19/1/2013: Ireland's cost of funding

An interesting chart in today's IMF review of Greece:

Now, that's right - prior to Bailout 2.0, Greece led the euro area in terms of its overall Government debt financing burden as % of GDP and Ireland ranked 3rd in these dubious (in virtue) rankings. After Bailout 2.0, Greece funding costs are now below euro area average (ranked 7th) and Irish ones are ranked 2nd highest after Italy.

Now, note that this means that Ireland has the highest debt financing costs of all countries in Troika bailouts. In other words, with hefty subsidy to our cost of funding via EFSF et al, we are coming out very poorly. What will happen if we 'regain access to the markets' at costs higher than those under the Troika bailout?..

Although approximate, a deal to bring Irish debt financing costs to euro area average would see the Government benefiting from savings of ca 2.3% of our GDP annually or ca EUR3.73 billion making measures passed in Budget 2013 in their entirety unnecessary.

18/1/2013: Some Lessons from the US Recovery

This is an unedited version of my article that appeared in Sunday Independent, January 6, 2013.



Basking in West Florida’s sunshine, downtown Venice is a sleepy affair – a quaint and quiet boulevard full of historic trees, if not historic buildings, leading beaches free of crowds and full of sea birds. An unlikely mirror to the US economy, in many ways, it nonetheless shares in the dynamics of the country’s leading economic indicators.

According to the majority of the forecasters, 2013 is going to be the year when the US economy is set to take off onto a new growth trajectory, pushing inflation-adjusted GDP by some 3-3.5%. Pent up economic capacity, capital investment and jobs creation, held in check since the end of 2007, should act as the major drivers for the world's largest economic engine. Meanwhile, four years of relatively robust deleveraging of the American households will be an economic lubricant, facilitating expansion of private sector credit.

In reality, these forecasts are not new. Year after year, since the end of the last official recession in June 2009, the US and international analysts have predicted that over the next 12 months the economy will post a real recovery, comparable to the exits from all previous recessions. Year after year their forecasts were proven to be overly optimistic. Instead of escaping the near-zero growth dynamics, the US economy continues to struggle with finding a solid ground.

In the likes of Venice, this translates into a strange split in the overall economic activity, best exemplified by the local property market. Robust sales of new construction homes are offset by the stagnant secondary market, reflecting the bifurcation of the American fortunes. Those who accumulated debts in the 1997-2007 bubble are still fighting for survival. Meanwhile those who entered either jobs or retirement since 2008 are enjoying robust savings on new, high quality, lower priced dwellings.

Much the same applies to the rest of the US. Headlines suggest that house prices are on the rebound, and mortgages lending is up. Mortgages rates are near historic lows, despite the fact that banks lending margins are near historic highs. Corporate debt issuance is up and unemployment rolls are slowly inching down.

The US markets had a blast of a year in 2012. with Nasdaq came up some 15.9%, DOW went up 7.26% and S&P 500 rose 13.4%.  The Small Cap stocks index, Russel 2000, ended 2012 up 14.6%. Despite the still unresolved fiscal deficit overhang, the breaching of the debt ceiling, and ballooning Federal debt, the US Government borrowing costs were sustained at a superficially low levels. Helped by high risk aversion amongst the global investors and the aggressive monetary easing by the Federal Reserve, the US 10 year Treasury bonds yields came down from 1.88% to 1.76%, while 5 year Treasuries yields compressed from 0.83% to 0.72% over the year. US 10-year bonds gained 1.86% in return terms in 2012, while 30-year Treasuries rose 1.5%.

Economic competitiveness gains in the US have been spectacular in 2012. On top of historically weaker dollar boosting exports and lowering demand for imports, the 'shale revolution' saw energy costs plummet. The US manufacturing is now experiencing a new on-shoring trend with corporates bringing back manufacturing capacity previously located outside the US. The most recent example of this is Ford's plan to build a new USD773 million factory in Michigan. Ford has now committed USD6.2 billion for investment in the US manufacturing over 2013-2015. The WTI-Brent spread (the differential in the cost of oil between the US and Europe) has declined USD18.39 per barrel (some 20% of the overall price) compared to 2001-2010 average as the US ramped up production from shale deposits to 6.99 million barrels per day - the highest level of crude output since 1993.

However, as in Ireland’s case, improved US competitiveness is yet to translate into a broader economic recovery. According to the Current Population Survey data, American median annual household income remained stagnant between January and November 2012. The November 2012 median household income was 4.4% lower than at the end of 2008-2009 recession and the beginning of the current ‘economic recovery’. 2012 incomes are some 6.9% below those reached at the end of 2007 and 7.6% lower than in January 2000. On top of this, the latest ‘fiscal cliff’ compromise raised taxes on virtually all working Americans, reducing disposable household incomes by some 2% by some estimates. The deal is estimated to cost the US economy 1% of GDP annually, starting with 2013.

Weak and narrowly focused on specific subsets of the economy (financials, ICT, exports-oriented sectors) economic growth in the US has been unable to lift the real economy out of the L-shaped ‘recovery’. In other words, the main lessons to be learned by Ireland’s policymakers from the US ‘recovery’ of 2012 are unpleasant ones. Firstly, gains in competitiveness and exports growth are not capable of propelling the economy onto a growth path. Secondly, even with fully-deployed monetary and fiscal policies tools, the debt crises are unlikely to lead to a J-shaped or even a U-shaped recovery any time soon. Thirdly, ‘green shoots’ in various pockets of the economy are not necessarily going to lead to a widespread recovery.

Even when these sources of stabilization are supported by expansionary monetary policies, debasement of the domestic currency and massive accumulation of debt – policies not available to Ireland – they are simply not enough.

In the case of Ireland, these lessons mean that in 2013 we will most likely remain stuck in near-zero growth scenario, with continued contraction in domestic consumption and investment.  Even if Ireland delivers on GDP growth of 1.1% in 2013, as forecast by the IMF, the associated uplift in our economic fortunes will be negligible, as all growth will remain concentrated in the MNCs-dominated exports sectors. Real GNP – a much better measure of our economic activity – is more likely to post a 0.1-0.3% rise, while Gross National Income (GNI) per capita is likely to stay at the levels some 22-23% below those attained in 2007. In fact, current inflation-adjusted GNI per capita in Ireland stands below 2000-2001 levels, implying that in real terms, Irish economy is now marking 12th year of the so-called ‘lost decade’.

With zero employment growth, our unemployment rate will stay static at around 14.5% only thanks to rampant emigration and the expiry of unemployment assistance supports for long-term jobless.

In other words, like the Western Florida’s economy, the Irish economy will continue bifurcating into the pockets of continued stability, underpinned by the Multinationals, amidst the general landscape of continued economic stagnation. Subtract Florida’s beaches and sunshine, and the 2013 economic outlook for Ireland is more pain, punctuated by the delirious Government pronouncements of turnarounds and recoveries that the rest of us will struggle to connect to the everyday reality on the ground.

Sunday Independent, January 6, 2013.

18/1/2013: Iceland's U-shaped Recovery

Back in December, there was quite a bit of controversy stirred around by a short note about the failures of the so-called Icelandic model for dealing with the crisis. The note - a blogpost (and I have no link to it right now) - was alleging that much of the reforms in Iceland were not voluntarily chosen by the Government (which is true), did not result in significant debt relief for homeowners (due to mortgages markets structure differences) and did not produce significant improvements in the economy.

At the time, some readers of the note in Ireland went on to accuse myself of 'talking up' Iceland to promote my 'personal agenda'.

Aside from the above accusations being complete and unadulterated bulls**t (I never said Iceland did everything right or that all of Iceland's policies should be adopted in Ireland), they were based on the reading of one blog post.

Not to stir up any controversy, here's a link to the Danske Bank note on Iceland's economy from December 2012. I am not going to make any judgements here - just read the note. I am reproducing few charts below for those unwilling to read through the entire report.

Quote:

"The recovery of the Icelandic economy has been challenged by the deteriorating conditions in the European trading partners, which account for a large share of the Icelandic exports. It looks like growth in Iceland will perform above most of Europe over the next few years and that its recovery will continue but the level is still well below the pre-crisis level. We expect growth rates of 2.5% y/y in 2012 and 2.2% in 2013. It is also worth noting that recent national account revisions showed that growth in 2011 was adjusted down.

While investment activity and inventories have been rather volatile recently, private consumption has held up relatively well and 2012 should show about 3.8% y/y growth. We expect it will slow somewhat in the following years, to a growth level just below 3%. Investment activity should be fairly solid too and we expect growth rates of about 8-9 % y/y in 2012 and 2013, perhaps with a slightly increasing trend.

Inflation remains above the central bank’s 2.5% target, and has been so for a while, but inflationary pressures have eased somewhat in 2012 and we expect this trend to continue. Our forecast for the GDP deflator is currently 3.7% y/y in 2012 and 3.1% in 2013.

As the economy has been undergoing recovery, the labour market has improved significantly too. While we do not see this trend ending, we do expect it to slow gradually  as the unemployment rate comes down. Consequently, our year-end unemployment rate forecast is 5.8% for 2012, falling to 5.3% in 2013"

Here you go: Iceland's U-shaped recovery and Danske's forecasts for 2013-on:

And for the commentariate loving to accuse me of just dropping numbers to 'fool the readers' - I am not giving a commentary on the above precisely because you accuse me too often of commenting. 

17/1/2013: Transparency & Budgetary Processes

An interesting statement by Nessa Childers, MEP:

I completely agree - all budget-related submissions and proposals should be made public and the Department of Finance should publish them all on their site, linked to Budget documentation. This issue is not only about transparency and lobbying (which are very important), but also about public access to ideas and potential foregone options presented to the Government.

16/1/2013: Irish Car Sales and German Exports Declines

Latest data from Ireland on new vehicles purchases is quite revealing of the broader problems faced by the German economy - a snapshot of what happens to exporting engine when demand in its trading partners slumps.

Let's run through some numbers.

• Overall demand for new vehicles in Ireland has fallen off the cliff in recent years. In 2007 we imported 180,754 new private cars, of which 54,703 came from Germany. Of all German cars imported, 17,394 came from 'luxury' carmakers (Audi, BMW, Mercedes and Porsche). In 2012 we imported 76,256 cars, or 57.8% down on the peak. Of the cars we did import, German automakers accounted for 23,529 vehicles, with German 'luxury' carmakers selling 8,728 vehicles here. 
• In summary, 2007-2012 changes in cars imports were -57.8% for all vehicles, -30.3% for Audi, -51.8% for BMW, -65.8% for Mercedes, - 69.1% for Opel, -84.5% for Porsche and -53.5% for Volkswagen.
• Between 2007-2011, due to aggressive sales promotions and due to skew to the income distribution in Ireland (preserving higher-range incomes more than mid-range), German car makers have managed to increase their share in the overall Irish market, with all German manufacturers' combined market share rising from 30.3% in 2007 to 30.9% in 2012, and 'luxury' makers' share rising from 9.6% in 2007 to 11.4% in 2012.

Nonetheless, there is huge opportunity cost of Irish recession to German automakers. Let's make some assumptions and estimate this cost:

1. Since 2000 and 2007 represent two peak years in terms of cars demand pre-crisis, dropping them from consideration, let's take an annual average demand for 2001-2006 as the 'old normal'. This amounts to 157,261 annual vehicles sales in total, of which 12,814 vehicles sales should accrue annually to German premium car makers and 41,166 sales to all German car makers.
2. Using the above average, we can estimate cumulative sales losses over 2009-2012 as 326,515 total vehicles not sold by all car makers, 75,626 vehicles not sold by all German carmakers and 20,863 vehicles not sold by German 'luxury' or premium car makers.
3. Assume that, on average, a new vehicle in Ireland sells for EUR22,500 per vehicle, inclusive of taxes, while an average 'premium' German vehicle retails for EUR42,500 opera vehicle, average non-premium German vehicle retails for EUR22,500-27,000 range, while Porsche sells an average vehicle for EUR70,000.
4. Based on (3) we have foregone / opportunity cost in EUR terms of cumulated EUR7,347mln for all motor trade (EUR1,837mln annual average) over 2009-2012. Of this, EUR2,275mln opportunity cost carried by all German car makers (EUR569mln annually on average), and of the latter EUR919mln cumulative (EUR230mln annual average) of the opportunity cost carried by German 'luxury' or premium car makers.

Now, let's put this into Euro-wide perspective. Obviously not all economies have experienced as dramatic collapse in sales of new cars as Ireland. But majority of economies did experience a fall-off. Given that Ireland accounts for under 2% of the euro area economy, and assuming that on average, euro area decline in sales was running at 1/10the rate of Irish market decline, German automakers should be some EUR3,100-3,200mln out of pocket on gross sales, annually, on average since 2009-2010.

The above of course is a crude calculation, as it disregards the issue of profit margins, which have probably shrunk, as car advertising had to accelerate in order to support sales. One example would be Audi, which has managed to increase its sales in the Irish market in 2012 compared to 2011 - the only German premium car makers who has managed to do this - on foot of very aggressive advertising campaigns. In addition, sales promotions and discounts, as well as sales of more smaller and less luxury models and fit-outs have also most likely contributed to lower profit margins. 

Here are some charts to illustrate the above.

16/1/2013: US Labor Market Q4 2012 in one chart

And another stunning chart from http://oregoneconomicanalysis.wordpress.com/2013/01/11/visualizing-labor-markets/
showing the overall summary of data on the US Labor Markets compared to Q4 2007 and Q4 2009 to current state.

16/1/2013: Some charts on US unemployment: Financial Crises v Recessions

Two absolutely fascinating charts showing just how different is the current Great Recession from the previous recessions and how the financial crises disruptions are much longer lasting structural in nature when it comes to unemployment than traditional recessions.

(Source: http://oregoneconomicanalysis.wordpress.com/2012/09/24/checking-in-on-financial-crises-recoveries/ )

First, financial crises:

And now, run-of-the-mill recessions:

And financial crises duration in terms of unemployment levels:

The above charts should really be a wake up call to the European 'leaders' still pretending that the recovery is only a matter of short time stroll through deficits reductions.

Here is a link to an excellent presentation (from April 2012, albeit) by the US Treasury on the crisis responses to-date, showing the complexity and the sheer magnitude of these responses. To anyone familiar with the EU response to the crisis - these amount at best to 1/10th of the scale/scope of the US responses.

Here's a telling comparative:

It is also telling to read the level of realism in the US Treasury's presentation as to the problems remaining in the economy that is virtually unparalleled with the reports from the EU and some National Governments (e.g. Ireland).

15/1/2013: ARRA - some evidence of a US welfare trap

A very interesting paper by Casey Mulligan of UofChicago on the effects of the American Reinvestment and Recovery Act (ARRA) - the act that underpinned early stage stimulus to the US economy and extended unemployment benefits.

In the paper, Mulligan estimates "distributions of marginal labor income tax rates for unemployed household heads and spouses …for three benefit and tax rule scenarios:

1. Actual rules under the ARRA, 
2. "Rules as they would have been if they had not been changed since 2007" (in other words 'no ARRA' scenario), and 
3. "Rules as they might have been with a bigger fiscal stimulus."

Conclusion: "About three million unemployed, with a variety of tax situations, had more disposable income while unemployed than they would have by accepting a job that paid 80-100 percent of their previous one. The number would have been less than one million under 2007 rules, and about eight million under a bigger stimulus."

Thus, per Mulligan, "Tax obligations and foregone unemployment insurance about equally erode the rewards from retaining a job, or starting a new one."

Source: Mulligan, Casey B., The Arra: Some Unpleasant Welfare Arithmetic (December 2012). NBER Working Paper No. w18591. Available at SSRN: http://ssrn.com/abstract=2186320

15/1/2013: Some data and ideas on Russian economy

Russian economy quick summary of some latest stats and some disconnected ideas:

• Q3 2012 real GDP +2.9% y/y down from +4% in Q2 and +4.9% in Q1 2012.
• Expected Q4 2012 GDP growth +2.5%
• November 2012 GDP growth of +1.9% y/y inflation-adjusted
• Q1-Q3 2012 GDP +3.5% y/y
• Q3 2012 consumption +5.1% y/y down from +6.9% in Q2
• Expected full year consumption growth +4% y/y.
• Consumer confidence down to lowest in 18 months (since Q2 2011) in Q4 2012 at -8, Q3 2012 reading was -6.
• Industrial production is up +1.9% y/y in November, manufacturing activity +4%, manufacturing PMI at lowest level in 14 months in December at 50.0
• Services PMI down to 56.1, from 57.1 in November
• Composite PMI at 54.1 - a 4 months low.

Inflation is still a major headache for the Central Bank Rossii, with the level above the target, despite being close to historical lows:

• Headline inflation at 6.6% in December against 6.1% y/y in 2011, making 2012 the second best year in terms of inflation in over 20 years.
• Food inflation is 4.4% for 2012, tobacco up 21.2%. 6% crops failure due to drought in 2012 is taking the blame. Non-food inflation was 5.6% and services inflation at 5.4%.
• Meat and poultry led food inflation (+8.3%), brad and eggs prices up 6.2%.
• Alcoholic beverages prices were up 10.1%

Some consumption trends - food:

• 2012 per capita food consumption (local currency) = +8.7%; forecast compound annual growth rate (CAGR) to 2016 = +10.2%
• 2012 beer volume sales = +2.8%; forecast CAGR to 2016 = +2.9%
• 2012 mass grocery retail sales (local currency) = +24.4%; forecast CAGR to 2016 = +28%

All good news for Irish exporters as food represents a strong component of our exports to Russia (see latest data here).

Central Bank raised inflation target for 2013 from 2012-set 4.5-5.5% for 2013 to 5-6% set on December 29th. 2012 target set in December 2011 was 5-6% range.

Capital outflows remain a problem in 2012:

• 2012 capital outflow stood at $56.8bn - the fourth highest yearly outflow since collapse of the USSR, with $9.4 billion outflows in Q4 2012, up on Q3 outflows of $7.6bn and Q2 outflows of $6.4bn, but down on massive $33.3bn outflows in Q1 2012.
• Net outflows were now recorded every year since 2007.
• Banks recorded an inflow of $23.6bn in 2012, in part pushed up by privatization of Sberbank ($5.2bn)
• Net outflows in non-banking sectors of economy amounted to $80.4bn in 2012.

I do expect moderating capital outflows from Russia in 2013 and still expect strong capex in Russia. Ruble valuations are likely to remain strong despite the Central Bank interventions. At any rate, the CB is likely to moderate interventions in the currency markets as it moves to inflation targeting by 2015 from current FX targets.

On the net, I am still bullish long-term on Russian Government (and corporate) bonds:

• Recent decisions to open rubles-denominated bonds sales to foreign investors via Euroclear Bank and Clearstream International will continue pushing yields down. Renaissance Capital estimated recently that OFZs (ruble-denominated state bonds) yields can fall 50-80bps in 2013
• In 2012, OFZs returned 1.12% against 0.38% for Brazil, 1.36% for India and 0.03% for China.

15/1/2013: Risk Taking Up, Cash Down

In contrast to CFA members cautious optimism (see here), markets bullishness is hitting historical highs:

via @Pawelmorski

And understandably, cash is not the King (see second chart here).

15/1/2013: Ireland-Russia Bilateral Trade: Jan-Oct 2012 data

Some good data on Irish bilateral trade in goods with Russia. A graph and a table to summarise:

Details in CSO release here.

Very robust rise in exports (+17.6% y/y in Jan-Oct 2012) and in trade surplus (+24.6% y/y). Balance in favour of Irish indigenous sectors, with food & drink sector exports exceeding those of medical devices and pharma and chemicals.

15/1/2013: CFA Survey 2013: cautious optimism, equities exuberance?

CFA Institute annual survey of economic conditions was published yesterday and here are some core snapshots (full study available here):

Expectations change in favor of economic expansion:

 Interestingly, continued stronger optimism in EMEA as opposed to APAC, weaker optimism in APAC than in AMER, and EMEA as the core driver for growth expected. Another interesting point, although consistent with path dependency, is continued stronger growth expectations for Advanced economies as opposed to the Developing ones.

Euro area crisis continuation is the largest source of overall risk to global capital markets, at 37%, followed by concerns over economic conditions. CFA Members were divided on their expectations concerning the euro area crisis, with 23% expecting crisis easing, 35% expecting worsening and 42% expecting crisis conditions to remain at the levels of 2012. In other words, 77% expect no improvement in the euro area. An interesting snapshot into both path dependency of forecasts and anchoring of expectations is that most optimistic responses came from worst hit countries: Spain (53% expecting improvement) and Italy (46%), as well as from two countries least impacted: France (43%) and Germany (43%). Least optimistic countries are all outside the euro area: Russia (45%), UAE (41%), the US and Singapore (both at 39%) and S. Africa (38%).

Optimism about local economy expansion went up, slightly, from 42% in 2012 to 45% in 2013.

 The following chart plots the % of members indicating the biggest risk to their own local market in 2013.

And on Asset Class performance, equity seems to be king, as I predicted some time ago on foot of the long term decline in debt and liquidity over-supply globally:

Overall, 50% of respondents expect equities to provide highest total expected return, up on 41% in 2012. Asia Pacific region led in equities outperformance expectations (41% in 2012 on 30% in 2012). Cash saw a significant drop in expectations.

No major surprises then: the balance is between continued and ameliorating crisis, plus liquidity surplus sloshing into equities. The former is yet to play out, the latter has already begun.