24/11/15: Captured Economics and the Victim State

Per Simon Wren-Lewis: “…Perhaps the problem at the heart of the Eurozone is that economic policy advice in Germany has been effectively captured by employers' interests, and perhaps the interests of banks in particular.” (source here)

For one caveat: economics as profession has been largely captured by the state.

The European states are, of course, themselves have been captured by corporatist interests, including (but not limited to) those of big businesses and banks. One can make a similar argument about other (non-European) states too. Which makes the capture of economists by business only a part of that more corroded chain, and not an exclusive part. Otherwise, how can one explain that it is State-employed economists and State-aligned economists (with State boards positions and State research contracts) that so vocally defend the very same corporate welfare that Simon Wren-Lewis seems to correctly worry about?

My view on the subject was covered here: http://trueeconomics.blogspot.ie/2015/10/301015-why-economists-failed-whats-up.html.

In simple terms, enough whitewashing the State as a victim of business interests - instead, time to see the State as a willing participant in a corporatist system that allows capture of policy development and implementation mechanisms and institutions by vested interests that define the State.

24/11/15: Europe's Dead Donkey of Productivity Growth

Remember the mythology of European productivity miracles:

1. The EU is at least as competitive as the U.S. (with Lisbon Agenda completed, or rather abandoned);
2. The EU growth in productivity is structural in nature (i.e. not driven by capital acquisition alone and not subject to cost of capital effects); and
3. The EU productivity growth is driven by harmonising momentum (common markets etc) at a policy level, with the Euro, allegedly, producing strong positive effects on productivity growth.

Take a look at this chart from Robert J. Gordon's presentation at a recent conference:

The following observations are warranted:

• EU convergence toward U.S. levels of productivity pre-dates major policy harmonisation drives in Europe and pre-dates, strongly, the creation of the Euro;
• EU productivity convergence never achieved parity with the U.S.;
• EU productivity convergence was not sustained from the late 1990s peak on;
• The only period of improved productivity in the EU since the start of the new millennium was associated with assets bubble period (interest rates and credit supply).

Darn ugly!

But it gets worse. Since the crisis, the EU has implemented, allegedly and reportedly, a menu of 'structural' reforms aiming at improving competitiveness.  Which means that at least since the end of the crisis, we should be seeing improved productivity growth differentials between Europe and the U.S. And the EU case for productivity growth resumption is supported by the massive, deeper than the U.S., jobs destruction during the crisis that took out a large cohort of, supposedly, less productive workers, thereby improving the remainder of the workforce levels of productivity.

Here is a chart from the work by John Van Reenen of LSE:

Apparently, none of this happened:

• EU structural reforms have been associated (to-date) with much lower productivity growth post-crisis than the U.S. and Japan;
• EU jobs destruction during the crisis has been associated with lower productivity increases than in the U.S. and Japan;
• All EU programmes to support growth in productivity, ranging from the R&D supports to investment funding for productivity-linked structural projects have produced... err... the worst outcome for productivity growth compared to the U.S. and Japan.

And the end result?

I know, I know... a Genuine Productivity Union, anyone?...

21/11/15: Be Kind to Economic Forecasting Dodos...

Oh, spare a kind thought for the economists... crippled by the intellectual feebleness of algebraic (and utterly useless) models and hamstrung by the need to sell 'good news' to naive retail clients pounded by the sell-side 'research', they have it tough in this life. And the things are going to get tougher.

So far, in anticipation of the U.S. Fed hikes, virtually all economics analysts working for sell-side stuff brokers have been declaring their firm conviction that once the Fed raises rates, things are going to be off to a neatly clean start - the U.S. economy will shake off any risks to growth, while the Euro area economy will get a devaluation boost from stronger dollar.

Which, by the way, may or may not happen, but as Reuters article (link here) clearly shows, it wouldn't be the economists crowd that will have any idea what is going to happen.

Here are two charts from Reuters:

Now, give this a thought: 2014 and 2015 were relatively 'trend' years for the U.S. economy. And yet, in both cases, analysts surveyed by Reuters vastly, massively, grossly missed the boat on their forecasts. The dodos did predict back in January 2015 that 1Q 2015 growth will be 2.8%, missing the mark by 3 percentage points. And they did chirp out a forecast of 2.5% growth for 1Q 2014 back in January 2014, missing the reality by a massive 5.4 percentage points.

And to give you some more flavour, here is a summary of IMF forecasts for advanced economies (not just the U.S.):

Which confirms the aforementioned truth: economic forecasts ain't got a clue where the major advanced economies are heading, with or without Fed rate hikes.

It would be laughable, if this was not serious: the same types of economists inhabit the forecasting halls of the Fed, providing 'technical (mis-)guidance' to the FOMC on which the decision to hike rates will be made. In other words, the blind are driving, the deaf are navigating them and we are all the passengers on their happy runaway train.

So buckle up. When Fed hikes rates, things might go smooth or they might go rough - we just don't know. But we do know as much: all these economic forecasters have not a clue what will happen...

20/11/15: For all that growth thinking, say 'Thanks' to the U.S. for leveraging up

While leadership of Ireland ponders the fortunes of our 'globally connected' (yet somehow always exceptional) economy, here is an actual global picture of who drove Europe's (and Ireland's) 'exporting economy' model of economic expansion.

The chart below plots current account imbalances by region as % of global GDP from 1980 through today.

Source here.

Since 1983, there has been only one, that i right, one year (1991) when the U.S. did not run a current account deficit. By converse, since 1994, there have been just four years when the EU run a statistically noticeable current account deficit.

Thus, leveraging of the U.S. economy, including through trade, household demand and corporate tax 'optimisations' was the consistent driving force behind the miracle of European growth (and global growth in general) since at least 1983. Since 2011 - the coincidentally very year of Irish recovery - U.S. deficits and growing deficits from the ROW have been coincident with rising surpluses for the EU.

Table below (compiled using IMF WEO database data) shows cumulated current account balances from 1980 through 2015 for the main groups of economies and the U.S. expressed in billions of euro:

For the readers' convenience, I shaded U.S., Euro area and EU positions. This shows just how dramatic was the acceleration in U.S. deficits position since 1997 compared to 1980-2015, and how symmetrically significant was the acceleration in the EU surpluses.

In a way, all strategy of 'national development policies' talk aside, brutal reality of the years ahead is that unless someone else picks up the U.S. leveraging game, there is little scope for the externally-driven economic models of Europe in the future.

Irish exceptionalist insiders should pause for some thought... perhaps on their way to a fancy state sponsored lunch at the Castle...

20/11/15: Gold's 'Road Back'?

No love for gold from Europe...

20/11/15: The Inversion Debate Isn’t Over: Credit Suisse

A brief Credit Suisse note on corporate inversions, with an honourable mentioning for Ireland: https://www.thefinancialist.com/spark/the-inversion-debate-isnt-over/ over the story covered on this blog earlier (see background here including further links).

I especially like that little twist on tax optimisation that are inter-company loans: whilst the original inversion leads to a direct negative impact on tax revenues for our trading and investment partners, it adds a cherry on the proverbial cake by reducing companies' tax liabilities even further through lending to U.S.-based business.

OECD compliant, it all is...

20/11/15: U.S. Households' Deleveraging: Painful & Long

An interesting set of charts plotting trends in U.S. household credit arrears over time, courtesy of the @SoberLook

Three things stand out in the above. 

Per first chart, credit cards debt is the only form of credit that saw arrears drop below pre-crisis levels. It also happens to be the form of debt that is easiest to resolve - largely unsecured and easily written down. Mortgages debt arrears - while declining significantly from crisis peak - still remain at levels above pre-crisis averages. Ditto for all other forms of household debt. 

Also per first chart, improving labour markets conditions are doing zilch for student loans arrears. These remain on an upward trend and close to historical highs.

Thirdly, from the second chart, new volumes household credit in arrears in 3Q 2015 are broadly consistent with the situation in the same quarter in 2014, with new arrears falling to 4Q 2007 levels, but still running at levels well above 2003-2006 levels.

This, in an economy characterised by more robust labour markets than those of Europe and by personal insolvency regimes and debt resolution systems more benign than those in Europe. In simple terms: deleveraging out of bad debt is a painful, long-term process. Good luck to anyone thinking that raising rates will do anything but delay it even longer and make the pain of it even greater.

17/11/15: Irish Rents: Welcome to More Consumer Whacking by Government

In efficient market, pre-announced policy changes get priced into market valuations before the policy change takes place. This was the case with the Gazprom's Nord Stream pipeline (working paper on this is forthcoming) and this is also true for much more liquid markets for rents.

Behold, Irish Government's latest stab at creating policies-driven evidence (or in other words, screw ups): http://www.independent.ie/business/personal-finance/property-mortgages/landlords-pile-on-rises-ahead-of-new-rent-controls-34206919.html.

As expected, Irish landlords were quick to price in future freezes in rents in advance of such freezes coming into force. Which means that already beleaguered Irish renters can now pay even more in rents over an even longer time horizon. Double whacking of consumers by the incompetent policy designers continues unabated...

16/11/15: IG Insights Summit: Markets Outlook

Recently, I took part at the IG Summit in Dublin on a panel covering the future direction of financial markets. Here is the link to the panel video: https://www.youtube.com/watch?v=iYFRnOCE4Mk.

My interview on the topic is available here: http://trueeconomics.blogspot.ie/2015/10/281015-flatter-growth-trend.html.

15/11/15: Ifo World Economic Climate Indicator 4Q

Ifo’s World Economic Climate Indicator for 4Q 2015 released recently shows further deterioration in global economic growth conditions, despite all the optimism talk in Europe and the U.S.

Ifo’s headline World Economic Climate index posted a reading of 89.6 for 4Q 2015, down on 95.9 in 3Q 2015 and below 95.0 rearing for 4Q 2014.This is the lowest reading since 4Q 2012 and is well below the 2012-present average of 94.7 and the historical average of 95.0. 4Q 2015 marks second consecutive quarter of declines in index reading.

In terms of key components of the headline index:

• Present Situation index fell to a low of 86.0 in 4Q 2015 from already unimpressive 87.9 reading in 3Q 2015. This marks the lowest reading since 1Q 2013 and the second consecutive quarterly decline in the index. 
• Expectations 6 months forward sub-index was down at 93.0 in 4Q 2015 from 103.5 in 3Q 2015 and is below 98.2 reading for 4Q 2014. The index reading is the lowest since 4Q 2012 and is down on 102.1 average reading for the period starting with 1Q 2012. Historical average for the sub-index is at 99.2 which is well above the 4Q 2015 reading.

In summary, global economic activity is once again showing signs of weakness with negative momentum not abating, but accelerating into 4Q 2015 despite massive glut of monetary liquidity and despite sharp reduction in energy costs.

14/11/15: My Comment on Portuguese Political Crisis

Two comments from myself on the topic of Portugal's political crisis effect on country macroeconomic and fiscal positioning:
http://expresso.sapo.pt/economia/2015-11-12-Divida-espanhola-e-portuguesa-sob-pressao and http://expresso.sapo.pt/economia/2015-11-11-Juros-da-divida-portuguesa-descem.-Mas-preco-dos-cds-continua-a-aumentar.

Full comment in English:

Do you think the financial markets and the debt agencies will move its focus from Greece to Portugal now and later on for Spain near or after theDecember 20 elections?

The latest euro area ‘periphery’ political crisis - the collapse of the Centre-Right Government in Portugal - sets the stage for a potential replay of the logistics of the Greek crisis of Summer 2015 scenario.

Both the markets and European leadership are likely to present the crisis as an isolated event, linked to the lack of ‘programme ownership’ in Portugal and not indicative of the broader political and policy trends across the EU. In other words, all official players in the sovereign debt markets will attempt to paint Portuguese situation as a ‘one-off’ event with no risk of contagion to other member states. As a result, rating agencies’ downgrades can be expected only if the crisis persists or if the new Government includes the elements of what is perceived to be ‘extreme Left’. At the same time, the rhetoric surrounding political crisis will be shifted into the discussion of domestic failures and the allegedly destructive role of populist politics. The key to this approach is the clear desire by the European leaders to contain the spread of political opportunism and limit the extent to which democratic politics can transmit public anger and dissatisfaction with post-crisis recovery from one ‘peripheral’ state to another, namely from Portugal to Spain and Italy, as well as, potentially, to Ireland which is likely to face elections in the first quarter of 2016. There are strong incentives for European authorities to send a warning message to Spanish electorate and political elites before December 20th elections, albeit it is difficult to see how such a warning can be structured in the case of Portugal. In my view, we are likely to see renewed talks about Portugal’s compliance with fiscal harmonisation rules and, potentially, a warning concerning the risk of the country running excessive deficits in 2016-2017 on foot of political realignment.


How do you evaluate the present risk of Portugal regarding the debt sovereign market? Yields will go for new highs in 2015?

Currently, CDS markets are pricing in 15.5% chance of sovereign default (under ISDA2003 rules) for Portugal, up on 14.5% a week ago, compared to 3.5% for Ireland, down from 3.8% a week ago. The trend to-date suggests some increased pressure on sovereign risk position for Portugal that has been priced in since the appointment of the Centre-Right Government and this is consistent with a view that relatively sharp increases in government debt yields represent possible overshooting of risk valuations. Two critical aspects of the crisis in the context of debt sustainability view are: how long the new political impasse will last and what signals a new Cabinet will send after appointment. If the crisis continues over a relatively prolonged period of time (more than a week) and /or if the new Cabinet is slow in clearly defining its position vis-a-vis the European policy direction toward sustained fiscal and structural reforms, bond yields are likely to continue rising, putting pressure on Portugal’s access to new funding. Absent significant worsening of the political crisis, Portugal’s debt sustainability dynamics are likely to remain hostages to economic fundamentals: the rate and the nature of economic growth over 2015-2016, rather than to political risks.

Most likely, given the degrees of uncertainty relating to the political nature of the latest crisis, DBRS will take a ‘wait-and-see’ position, issuing negative watch warning on its ratings, but staying out of moving for an outright downgrade this time around. However, the risk of the downgrade remains significant and the impact of such a downgrade can also be material. Given that all major rating agencies have already downgraded Portugal Sovereign ratings, a DBRS downgrade will force the ECB to either halt purchases of Portuguese bonds in its QE programme or to issue a waver for eligibility criteria. In the former case, pressures on sovereign yields are likely to be severe making new issuance of debt much more costly proposition.


Note: DBRS did take a 'wait-and-see' position on Friday (see here)

14/11/15: More Evidence U.S. Capex Cycle is Still Lagging

In a recent post (link here), I covered the issue of shares buy-backs and the lack of capex at the S&P500 constituents level. A recent report by Credit Suisse titled "The Capital Deployment Challenge" takes a look at the same problem.

Per report: "Companies in the US market are currently in great health as corporate profitability is approaching historical highs. This high level of profitability has produced record levels of corporate cash, and thereby has created a challenge for managers: how to allocate all of this excess cash. Companies may choose to reinvest in their businesses – organically or through M&A – or they may return the cash to capital providers, through dividends, share buybacks or by paying down debt..."

"Historically, companies have deployed an average of 60% of cash flows in capital investment (28% in organic growth and 32% in M&A) and have returned  26% to shareholders (12% dividends and 14% share buybacks). In the past several years, the capital allocation balance has swung away from growth towards buybacks and dividends: capital invested has dropped to 53% (27% organic growth and 26% M&A), while cash returned to shareholders has increased to 36% (15% dividends and 21%
buybacks)."

A handy chart to illustrate the switching:

So Credit Suisse divide the S&P500 universe into two sets of companies: reinvestors and returners. The former represents companies which predominantly direct their cash balances to organic reinvestment and/or M&A, whilst the latter are companies that prefer, on balance, to use cash surpluses for dividends and/or shares buybacks.

The report looks at three metrics across each type of company: underperformers within each group - companies that underperformed their peers average in terms of total shareholder returns, outperformers - companies that outperform their peers average, and average across all companies.

Chart below shows the extent of differences across two types of companies and three categories in terms of cash flow return on investment (CFROI):

The chart above "shows that the initial level of returns on capital is generally lower for reinvestors than for returners, with an average of 9% and 11%, respectively. The reinvestors and returners who outperformed their peers both improved their CFROI. However, the outperforming reinvestors generated a greater operating improvement (180bps vs 150bps for returners)."

Which is all pretty much in line with what I said on numerous occasions before: no matter how you twist the data, average returns to not re-investing outpace returns from investing. Meaning that: either companies are getting worse at identifying and capturing investment opportunities or investment opportunities are thin on the ground. Or both...