28/7/2014: Steady decline in Russian Reserves since Q1 2013

Russia's firepower in financial terms is formidable at USD472 billion, albeit declining since the 'local' maximum at around Q4 2012-Q1 2013:

28/7/2014: Western Banks Exposures to Russia

Last week I posted two charts detailing largest FDI exposures to Russia. Here is a chart, courtesy of Bloomberg, showing banks exposure to Russia by country:

28/7/2014: Double Down or Stay Course in Ukraine: the Only Rational Alternatives for Moscow?

The latest reports from the U.S. strongly suggest that Russia is perceived as an un-yielding adversary in Ukraine and that Moscow is about to 'double-down' on its gambit in Ukraine (see here).

The point is that if so, then why and then what?

Why? Russia has currently no exit strategy from the conflict in Ukraine. Forcing complete and total closure of the separatists operations is

1. Infeasible for Moscow (the separatists are not directly controlled troops that can be withdrawn on orders and indications are, they are not all too well coordinated and organised to be following any orders);
2. Were it even theoretically feasible, will be immediately visible to the external observers. Note that, for Moscow, (1) means political benefits of such an action will not be immediately apparent, while (2) means political costs of such an action will materialise overnight.
3. As sanctions escalate, the marginal returns of domestic political support become more important, since external economic benefits from cooperation vanish, but marginal costs remain (see below).

On marginal external benefits: it is absolutely uncertain what exact conditions Russia must fulfil to completely reverse the sanctions: is it

• (a) compel the rebels to surrender unconditionally to Kiev troops? 
• (b) compel them to surrender to either official troops or pro-Kiev militias, unconditionally? 
• (c) compel them to surrender conditionally - without any conditions set and without any mechanism to enforce these in place? 
• (d) compel them to declare a ceasefire - without any conditions set and without any guarantees of enforcement by the opposite side? 
• (e) compel the separatists to engage in peace talks - not on offer by Kiev? 
• (f) compel the separatists to stand down - in some fashion - and enter into negotiations with Kiev on Crimea? 
• (g) Is Crimea at all on the table? and so on...

On marginal costs: the costs of sanctions are tied to Russia delivering some sort of compliance with Western demands. Can someone, please, point to me a website where these demands are listed in full and the states that imposed sanctions have signed off on a pledge that once these conditions are satisfied, sanctions will be lifted?

Thus, in simple terms, current Western position leaves little room for Moscow not to double down in Ukraine. The only other viable alternative for Moscow currently is not to escalate. De-escalation, as much as I would like to see it take place, is not within rational choice alternatives. The core reason for this is that when one constantly increasing pressure in forcing their opponent into the corner without providing a feasible exit route for de-escalation, the opponent's rationally preferred response, at certain point in time, becomes to strike back and double down.

Update: interestingly, Reuters editorial today (29/7/2014: http://www.reuters.com/article/2014/07/29/us-ukraine-crisis-putin-analysis-idUSKBN0FY1AC20140729?feedType=RSS&feedName=topNews&utm_source=twitter) provides very similar lines of argument on costs and incentives for Moscow to de-escalate the situation in Eastern Ukraine.

28/7/2014: Germany: Independent Views on Russian Sanctions

Two research institutes covering economic policy in Germany on Russia sanctions:

• Detailed analysis by DIW Berlin: https://www.diw.de/de/diw_01.c.469198.de/presse/diw_roundup/are_the_economic_sanctions_against_russia_effective.html
• Brief note from Ifo Institute on sanctions linked to longer term strategy: http://www.cesifo-group.de/ifoHome/presse/Pressemitteilungen/Pressemitteilungen-Archiv/2014/Q3/press_20140725_Russland-Konflikt.html

28/7/2014: Russia's Budgetary Framework 2015-2017

This month, Russian government approved the 2015–2017 Budgetary Framework, BOFIT issued a good summary of this and here are some of the main details.

The multi-annual framework is subject for frequent adjustments, but serves the purpose of introducing at least indicative / directional targets to fiscal policy.

Over the 3 years horizon, Russian Government aims for total (federal and regional budgets and social funds) revenues increasing at 6‒6.5% pa, slightly ahead of inflation forecasts. Oil and gas production taxes and export duties revenues are projected to rise in 2014, but remain flat thereafter. The Framework assumes roughly USD100/barrel price of Urals-grade oil.As the result, revenue share of GDP is expected to fall from 36.5% of GDP in 2013 to 35% in 2017.

One innovation - discussed for some time and yet to be adopted - is that the Government is considering given local (regional) authorities power to introduce local sales taxes.

The Framework projects government deficit rise slightly to around 1.5‒2% of GDP, driven primarily by regional not federal deficits. Federal budget deficit is projected at around 0.5% of GDP, well below the 1% Budget Rule ceiling.

Between 2014 and 2016, the Framework expects a rise in Government expenditure, but rates of increases are set below inflation rate. From 2016, spending as a share of GDP is forecast to fall gradually below 37% against 38% in 2013.

Capital investment spending will be funded by long-term lending from the National Welfare Fund - cumulative spending between 2015 and the end of 2017 will involve close to 1/4 of the National Welfare Fund (roughly 1% of GDP).

Federal debt (including government guarantees) is expected to rise closer to 15% of GDP by end-2017, of which debt will amount to around 10% of GDP. On net debt side, assets in Federal Reserve Fund are forecast to increase slightly. The combined value of the Federal Reserve Fund and the National Welfare Fund will stay just below 10% of GDP.

BOFIT provides a chart summarising the Budgetary Framework 2015-2017:

28/7/2014: Of Savings, Cash and Hedge Funds...

The current crisis, on monetary aggregates side, can be characterised by the rising prevalence of cash over savings. In other words: shrinking stock of credit and deposits relative to cash.

The current crisis, on media commentary side, can be characterised by the endless talk about high savings rates in the private sector.

Here is the problem: savings = inflows into stock of savings (aka, deposits) or investment or divestment out of loans (including forced restructurings, bankruptcies, insolvencies and foreclosures). We know that Irish investment is not growing at the rates worth even mentioning. Which means that Either deposits should be growing to reflect 'high savings' or debt should be shrinking.

Take a look at the difference between M3 money supply and M1 money supply.

By definition:

• "Money Supply (M1) to euro area -M1 is the sum of overnight deposits and currency issued (this comprises the Central Bank's share of euro banknotes issued in the Eurosystem, in proportion to its paid-up shares in the capital of the ECB, plus coin issued by the Bank less holdings of issued euro banknotes and coin by the MFI sector). " 
• "Money Supply (M2) to the euro area -M2 is the sum of M1 plus deposits (with agreed maturity of up to 2 years; redeemable at notice of up to 3 months and Post Office savings bank deposits)."
• M3 is M2 plus deposits with maturity over 2 years.

So the gap between M1 and M3 is deposits.

The M3-M1 gap has fallen since the onset of the crisis. It has fallen along the steady trend line, with some volatility around the dates of banks recapitalisations. And it continues to fall. In fact, between December 2013 and May 2014 we have the longest uninterrupted decline in deposits in history of the series. Current level of the gap is sitting only EUR7 billion above the all-time historical record low. In fact, during this 'historically high savings rates' period, Irish monetary system has managed to reduce the stock of deposits, compared to pre-crisis levels, by EUR85.91 billion.

But while savings (deposits) are falling, 'savings' (debt deleveraging) is all the rage:

You can see what has been happening in the Money Supply territory and private credit here:

With all of these 'high savings' promoted by the official statistics and 'new lending' promoted by the Banking Federation, the Central Bank is now officially giving up on getting those 'repaired and recapitlaised banks' to lend into the real economy (something they were supposed to do since early 2009 - based on the promise of the October 2008 Guarantee, then since early 2010 - based on the various Government programmes, then since first half 2011 - based on the banks recaps and PCARs, then since 2012, based on Government programme agreed with the Troika, then since early 2013, based on Government spin of a turnaround in the economy...). Instead of hoping for the Pillar Banking System to miraculously come back to life, the Central Bank is opening up the floodgates for the hedge funds (here courtesy of fire sales of assets by Nama) to lend into economy, despite the fact that such lending is considered to be a high-risk activity. Nothing like selling pennies on the euro and then celebrating euros on pennies debt reload...

27/7/2014: TrueEconomics' Scariest Chart Covered by ZeroHedge

Nice to see my 'New Scariest Chart in America' making its way to ZeroHedge: http://www.zerohedge.com/news/2014-07-21/new-scariest-chart-america

Honoured, as always.

27/7/2014: "Kragle!"... Lord Business' Prescription for the Irish Economy

There is an interesting and mildly entertaining article in the Sindo (http://www.independent.ie/business/irish/patrick-honohan-stay-the-course-its-paying-off-30460638.html#sthash.fHeQGdJO.dpuf), penned by the Governor of the Central Bank, Professor Honohan.

Now, before I make few comments on the article, a disclosure: I like reforms and changes Professor Honohan brought to the Central Bank. And I think Professor Honohan has done an excellent job in the past to subtly highlight major bottlenecks in the Irish economic policies.

With that in mind, here are few quotes and some of my comments:

"Managing domestic demand, ensuring the banks are healthy, and offering advice to Government: these are the tasks of the Central Bank, and our measured approach to all three over the past few years has, I believe, borne fruit. Recovery remains slow and partial," said Professor Honohan.

So where are we on these tasks?

Per Professor Honohan, on the banks health: "...it is still not possible to describe them as being fully restored to health and delivering the services needed by the economy." In other words, ensuring the banks are healthy is still unfinished business. Central Bank either walks away from the test on this, or gets a poor grade - you choose.

On domestic demand: "…the total number at work and average living standards are both still well below the peak reached at the top of the bubble. And the elevated debt levels remain a lasting legacy." Now, wait, this also doesn't look like the Central Bank's finer moment, is it?

That was just Professor Honohan's own admissions. Now, here's a chart plotting evolution of domestic demand, 'managed' by the Central Bank:

You wouldn't be calling this 'managing' unless your management job is in demolition business...

Professor Honohan credits the ECB for providing 'some insulation' to mortgagees "who can currently just afford to pay" in the form of "exceptionally low interest rates". But there is a problem with this from the Central Bank's point of view. ECB rates did drop. Significantly. From 3.1% pre-crisis average to 0.15% today - a swing down of 2.95 percentage points. Yet, with all the trackers in, current retail interest rates for outstanding loans have declined (compared to pre-crisis average) by only 0.86 percentage points for mortgages with original maturity between 1 and 5 years, and by only 1.14 percentage points for mortgages with maturity over 5 years. Short term consumer loans rates and overdrafts rates have actually risen. Things are even worse if we are to measure the average rates to peak property lending around 2006, omitting 2007. So 'insulation' might have been provided by the ECB, but as far as Irish Central Bank actions go, these have ensured that the banks can extract more blood out of the economy, not that the banking system supports households in trouble.

There is a bigger problem for Professor Honohan here: if these borrowers 'can currently just afford to pay', what happens to their ability to pay when rates do rise? Or is Central Bank's 'managing banks and domestic demand health' not including looking into the near-term future?

Finally, on something from the Central Bank's own frontline: the mortgages arrears. "At the same time, far too many cases persist where no adequate cooperation between bank and borrower has been achieved. It is mainly for these cases that the banks have gone down the legal path towards repossession. ...I would urge borrowers who have not been cooperating to recognise that that is a hazardous course of action: bear in mind that banks can get court approval for repossession if borrowers are not cooperating."

Professor Honohan is correct - there are many cases in which borrowers in arrears fail to cooperate with the banks. But Professor Honohan neatly omits thousands of cases where certain banks - two of which are Irish Government-rescued and form the 'Pillars' of the 'new banking system' here - are not cooperating with the borrowers. Presumably, criticising the borrowers is Central Bank's job, but criticising the lenders is not…

To sum up, the Central Bank has done quite a bit of a good heavy-lifting job on all fronts. But this is hardly the right time to start talking up its achievements to-date. As Governor Honohan points out himself: "our measured approach to all [policies areas] over the past few years has, I believe, borne fruit." That fruit is: "Recovery remains slow and partial". Not exactly commemorative medals time, yet, eh?..

26/7/2014: This Week in Corporate 'Not Tax Haven' News

Earlier today I wrote about the round of 'assert-deny' salvos fired across Ireland's deck by German economic policy adviser and the Department of Finance (http://trueeconomics.blogspot.ie/2014/07/2672014-of-germans-bearing-ugly-truth.html). This was hardly the only defensive that Ireland Inc had to run this week. A much larger one came on foot of the US President Barak Obama singling Ireland out as the key global player in the dirty game of corporate tax inversions.

Newsflow was not too generous to Ireland on this front (corporate tax evasion and optimisation) this week.

It started with a report by Reuters (http://www.reuters.com/article/2014/07/24/deals-taxinversions-lawfirms-idUSL2N0PK1L820140724) on how Irish legal eagles are leading the way in advertising this land of human capital and regulation arbitrage riches as a [not a] tax haven. Singled out in the report are: Arthur Cox, A&L Goodbody, and Matheson. But other firms are into this game too. And not just in the US. In fact, there are plenty 'country specialists' employed in the legal offices in Ireland and around the world, tasked with 'selling' Ireland's 'unique competitiveness points' to potential clients interested in optimising their tax exposures.

Obama weighted in later in the week and, of course, the Government had to weigh in with a hefty doses of 'we deny we do it': http://www.businessworld.ie/bworld/livenews.htm?a=3192721 and http://www.reuters.com/article/2014/07/25/ireland-tax-inversions-idUSL6N0Q03LS20140725

The problem is that denying direct Government involvement is hardly a defence. Facts are: Ireland is being promoted as a tax optimisations destination and not solely on foot of our headline 12.5% tax rate. This promotion is known, brazen and visible, and it comes via law firms with direct links - contractual and advisory - the the Government and the State.

And the stakes, relating to the above promotion, are high: http://www.independent.ie/business/irish/accountants-warn-tax-changes-could-harm-investment-30457978.html on policy side and on business side: http://www.independent.ie/irish-news/google-pays-27m-corporation-tax-on-17bn-revenue-30458696.html

In short, things are ugly and are going to get even more ugly as OECD is preparing road maps for addressing more egregious abuses, while the US, UK, EU, European member states and even Australia and Japan are now firmly in the need to 'do something' about losses of Government revenues arising from sharp tax optimisation practices. Irish Government can put as many junior ministers as it wants onto RTE to talk about Ireland being 'unfairly singled-out' or 'misunderstood' or whatever else, but

1. Fact remains fact: tax arbitrage policies of this state are starting to cost us dearly in reputation and actual economic costs (http://trueeconomics.blogspot.ie/2014/06/2562014-imf-on-corporate-tax-spillovers.html and http://trueeconomics.blogspot.ie/2014/06/1762014-irelands-regulatory-resource.html and http://trueeconomics.blogspot.ie/2014/02/822014-yahoos-tax-base-err-optimisation.html and http://trueeconomics.blogspot.ie/2014/01/2112014-no-special-ict-services-tax-but.html)
2. We are but a small open economy caught (due to our own fault) in between the irate giants who not only set global policies, but also control our access to markets and investment

Time for us to stop playing ostriches with our ministers, but to get into the game of leading the reforms at home and internationally.

26/7/2014: Of Germans Bearing the Ugly Truth?..

German experts and analysts have an un-Irish capability of speaking their own mind... and when they do (and they do it anywhere, including when visiting this country of ours), they don't mince words. Behold the latest 'visitor' from the land of 'Nein!': Dr. Joachim Pfeiffer, the economic policy spokesman for the parliamentary group of the ruling Christian Democrats. Dr. Pfeiffer was in Dublin this week. Somewhere between a nice dinners and customary ritual of witnessing the Irish 'craic' in a pub, the learned Doktor sneaked a few minutes to tell us that "Ireland has “no chance” of securing a deal on its legacy bank debt" and that "the euro zone’s new bailout fund had not been established for nor would be it used for retroactive bank recapitalisation."

Quoted in the Irish Times: “There is no chance Ireland’s legacy assets will be paid by the European Stability Mechanism (ESM). This instrument is only an instrument for emergency.”

R. Pfeiffer was in Dublin to speak at the German-Irish Chamber of Industry and Commerce, the same Chamber that recently sponsored a cheerful book on Ireland & Germany being the best pals in economic and policy terms. The best pals, alas, do not help each other all too much, and one of them has no problem telling the other that 'your mess is your mess': "Dr Pfeiffer said the financial meltdown in Ireland “did not fall from heaven . . . there were bubbles in the real estate sector, there were bubbles in the banking sector and all of this was home-made”."

As to the reasons why ESM cannot be used for retroactive assistance to the Irish state, Dr Pfeiffer evoked the same logic that I advanced for some years now: "If the ESM was to be used retroactively to compensate Ireland, he said other countries such as Greece, Spain, Portugal and potentially Italy would want similar compensation."

Needless to say, Department of Finance immediately chipped in with a denial of denial that denial is possible as a denial. I am certain Dr. Merkel in Berlin was all ears...

26/7/2014: An Ethno-Linguistic Map of Ukraine

A neat summary of ethno-linguistic mess that is Ukraine:

Source: Vox.com

The problem is not multiplicity of languages and their concentrations in specific, defined and often contiguous areas. The problem is not even the fact that many such areas are defined by different and distinct historical and cultural identities that variably place the dominant groups within each region either with Russia, or Ukraine, or Poland, or Romania, or Moldova...

The problem is that the only way to address such divisions is via a federal structure of governance - something that Kiev and Western Ukraine fear and loath.

25/7/2014: WLASze: Weekend Links on Arts, Sciences and zero economics

The is WLASze: Weekend Links on Arts, Sciences and zero economics

Admittedly, the WLASze has become a rather irregular feature on this blog. Still, occasionally, I come across some interesting reading on a variety of arts and sciences subjects worth sharing… lighter and heavier alike.


On a heavy side of thing, Rupert Read and Nassim Nicholas Taleb essay "Religion, Heuristics, and Intergenerational Risk Management" (ECON JOURNAL WATCH 11(2) May 2014: 219-226: http://econjwatch.org/articles/religion-heuristics-and-intergenerational-risk-management).

As anything Taleb puts his mind to, this is worth a read. It is short, fundamentally cohesive and, although not new as far as thinking is concerned, certainly novel in exposition of the argument.

"… we believe that religion has traditionally performed a powerful risk-management function at the level of the individual and the collectivity, particularly in preventing the accumulation of debt in systems and in preventing some kinds of experimentation with natural systems, ones that produce errors with irreversible effects. We argue that religion transmits heuristics of risk control across generations, and that religion does so in modes that only it can."

Big enough? Not for Taleb. He takes the argument beyond simple 'demand-supply' relationship: "It is not just that religion is a helpful source of sound heuristics for resisting gambler’s ruin and similar hazards. More strongly, we should say that we humans actually don’t know whether human beings can live sustainably without something like religion."

If so, then society's devolution from religious belief systems can be a risk. Not to hold back Read and Taleb oblige: "Modernity is in this sense a dangerous uncontrolled experiment. The amount of historical time that any significant number of humans have lived without religion is infinitesimal compared to the sweep of history. Given that, the amount of time that we have sought as societies, as a species, to live without religion is almost nil. It is a symptom of chronic short-termism and over-optimism that people now assume that living in such a way is sustainable."

Over-optimism? Why not - we had Age of Determinism before, Age of Engineering, Machine Age and so on - all were based on solid assumptions that world can be made deterministic and thus manageable. All blew up in the face of history, under the impact of 'Black Swans' that were un-programmable, un-manageable ex ante.

"Just as nature is ‘wiser’ than us (in a statistical, risk-management sense) with regard to a vast swathe of threats, illnesses, etc., just as our knowledge only surpasses nature’s in unusual and rare circumstances, so religious man is wiser than irreligious and non-religious man with regard to a vast swathe of threats, moral and spiritual illnesses and problems, etc. The knowledge of irreligious and non-religious man surpasses that of religious man only in rare and unusual circumstances."

Exciting stuff… And to add to it, here's another example of Read's thinking: "Why There Cannot be Any Such Thing as “Time Travel”" http://authorservices.wiley.com/bauthor/onlineLibraryTPS.asp?DOI=10.1111/j.1467-9205.2011.01446.x&ArticleID=838743

Read contributes to a fantastic blog http://blog.talkingphilosophy.com/?author=26&paged=3 that is worth a read… ok, not a read, a follow.


On a more visual side of things (you would not call it 'lighter' by any means), Tate is showing Malevich's retrospective: http://www.tate.org.uk/whats-on/tate-modern/exhibition/malevich


On the opposite side of the spectrum to philosophy and art, rests technology. Except on some occasions when new tech enters old art - the figurative art - without first becoming established in new art - the conceptual fields. Thus, the question of this decade for tech v art geeks: 3-D Printing http://www.theartnewspaper.com/articles/Taking-it-to-a-new-dimension/33304 Wait till the boffins of high art learn about 4D-Printing and other toys Pentagon is funding… (see link on 4D printing here: http://trueeconomics.blogspot.ie/2013/10/4102013-wlasze-part-1-weekend-links-on.html).

Update: an absolutely amazing and fascinating discovery just 'printed': http://www.dezeen.com/2014/07/25/movie-silk-leaf-first-man-made-synthetic-biological-leaf-space-travel/ the creation of the first ever synthetic leaf with all core properties of a living photosynthetic cellular structure - a major breakthrough that is now reaching beyond 4D printing.


And figurative artist Jeff Koons is probably one of those who can use 4D printing in his works. I am not a fan, but he is worth studying, if only as a counterpoint to one's biases.

"Critical opinion is divided, to say the least, over Koons’s work. He is castigated for the slickness of his product, and the pretentious claims he makes for it; but he is also lauded for his cleverness in combining the monumental effect of high art with the cheap pleasures of the banal. He has, according to veteran critic Robert Hughes, “the slimy assurance … of a blow-dried Baptist selling swamp acres in Florida”. But even this denigrator-in-chief admits: “The result is that you can’t imagine America’s singularly depraved culture without him.”" Here is an LAesque in its size and comprehensiveness collection of material on him: http://fireplacechats.wordpress.com/2014/06/21/on-americas-wunderkind-artist-jeff-koons-articles-interviews-and-texts/

“the slimy assurance … of a blow-dried Baptist selling swamp acres in Florida” I love it!...