28/8/2013: Some charts on China's debt addiction (via FT)

China has been the 'Big Asian Hope' when it comes to global growth and more recently, the 'Big Asian Worry'. The problem, however, is that China is not unique. Like the rest of the world, China is incapable of delivering growth at the rates below the rate of expansion of debt. Leveraging seems to be the worldwide story when it comes to growth generation, as if the entire global economy is populated by compulsive gambler-states...

FT has a fascinating set of slides on China's debt-growth links: http://www.ft.com/intl/cms/s/0/e76db82e-0a4d-11e3-aeab-00144feabdc0.html#slide0

And here are my two favourites:

Chart above clearly shows that China is in a league of its own when it comes to debt vs GDP per capita. If anything, the healthy due of countries by these metrics are Russia and Mexico (note South Korea, in my opinion, does not belong with Emerging Markets - it is an advanced economy). India is a sick economy, compared to the rest. But China... well, China is on its own.

Worse, however, as the chart below shows, China's mountain of debt is now shifting out of the banking sector and into the least transparent and trust loans markets:

Now, trust loans are debt that has been dressed up as 'investment product' and sold onto retail investors. This debt is funded usually by banks and/or investors. Back in 2010 these were problematic already, but arguably manageable. Since then they have shot up in importance. Trust loans are short-term finance, with maturities of few months and up to a year, implying high risk of exposure to liquidity shocks and interest rates shocks. They are also expensive. Roll over risk is rising in the Chinese economy.

FT had additional coverage on these back in 2010 here: http://ftalphaville.ft.com/2010/07/15/286766/chinas-trust-factor/

All of the above speaks of severe debt addiction in the Chinese economy. 

27/8/2013: Ifo Business Expectations: Germany, August 2013

On foot of my previous post (http://trueeconomics.blogspot.ie/2013/08/2782013-ifo-business-climate-survey-for.html), here is a longer-term view of the role expectations play in co-determining / tracking the subsequent realisation of business conditions and climate under the Ifo index.

Answer is: not much. The same picture holds for 12 months lags.

In other words, as I said above: expectations (in the case of German businesses) are more conservative and less volatile than either current situation index or climate index. And this suggests that expectations tend to adjust to current climate imperfectly but stronger than lead the future index readings. For the forecasting purpose, it is probably the longer-run averages, in more complex econometric structures, that are more likely more indicative of the true underlying dynamics being declared under the expectations. In simple terms: don't read too much into short term changes (short-term being 12 months and less) in expectations...

Interestingly, the Ifo series are high quality data, unlike many other series, such as, for example, smaller economies' PMIs. Yet, to my knowledge, no one does any serious analysis of expectations and their predictive power for any of the regularly-released series on business activity. This just goes to show how simplistic the markets-related macro analysis can be.

27/8/2013: Ifo Business Climate Survey for Germany: August 2013

CES Ifo Business Climate figures for Germany are out today, showing further gains in underlying economic conditions and expectations forward.

Year on year, business climate index reading improved 5.2% to 107.5 in August 2013, with monthly improvement of 1.2%. 3mo average over the last 3 months was 106.5 against 105.6 average for the 3mo period through May 2013 and 103.5 3mo average through August 2012.

On business situation side, index rose to 112.0 in August 2013, up 1.7% on July 2013 and 0.9% on August 2012. 3mo average through August 2013 stood at 110.5, ahead of 109.1 3mo average through May 2013, but below 112.1 average through August 2012.

Business expectations index also rose in August to 103.3 from 102.4 in July, showing a monthly gain of 0.9% and an annual gain of 9.8%. 3mo average through August 2013 is at 102.7 against 3mo average through May 2013 102.3, suggesting that pick up in overall expectations has been rather subdued. This might be due to the index overall showing lower volatility around the mean than other two indices. In other words, conservative expectations are staying closer to the mean and watching if the rest of the series do catch up with expected expansion. 3mo average through August 2012 was 95.6, suggesting that overall, there has been some serious optimism built up over the last 12 months, further warranting some moderation in the rate of optimism growth forward.

Chart to summarise:

25/8/2013: WLASze Part 2: Weekend Links on Arts, Sciences and Zero Economics

In the previous WLASze post, I promised to cover in more detail the Future Generation Art Prize 2013 at Venice Biennale. Here are some links and this year's artists.

The newsletter covering applicants and participants is here,  and you can explore all of the artists exhibited in Venice here.

An architectural/spatial geometric installation with fractal-like dynamic repetition of the subsets is somewhat clinical in nature, yet, the size and span of it do impress, as well as superbly un-natural and inorganic reduction in size...

Like extra-human on extra-terrestrial scale...


Lynette Yiadom-Boakye is a well-recognised painter and her work deserves some series consideration: "Underlife" illustrates

Although not all of it is of consistent quality (I guess this is why she is still in the 'future generation' league), as "The Edifying Oracle's Cheque, 2012 shows:

Incomplete work both compositionally and figuratively.


Jonathas de Andrade from Brazil "Nostalgia, a Class Sentiment" is an installation that merges the lego-like figurative formalism (not quite an abstraction) with text-based contextualisation. The result is rather poor attempt at making cataloguing fun...

I am not a fan of this stuff... It is neither nostalgic (being deprived of emotional content) nor sentimental (being deprived of emotive form). It might be relevant to 'class' as it speaks directly to the academists... Why on Earth would I care to put this here? Precisely because someone, somewhere on this plant thought this is a potential for the Future in art... right...


Neither am I a fan of post-Rauschenbergian collections of refuse as installation art. Rauschenberg was an indisputable master of assemblage: http://www.rauschenbergfoundation.org/ and since his works, the approach of amassing discarded objects into some sort of meaning has become a very-hard-to-execute form of art. Abigail DeVille's "Nostalgia, a Class Sentiment" just doesn't cut it:

According to curators, DeVille "creates archaeological constructs full of cultural and historical references. Her dark sculptural installations steeped in “destruction” and “decay” are a reflection on social repression, racial identity and discrimination in the ruinous decadence of the big city. With building waste and rubbish from the streets, which she incorporates as found objects and “intergenerational debris”, DeVille builds black holes and vortexes like metaphorical time warps. In the periphery of this constructed decay, or once through the vortex, we meet lost individuals, grotesque parodies of how blacks were perceived in the American past."

Blah, blah, blah... DeVille's 2012 installation, "a vortex representing street life based on Claes Oldenburg’s found object environment The Street at the Judson Gallery in New York 1960."

Sorry, folks, but Oldenburg was cool. DeVille missed the point: there is no need to 're-narrate the 1960s'. This isn't Hollywood, where routine running out of plots to produce movies on results in re-narration of old classics. Oldenburg's links: http://www.moma.org/collection/artist.php?artist_id=4397 and http://www.tate.org.uk/art/artists/claes-oldenburg-1713 and http://www.guggenheim.org/new-york/collections/collection-online/artists/bios/689 and so forth... I just don't dig this 'connection' to De Ville - except at the most superficial...

Between - assemblage, cataloguing and objects-based installations are best exemplified by the master of the art: Ilya Kabakov (http://www.tumblr.com/tagged/ilya-kabakov). Eat your "vortex representing ...life ... based on... found object environment", DeVille:

 and your sentimental nostalgia catalogue, Jonathas de Andrade: 

Source for the latter: http://contemporaryrubbish.wordpress.com/garbage/the-garbage-man-the-man-who-never-threw-anything-away/#main for the former: http://noyspi.com/kabakov.html

Enough of stuff I don't like, here's some that actually looks good.

Mykyta Kadan from Ukraine has a classical education in art and this shows - in contrast to the majority of Western artists who often have only scant command of composition and practical experience in 'crafting' their works. Ideas are fine and necessary, but remember - art, like poetry, maths, philosophy etc is more than just ideas. it is also about execution.

"Kadan combines intellectual reflection with continuous social engagement, using his artistic practice to act in the socio-political discussions in Ukraine. With a strong historical awareness, Kadan focuses his research on the urban transition of Kyiv, a city in continuous transformation losing its historical roots and its public spaces to commercialism. Kadan works mostly in painting and sculpture, and in his use of abstraction and modelling he references the Russian avant-garde movements from the turn of the 20th century." Can't agree more. Fantastic dynamism, merged organically with pure statism, accentuated by the intensity of colours.

24/8/2013: WLASze Part 1: Weekend Links on Arts, Sciences and Zero Economics

Due to travels, I have taken a break away from posting WLASze: Weekend Links on Arts, Sciences and zero economics last week. This is the return of my blog's regular weekly feature.

Thus, fresh from Biennale in Venice, few thoughts for the opener of this week's WLASze. Enjoy


Overwhelming sense of being underwhelmed is the best way to describe the Biennale 2013. My concern was evident from the main pavilions of Giardini on: much of this year's Biennale is banal, over-selected, non-challenging and yawn-inducing academism of post-modernist art. It is as if the two sources of artistic expression: ideas and forms, all have been mined out to hollow caverns filled with brackish polluted water and no longer capable of producing gem stones.

Perhaps the best performance art (and there was some around that pretended to be such, inclusive of two women moaning at each other in the middle of the large hall in the main hall of Giardini - I personally thought the moderately-sized crowd of art-refusnik professorial types gobbling it all up watching them was probably a better part of the performance) for the entire Biennale is the permanent installation of Venezuela pavilion next to Switzerland. What a contrast to the irony and though-free general outlook of the Biennale itself. The juxtaposition of a resources-rich self-impoverished economic blackhole of Venezuela and self-made resources-impoverished uber-rich Switzerland.

Let's go for the rest of it.

Spanish pavilion was… booooooring… it contained a large collection of various piles… of various stuff… bark, rocks, dirt…

The best bit was a small lizard that made the pile of rocks its home and calmly lazed about while viewers were exerting much effort to comprehend why would an insolvent Spain send to Venice a pile of rocks, plus three tiny weeds that sprung leaves from the pile, allegorically suggesting green shoots amidst what appeared to be a representation of Spanish housing market collapse... Neither intended, both more original than the installation itself.

Dirt-in-the-room thingy has been done. Ages ago. Walter de Maria did it best - DIA still has it…

Reinventing the wheel… Enough said.

Still, little delightful surprise (albeit in a very large shape) awaited us in the next pavilion - Belgium, which was represented by Berlinde De Bruyckere's Kreupelhout – Cripplewood.

I like Coetzee's work, fine writer, full of textbook sensitivities, yet very much outside the traditional space of 'African' literature. Alas, I disagree with Coetzee: knots of human reason are infinitely more complex than knots of that occur in nature. Nature has finite dimensions, until a human being enters the picture.

Yet, more good stuff awaited in Mark Manders's "Room with a Broken Sentence" at the Dutch pavilion:

Aurelien Froment, Pulmo Marina and other from the Future Generation Art Prize

I am planning to post more on this later.


In the main hall of Giardini, majority of works were fully captured by relentless academism. Formulaic stuff, delivered with competence and, thus, made even less exciting.

Here are few exceptions, though even these are not exactly earth-shattering. Jean-Frederic Schnyder's Swiss folkeshism so much loved by kids...

Thierry De Cordier's series of dark, brilliant oils... begging for some larger canvases and bigger walls:

Sarah Sze's installations at the US pavilion were quite a hit, an occasionally intricate, but at times perhaps too-direct interplays between nature, stasis, imbedded dynamic and restraint, they were fresher than the average stuff on show.

Sarah Sze did grand work also mixing up some clinical variety of counterbalancing thought and expression. Her brilliant triple point (planetarium) is large, lab-reminiscent and only tangentially related to stars… which is a sort of… the main point o a planetarium

And this brings us to my favourite of the Biennale 2013: the Russian pavilion, where performance art of high quality infused sarcasm and satire, mixed up with some basic ethics, amidst what would pass for a good quality installation art too… Vadim Zacharov pulled no punches in his work:

Double-take on 'semechki'... :-) I smiled... MrsG loved it... and then there was the main installation (which we first experienced by MrsG walking under the coins shower):

You can see the coins rain:

Note: only 'ladies' (no girls or men or boys) were allowed to walk under the 'rain' and collect coins to bring back into the entrance hall. The rain, however, was generated by a man:

Sort of gender play / role restatements.

Russian pavilion was simply brilliant. By far the best of all we have seen, followed by the US pavilion.


I shall take a break… stay tuned for Part 2.

23/8/2013: IMHO statement on Mortgages Arrears for Q2 2013

Irish Mortgage Holders Organisation (IMHO) issued opinion on today's mortgages arrears figures: https://www.mortgageholders.ie/another-false-start-in-resolving-mortgage-crisis/

My detailed analysis of the figures is here: http://trueeconomics.blogspot.ie/2013/08/2382013-irish-mortgages-arrears-q2-2013.html

23/8/2013: Irish Mortgages Arrears: Q2 2013

Mortgages rears figures are out for Q2 2013 and guess what, things are (predictably) getting worse. I am sure the Government will say that 'getting worse today'='getting better in the future'. As such, we do live in the world where stabilisation = decline in the rate of decline, while a slight uplift on any time series is greeted as an indisputable 'gathering growth momentum'.

What do the numbers of mortgages arrears tell us, spin aside? I highlight main conclusions in bold.

In Q2 2013 there were 919,139 mortgages accounts outstanding (EUR139,883 million in total), of which 770,610 accounts were for primary residences (EUR109,147 million). Primary residences are referenced as PDH accounts in CBofI. The balance of 148,529 accounts  (EUR30,626 million) relate to Buy-to-lets, BTLs.

This means that over the year through the end of H1 2013, the number of mortgages accounts rose 0.4% and their outstanding volumes fell 2.41%. Deleveraging is very slow in the economy, given the crisis scope: number of primary mortgages accounts rose 0.7% and their volume shrunk 2.52%, while the number of BTLs fell 1.1% and their volume shrunk 2.01%. In fact, as the chart shows, deleveraging process so far is not helping the workout of arrears:

Total number of primary accounts in arrears of any duration is up 11.46% y/y, underlying volume of mortgages represented by these is up 9.1% to EUR25.69 billion from EUR23.55 billion a year ago, while amounts in arrears are up 36.46%, breaching EUR2 billion for the first time. This means that, penalties inclusive, the arrears are now attracting ca EUR202 million in roll up charges annually or about 40% of the annual savings that we need to deliver in Budget 2014 from the social welfare funds.

Total number of BTLs in arrears was up 15.06% y/y and the amounts of mortgages outstanding for the BTLs in arrears rose to EUR10.94 billion - up 11.45% y/y, while the actual cumulated levels of arrears hit EUR1.207 billion, up 43.63% y/y.

All in, there were 182,840 accounts in arrears, representing cumulative amount outstanding of EUR36,634 million and cumulated arrears of EUR3,231 million. These were up: +11.39% y/y for account numbers (+19,924 accounts), +EUR3.267 billion or 9.79% y/y for mortgages outstanding, and +EUR 907 million or +39.05% y/y for actual arrears.

Repossessions accelerated, but remained subdued overall, rising to 1,503 accounts (1,001 accounts for primary residences). This represents a y/y increase of 13.69% for all accounts, 6.04% rise for primary residences and 32.8% jump for BTLs.

Restructured mortgages numbers declined in Q2 2013, from 106,612 accounts to 100,920 accounts over the period of 12 months through June 2013. This breaks down as per decline of 6.57% for primary residences from 84,941 to 79,357 accounts, and a decline of just 0.5% for BTLs from 21,671 to 21,563 accounts.

Performance of restructured mortgages somewhat improved, although we do not know as to why this was the case. Restructured mortgages that were not in arrears as percentage of the total number of restructured mortgages has improved from 47.35% to 53.31% for primary mortgages, and from 51.17% to 61.13% for BTLs.






And some scarier figures for the end:

• Total number of mortgages at risk of default or defaulted (mortgages in arrears, mortgages restructured and not in arrears, and repossessions) rose to 239,834 in H1 2013 (up 11.27% y/y)

• Total number of primary mortgages at risk or defaulted rose to to 186,202 in H1 2013 (up 9.94% y/y)
• Total number of BTL mortgages at risk or defaulted rose to to 53,632 in H1 2013 (up 16.12% y/y)

• 20.26% of all primary residential mortgages were in arrears or at risk of default in Q1 2013, against 18.50% in Q2 2012.
• 36.11%of all BTL mortgages were in arrears or at risk of default in Q1 2013, against 30.75% in Q2 2012.
• 26.09% of all residential mortgages were in arrears or at risk of default in Q1 2013, against 23.55% in Q2 2012.
• By volume of mortgages outstanding, 33.35% of the total mortgages pool or EUR46,618 million were mortgages either in arrears, or restructured at the end of Q2 2013, up on 29.51% (or EUR42,258 million) at the end of Q2 2012.

22/8/2013: Bank Resolution Costs, Depositor Preference, and Asset Encumbrance: IMF Paper

Daniel Hardy's paper "Bank Resolution Costs, Depositor Preference, and Asset Encumbrance" (July 2013, IMF Working Paper No. 13/172. http://ssrn.com/abstract=2307415) looks at the banks resolution structure from the point of view of costs of bankruptcy / debt restructuring arrangements.

Hardy states that "bank resolution, like bankruptcy and debt restructuring generally, inherently involves a great deal of negotiation and uncertainty…" Based on the experience, especially from the current financial crises, conflicts arising from bankruptcy or restructuring "…can add substantially to costs and delays in resolution".

To mitigate such costs, Hardy suggests, the regulators can "make some claims bankruptcy remote" via "statute and policy, as when depositors enjoy preferred status as a matter of law, or through private agreements, as when banks issue covered bonds backed by a pool of high-quality assets."

Because such 'remoteness' reduces conflicts resolution costs in the case of restructuring or bankruptcy, "the asset encumbrance that results from either mechanism can be desirable insofar as it reduces bankruptcy costs, and, through lower overall funding costs, lowers the probability of distress."

The effects of remoteness are multiple and interactive:

1. "…the gain should be capitalized into the value of the bank, which enjoys an overall reduction in funding costs." 
2. Non-secured borrowers need not "be disadvantaged in expectational terms: they earn more when the bank survives but bear larger net losses in case of resolution (though they spend less contending for their claims)."
3. "Granting preferred status to (some) depositors need not provoke increased collateralization of other credits: from the point of view of the borrowing bank, collateralization and statutory depositor preference are near substitutes…" 

Note 1: point 3 above establishes non-zero value of depositors. Recall that collateralisation is the source of funding. It represents a liability on the balance sheet, but such liability is cost-reducing. Cost savings arising from collateralisation as (1) decreasing in volume of collateralisation, and (2) have a positive value the bank. Deposits-related cost savings are not decreasing in volume (no marginal pricing) for a small-medium bank (although they might be increasing for a larger bank). This is the fundamental difference in pricing of deposits.

Note 2: limited depositor guarantee schemes (DGS), consistent with the above structure (1)-(3) would be required to remain stable, with the limits of protection not subject to alteration downward in the case of the crisis.

Now, back to the paper.

"For these [remoteness inducing] measures to be valuable", the legal foundations on which they rest must be secure, and the resolution process can only start "when the borrowing bank still has enough residual assets that preferred or collateralized claims can be met. If, ex post, these conditions are not met, conflict may be intensified. Hence, bank stability might be enhanced by limiting total asset encumbrance (preferred deposits plus collateralized borrowing) to below the likely minimum level of residual assets. Authorities that are willing and able to take early corrective action, and therefore rarely have to deal with banks left with scant residual assets, can be more sanguine about asset encumbrance."

Note: the above implies that any DGS must price-in the call on assets that is senior to the collateralized call, since the timing of deposits is less tractable (due to demand deposits and short-term notice deposits) than the call on assets relating to collateralized claims. This is non-trivial, but not covered in the paper.

The conclusions of the study also "lead on to other questions [or conclusions] of practical relevance", include the following:

• "Why is information on bank asset encumbrance not more readily available? Appropriate pricing of both collateralized and non-collateralized borrowing depends on making good estimates of probability of failure and of loss given default facing different creditors, and thus of the degree of outstanding asset encumbrance. Yet it is difficult to obtain current or detailed, bank-by-bank information …typically one cannot know the volume of assets pledged in the interbank market, to the central bank, in liquidity swap and derivative deals, etc." 
• "What are the implications for funding behavior and stability of heterogeneity among creditors in their litigating/lobbying ability and incentives?"
• "In what ways would statutory bail-in of unsecured creditors be symmetric to the granting depositors preferred status, and in what ways would contingent capital (“CoCos”) be symmetric to collateralized credit?" 

Overall, the main conclusion of the paper is: "Depositor preference and collateralization of borrowing may reduce the cost of settling the conflicts among creditors that arises in case of resolution or bankruptcy. This net benefit, which may be capitalized into the value of the bank rather than affect creditors’ expected returns, should result in lower overall funding costs and thus a lower probability of distress despite increasing encumbrance of the bank’s balance sheet. The benefit is maximized when resolution is initiated early enough for preferred depositors to remain fully protected."

22/8/2013: Hedges & Safe Havens out in print

Our paper on hedges and safe havens is finally out in print. Full citation:

Cetin Ciner, Constantin Gurdgiev, Brian M. Lucey, "Hedges and safe havens: An examination of stocks, bonds, gold, oil and exchange rates"

International Review of Financial Analysis, Volume 29, September 2013, Pages 202-211

ISSN 1057-5219

http://dx.doi.org/10.1016/j.irfa.2012.12.001.
http://www.sciencedirect.com/science/article/pii/S1057521912001226

Keywords: Safe havens; Quantile regressions gold; Oil

22/8/2013: Burry the Debt... Forever!

Pierre Pâris, Charles Wyplosz, 6 August 2013 column for Vox.eu, titled "To end the Eurozone crisis, bury the debt forever" is a perfect referencing point for my thinking on the debt crisis. Read it here: http://www.voxeu.org/article/end-eurozone-crisis-bury-debt-forever

Synopsis: "The Eurozone’s debt crisis is getting worse despite appearances to the contrary. How can we end it? This column presents five major options for reducing crisis countries’ debt. Looking into the details, it seems the only option that is both realistic and effective is for countries to default by selling monetised debt to the ECB. Moral hazard aside, burying the debt seems to be the only way we can end the crisis".

Can't say it better myself!

22/8/2013: Sovereign Default Risk & Banks in the Euro Area Setting: Harald Uhlig

Harald Uhlig's latest paper "Sovereign Default Risk and Banks in a Monetary Union" (CEPR DP9606, August 2013, http://www.cepr.org/pubs/dps/DP9606) "seeks to understand the interplay between banks, bank regulation, sovereign default risk and central bank guarantees in a monetary union".

The rationale for the paper is that the "European Monetary Union is in distress. Mechanisms that were meant to safe-guard key institutions and to assure stability have become sources of balance sheet risk for these very institutions. Liquidity provision within
the European Monetary Union rests upon repurchase agreements, by which banks guarantee the repurchase of assets deposited with the ECB. If either the bank fails or the asset fails, but not both, this mechanism safe-guards the repayment to the ECB, since it can either rely on the repurchase by the bank or sell the asset. However, when both fail as well as the bank home country fails, the ECB incurs a loss."

Abstracting away from the (important) debate about the implications of such a 'loss', the theoretical framework described by Uhlig is insightful and interesting. The author assumes "that banks can use sovereign bonds for repurchase agreements with a common central bank, and that their sovereign partially backs up any losses, should the banks not be able to repurchase the bonds."

Furthermore, "In the model, banks pursue their investment strategy voluntarily: it is up to regulators to potentially constrain them. Other explanations are conceivable, of course". This is different from the currently dominant views, as per Reinhart (2012a) as well as Claessens and Kose (2013). Specifically, it is distinct from Reinhart (2012b) argument as to why banks hold bonds of their home country. Reinhart argues that in a “financial repression” setting the regulators "make
[the banks] hold the sovereign bonds, perhaps with strong-arm tactics, perhaps in exchange for “looking the other way” concerning weak portfolios of commercial loans and mortgages, or simply as a “favor” in a long, ongoing relationship. Since the banks could potentially refuse, though at considerable cost, it still must ultimately be preferable to them to hold own-country bonds rather than invest elsewhere or to close: so, in some ways, this paper may also be understood as a model of financial repression." Another view for the system by which the banks end up holding rising exposures to domestic sovereign bonds is a political economy argument: "if sovereign bonds are held by home banks, it makes it politically harder to default on these bonds, as this will hurt domestic banks and savers. If so, then such a portfolio arrangement might serve as a commitment device for the government in trouble."

Uhlig's (2013) paper is not covering the underlying reasons for the holding of the bonds.

Overall, "the issue of sovereign default risk, bank portfolios and the role of the central bank has received considerable attention in the recent literature. Acharya and Steffen (2013) is a careful empirical analysis of the “carry trade” by banks, which fund themselves in the wholesale market and invest in risky sovereign bonds. They document, that “over time, there is an increase in ’home bias’ – greater exposure of domestic banks to its sovereigns bonds – which is partly explained by the ECB funding of these positions"… Relatedly, Corradin and Rodriguez-Moreno (2013) show that USD-denominated sovereign bonds of Euro zone countries became substantially cheaper (i.e., delivering a higher yield) than Euro-denominated bonds during the Euro zone crisis, and ascribe it to the usefulness to banks of Euro-denominated bonds as collateral vis-a-vis the ECB, while USD-denominated bonds do not offer this advantage." In addition, "Drechsler et. al. (2013) document “a strong divergence among banks’ take-up of” Lender-of-Last-Resort assistance “during the financial crisis in the euro area, as banks which borrowed heavily also used increasingly risky collateral”. They test several hypothesis and argue that their “results strongly support the riskshifting explanation”…"

The above supports the Uhlig (2013) model that concludes that:
-- "…Regulators in risky countries have an incentive to allow their banks to hold home risky bonds and risk defaults, while regulators in other “safe” countries will impose tighter regulation."
-- "…Governments in risky countries get to borrow more cheaply, effectively shifting the risk of some of the potential sovereign default losses on the common central bank."
-- "As a result, the monetary union has become a system engineered to deliver underpriced loans from country banks to their sovereigns, and to implicitly shift sovereign default risk onto the balance sheet of the ECB and the rest of the Eurosystem."

The last sentence is the key to it all: the euro system is now "engineered to deliver underpriced" credit "from country banks to their sovereigns", while shifting "sovereign default risk onto… the ECB and the rest of the Eurosystem".

22/8/2013: Why This Time Things Might Be Different...

The readers of this blog know that I am seriously concerned with the issues of private (household) debt sustainability in the Euro area, as well as in other advanced economies around the world. In fact, my (simplified or stylised) POV on the current crisis is that we have now reached the point of long-term saturation with leverage and this is the main driver for the current Great Recession.

In a normal recession, deleveraging by one side of the economy is accommodated by leveraging up in another. For example, in a Keynesian policy set up, deleveraging of the households and non-financial corporates is accommodated by leveraging up of the fiscal side of the GDP equation. In a monetary policy setting, deleveraging of fiscal / public sector side is accommodated by lowering debt costs and thus increasing credit to the private economy. Lastly, in a normal balancesheet recession, both side of the economy can be helped in deleveraging by a combination of two policies accommodation.

In the current Great Recession, neither one of the three approaches above can work, unless at least one approach directly reduces debt levels - either via a sovereign default/writedown or a private sector writedown on a systemic scale. The reasons for this are two-fold:

1. Too much debt on all lines of the economic balancesheet: fiscal, household, NFCs and, thus, banks means that lowering the cost of debt financing is not sufficient to deliver signifcant enough room for new debt expansion; and
2. With emerging markets and middle income economies showing increasingly South-South internalised trade and investment flows patterns, the advanced economies are witnessing structural reductions in the pools of surplus (investable) savings available to them - the effect that is compounded by the adverse demographics in these economies. This means that monetary policy accommodation is funding the liquidity in the financial markets, where normally it would have been going to fund real activity.

In short, debt is the source of the crisis this time around, not the solution to the crisis as in previous recessions. And it is a proverbial perfect storm, as it comes on foot of demographic decline coincident with severe fiscal crises. The resulting squeeze on pensions in the advanced economies and on other age-related public services is yet to come.

Here is an interesting view on the continued crisis dynamics in the area of household debts in the US (with an ample warning for the rest of the advanced world) from Michael Hudson: http://www.alternet.org/economy/big-threat-economy-private-debt-and-interest-owed-it-not-government-debt (H/T to @rszbt Beate Reszat).