel dataset on the distribution of income and expenditure." The data "spans 672 yearly observations across 128 countries" allowing the authors "...to gauge whether a larger middle class has a causal effect on policy and institutional outcomes in three areas:

• social policy in health and education 
• market- oriented economic structure and 
• quality of governance." 

The study finds that "when the middle class becomes larger (measured as the proportion of people earning more than US$10 a day),

• social policy on health and education becomes more progressive [expansion of share of these expenditures to GDP], and 
• the quality of governance (democratic participation and official corruption) also improves. 
• This trend does not occur at the expense of economic freedom, as a larger middle class also leads to more market-oriented economic policy on trade and finance." 

From data (econometrics) perspective: "These beneficial effects of a larger middle class appear to be more robust than the impact of lower poverty, lower inequality or higher gross domestic product per capita."

The causality of the latter effect is itself an interesting point: "That may be linked to the evolution of the middle class: they are more enlightened, more likely to take political actions and have a stronger voice. They also share preferences and values for policy and institutional reforms, as well as higher stakes in property rights and wealth accumulation."

The authors note that their results show that "the indicators of poverty and inequality are also relevant determinants for social policies, economic structure, and governance quality, but not always in the expected way or with the consistency shown by the middle class measure. For instance, a decrease in income inequality seems to produce a decline in official corruption (as possibly expected) but also a reduction in democratic participation (which may be harder to explain). Similarly, a decrease in the poverty headcount appears to induce a liberalization of international trade but also, surprisingly, a constriction of credit markets."

Fascinating stuff, in my view.

2/4/2012: Two studies on Global Financial Crisis

An interesting analysis of the International Financial Crisis of 2007-2009 from Gary Gorton and Andrew Metrick, both Yale and NBER just out - see link here. Worth a read and contrasting with Taleb's excellent paper on same (earlier work than that of Gordon and Metrick) here.

2/4/2012: Banks bailouts and bonds eligibility

Two important documents relating to banks bonds, Sovereign Guarantees and the bondholders' haircuts.

First, the ECB decision of March 21 that was rumored to have been implemented by the Bundesbank last week - allowing the NCBs not to accept as collateral Government-guaranteed bank bonds from the countries currently in the EU-IMF financial assistance programmes (aka Greece, Ireland and Portugal). Here's the link. Key quote (emphasis mine):
"Acceptance of certain government-guaranteed bank bonds: On 21 March 2012 the Governing Council adopted Decision ECB/2012/4 amending Decision ECB/2011/25 on additional temporary measures relating to Eurosystem refinancing operations and eligibility of collateral. According to that Decision, National Central Banks (NCBs) are not obliged to accept as collateral for Eurosystem credit operations eligible bank bonds guaranteed by a Member State under an EU-IMF financial assistance programme, or by a Member State whose credit assessment does not comply with the Eurosystem’s benchmark for establishing its minimum requirement for high credit standards. The Decision is available on the ECB’s website."

Hat tip for the link to @OwenCallan of Danske Markets.

However, the latest information is that Bundesbank clarified that it will continue accepting all EA17 Government bonds. See link here. Confusion continues as to what Bundesbank will and will not accept.

Second, today's release by the EU Commission of the consultation paper on dealing with future banks crises and bailouts. Titled "Discussion paper on the debt write-down tool – bail-in". The paper clearly states (emphasis is mine, again):

"Rather than relying on taxpayers, a mechanism is needed to stop the contagion to other banks

and cut the possible domino effect. It should allow public authorities to spread unmanageable

losses on banks' shareholders and creditors."

The proposals advanced by the EU are not new: "In most countries, bank and non-bank companies

in financial difficulties are subject to "insolvency" proceedings. These proceedings allow either

for the reorganization of the company (which implies a reduction, agreed with the creditors, of its

debt burden) or its liquidation and allocation of the losses to the creditors, or both. In all the

cases creditors and shareholders do not get paid in full."

Per EU: "An effective resolution regime should:

• Achieve, for banks, similar results to those of normal insolvency proceedings, in terms of allocation of losses to shareholders and creditors
• Shield as much as possible any negative effect on financial stability and limit the recourse to taxpayers' money
• Ensure legal certainty, transparency and predictability as to the treatment that shareholders and creditors will receive, so as to provide clarity to investors to enable them to assess the risk associated with their investments and make informed investment decisions prior to insolvency."

There is no point at this stage to explain that in Ireland's case, NONE of the above points were delivered in the crisis resolution measures supported by the EU and actively imposed onto Ireland by the ECB.

It is, however, worth noting that the Option 1 advanced by the EU includes imposing losses on senior bondholders and that the tool kit for doing this includes debt-equity swaps. Readers of this blog would be well familiar with the fact that I supported exactly these measures.

2/4/2012: Improved Manufacturing PMI - March 2012

Manufacturing PMI for March is out and there are some nicely positive surprises.

First off - we bucked the trend on euro area manufacturing PMIs which signal contraction. Second headline - we bucked the trend within recent months for our own PMI. Third, PMIs are volatile, manufacturing PMI is even more volatile and we have to be careful reading the 'trend'.

Details, then:

• March PMI headline reading is 51.5 - in an expansion territory, but statistically within 1/2 Standard Deviation of 50.0. This marks the first increase above 50.0 reading since October 2011 and the highest reading in headline PMI since May 2011. Per NCB/Markit statement: "Although only slight, the improvement in operating conditions was the first in five months".
• 12mo MA of headline PMI is now at 50.0 - meaning that on average, manufacturing activity stood still over 12 months. 3mo MA is very close to that at 49.8, which is an improvement of sorts of previous 3mo MA of 49.1. 2011 3mo to March average is 56.1 - that was reflective of robust growth reading back then. In 2010, 3mo average to March was 49.9.
• Volatility of the series remains above pre-crisis levels - standard deviation for the series rose from 4.54 for full sample (1998-present) and 4.46 for pre-2008 period to 5.60 since 2008.

More details on the data:

• Output sub0index posted stronger reading than core PMI index, rising to 52.8 in March from 50.4 in February and marking second month of above-50 readings. March level was statistically significant relative to 50.0. 12mo MA is now at 51.1 and 3mo MA at 50.2 against previous 3mo MA of 49.9. These series generally run above the core PMI index, with 3mo through March averages in 2010 of 51.2 and in 2011 at 59.2. The sub-index also has higher volatility than core PMIs with crisis-period stdev at 6.35.
• New orders sub-index also hit statistically significant expansion reading at 52.7 in March up on 50.1 in February. 12mo MA is now at 49.8 and 3mo average at 49.9 against previous 3mo average of 49.0. 
• New Export orders sub-index rose robustly to 55.1 in march from a weak contraction level of 49.7. This is a massive gain, although the sub-index is volatile. NCB analysis suggests that the reason for the rise is due to Irish economy exposure to stronger US economy, offsetting the negative forces from the euro area recession. 12mo MA is now at solid 52.5, 3mo average through March at 51.9 a small rise on 50.2 for 3mo period average through December 2011. These readings, however, are still far behind the reading of 60.4 in 3mo through March 2011 and 57.4 for 3mo through March 2010. Volatility of new exports orders sub-index is one of the highest amongst core sub-indices at 6.97 for crisis period, up on 4.99 in pre-crisis period.

Some other sub-indices:

On the net, majority of other subcomponents continue to show weakness, but all are improving in rates of signalled contraction. Backlogs of work are down again, but at a slower rate. Post-production inventories of finished goods continue to fall, but the rate of fall is moderating. Inputs purchases expanded robustly from 48.7 in February to 53.8 in March in line with growth in orders and exports.

On tow core points of employment and profitability (both will be covered in individual posts once we have Services PMI data as well):

• Profit margins continued to shrink in Manufacturing - compounding months of deterioration, which is bad news for the sector
• Employment sub-index reached back into growth territory at 51.2, for the first time since December 2011. 12mo MA is now at 49.6 and 3mo average is 50.0. Both are an improvement, but overall employment sub-index is not exactly a great predictor of actual jobs creation. In particular, in 2011 3mo average through March stood at 53.2 and there was no jobs creation of any appreciable quantity.

So core conclusion: cautiously, this is good news. But I must stress the point that it is only 'cautiously' so because:

• Core index and sub-indices are volatile, and
• The oerall trend since around June 2011 remains relatively flat and close to statistically identical to flat-line economy at 50.0

1/4/2012: Flightless dodo - the Hunt of Chief Noonan

I am not usually prone on updating my past posts, but the Promissory Notes 'deal' announced last week by Minister Noonan just keeps on giving more and more backlash and analysis. So:

• My original post here.
• Note the updates in the above
• FT Alphaville view here which is broadly in agreement with my view and with links I posted in the original post updates.
• Interesting information coming out of ECB on Minister Noonan's claims that the 'deal' is a part of some 'broader plan' - via the Irish Times, here.

Reiterating my view:

• Promo Notes have been paid, not deferred
• Payment of Promo Notes was originally to be based on Government borrowing cash from the Troika. Under the 'deal' it has been replaced by the Government borrowing cash from BofI
• Payment of Notes under the 'deal' cost us more in new debt and increased deficit in 2012, but will decrease interest payment in 2013 compared to original arrangement. Net effect on interest cost - nearly a wash.
• The 'deal' is NOT (see ECB official statement) a part of any 'broader deal'.
• The ECB are now clearly on a defensive - which means they will be unlikely to support any further 'deals'.

Having gone out with a brave claim to spot a bald eagle soaring in the sky and get a feather for his war bonnet, Chief Noonan came back with a smudgy mud-print of a dodo, a bill for €400mln+, and a promise to go hunting again. Next stop, trading gold for glass beads... oh, they sparkle so nice.

(Obviously - an allegorical analogy. For those rare readers lacking in humor department.)

On a serious note - I find it discomforting and sad that an excellent seasoned politician and a very promising Minister for Finance has been forced into this position of defending the failure. Let's hope his luck (and progress) change in the nearest future.

30/3/2012: Irish bilateral trade with Russia - 2011 results

The latest data on Irish-Russian bilateral trade:

29/3/2012: China's Banking Sector Analysis

A very revealing paper on Chinese banking sector - link here. A lengthy summary of some points:

The study describes "aggregate developments of the sector and compare them to the situation in other countries. ...Our results confirm that the Chinese banking sector is truly in a class of its own, especially given the level of China’s economic development. Despite significant reforms, the state and various public organizations still own controlling shares in the largest commercial banks. The state is also present on the borrowers’ side; it is estimated that about half of state-owned commercial bank lending still goes to state-controlled companies." [Note: this induces rather unique risk into China's banking sector - the risk of losses on both sides of the transaction and also quality risk to banks assets, as state-owned enterprises in China tend to be higher risk]. 

Furthermore: "More than 90% of total banking sector assets are state-owned in China (Economist, 2010), while Vernikov (2009) puts the corresponding figure for Russia at 56%. In general, reforms in the Chinese banking sector have lagged relative to other sectors of the economy."

Thus, "Chinese policy has striking parallels to the Russian experience; there has never been a major effort to privatize banking and banks today continue to be directly or indirectly controlled by the state or public institutions." Except, in Russian case, there are far fewer state enterprises and once controlled for extraction sector enterprises [less subject to traditional risks], there are even fewer state-controlled enterprises links to state-controlled banks of the lender/borrower relations side. Furthermore, "the lack of capital controls, of course, means that Russians have greater freedom in choosing providers of their financial services."

"Despite listing and the presence of foreign investors, all the large commercial banks are still majority state-owned. The share of state and state-owned entities at the end of 2010 was 83.1% in ABC, 70.7 % in ICBC, 67.8 % in BOC, and 60.1 % in CCB. The corresponding number for the Bank of Communications was 32.4 %"

"In this way, the banking system can serve as an important policy tool. (see below)

"Another distinctive feature of the Chinese banking sector is the variety of its banking institutions. New types of banking institutions, especially those serving rural areas, are emerging all the time. While equity and debt markets are still tiny relative to the banking sector and their importance as sources of financing of investment remain minor, they have evolved rapidly in recent years."

Some interesting facts: "The government’s stimulus efforts to avoid recession in 2009 resulted in a massive spike in bank lending that increased the consolidated banking sector balance sheet by approximately a third. Rather than pull back, bank lending went on to expand an additional 20 % in 2010. Lending outside the banking sector’s balance sheet has also grown strongly (García-Herrero and Santabarbara, 2011). These lending trends in themselves should be sufficient to raise concerns about the quality of bank loan portfolios and the need to curtail growth of bank lending in coming years..."

"Bank loans are the most important source of external funding for the non-financial sector in China. They accounted for 75% of all external funding sources at the end of 2010, and exceeded 80% during the crisis years of 2008 and 2009 when other external sources were difficult to obtain. As we saw in early 2009, the Chinese authorities can turn to bank lending as a policy tool when the need arises."

The unbalanced nature of Chinese banking translates into significant concentration of State power in lending: "Bank lending grew between 2006 and 2010 at the average rate of 20% a year, thanks in part to the government stimulus program in the face of the global economic re- cession. Loans to non-financial companies accounted for around 70% of new loans. State- owned commercial banks (SOCBs), traditionally the biggest loan providers, accounted for 43% of all new loans issued in 2009 (their share was 51% in 2001). SOCBs accounted for about half of the total banking sector loan stock at the end of 2010. This proportion corresponds to their share in total sector assets."

And more: "Even though the Chinese banking sector is huge for a middle-income nation, bank lending is heavily skewed to state-owned companies. Allen et al. (2008) note that the size of China’s banking system, in terms of total bank credit to non-state sectors, was 31% of GDP in 2005. This figure is not too different from the average of other major emerging economies with a weighted average of 32% of GDP. Looking at total bank credit, including loans to state sectors, the ratio of China’s bank credit to GDP rises to 110% − a level higher than even in countries with German-origin legal systems (weighted average 106%). The difference between total bank credit and private credit suggests that most of the bank credit is issued to companies that are ultimately owned by the state. Also Okazaki et al. (2011) report that bank lending in the recent years has mostly gone to large SOEs. In 2009, about 50% of SOCB loans were extended to large SOEs. Private enterprises received some 14% of total lending provided by the banking sector."

29/3/2012: Promissory Note 'deal' 2012

Trying to sort out the convoluted 'deal' announced by the Minister today and juggle two kids, plus struggle against the computer on a strike from too many files open is a challenge. I might be missing something, but here's my understanding of the thing.

1. €3.06bn will be delivered not i cash, but in a long-term Government bond of the equivalent fair value
2. We do not know maturity, but 2025 was mentioned before. Ditto for coupon rate, though Prof Honohan mentioned 5.4% coupon.
3. Current pricing in around 88% of the FV, so €3.06*0.88=€3.47bn issuance to deliver fair value. If average  over longer term horizon is taken - that would go up. If yield is higher - that will go up. It is unclear what fees will be involved as the transaction is complicated (see following).
4. As is - at current market pricing, there will be an increase in Government debt of roughly €410 million, plus the cost of transactions.
5. As described above, and as indicated by Minister Noonan, Government deficit will increase by €90mln (approximately: 5.40%*410mln=€22mln plus margin on Government bond yield over interest rate holiday under Promo Notes in 2012).
6. IBRC will receive the bonds and will repo them to Bank of Ireland on a 1 year deal. In other words, Bank of Ireland will buy the bond from IBRC then put it into ECB repo operations. LTRO being now closed, this will have to be normal repo with ECB. Bank of Ireland will repo IBRC-owned Government bond at ECB Repo rate (1%) + 1.35% margin. In effect, margin is the gross profit to the Bank of Ireland on this transaction.
7. Before Bank of Ireland formally approves the transaction, bond will be financed by NAMA against IBRC collateral (now, imagine that - NAMA holds IBRC's assets and has a working relationship with IBRC. IBRC has no collateral that is equivalent to Government bonds - hence it cannot repo anything at ECB. So by definition, the collateralized pool backing NAMA-IBRC repo will have to be stretched). A year later, BofI might reconsider and roll the deal, but one has to assume that the margin will remain either fixed or go up, plus whatever the repo rate will be then?
8. NAMA, as far as I understand, has no mandate to carry any of these operations, thus potentially acting outside its legal mandate.
9. Minister for Finance will guarantee the entire set of transactions, including Bank of Ireland exposure. In effect, Minister will guarantee Government bonds (which is silly), collateral from IBRC, NAMA exposure, Bank of Ireland exposure and so on.
10. NAMA will use own cash to finance the bridging transaction.
11. Having received the funds from the repo, IBRC will remit these to (€3.06bn) to the CBofI to cancel corresponding amount in ELA.
12. Has Net Present Value of the debt been altered? We do not know. We need to have exact data on bond maturity and the coupon rate, plus on overall profile of the rest of the notes to make any judgement here. Any change in the NPV under the above outline (1-5) is immaterial. 
13. The positive factor of so-called 'more flexible fiscal buffer' is a red herring, in my view. The idea is that we are 'saving' cash allocation of €3.06bn this year, making it 'available' for borrowing in 2013. This is rather stretching the reality - the 'cushion' has been pre-provided to us by the Troika deal and is specific to the Promissory Notes. There is no indication that it can be used for any other purposes. Even if it were to be used for any other purpose, it would be an addition to the bond issued, so our debt will increase by the amount we use from the 'cushion'. Furthermore, the deal runs out in 2013 and thereafter no 'cushion' is available. So on the net, we have just paid 400mln increase in debt, plus 90mln in deficit to buy ourselves an 'insurance' policy that should we need 3bn in 2013, we will be able to ask for it from the kindness of the EU and have it for no longer than a year. That's pretty damn expensive insurance policy.
14. The negative factor is that we now have almost 3.5bn worth of extra debt that is senior to the promissory notes it replaced and once it is repoed at the ECB it will be senior to ELA exposure. 
15. Furthermore, this debt is in the form of Government bonds. So suppose we want to return to the debt markets in 2014. We have higher stock / supply of Government bonds (albeit 3.47bn isn't much - just a few percentage points increase) that markets will price in. Higher supply, ceteris paribus, means lower price, higher yield on bonds we are to issue in 2014. 
16. Minister Noonan and a number of other Government parties' members have mentioned 'jobs creation' capacity expansion as the result of this deal. The only way, in theory, this deal can lead any jobs creation is if the Government were to use €3.1bn allocation available for Promo Notes under the Troika deal for some sort of public spending programme. Which, of course, means our debt will increase by the very same amount used.

Brian Hayes on Today FM described the 'deal' (H/T to Prof Karl Whelan) as 'A creative piece of financial engineering.' Presume safely that Brian Hayes has a firm idea that this description is a 'net positive' for the Government.

Following the announcement by the Minister, there were no questions allowed by Dail members and the Minister moved on to the really important stuff - straight to press briefing in the Department of Finance. He might have opted for the right move, however, since the Dail, without any interrruption vigorously engaged in a debate on this important topic:

On that note, the last word (for now) goes to Prof Whelan: "Ok, after exchanges with very wise @OwenCallan I have decided that this deal defers the 3.1bn payment by only one year. Worse than hoped for" (quoting a tweet).

Welcome to the wonderland of wonderlenders.


Updates:

Adding to the above, it is worth postulating directly - as I have argued consistently, ELA is the only debt we can - at least in theory - restructure and promo notes are a perfect candidate for such a restructuring. By converting a part of these into Government debt we are now de fact increasing probability of a sovereign default or restructuring.

Karl Whelan has an excellent post on the 'deal' - here.

ECB statement on Ireland's 'deal' is here. This clearly states that there is no deferral of any payment on Promo Notes and that the Noonan's 'deal' is a one-off. Thank gods it is - because at a cost of €400mln in added debt, plus €90mln in deficit, repeating this exercise in PR spin would be pretty expensive.


Update 30/03/2012:


Today Irish Times is reporting that:

"Minister for Finance Michael Noonan said the big benefit was the money would not have to be borrowed to pay this year’s instalment on the promissory notes, the State IOUs paying for the bailouts."

A truly extraordinary statement, given the state will borrow the money (some €410mln more in principal and €90 mln more in interest than actually it had to borrow) using a Government bond to pay said IOU!

The Irish Times headline reads: "Government wins backing on €3.06bn payment". Yet there is no any 'backing' from anyone on this deal, because the deal does not change the payment itself. Read the above-linked ECB statement on the 'deal'.

In another extraordinary statement, the Irish Times (this is their own claim) says: "Further talks on a long-term deal on the remaining repayments as part of a wider restructuring of the banks will continue between the Government and the troika of the EU Commission, the ECB and the International Monetary Fund." Is there ANY evidence that any such negotiations are ongoing? Where is this evidence? Please, produce!


And an excellent piece from Namawinelake on the above: here.

28/3/2012: Sunday Times 25/3/2012 - Irish emigration curse

Below is the unedited version of my article for Sunday Times from 25/03/2012.

Last week, as Ireland and the world celebrated the St Patrick’s Day, close to fifteen hundred Irish residents, including close to a thousand of Irish nationals, have left this country. In all the celebratory public relations kitsch, no Irish official has bothered to remember those who are currently being driven out of their native and adopted homeland by the realities of our dire economic situation.

According to the latest CSO report – covering the period from 1987 through 2011, emigration from Ireland has hit a record high. In a year to April 2011 some 76,400 Irish residents have chosen to leave the country, against the previous high of 70,600 recorded in 1989. For the first time since 1990, emigration has surpassed the number of births.

Given the CSO methodology, it is highly probable that the above figures tell only a part of the story. Our official emigration statistics are based on the Quarterly National Household Survey, unlikely to cover with reasonable accuracy highly mobile and less likely to engage in official surveys younger households, especially those that moved to Ireland from East Central Europe.

For example, emigration numbers for Irish nationals rose 200% between 2008 and 2011, with steady increases recorded every year since the onset of the crisis. Over the same period of time, growth in emigration outflows of EU15 (ex-UK) nationals from Ireland peaked in 2008-2009 and halved since then. Prior to 2010, Irish nationals contributed between 0% and 10% of the total net migration numbers. By 2010 and 2011 this rose to 42% and 68% respectively. Meanwhile, the largest driver of net migration inflows prior to the crisis - EU12 states nationals - were the source of the largest emigration outflows in 2009, but their share of net outflows has fallen to 39% and 13% in 2010 and 2011 respectively. There were no corresponding shifts in Irish and non-Irish nationals’ shares on the Live Register. In other words, unemployment data for non-Nationals does not appear to collaborate the official emigration statistics, most likely reflecting some significant under-reporting of actual emigration rates for EU12 and other non-EU nationals.

There are more worrisome facts that point to a dramatic change in the migration flows in recent years. Back in 2004-2007 there were a number of boisterous reports issued by banks and stockbrokerages that claimed that Irish population and migration dynamics were driving significant and long-term sustainable growth into the Irish economy. The so-called demographic dividend, we were told, was the vote of confidence in the future of this economy, the driver of demand for property and investment, savings and consumption.

In 2006, one illustrious stockbrokerage research outfit produced the following conclusions: “The population [of Ireland] is forecast to reach 5 million in 2015… The labour force is projected to grow at an annual average 2.2% over the whole period 2005 to 2015. Combined with sustained 3% annual growth in productivity, this suggests the underlying potential real rate of growth in Irish GDP in the five years to 2010 could be close to 5.75%. Between 2011 and 2015, the potential GDP growth rate could cool down to around 5%.”

Since the onset of the crisis, however, the ‘dividend’ has turned into a loss, as I predicted back in 2006 in response to the aforementioned report publication. People tend to follow opportunities, not stick around in a hope of old-age pay-outs on having kids. In 2009, only 33% of new holders of PPS numbers were employed. Back in 2004 that number was 68%. Amazingly, only one third of those who moved to Ireland in 2004-2007 were still in employment in 2009. Almost half of those who came here in 2008 had no employment activity in the last 2 years on record (2008 and 2009) and for those who came here in 2009 the figure was two thirds.

In more simple terms, prior to the crisis, majority (up to 68%) of those who came here did so to work. Now (at least in 2009 – the last year we have official record for) only one third did the same. It is not only the gross emigration of the Nationals and Non-Nationals that is working against Ireland today. Instead, the changes in employability of Non-Nationals who continue to move into Ireland are compounding the overall cost of emigration.

In order to assess these costs, let us first consider the evidence on net emigration in excess of immigration. In every year – pre-crisis and since 2008, there were both simultaneous inflows and outflows of people to and from Ireland. In 2006, the number of people immigrating into Ireland was above the number of people emigrating from Ireland by 71,800. Last year, there was net emigration of 34,100. Between 2009 and 2011, some 76,400 more people left Ireland than moved here.

Assuming that 2004-2007 period was the period of ‘demographic dividend’, total net outflows of people from the country in the period since 2008 through 2011 compared to the pre-crisis migration trend is 203,400 people. In other words, were the ‘demographic dividend’ continued at the rates of 2004-2007 unabated through the years of the current crisis, working population addition to Ireland from net migration would have been around 2/3rds of 203,400 net migrants or roughly 136,000 people. Based on the latest average earnings of €689.54 per week, recorded in Q4 2011, and an extremely conservative value added multiplier of 2.5 times earnings, the total cost of the ‘demographic losses’ arising from emigration can be close to 8% of our GDP. And that is before we factor in substantial costs of keeping a small army of immigrants on the Live Register. Some dividend this is.

This is only the tip of an iceberg, when it comes to capturing the economic costs of emigration as the estimates above ignore some other, for now unquantifiable losses, that are still working through the system.

In recent years, Ireland experienced a small, but noticeable baby boom. In 2007-2007, the average annual number of births in Ireland stood at just below 60,000. During 2009-2011 period that number rose by almost 25%. 2011 marked the record year of births in Ireland since 1987 – at 75,100. In the environment of high unemployment, elevated birth rates can act to actually temporarily moderate overall emigration, since maternity benefits are not generally transferable from Ireland to other countries, especially the countries outside the EU. Even when these benefits do transfer with families, new host country benefits replacement may be much lower than the benefits in Ireland. Which, of course, means that a number of emigrants from Ireland can be temporarily under-reported until that time when the maternity benefits run their course and spouses reunite abroad.

Even absent the above lags and reporting errors, net migration is now running close to its historic high. In 2011, there were total net emigration of 34,100 from Ireland against 34,500 in 2010. These represent the second and the first highest rates of net emigration since 1990.

At this stage, it is pretty much irrelevant – from the policy debate point of view – whether or not emigrants are leaving this country because they are forced to do so by the jobs losses or are compelled to make such a choice because of their perceptions of the potential for having a future in Ireland. And it is wholly academic as to whether or not these people have any intentions of returning at some point in their lives. What matters is that Ireland is once again a large-scale exporter of skills, talents and productive capacity of hundreds of thousands of people. The dividend is now exhausted, replaced by a massive economic, not to mention personal, social, and political costs that come along with the Government policies that see massive scale emigration as a ‘safety valve’ and/or ‘personal choice’.

Charts:

Box-out:

On 14^th of March, Governor of the Central Bank of Ireland, Professor Honohan has told Limerick Law Society that Irish banks should be less inhibited about repossessing properties held against investment or buy-to-let mortgages. This conjecture cuts across a number of points, ranging from the capital implications of accelerated foreclosures to economic risks. However, one little known set of facts casts an even darker shadow over the banks capacity to what professor Honohan suggests they should. All of the core banking institutions in the country currently run large scale undertakings relating to covered bonds and securitizations they issued prior to 2008 crisis. Since 2008, the combination of falling credit ratings for the banks and accumulation of arrears in the mortgages accounts has meant that the banks were forced to increase the collateral held in the asset pools that back the bonds. In the case of just one Irish bank this over-collateralization increased by 60% in the last 4 years. This is done in order to increase security of the Covered Bond pool for the benefit of the Bondholders and is achieved by transferring additional mortgages into the pool. In just one year to December 2011, the said bank transferred over 26,000 new mortgages into one such pool. As the result of this, the bank can face restrictions and/or additional costs were it to foreclose on the mortgages within the pool. Things are even worse than that. In many cases, banks now hold mortgages that had their principal value pledged as a collateral in one vehicle while interest payments they generate has been collateralized through a separate vehicle. The mortgage itself can potentially even be double-collateralized into the security pool as described above. The big questions for the Central Bank in this context are: 1) Can the banks legally foreclose on such loans? and 2) Do the banks have sufficient capital and new collateral to cover the shortfalls arising from foreclosing mortgages without undermining Covered Bonds security?