10/8/2014: Can EU Rely on Large Primary Surpluses to Solve its Debt Problem?

Another paper relating to debt corrections/deflations, this time covering the euro area case. "A Surplus of Ambition: Can Europe Rely on Large Primary Surpluses to Solve its Debt Problem?" (NBER Working Paper No. w20316) by Barry Eichengreen and Ugo Panizza tackle the hope that current account (external balances) surpluses can rescue Europe from debt overhangs.

Note: I covered a recent study published by NBER on the effectiveness of inflation in deflating public debts here: http://trueeconomics.blogspot.it/2014/08/1082014-inflating-away-public-debt-not.html.

Eichengreen and Panizza set out their case by pointing to the expectations and forecasts underpinning the thesis that current account surpluses can be persistent and large enough to deflate Europe's debts. "IMF forecasts and the EU’s Fiscal Compact foresee Europe’s heavily indebted countries running primary budget surpluses of as much as 5 percent of GDP for as long as 10 years in order to maintain debt sustainability and bring their debt/GDP ratios down to the Compact’s 60 percent target." More specifically: "The IMF, in its Fiscal Monitor (2013), sketches a scenario in which the obligations of heavily indebted European sovereigns first stabilize and then fall to the 60 percent level targeted by the EU’s Fiscal Compact by 2030. It makes assumptions regarding interest rates, growth rates and related variables and computes the cyclically adjusted primary budget surplus (the surplus exclusive of interest payments) consistent with this scenario. The heavier the debt, the higher the interest rate and the slower the growth rate, the larger is the requisite surplus. The average primary surplus in the decade 2020-2030 is calculated as

• 5.6 percent for Ireland, 
• 6.6 percent for Italy, 
• 5.9 percent for Portugal, 
• 4.0 percent for Spain, and 
• (wait for it…) 7.2 percent for Greece."

It is worth noting that Current Account Surpluses strategy for dealing with public debt overhang in Ireland has been aggressively promoted by the likes of the Bruegel Institute.

These are ridiculous levels of target current account surpluses. And Eichengreen and Panizza go all empirical on showing why.

"There are  both political and economic reasons for questioning whether they are plausible. As any resident of California can tell you, when tax revenues rise, legislators and their  constituents apply pressure to spend them." No need to go to California, just look at what the Irish Government is about to start doing in Budget 2015: buying up blocks of votes by fattening up public wages and spending. Ditto in Greece: "In 2014 Greece, when years of deficits and fiscal austerity, enjoyed its first primary surpluses; the government came under pressure to disburse a “social dividend” of €525 million to 500,000 low-income households ... Budgeting, as is well known, creates a common pool problem, and the larger the  surplus, the deeper and more tempting is the pool. Only countries with strong political and budgetary institutions may be able to mitigate this problem (de Haan, Jong-A-Pin and Mierau 2013)."

More significantly, Eichengreen and Panizza show that "primary surpluses this large and persistent are rare. In an extensive sample of high- and middle-income countries there are just 3 (non-overlapping) episodes where countries ran primary surpluses of at least 5 per cent of GDP for 10 years." These countries are: Singapore (clearly not a comparable case to Euro area countries), Ireland in the 1990s and New Zealand in the 1990s as well.

"Analyzing a less restrictive definition of persistent surplus episodes (primary surpluses averaging at least 3 percent of GDP for 5 years), we find that surplus episodes are more likely when growth is strong, when the current account of the balance of payments is in surplus (savings rates are high), when the debt-to-GDP ratio is high (heightening the urgency of fiscal adjustment), and when the governing party controls all houses of parliament or congress (its bargaining position is strong). Left wing governments, strikingly, are more likely to run large, persistent primary surpluses. In advanced countries, proportional representation electoral systems that give rise to encompassing coalitions are associated with surplus episodes. The point estimates do not provide much encouragement for the view that a country like Italy will be able to run a primary budget surplus as large and persistent as officially projected."

Good luck spotting such governance institutions in the euro area 'periphery' nowadays. "Researchers at the Kiel Institute (2014) conclude that “assessment of historical developments in numerous countries leads to the conclusion that it is extremely difficult for a country to prevent its debt from increasing when the necessary primary surplus ratio reaches a critical level of more than 5 percent.”"

Eichengreen and Panizza take a sample of 54 emerging and advanced economies over the period 1974-2013. They show that "primary surpluses as large as 5 percent of GDP for as long as a decade are rare; there are just 3 such non-overlapping episodes  in the sample. These cases are special; they are economically and politically idiosyncratic in the sense that their incidence is not explicable by the usual economic and political correlates. Close examination of the three cases suggests that their experience does not scale."

As mentioned above, one case is Ireland, starting from 1991. "Ireland’s experience in the 1990s is widely pointed to by observers who insist  that Eurozone countries can escape their debt dilemma by running large, persistent primary surpluses. Ireland’s move to large primary surpluses was taken in response to an incipient debt crisis: after a period of deficits as high as 8 per cent of GDP, general government debt as a share of GDP reached 110 per cent in 1987. A new government then slashed public spending by 7 per cent of GDP, abolishing some long-standing government agencies, and offered a one-time tax amnesty to delinquents. The result was faster economic growth that then led to self-reinforcing favorable debt dynamics, as revenue growth accelerated and the debt-to-GDP ratio declined even more rapidly with the accelerating growth of its denominator. This is a classic case pointed to by those who believe in the existence of expansionary fiscal consolidations (Giavazzi and Pagano 1990). But it is important, equally, to emphasize that Ireland’s success in running large primary surpluses was supported by special circumstances. The country was able to devalue its currency – an option that is not available to individual Eurozone countries – enabling it sustain growth in the face of large public-spending cuts by crowding in exports. As a small economy, Ireland was in a favorable position to negotiate a national pact (known as the Program for National Recovery) that created confidence that the burden of fiscal austerity would be widely and fairly shared, a perception that helped those surpluses to be sustained. (Indeed, it is striking that every exception considered in this section is a small open economy.) Global growth was strong in the decade of the
1990s (the role of this facilitating condition is emphasized by Hagemann 2013). Ireland, like Belgium, was under special pressure to reduce its debt-to-GDP ratio in order to meet the Maastricht criteria and qualify for monetary union in 1999. Finally, the country’s multinational-friendly tax regime encouraged foreign corporations to book their profits in Ireland, which augmented revenues."

The point of this is that "Whether other Eurozone countries – and, indeed, Ireland itself – will be able to pursue a similar strategy in the future is dubious. Thus, while Irish experience has some general lessons for other countries, it also points to special circumstances that are likely to prevent its experience from being generalized."

Another country was New Zealand, starting with 1994. "New Zealand experienced chronic instability in the first half of the 1980s; the budget deficit was 9 percent of GDP in 1984, while the debt ratio was high and rising. Somewhat in the manner of Singapore, the country’s small size and highly open economy heightened the perceived urgency of correcting the resulting problems. New Zealand therefore adopted far-reaching and, in some sense, unprecedented institutional reforms. At the aggregate level, the Fiscal Responsibility Act of 1994 limited the scope for off-budget spending and creative accounting. It required the government to provide Parliament with a statement of its long-term fiscal objectives, a forecast of budget outcomes, and a statement of fiscal intentions explaining whether its budget forecasts were consistent with its budget objectives. It required prompt release of aggregate financial statements and regular auditing, using internationally accepted accounting practices. At the level of individual departments, the government set up a management framework that imposed strong separation between the role of ministers (political appointees who specified departmental objectives) and departmental CEOs (civil servants with leeway to choose tactics appropriate for delivering outputs). This separation was sustained by separating governmental departments into narrowly focused policy ministries and service-delivery agencies, and by adopting procedures that emphasized transparency, employing private-sector financial reporting and accounting rules, and by imposing accountability on technocratic decision makers (Mulgan 2004). As a result of these initiatives, New Zealand was able to cut public spending by more than 7 per cent of GDP. Revenues were augmented by privatization receipts, as political opposition to privatization of public services was successfully overcome. The cost of delivering remaining public services was limited by comprehensive deregulation
that subjected public providers to private competition. The upshot was more than a decade of 4+% primary surpluses, allowing the country to halve its debt ratio from 71 per cent of GDP in 1995 to 30 per cent in 2010."

Agin, problem is, New Zealand-style reforms might not be applicable to euro area countries. Even with this, "it is worth observing that it took full ten years from the implementation of the first reforms, in 1984, to the emergence of 4+% budget surpluses in New Zealand a decade later."


Key conclusion of the study is that "On balance, this analysis does not leave us optimistic that Europe’s crisis countries will be able to run primary budget surpluses as large and persistent as officially projected." Which leaves us with the menu of options that is highly unpleasant. If current account surpluses approach to debt-deflation fails, and if inflation is not a solution (as noted here: http://trueeconomics.blogspot.it/2014/08/1082014-inflating-away-public-debt-not.html) then we are left with the old favourites: debt forgiveness (not likely within the euro area), foreign aid (impossible within the euro area on any appreciable scale), or debt restructuring (already done several times and more forthcoming - just watch Irish Government 'early repayment' of IMF loans).

10/8/2014: Inflating Away the Public Debt? Not so fast...

There is a lot of talk amongst Irish and european policymakers about the big great hope for deflating public debts across euro area periphery: the prospect of inflation taking chunks out of the real debt burdens. This hope is based on a major misunderstanding of history. In many a cases, in the presence of debt overhang, higher inflation does help erode the real value of debt. Alas, "While across centuries and countries, a common way that sovereigns have paid for high public debt is by having higher, and sometimes even hyper, inflation, this rarely came without some or all of fiscal consolidation, financial repression, and partial default (Reinhart and Rogoff, 2009)." This quote starts the new NBER paper, titled "Inflating Away the Public Debt? An Empirical Assessment" by Jens Hilscher, Alon Raviv, and Ricardo Reis )NBER Working Paper No. 20339, July 2014)

In other words, it remains to not entirely clear just how effective inflation can be in current environment, given there are no defaults and there are no direct and aggressive financial repression measures implemented in the majority of the advanced economies, yet.

The NBER paper takes on the issue from the U.S. debt perspective. Per authors, "…with U.S. total public debt at its highest ratio of GDP since 1947, would higher inflation be an effective way to pay for it?"

"Providing an answer requires tackling two separate issues:

1. "The first is to calculate by how much would 1% unanticipated and permanently higher inflation lower the debt burden. If all of the U.S. public debt outstanding in 2012 (101% of GDP) were held in private hands, if it were all nominal, and if it all had a maturity equal to the average (5.4 years), then a quick back-of-the-envelope answer is 5.5%.1 However, we will show that this approximation is misleading. In fact, we estimate that the probability that the reduction in U.S. debt is as large as 5.5% of GDP is below 0.05%. The approximation is inaccurate since the underlying assumptions are inaccurate. The debt number is exaggerated because large shares of the debt are either held by other branches of the government or have payments indexed to inflation and the maturity number is inaccurate because it does not take into account the maturity composition of privately-held nominal debt."
2. "The second issue is that assuming a sudden and permanent increase in inflation by an arbitrary amount (1% in the above example) is empirically not helpful. After all, if the price level could suddenly jump to infinity, the entire nominal debt burden would be trivially eliminated. It is important first to recognize that …if investors anticipated sudden infinite inflation, they would not be willing to hold government debt at a positive price. Second, the central bank does not perfectly control inflation, so that even if it wanted to raise inflation by 1% it might not be able to. Moreover, there are many possible paths to achieving higher inflation, either doing so gradually or suddenly, permanently or transitorily, in an expected or unexpected way, and we would like to know how they vary in effectiveness. Therefore, it is important to consider counterfactual experiments that economic agents believe are possible."

The authors "calculate novel value-at-risk measures of the debt debasement due to inflation, and ...consider a rich set of counterfactual inflation distributions to investigate what drives the results. Using all these inputs, [authors] calculate the probability that the present value of debt debasement due to inflation is larger than any given threshold. The 5th percentile of this value at risk calculation is a mere 3.1% of GDP, and any loss above 4.2% has less than 1% probability. Interestingly, much of the effect of inflation would fall on foreign holders of the government debt, who hold the longer maturities. The Federal Reserve, which also holds longer maturities, would also suffer larger capital losses."

The paper also "…explores the role of an active policy tool that interacts with inflation and is often used in developing countries: financial repression. It drives a wedge between market interest rates and the interest rate on government bonds, and acts as a tax on the existing holders of the government debt. We show that extreme financial repression, where bondholders are paid with reserves at the central bank which they must hold for a fixed number of periods, is equivalent to ex post extending the maturity of the debt. Under such circumstances inflation has a much larger impact, such that if repression lasts for a decade, permanently higher inflation that previously lowered the real value of debt by 3.7% now lowers it by 23% of GDP."

In short, there is no miracle inflationary resolution of the U.S. debt conundrum. And similarly, there is probably none for the euro area sovereigns stuck with debts in excess of 90-100% of GDP. The pain of inflation alone is simply not enough to magic away debts. Instead, the pain of inflation will have to be coupled with the added pain of financial repression, and in the euro area case, this pain will befall more domestic investors and savers, than in the U.S. case simply due to differences in debt holdings. While no one expects the financial repression in the euro area to match that deployed in Greece and Cyprus, one can expect the financial repression measures (higher taxation in general, higher taxation of savings and overseas investments, higher rates of cash extraction from consumers via public sector pricing and higher concentrations in the financial services sector to increase rates of cash extraction by the banks) are here to stay and to most likely get worse before things can improve a decade later.

The myth of higher inflation as a (relatively) painless salvation to our debt ills is getting thinner and thinner...

9/8/2014: WLASze: Weekend Links on Arts, Sciences and zero economics

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

Flyfishing in the Dolomites right ahead of the approaching rain is a borderline crazy form of fun. The fish are rising to the shallower waters to feed, the insects are forced closer to the water surface and the rumblings of thunder seem so distant, so non-threatening… until within seconds air turns water and within a minute you can't tell weather you've been wading knee-deep or took a full swim in a 2 meters deep hole.

Here's a picture of my fishing hole just an hour before the storm rolled in.

Water is amazing - it is an artist and a menace, a nurturer and a destroyer, a living thing that is ice-cold and hostile, yet reads like a mystery novel.

Water is what makes Earth. Or we think it makes the surface of Earth and small bit of the subterranean kingdom of aquifers and underground rivers. But no more. Most recent scientific research strongly indicates that in fact oceans worth of water exist some 400 miles below Earth's surface, stored in mantle rocks. Here are two links on this research: http://www.sciencedaily.com/releases/2014/06/140612142309.htm and http://www.sciencedaily.com/releases/2014/03/140312150229.htm?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+sciencedaily%2Ftop_news%2Ftop_science+%28ScienceDaily%3A+Top+Science+News%29

I doubt the oceans at 250-400 miles below Earth surface have trout in them. And I doubt there will be any fishing trips planned for the location any time soon, but that water shapes, just as surface water does, Earth's 'climate'. Instead of actual atmospheric weather, however, that climate is geological. Per one of the articles linked: "One of the reasons the Earth is such a dynamic planet is the presence of some water in its interior," Pearson said. "Water changes everything about the way a planet works."

Of course, climates are possible absent water, for otherwise the skies of the waterless planets that surround us would have been un-animated. They are not. In fact, waterless worlds generate much more extreme weather than our planet, even when you control for the global warming. Here's a neat summary of some spectacular weather you can expect were you to be able to travel there: http://theweek.com/article/index/257040/the-wildest-weather-in-the-universe?utm_source=links&utm_medium=website&utm_campaign=twitter


"Heavy-Metal Frost on Venus"… may be so... down on Earth, rushing from my flyfishing hole tonight, soaked through to the insides of layers of my gear, and listening to AC/DC's 'Hell's Bells' the fog of clouds stuck around me on the mountainsides looked like a frost-covered forest. Venus it was not, but the Dolomites above and ahead of my bike were looking more like an exoplanet of sorts, full of heavy-metal frost of an entirely different chemical composition…

And for what it's worth, an advice, don't try flyfishing in the alpine thunderstorms at home. It takes a pro… and a good dry room nearby…

Oh...and I almost forgot... a piece of music: https://www.youtube.com/watch?v=6Rt2pJ2AFpY by Nikolai Medtner, Piano Concerto number 1 (op.33). It is about memory, which is like water, slave of gravity and shaper of gravity simultaneously.

9/8/2014: Europe's bank risks back under the spotlight: ECR

Euromoney Country Risk report this week is covering rising risks in the European banking systems, with a brief comment from myself:

And unloved European banks chart, showing risk scores (higher score, lower risk):

7/8/2014: Russian response to new sanctions

Sanctions tit-for-tat between Russia and the West keeps going on.

Yesterday, Canada announced new economic and travel sanctions against Russian banks and high-ranking officials to match the latest round of of the EU and the US measures (see: http://trueeconomics.blogspot.it/2014/08/282013-sanctions-v-russia-some-fallout.html).

Canadian Prime Minister Stephen Harper said that: "Export restrictions announced by the European Union with respect to military and military dual-use goods destined to Russia are already in place in Canada. We are also committed to imposing the necessary regulations to enact export restrictions on technologies used in Russia's oil exploration and extraction sector. Those will be implemented in parallel with our allies."

The Russian entities hit by the sanctions are:

• Bank of Moscow
• Dobrolet Airlines
• Russian Agricultural Bank 
• Russian National Commercial Bank
• United Shipbuilding Corporation
• VTB Bank OAO

Canada's list of sanctioned individuals excludes three business owners who are sanctioned by the US and EU, but have extensive business interests in Canada. The full list of entities and individuals impacted by Canadian sanctions is available here: http://www.ctvnews.ca/politics/canada-to-deploy-military-supplies-equipment-to-ukraine-ctv-news-1.1948163

What Russia is doing to mitigate the adverse effects of sanctions?

1) Imports substitution (long-term process) - ramping up production of components usually imported by its own defence industries to replace supplies lost due to sanctions and Ukraine trade disruption. For example:

• Sukhoi jets and other aircraft components imported from Ukraine; 
• Caterpillar & JCB sales in Russia have been falling while those of their major competitors, such as Russian Kamaz and Belorussian Belaz have been rising. This trend continues since 2008-2009. Russian manufacturers share of the domestic market rose more than 30% since 2009, but this is now likely to accelerate, rapidly; and 
• Switching to Russian-manufactured foreign equipment, e.g. Komatsu plant in Yaroslavl

2) Imports switching by substituting new longer term contracts for supply of goods and services in favour countries that are not imposing sanctions. Three examples:

• In aircraft leasing (Dobrolet and Aeroflot) contracts are being moved from Ireland to Hong Kong; 
• Turkey will be the alternative source of supply of fresh fruit and vegetables to Russia, as announced yesterday; 
• Russia has negotiated a major beef deal with Brazil and there are advanced talks on same with Argentina aiming to largely replace European shipments. Russia also announced it will switch to purchasing New Zealand dairy products, especially cheese.
• So Russia is not going for an autarchy in food markets, but rather for switching away from EU and US suppliers.

3) Longer-term exits from the markets:

• In June, Gazprombank raised EUR1 billion at 4% pa in the foreign markets via a bond sale on the Irish Stock Exchange. Gazprombank has one of the largest exposures to international funding markets of all other Russian financial institutions - it has 78 outstanding eurobond issues denominated in a number of currencies. All these will be migrating on maturity to different geographies as long as sanctions continue. It is also highly likely that even once sanctions are listed, Russian banks and corporates are likely to hold back their debt issuance in Western markets.
• Rosneft has a finance arm in Dublin : Rosneft International Finance Ltd. which placed on December 6, 2012 two bond issues totalling $3bn, the oil major said in a statement. The first $1bn issue carries a 3.15% coupon rate and is scheduled to mature on March 6, 2017. The second $2bn issue carries a 4.20% coupon rate and is scheduled to mature on March 6, 2022. The bonds were listed and admitted to trading on the Irish Stock Exchange on December 7, 2012.
• Irish law firms advise a range of Russian companies, including on Russian LPN, bond issues and ECP programmes: AHML, Federal Grid, Gazprombank, VTB, VEB, Rosneft, Uralkali, Norilisk Nickel, EDC, Borets, Metallionvest, Brunswich Railways, RenCredit, Alfa Bank, ABH Financial, Domodedovo Airport, Russian Railways, Promsvyaz and Probusinessbank.(see: http://www.arthurcox.com/practice_area/capital-markets/debt-capital-markets/).
• VTB, via its VTB Eurasia Limited (an Irish company) issued U.S.$2.25bn Perpetual Loan Participation Notes via an Irish branch.

Retaliatory sanctions

In retaliation against Western sanctions, Russian President Vladimir Putin on Wednesday signed a decree limiting the import of agricultural, raw and food products from countries that imposed sanctions against Russia. Moscow banned, for one year (mating duration of Western sanctions) imports of all meat, fish, dairy, fruit and vegetables from the US, EU, Canada, Australia and Norway.

Further sanctions are likely. These are expected to impact:

• Possible bans on breeding stock sales, biotech agricultural inputs sales, as well as
• Possible ban on drinks imports from the EU.

Irish agricultural sales to Russia (see here: http://trueeconomics.blogspot.it/2014/07/1772014-irish-bilateral-trade-in-goods.html) are

• EUR202.2 million in 2013, roughly 52% of Canada's trade of CAD563 million (EUR385 million) agricultural trade with Russia.
• Roughly 1/3 of these sales comes from coffee, tea, cocoa, and products thereof, and another 1/3 from meat & meat preparations
• Beverages - on top of the above - ca EUR12.1 million in 2013 in officially recorded exports. This excludes sales by major international brands which are predominantly imported into Russia via European subsidiaries and distributors. One example is Jameson Whiskey is now leading brand in whiskey sales in Russia since 2012. In 2012/2013 Jameson sales in Russia grew by 23% by volume (http://pernod-ricard.com/files/fichiers/Commun/Documents/RA2012_13_VGB_MiseEnLigne_28102013.pdf)

Conservatively estimating the sales via subsidiaries and distributors, Irish exports to Russia run at around EUR800 million, with roughly 1/3 of these coming from Agriculture, Food and Drinks sectors.

Some estimated 42% plus of these sales come from sectors dominated by Irish indigenous companies with roughly 50% of these accounted for Irish SMEs. There are some really brilliant examples of smaller Irish firms entering Russian markets in recent years and obtaining long term contracts to provide specialist goods and services that are provided from Ireland with zero tax arbitrage component to value added. In other words, when it comes to our trade with Russia, we have much higher indigenous jobs creation and real economic activity generation per euro of exports to Russia than from our exports to other major trading partners.

Few aside facts:

• Russia is the fifth largest (by volume) importer of food in the world (http://www.businessinsider.com/worlds-leading-food-importers-2014-8)
• Russia imported USD43 billion worth of food in 2013
• Russia is the biggest consumer of EU fruit and vegetables
• Russia is the second biggest buyer of U.S. poultry 
• Russia is one of the largest importer fish, meat and dairy in the world
• Russia bought 28% of EU fruit exports and 21.5% of its vegetables exports in 2011
• Russia purchased 8% of US chicken meat exports last year.

Chart via Business Insider:

Net conclusions: sanctions response by Moscow will cost Russian consumers through increased prices. That is beyond any doubt. But the sanctions will be supportive (in the medium term) of improved agricultural production and food sector development in Russia. This effect is similar to the one achieved in the devaluations of the ruble post-1998 crisis. Sanctions by Moscow can have a significant impact on smaller open economies of Europe, like Ireland, with this impact concentrated on smaller domestic indigenous producers. If sanctions are broadened to include drinks, there will be even more substantial declines in Irish exports. It is clear that there will be no winners from the tit-for-tat sanctions wars.

6/8/2014: Italy's New Old Recession...

In Q1 2014, Italian GDP shrunk 0.1%, in Q2 2014 it fell 0.2% just as all indicators were suggesting that the Italian economy was starting to regain some growth momentum.

Meanwhile, latest data for new orders in Germany posted a fall of 3.2% in June compared to May.

Much has been made of the effects of Russia-EU trade sanctions on both figures. And much has been made of the effects of slower global growth on both figures. Little has been made of the fact that absent foreigners' demand for European goods, there is no real growth in Europe. That is because this fact hides horrific truth - European consumers and households have been hit by a freight train of banks bailouts, Government deficits adjustments and the need to support EU and national politically connected cronies - corporate, sectoral and individual. While pensions provisions for currently working middle classes shrink, taxes rise, indirect taxes, crates and levies climb sky high, there is hardly any decline in subsidies pots distributed by Europe to predominantly wealthy landowners, industrialists and an entire class of NGOs/R&D/Social Enterprises.

Thus, European investors' confidence is a feeble organism so vulnerable to shocks that a war in Ukraine's East can knock it out of its tracks. Thus, the only hope still remaining in European capitals is for the ECB to prime the proverbial printer. On the eve of the ECB monthly interest-rate-setting meeting, European banks still prefer to lend to the Governments rather than to the real companies. Why? May be it is because of some technical mumbo-jumbo of 'markets fragmentation' or may be it is because the real economy is left holding the bag for banks bailouts and Governments bailouts and cronies bailouts and as the result, European producers need Russian, Ukrainian, Chinese, Turkish and so on consumers?

Spanish economy, in contrast with Italian, posted 0.6% growth in GDP, but much of this (and previous 3 quarters) growth is down to the rate of economic activity destruction in previous years.

Meanwhile, Bundesbank is prepping the public to what might be a lacklustre growth release for Q2 figures due on August 14. Consumer and producer confidence indicators in Germany are pointing to a slowdown in economic activity there. Ifo German business sentiment indicator posted three consecutive months of declines in July 2014, falling to the levels last seen in October 2013. German investor confidence index published by ZEW has been now on the decline for seven consecutive months.

All in, the much-publicised recovery in euro area economy remains fragile and prone to reversals on foot of external shocks. Meanwhile, internal growth dynamics remain weak and unyielding to the PR blitz promoting the reversals of the crisis. Italy is just a proverbial canary in the mine… the only question is whether it is motionless from something that hit it before it was brought to the ICU in 2013, or from something new it caught in the ICU… 

5/8/2014: Two Maps, Two Roads Ahead... Choose Wisely...

In the context of often heard Russian grievances vis-a-vis Nato, here is a handy set of maps - via Der Spiegel:

And another map showing years of expansion:

With Nato forces fully controlling Skagerrak Strait and Sea of Marmara, Russia is de facto left landlocked on its South-Western and Western borders. With Nato previously implicitly acting as an anti-Russian alliance and now explicitly moving toward acting as a de jure and de facto containment mechanism against Russia, is anyone surprised Russia is not too keen on 'engaging' with the West and is rather re-orienting itself toward East?

After all, even its trade routes are now landlocked by the EU and Nato. EU forcing Russia to fund gas pipelines to which Russia subsequently is required to grant access for other suppliers shows that EU has no problem with distorting international trade to suit its own objectives.

Security-wise and trade-wise, isolation of Russia is not a solely self-inflicted wound. Rather, it is in part a logical outcome of the largely Eastern European hostility to Russia that has been allowed to dominate the EU and Nato policies since the late 1990s.

In my view, there is an urgent need to rethink Nato's role in Europe. One point of this exercise should be to strengthen sense of security within the alliance. Currently, a number of Eastern European member states express their concerns that Article 5 common defence clause is not enforceable. These fears should and can be alleviated. Another point is that Nato must act to reduce its adversarial position vis-a-vis Russia. Engagement, not containment; reform of Nato, not elbowing of Russia by courting Ukraine, Georgia, Moldova and Azerbaijan; recognition of mutual security interests (security of Eastern Europeans and security of Russians are not contradictory objectives, but complementary) not relentless push into Russian security space must be the main objectives.

5/8/2014: Of Coming Russian Debt Showdown...

September and December 2014 are going to be crunch time for redemptions of Russian bonds, followed by 3rd and 4th quarters of 2015... All data below is in billions USD.

To the above: red bars = government debt issuance, pink = banks and blue = corporates.

And here is how Russian economy's dependence on external funding markets has grown over time:

Per above: red bars are state-owned banks external debt, pink bars are state-owned non-financial corporates, darker blue private banks, lighter blue private non-financial corporates.

All data sourced from RBKDaily which cites as sources Central Bank and Morgan Stanley Research.

The big question is how these maturities will be met, as EU and US are prohibiting issuance of any new debt in excess of 90-days duration...

5/8/2014: BRIC PMIs Signal Some Improvements in Economic Growth in July

Markit released all BRIC PMIs for July, so here is the summary of top-of-the-line changes:

As the above shows, Manufacturing PMIs improved m/m in all BRIC countries, although Brazil remained at levels below 50.0. For Services, PMIs deteriorated in all BRIC countries, and in Russia these remained at the levels below 50.0.

Year on year, Manufacturing PMIs are stronger in all BRIC countries, with Russia reaching into above 50.0 territory in July 2014. Russia PMIs are covered in detail here: http://trueeconomics.blogspot.ie/2014/08/582014-russia-manufacturing-services.html while BRIC Manufacturing PMIs are covered in detail here: http://trueeconomics.blogspot.ie/2014/08/282014-bric-manufacturing-rebound-july.html

Now, Services PMIs. Y/y these deteriorated in Brazil and China, improved in Russia, but remained below 50.0 line, and strongly improved in India.

Combined PMIs-signalled activity:

5/8/2014: Russia: Manufacturing, Services & Composite PMIs: July 2014

Russia Services and Composite PMIs are out for July (released by Markit and HSBC). Here are the top-level numbers:

• Recall that Manufacturing PMI cam in at 51.0 in July, up on 49.1 in June and 49.2 in July 2013. This marks the first month of above 50.0 reading. Manufacturing went below 50.0 mark in July 2013, so this means we had 11 months of contracting output from July 2013 through June 2014 and one month of expansion at 51.8 back in October 2013. This is evidence of a structural slowdown in the economy, compounded by the Ukrainian crisis, although the effects of the crisis are not the only explanatory factor here.
• Services PMI came in at 49.7 - marginally below 50.0 and slightly lower than 49.8 reading in June 2014. In July 2013 the index stood at 48.7. All in, we now have 5 consecutive months of readings below 50.0 with marked slowdown in growth starting around July 2013 and accelerating from March 2014 through June 2014. 3mo MA is now at 48.5 which is nearly identical to 48.4 3mo MA through April 2014. 3mo MA for 3 months through July 2013 was at 49.6. Again, structural slowdown is evident in the series and again, the slowdown is being exacerbated by the Ukrainian crisis.
• Composite PMI came in at 51.3, marking second consecutive month of above 50.0 readings (although June reading of 50.1 was extremely weak). 3mo MA through July 2014 is at 49.5 and 3mo MA through April 2014 was 48.5, while 3mo MA through July 2013 was at 49.9. Exactly the same story as with the above sectoral indices: manifestation of a slowdown in July 2013, followed by continued weakness through February 2014 and deepening in slowdown from March 2014 through May-June 2014.

Chart to illustrate:

All PMIs remain in 'troubled waters' per trend - it will take at least 3 months to reestablish any upward trend and there is significant risk that fragile July improvements can be reversed in months ahead. The Ukrainian crisis is now starting to bite - gradually ramping up downward pressure on the economy.

3/8/2014: This Week in Corporate 'Not Tax Haven' News

Some links from recent press articles on Irish Corporate Tax regime:

• BloombergView on the U.S. politicians' logic concerning the issue of tax breaks: http://www.bloombergview.com/articles/2014-07-28/by-lew-s-logic-all-tax-breaks-are-unpatriotic With respect to Ireland, it no longer matters if there is any logic whatsoever to the U.S. Government and senior officials' statements on the matter. What does matter, however, is that we are now being increasingly / more frequently presented as an international tax arbitrage facilitators. That is the reputational cost of our decades-long policies. The real economic cost of our tax policies is that we no longer have any meaningful strategy or long-term outlook on manufacturing, productivity growth and/or investment. Instead, we have a strategy that relies, in part explicitly, but in full implicitly, on beggar-thy-neighbour tax arbitrage facilitation. 
• Vox provides its own musings on the matter in "Tax inversions: 9 questions about the hottest new trend in tax avoidance" article. It describes tax inversion with a direct reference to Ireland (and Switzerland) as: "So a company whose business is subject to relatively heavy taxation in one country (say, the United States) can buy a smaller company located in a country where its business is taxed at a lower rate (say, Ireland) and then declare the merged entity to be domiciled in the low-tax country for the purposes of taxation. Walgreens, for example, is in the process of buying a Swiss company called Alliance Boots and is considering re-labelling itself as a subsidiary of the Swiss company to pay lower Swiss tax rates." This is not a debate about Double-Irish scheme or other aggressive tax optimisation loopholes, but about the actual headline tax rate - the sacred Irish cow of 12.5%. And this is serious, real danger to Ireland, as we have no meaningful industrial / manufacturing / services etc growth pillars outside our reliance on tax-attracted FDI. The full article is here: http://www.vox.com/2014/7/28/5944263/corporate-tax-inversions-deserters-vs-economic-patriotism
• Reuters wades in with an excellent piece on the potential costs of Ireland losing the war on international tax regime. "Ireland has too much to lose to deter U.S. companies re-homing" (http://www.reuters.com/article/2014/07/30/us-usa-tax-ireland-analysis-idUSKBN0FZ1FA20140730?feedType=RSS&feedName=businessNews) also dives into the issue of our 12.5% rate. "It would be difficult to block inversions without jeopardizing the broader benefits," says the author. Which I agree with. We have lost the leadership momentum in the global debate on tax optimisation and now our headline rate is firmly in the crosshair. But our delirious tax advisory experts are still not getting the picture: ""It's a dangerous road to go down," said Kevin McLoughlin, who as head of tax at accounting firm Ernst & Young… I really struggle to see how they can legislate against companies choosing Ireland as a destination in a way that's confined only to these types of situations. I think it's extremely unlikely because I just don't know what they can do." Well, the problems of legislating outside of Ireland may be tough, but I'd love to see Kevin struggling to fill the potential void left in our economy if the legislators abroad do succeed in legislating on the matter. Somehow, I doubt EY will be that creative with coming up with economic development strategy ideas as they are with coming up with tax optimisation ideas.
• Robert Reich writes in Salon.com that “American” corporations are a farce (http://www.salon.com/2014/07/29/robert_reich_american_corporations_are_a_farce_partner/) and names a list of the Irish-based European operations of blue-chip corporates as the "American farce". Reich pushes the agenda of tax optimisation to R&D supports… which is… oh, surprise surprise, at the top of Irish Government agenda… Now, is there an area of tax arbitrage we haven't captured yet?..
• Last, but not least, remember the solemn, stern statements from Irish senior public figures arguing that Ireland does not promote itself as a tax arbitrage play, but rather focuses on 'human capital', 'regulatory environment' (aka - regulatory arbitrage) and 'headline rate of tax' (aka - inversions-enabling rate)? Well, they don't have to - instead of senior political and state leaders, we have a swarm of senior lawyers and accountants and corporate finance specialists and… to do the bidding, as reported by Reuters in "Irish, Dutch, UK law firms in tax inversion beauty contest in U.S." (http://www.reuters.com/article/2014/07/24/deals-taxinversions-lawfirms-idUSL2N0PK1L820140724).

Time to cut some FDI ribbons, Ministers…

Note: you can track previous links and discussions relating to Irish corporate tax policies and debates by using 'search' option for 'corporate tax' on this blog or by following blog-links from here: http://trueeconomics.blogspot.ie/2014/07/2672014-this-week-in-corporate-not-tax.html

3/8/2014: EUObserver on EU sanctions

EU Observer run a brief comment by myself on EU sanctions against Russia: http://euobserver.com/foreign/125168