3/2/2015: Japanification of Europe?

One of the main narratives for understanding European economy's longer term growth outlook has been the risk of Japanification: a long-term stagnation punctuated by recessionary periods and accompanied by low inflation and or deflationary episodes and pressures. I posted on the topic before (see for example here: http://trueeconomics.blogspot.ie/2014/10/19102014-chart-of-week-japanising-europe.html) and generally think we are witnessing some worrying similarities with Japan, driven primarily by longer-term trends: debt overhangs across real economy, nature of debt allocations (concentrated in less productive legacy assets, such as property in some countries, physical capital in others) and, crucially, demographics-impacted political and institutional paralysis.

One recent paper, titled "The Macroeconomic Policy Challenges of Balance Sheet Recession: Lessons from Japan for the European Crisis" by Gunther Schnabl (CESIFO WORKING PAPER NO. 4249 CATEGORY 7:MONETARY POLICY AND INTERNATIONAL FINANCE, MAY 2013) sets out the stage for looking into the direct comparatives between Japan's experience and that of the EU.

Per Schnabl, "Japan has not only moved through a boom-and-bust cycle …almost 20 years earlier than Europe but has also made important experiences with a crisis management in form of monetary expansion, unconventional monetary policy making, fiscal expansion and recapitalization of banks. Although Japan has reached the (close to) zero interest rate environment more than a decade earlier than Europe and gross general government debt (in terms of GDP) has gone far beyond the levels, which are today prevalent in Europe, growth continues to stagger."

In other words, as we know all too well, Japan presents a 'curious' case of an economy where neither monetary, nor fiscal policies appear to work, even when applied on truly epic scale.

What Schnabl finds is very intriguing. "The comparison between the boom-and-bust cycles in Japan and Europe with respect to the origins of exuberant booms, the crisis patterns, the crisis therapies, and the (possible) effects of the crisis therapies shows that despite significant differences important similarities exist. With the growing socialisation of risk Europe follows the Japanese economic policy decision making pattern, with – possibly – a similar outcome for European growth and welfare perspectives. The gradual decline in real income in Japan should be incentive enough for a turnaround in economic policy making in both Europe and Japan."

The key to the above is in the phrase "With the growing socialisation of risk Europe follows the Japanese economic policy decision making pattern" which of course has several implications:

• Mutualisation / Socialisation of risk is actually mutualisation and, thus, socialisation of debt - clearly suggesting that the path toward debt deleveraging is not the one we should be taking. The alternative path to debt deleveraging via mutualisation / socialisation is debt restructuring.
• To date, no European leader or organisation has come up with a viable alternative to the non-viable idea of 'internal devaluation'. In other words, to-date we face with a false dichotomous choice: either mutualise debt or deflate debt. Neither is promising when one looks at the Japanese experience. And neither is promising when it comes to European experience either. See more on this here: http://trueeconomics.blogspot.ie/2014/08/1082014-can-eu-rely-on-large-primary.html and http://trueeconomics.blogspot.it/2014/08/1082014-inflating-away-public-debt-not.html.
• ECB policies activism - the alphabet soup of various programmes launched by Frankfurt - is still treating the symptom (liquidity or credit supply to the real economy) instead of the disease (debt overhang). And the outcome of this activism is likely to be no different from Japan: debt overhang growing, economy stagnating, asset prices and valuations actively concealing the problem, data detaching from reality.

Here are some slides from Schnabl's November 2014 presentation on the topic:

So here's the infamous monetary bubble / illusion:

And the associated public sector balloon (do ignore some of the peaks that were down to banks rescue measures and you still have an upward trend):

And an interesting perspective on the Japanification scenario for Europe:

Happy demanding more Government involvement in the economy, folks... for this time, all the monetary, fiscal, regulatory, institutional, propagandistic etc 'easing' will be, surely, different... very different... radically different...

3/2/15: Global Trade Growth: More Compression, Whatever About Hope...

As I noted just a couple of days ago, global trade growth is falling off the cliff (see: http://trueeconomics.blogspot.ie/2015/02/1215-world-trade-growthnow-scariest.html). And euro area's trade growth is leading to the downside:

So no surprise there that the Baltic Dry Index is tumbling. As noted by @moved_average, the index is now down 577 - the level below the crisis peak lows and consistent with those observed back in 1985-1986 lows.

Ugly gets uglier... but you won't spot this in PMIs...

As an aside, in the chart above, perhaps a telling bit is the lack of any positive uplift in euro area trade growth from the introduction of the euro. 

2/2/15: Greek Primary Surplus: A Steep Hill to Climb

My comment for Expresso (January 31, 2015, pages 8-9) on Greece:

Greece has undertaken an unprecedented level of budgetary adjustments as reflected in the rate of debt accumulation on the Government balance sheet and the size of the primary surplus. Stripping out the banking resolution measures, Greek Governments have managed to deliver general government deficit consolidation of some 13.8 percentage points based on forecast for 2015, compared to the peak crisis, with Irish Government coming in a distant second with roughly 9 percentage points and Portuguese authorities in the third place with 7.7 percentage points. These figures are confirmed by the reference to the structural deficits and primary deficits. 

Given the level of austerity carried by the Greek economy over the recent years, and taking into the account a significant (Euro16 billion) call on debt redemptions due this year, it is hard to see how the Greek Government can deliver doubling of a primary surplus from IMF-estimated 1.5% of GDP in 2014 to forecast 3% of GDP in 2015 and 4.5% in 2016. Even assuming no adverse shocks to the Greek economy, these levels of surpluses appear to be inconsistent with the structural position of the Greek economy and I would have very severe doubts as to whether even the 2-2.5% range of surpluses can be sustained over the medium term (2015-2020) horizon.

2/2/15: Russian External Debt: Falling & So Far Sustainable

BOFIT published an update on Russian external debt as of the end of December 2014. The update shows the extent of debt deleveraging forced onto Russian banks and companies by the sanctions.

In H2 2014, repayments of external debt accelerated.

Banks cut their external debt by USD43 billion to USD171 billion over the year, with much of the reduction coming on foot of two factors: repayment of maturing debt and ruble devaluations. Ruble devaluations - yes, the ones that supposed to topple Kremlin regime - actually contribute to reducing Russian external debt. Some 15% of banks' external debts are denominated in Rubles.

Corproate external debt fell by USD60 billion to USD376 billion, with Ruble devaluation accounting for the largest share of debt decline, as about 25% of all external corporate debt is denominated in Rubles.

So do the maths: Ruble devaluations accounted for some USD16 billion drop in banks debts, and some USD54 billion in corporate debt in 2014 (rough figures as these ignore maturity of debt composition and timing).

Additional point, raised on a number of occasions on this blog, is that about 1/3 of corporate debt consists of debt cross-held within corporate groups (loans from foreign-registered parent companies to their subsidiaries and vice versa).

All in, end-2014 external debt of Russian Government, banks and corporates stood at USD548 billion, or just below 30% of GDP - a number that, under normal circumstances would make Russian economy one of the least indebted economies in the world. Accounting for cross-firm holdings of debt, actual Russian external debt is around USD420 billion, or closer to 23% of GDP.


CBR latest data (October 2014) puts debt maturity schedule at USD108 billion in principal and USD20 billion in interest over 2015 for banks and corporates alone. Of this, USD37 billion in principal is due from the banks, and USD71 billion due from the corporates. Taking into the account corporates cross-holdings of debt within the enterprise groups, corporate external debt maturing in 2015 will amount to around USD48 billion. Against this, short-term banks' and corporate deposits in foreign currency stand at around USD120 billion (figures from October 2014).

In other words, Russian banks and companies have sufficient cover to offset maturing liabilities in 2015, once we take into the account the large share of external debts that are cross-held by enterprise groups (these debts can be easily rolled over). Of course, the composition of deposits holdings is not identical to composition of liabilities, so this is an aggregate case, with some enterprises and banks likely to face the need for borrowing from the CBR / State to cover this year's liabilities.

BOFIT chart summarising:

2/2/15: Irish Manufacturing PMI: January 2015

Markit/Investec Irish Manufacturing PMI is out for January, posting 55.1, down on 56.9 in December and the lowest reading in any month since May 2014. Still, 55.1 is a strong performance.

3mo MA is now at 56.1 which is slightly worse than 56.5 3mo reading through October 2014, but is ahead of 55.7 average for 12 months through January 2015.

The growth rate is slowing down, but the activity remains robust:

2/2/15: Russian Manufacturing PMI slips in January

Russian Manufacturing PMI (Markit and HSBC) for January came in at 47.6, below 50.0 (statistically significant sub-50 reading), down from 48.9 in December. This is the second consecutive month of below 50 readings.

3mo MA through January is at 49.4, which is well down on 3mo MA through October 2014 which stands at 50.6, but ahead of 3mo MA through January 2014 which was 47.6.

The trend remains negative and has been reinforced in January.

1/2/15: Oh, those largely repaired Irish banks...

What do foreign 'experts' like BofE Mark Carney forget to tell you when they say that Ireland's banking system has been [largely] repaired?

Oh a lot. But here are just two most important things:

Both, in level terms and in growth terms, Irish banks remain zombified. 'Repaired' into continuously shrinking credit supply and stagnant household deposits base, the banks have been flatlining ever since the beginning of the crisis. In the last 6 consecutive quarters, household deposits posted negative rates of growth - a run of 'improvement' that is twice longer than the 'recovery period' of Q3 2012 - Q1 2013 when the deposits rose (albeit barely perceptibly).  Meanwhile, credit continues to shrink in the system with not a single quarter of positive growth (y/y) since Q4 2009. In four quarters through Q3 2014, credit for house purchases shrunk at just around 3.05% on average - the steepest rate of decline since the start of the crisis.

"Yep, [largely] repaired, Mr. Carney", said undertaker firming up the dirt on top of the grave...

1/2/15: World Trade Growth:Now a Scariest Chart Candidate

The scary chart of the month: post-Great Recession, World Trade volumes are growing at the slowest average pace in 35 years (even if we are to 1) exclude recession effects, and 2) accept IMF's rosy projection for 2015 and ignore latest Baltic Dry Index tumbling):

30/1/15: Timeline of Russian Credit Ratings

A neat summary of Russian sovereign ratings changes over time via RBC.ru:

Click on image to enlarge

Source: http://top.rbc.ru/economics/26/01/2015/54c6832e9a7947485b5dc04e#[lenta_body]-[news

29/1/15: Where the Models Are Wanting: Banking Sector & Modern Investment Theory

My new post for Learn Signal blog covering the shortcomings of some core equity valuation models when it comes to banking sector stocks analysis is now available here: http://blog.learnsignal.com/?p=152.

Tune in next week to read the second part, covering networks impact on core valuation models validity.

27/1/15: Greek Debt: Non-Crisis Porkies Flying Around

There is an interesting sense of dramatic contradictions emerging when one considers on the one hand the outcome of the Greek elections, and on the other hand the statements from some EU finance ministers (for example see this: http://www.bloomberg.com/news/2015-01-27/schaeuble-says-greece-needs-no-debt-cut-due-to-no-interest-phase.html). The basic contradiction is that one set of agents - the new Greek government and the Greek electorate - seem to be insisting on the urgency of a debt writedowns, while the other set of agents - majority of the European finance heads - seem to be insisting on the non-urgency of even discussing such.

What's going on?

Here is a neat summary of official (Government) debt redemptions coming up, by the holder of debt (source: @Schuldensuehner):

This clearly, as in daylight clear, shows 2015 as being a massive peak year for redemptions.

Note to the above: GLF debt reference covers GDP-linked bonds - see https://www.diw.de/documents/publikationen/73/diw_01.c.488644.de/diw_econ_bull_2014-09-5.pdf.

Alternative way of looking at the burden of debt is to compare debt dynamics and debt funding costs dynamics. Here these are for Greece, based on IMF data:

Take a look at the above blue line: in effect, this measures the cost of carrying Government debt. This cost did improve, significantly in 2012 and 2013, but has been once again rising in 2014. It is projected to continue to rise into 2019. So Greece can run all the primary surpluses the Troika can demand, the cost of servicing legacy debts is on the upward trend once again and Herr. Schaueble and his ilk are talking tripe.

Now, consider the red line in the chart above: in absolute terms, there is no reduction in Greek debt to-date compared to 2012. But do note the third argument advanced by Herr. Schaueble in the link above, the one that states that Greek debt reductions have exceeded those forecast under the programme. Did they? Chart below shows the reality to be quite different from that claim:

What the chart above shows is that 2015 projections for debt/GDP ratio (the latest being published in october 2014) range quite a bit across different years when forecast was made. Back in October 2010, the IMF predicted 2015 level of debt/GDP ratio to be 133.9%, this rocketed to 165.1% in October 2011 forecast, rose again to 174.0% forecast published in October 2012, declined to 168.6% in forecast published in October 2013 and rose once again in forecast published in October last year to 171% of GDP.  In other words, debt outlook for Greece for 2015 did not improve relative to 3 forecast years and improved only relative to one forecast year. Rather similar case applies to 016 projections and 2017 projections and 2018 projections. So where is that dramatic improvement in debt profile? Ah, nowhere to be seen.

And then again we keep hearing about the fabled end of contagion, 'thank God', that Herr. Schaeuble likes referencing. I wrote about this before, especially about the fact that risk liabilities have not gone away, but were shifted over the years from the shoulders of German banks to the shoulders of German taxpayers. But you don't have to take my word on this, here's a German view: http://www.cesifo-group.de/de/ifoHome/policy/Haftungspegel/Eurozone-countries-exposure.html#losses.

27/1/15: Bankruptcy & Capitalism Are Not the Same as Religion & Hell

I have recently seen some economists offer the following explanation of the role of bankruptcy in the market economy: "Capitalism without bankruptcy is like catholicism without a concept of hell".

That is a fallacious view at best, and a dangerous basis for policy formation to boot.

It is fallacious for a number of reasons, relating to both philosophy and economics.

Firstly: Capitalism, unlike religion is an ethical, but not a moralist (imperative) system. Hence, a concept of eternal damnation simply does not apply, nor should apply, to capitalism. Nothing eternal (imperative) is relevant to capitalism, including the principle of permanently enshrined law. In fact, capitalism is a system that is based on change, including change applying to its core principles. Example: transition in property rights definition as it evolved under capitalism. Change is something that is impossible in a moral imperative systems: the Hell is the Hell and it will always be the Hell. In contrast, even the most basic foundations of capitalism evolve over time. Humanity used to have markets for slaves. We no longer do, for a good of the system. Capitalism used to define capital as physical 'stuff', it now includes 'intangibles'. And so on. This ability of capitalism to change - both continuously (evolutionary) and discontinuously (revolutionary) - preempts any possibility of an 'eternal' value concept, such as 'Hell', applying to it.

Secondly: Capitalism is based on utilitarian ethics. It is ok to alter private property rights (even with partial only compensation) under certain circumstances. It is ok to restrict some markets and transactions, when Pareto efficiency allows us. And so on... There can be no Pareto efficiency justification for a fundamental sin. Hence, bankruptcy in capitalism is not a form of punishment (damnation) a priori, but a system for resolving dilemma of un-recoverable liabilities. It is instrumental - a resolution system and a restart system. Hell is a permanent state, inescapable once entered into. And Hell exists solely for the purpose of punishment. It is not instrumental - it is absolute.

Thirdly: Bankruptcy is a manifestation of the process of creative destruction. Which is a dynamic process and also value-additive process. Hell is a system of a final state of being. There is neither a desirability for finality, nor transformative imperative to alter a being through bankruptcy.

In short, a statement of "Bankruptcy ~ Hell", while sounding remotely plausible, commits a basic fallacy of moralism: over-extending an imperative moral consideration to something that requires none.

So why do I take this statement to task?

Precisely because our system of bankruptcy is erroneously designed to follow that fallacious principle. We use bankruptcy not to resolve the problem of un-repayable liabilities in the first action, but to punish the person / entity that caused the problem. We make bankruptcy painful beyond the reason of simply maximising the recovery of losses in order to 'teach others a lesson' in a way that the threat of Hell is supposed to do.

As long as we keep following such a moralist view of bankruptcy, we will continue to unncessarily penalise entrepreneurship and risk-taking; we will continue to force unnecessarily high costs of failure on enterprises and people that undertake enterprise. In other words, we will continue to subsidise returns and rewards to statism to a life of secured complacency.

Capitalism without bankruptcy is a prison without an exit. It imprisons, wrongly, the innocents to rescue bankrupt enterprises (as in the case of banks rescues), or it imprisons too harshly those who take a risk and experience a failure (as in the case of some entrepreneurs trapped in, say, Nama). In both cases, absence of a utilitarian (not absolutist or moralist) bankruptcy destroys value - economic, social and personal.

Hell is the concept of an ultimate judgement and eternal punishment for moral sins, best left to God to apply, than economists.