4/2/16: Smal v Large Cap Stocks: Recession Cycle Performance

Credit Suisse did an interesting exercise recently in a note to clients. They took U.S. equities indices for large cap (S&P500) and small cap (Russell 2000) stocks and computed an average downside to each index across all U.S. recessions from 1980 on and then to the upside from the post-recession trough. The episodes averaged over are: 1980, 1981-1982, 1990-1991, 2001, and 2007-2009. As a caution, there is no survivorship bias (index composition risk) adjustment to the resulting data.

So per CS: “Measuring the average peak-to-trough performance of the Russell 2000 and S&P 500 from one year before the start of each recession to the end of the downturn, the bank found that large caps were more resilient than small caps across the five slumps: the S&P 500 fell by an average of 32 percent, while the Russell 2000 dropped 37 percent. But it was a different story on the way back up. The Russell 2000 averaged returns of 86 percent from the start of each recession to one year after its end, while the S&P 500 posted returns of just 51 percent.”

So over the part of the cycle covered by CS, Russell 2000 was up, net, 17 percent, while S&P was up, net, only 3%.

4/3/16: Irish PMIs for January: Growth Is Up at Year Start

Irish Manufacturing and Services PMIs for January were published earlier this week and are worth looking into as a signal for the underlying economic activities at the start of 1Q 2016.

Irish Manufacturing PMIs rose for the second month in a row in January, reaching 54.3 from 54.2 in December. This is the highest level of activity since July 2015 and confirms some reversal of PMIs dynamics from slower growth recorded from August 2015 through November. Of course, when we are talking about ‘slower growth’ we are talking about still very high rates of expansion as singled by PMI. 3mo average through January 2016 is at blistering 53.9, which is up on scorching 53.7 3mo average through October 2015 and down on scorching 56.1 3mo average through January 2015. These telephone numbers compare extremely well against the historical average of 51.0 and even post-crisis average of 53.0.

Per Markit: “Business conditions in the Irish manufacturing sector improved solidly at the start of 2016, as had been the case at the end of 2015. A sharp and accelerated expansion in new orders was the key driver of strengthening conditions, with output and employment also continuing to rise. Lower raw material costs led to the sharpest fall in input prices in three months, while output charges decreased for the first time since last October… The health of the sector has now strengthened in each of the past 32 months.”

Notably, per Markit: “The decrease in output prices ended a two-month sequence of inflation” which is suggesting that Irish producers are now contributing to downward pressures in Euro area markets.

Meanwhile, Irish Services PMI also rose robustly in January, reaching 64.0 against 61.8 in December 2015. Again, these are unbelievably strong  numbers that raise some serious questions about the survey methodologies and/or coverage, but more on this later. 3mo average Services PMI for Ireland was at 61.5 in 3 months through October 2015 and rose to 63.1 in 3mo period through January 2016, up on already unbelievable 62.2 for the 3 months through January 2015. Historical average of 54.9 - again, extremely strong by any measure - is in the dust.

Per Markit, Services PMI “signalled the sharpest expansion in services output since June 2006. Activity has now risen in each of the past 42 months. Companies expect further improvements in economic conditions over the coming 12 months to lead to growth of activity. Business sentiment picked up slightly at the start of 2016. The rate of expansion in new business also quickened in January, and was the joint-fastest since August 2000. New orders have risen continuously throughout the past three-and-a-half years. As has been the case throughout the past four-and-a-half years, new export business rose in January. Moreover, the rate of expansion accelerated from that seen in December. … Consequently, employment rose at a substantial pace during January and one that was sharper than seen in the previous month. A further sharp rise in input costs was recorded in January, as the effect of higher wages and salaries outweighed the downwards impact of lower fuel costs. The rate of inflation across the service sector ticked up marginally, remaining above the series average.”

As per chart above, both Services and Manufacturing sectors are now in a massive expansion, with rates of growth in the underlying activity well in excess of those historically anchored in the pre-crisis period. Services divergence toward higher growth is still being contrasted by lagging growth in Manufacturing, but signs of possible catching up in Manufacturing to the upside are also present.

Per chart above, we can confirm new growth trend in Services and the potential for sustained growth acceleration in Manufacturing (albeit no new trend yet).

Per chart above, both sectors of the Irish economy are operating at the margins of economy’s potential (judging by historical trends). This is hard to interpret as an organic shift in potential rates of growth, so most likely, we are going to witness some growth moderation in months ahead.

Still, current performance raises serious questions as to where this data is coming from. It has long been suspicion of this author that the surveys dynamics have been driven by multinational enterprises operating in both sectors. We have no confirmation of this nor denial of this from Markit and we do not know the quality of their coverage across two sectors. However, one has to be aware of the simple fact - as shown on this blog in the past, survey results have been (in the past) deeply out of line with actual underlying activity registered in the sectors. Currently, both Services and Manufacturing indices are running fairly closely correlated with the reported activity in these sectors, but past low correlations with GDP and GNP and sectoral value added metrics suggests that the survey base can be skewed in favour of unweighting MNCs.

4/2/16: BRIC Composite PMIs: January

In two recent posts, I covered

• Services PMIs for BRIC economies http://trueeconomics.blogspot.com/2016/02/3216-bric-services-pmis-for-january.html and
• Manufacturing PMIs for BRCI economies http://trueeconomics.blogspot.com/2016/02/1216-bric-manufacturing-pmi-january.html

Now, let’s take a look at the Composite PMIs.

As noted in a more in-depth analysis, here: http://trueeconomics.blogspot.com/2016/02/3216-russian-services-composite-pmi.html, Russia’s Composite Output Index remained in contraction territory in January, posting a reading of 48.4, up on 47.8 in December 2015. The Composite index was helped to the upside by the Manufacturing PMI which was also in a contractionary territory at 49.8, but above the very poor performance levels of the Services PMI. January marked second consecutive month that both Manufacturing and Services PMIs for Russia were below 50.0. Last time that this happened was in December 2014-January 2015 and in February-March 2015 - in other words, at the dire depth of the current crisis. Overall, Russia is once again (second month in a row) ranks as the second lowest BRIC performer in terms of Composite PMI reading, ahead of only a complete basket case of Brazil.

As also noted in an in-depth analysis here: http://trueeconomics.blogspot.com/2016/02/2216-china-services-composite-pmis-for.html due to a substantial improvement in the Services PMI, China’s Composite PMI signalled stabilisation in overall economy-wide business activity in January, with Composite Output Index registering fractionally above the no-change 50.0 value at 50.1, up from 49.4 in December. However, overall, Composite PMI of China has been above 50.0 in only two of the last 6 months and on both occasions, index readings were not statistically distinguishable from 50.0. 3mo average through January for Composite PMI stood at 50.0 (zero growth) against 48.9 average through October 2015 and 51.3 average through January 2015. In other words, the economy, judging by Composite PMI might be closer to stabilising, but growth is not exactly roaring back.


India’s Composite PMI rose from 51.6 in December to an 11-month high of 53.3 in January. Per Markit, “Lifting the index were a rebound in manufacturing production as well as stronger growth of services output.” 3mo average for Composite reading is now a5 51.7, slightly down from 52.3 3mo average through October 2015 and compared to 52.8 3mo average through January 2015. With manufacturing and services order books now in an expansionary territory, “growth of new business across the private sector as a whole was at a ten-month high… Higher workloads encouraged service providers to hire additional staff in January, following a stagnation in the prior month. …Meanwhile, manufacturing jobs rose at a marginal rate.” While overall Indian economy has clearly returned to robust growth, underlying conditions remain relatively weak by historical standards. 3mo average Composite index at current 51.7 is well below the historical average of 54.8. India remained on track to being the strongest economy in the BRIC group overall for the 7th month in a row.

In the case of Brazil’s Composite PMIs, the index registered continued rate of contraction rate of contraction for 11th month in a row - a record that is worse than that for Russia. Over the last 24 months, Brazil’s Composite PMI has managed to reach above 50.0 on only 5 occasions, against Russia’s Composite PMI’s 7. Over the last 12 months, Brazil’s Composite PMI was above 50.0 only once, with Russian counterpart rising above 50.0 in 4 months. On a 3mo average basis, Brazil’s Composite PMI stood at 44.5 in January 2016, slightly better than 43.4 reading for the 3mo period through October 2015, but below 49.3 reading attained in January 2015. Per Markit: “January saw Brazil’s economic recession weighing on the private sector for another month …the seasonally adjusted Composite Output Index remained in contraction territory, highlighting a further sharp drop in activity. Moreover, the current sequence of continuous downturn has been extended to 11 months, the longest in almost nine years of data collection.” Both Services and Manufacturing sectors order books posted contractions, meaning that “the private sector as a whole posted an eleventh successive monthly decline in new business. Firms reported tough economic conditions and a subsequent fall in demand.” Once again, Brazil retained its dubious title as the worst performing BRIC economy - a title it has been holding for the last 11 months.

Charts and table to illustrate:

As shown in the above charts, Russia is now exerting a downward momentum on overall BRIC growth dynamics for the second month in a row. However, due to improvements in India and China, BRICs as a whole are now adding positive support for global growth. That support is relatively new and still fragile enough not to call a change in trend in the series.

3/2/16: BRIC Services PMIs for January: Some Rays of Hope

In the previous two posts, I covered

• Russian Services and Composite PMIs: see detailed discussion here http://trueeconomics.blogspot.com/2016/02/3216-russian-services-composite-pmi.html and 
• China Services and Composite PMIs here: http://trueeconomics.blogspot.com/2016/02/3216-russian-services-composite-pmi.html

Now, let’s take a look at the Services PMIs for all BRIC economies, followed by a post on their Composite PMIs.


Russian Services PMI for January 2016 came in with a hugely disappointing reading of 47.1 from already poor 47.8 recorded in December. On a 3mo average basis, the index is now at 48.2, worse than already poor 49.4 average for the 3 months through October 2015, although, as expected - well above the abysmal 44.7 average for the 3mo period through January 2015. The Services sector has now posted sub-50 PMI readings in 4 consecutive months, with deteriorating readings in 3 consecutive months, signalling no respite to the Services sector contraction.


China Services PMI came in at a surprising uplift in January, reaching 52.4 - the highest reading since August 2015, and up on 50.2 in December. This move was surprising since Chinese services PMI has been deteriorating every month from October 2015. As a reminder, the downturn in the manufacturing sector hit Chinese Manufacturing PMI hard with index falling to a 3-mo low in January and staying below 50.0 line of zero growth for 11 months in a row.


Brazil Services PMI remained the weakest of all BRIC economies at 44.4 in January up on a truly abysmal 43.5 in December. 3mo average for Brazil Services PMI was at 44.5, which is somewhat better than 43.2 average for the 3mo period through October 2015, but worse than 48.7 3mo average through January 2015. Brazil’s Services PMIs have now been below 50 line for 11 months in a row.

According to Markit: “Current downturn longer than 08-09 crisis… Activity decreased in all six monitored categories, with the quickest contraction seen at Renting & Business Activities. Leading services output to fall was another decline in incoming new work. Inflows of new business dipped at a softer pace, but one that remained sharp.” As in the case with Russian economy, inflationary pressures, primarily driven by currency devaluations, have created adverse headwinds for Services sector firms in Brazil. “January data pointed to a build-up of inflationary pressures in Brazil’s service economy. A weaker currency (particularly against the US dollar) combined with higher utility bills had reportedly resulted in an overall increase in cost burdens. The rate of inflation climbed to a three-month high and was well above the long-run series trend. As a consequence, service providers raised their average tariffs again, and at the fastest pace since October.”

Brazil’s economy not only continuing to contract, but remains the weakest of all BRIC economies, in Services sector terms since April 2015.


India Services PMI posted an impressive rise from already rather robust 53.6 in December to 54.3 in January 2016. The 3mo average has reached 52.7 in the period through January 2016, which is stronger than 52.1 recorded for the period through October 2015 and ahead of 52.0 3mo average through January 2015. Overall, this was the highest Services PMI reading for India since January 2013 and marks second consecutive month of PMIs acceleration. With this, Indian economy clearly has shaken off some of the downward momentum on growth that was building up in May-September 2015 and again roared it’s head in November 2015.

Per Markit: “Posting a 19-month high… Services Business Activity Index pointed to a marked and accelerated expansion of activity across the sector. Growth was noted in four of the six monitored categories, the exceptions being Hotels & Restaurants and Transport & Storage. Underpinning the overall increase in services output was a seventh successive monthly expansion of new business inflows. Having accelerated to the joint-fastest since June 2014, the growth rate was marked. Anecdotal evidence highlighted strengthening underlying demand and improved weather conditions.”

Overall, January marks the second month of India’s Services PMI leading other BRIC economies to the upside.

Chart and summary table to illustrate:

3/2/16: Russian Services & Composite PMI: Poor Start for 2016

Russian Services PMI for January 2016 came in with a hugely disappointing reading, falling to 47.1 from already poor 47.8 recorded in December. Per Markit: “This fall was driven by a solid contraction in new business levels, leading to another deterioration in backlogs of work. Meanwhile, job shedding persisted throughout the sector as firms turned pessimistic towards their future outlook for activity. Input prices continued to rise at a much quicker pace than average charges.”

On a 3mo average basis, the index is now at 48.2, worse than already poor 49.4 average for the 3 months through October 2015, although, as expected - well above the abysmal 44.7 average for the 3mo period through January 2015. Just how bad the current 3mo average and the latest monthly index reading is? Historical average for Russian services PMI is at 55.0 - full 7.9 points ahead of January reading.

Bad news is that the Services sector contraction has now accelerated (on both monthly basis- for the second consecutive month) and on 3mo basis too.

Again, per Markit: “Operating conditions in the sector remained challenging… Down from 47.8, the latest reading signalled the quickest decline in output for ten months.”

Chart to illustrate the Services sector woes:

Meanwhile, Russia’s Composite Output Index remained in contraction territory in January, posting a reading of 48.4, up on 47.8 in December 2015. The Composite index was helped to the upside by the Manufacturing PMI which was also in a contractionary territory at 49.8, but above the horror show of Services PMI. January marked second consecutive month that both Manufacturing and Services PMIs for Russia were below 50.0. last time that this happened was in December 2014-January 2015 and in February-March 2015 - in other words, at the dire depth of the current crisis.

Note: I covered Russian Manufacturing PMIs in detail here: http://trueeconomics.blogspot.com/2016/02/1216-russian-manufacturing-pmi-january.html.

Per Markit, “the rate at which incoming new orders contracted [for Services providers] was the fastest since March 2015, with anecdotal evidence linking this to a lack of market demand. That said, Russian manufacturers reported a slight expansion in incoming new orders in January, having registered a decline in December.”

Overall, Russia is once again (second month in a row) ranks as the second lowest BRIC performer in terms of Composite PMI reading, ahead of only a complete basket case of Brazil. More on this to come, so stay tuned.

2/2/16: China Services & Composite PMIs for January: No Signs of Roaring Growth

China Services PMI came in at a surprising uplift in January, reaching 52.4 - the highest reading since August 2015, and up on 50.2 in December. This move was surprising since Chinese services PMI has been deteriorating every month from October 2015.

Per Markit: services “providers had a strong start to 2016, with business activity increasing at the fastest rate in six months. …According to panellists, improved inflows of new business underpinned the latest expansion of services activity.”

As a reminder, the downturn in the manufacturing sector hit Chinese Manufacturing PMI hard with index falling to a 3-mo low in January and staying below 50.0 line of zero growth for 11 months in a row. Details of Manufacturing PMI dynamics are covered in-depth here: http://trueeconomics.blogspot.com/2016/02/1216-bric-manufacturing-pmi-january.html.

On a 3mo moving average basis, China Services PMI stood at 51.3 in January 2016, exactly the same as for the 3mo period through October 2015 and down on 52.7 reading for the 3mo average through January 2015. It is worth noting that the index never dipped below 50.0 in its entire history and the historical average for the index is at 55.1. Current reading is statistically significantly below the historical average.

Due to substantial improvement in the Services PMI, China’s Composite PMI signalled stabilisation in overall economy-wide Chinese business activity in January, with Composite Output Index registering fractionally above the no-change 50.0 value at 50.1, up from 49.4 in December. However, overall, Composite PMI of China has been above 50.0 in only two of the last 6 months and on both occasions, index readings were not statistically distinguishable from 50.0.

Still, 3mo average through January for Composite PMI stood at 50.0 (zero growth) against 48.9 average through October 2015 and 51.3 average through January 2015. In other words, the economy, judging by Composite PMI might be closer to stabilising, but growth is not exactly roaring back.

2/2/16: Irish Examiner on Electioneering and Fiscal Policy Space

Irish Examiner article on fiscal policy space entertained by various political parties with a couple of comments of my own: http://www.irishexaminer.com/ireland/opposition-claims-fine-gael-and-labour-figures-on-the-economy-just-dont-add-up-379637.html.

2/2/16: MNC Ireland: A new Documentary

A new and well-worth watching documentary on the power of multinational companies in Ireland and Ireland's status as a corporate tax haven is available here: https://vimeo.com/137175562.

Note: Strangely enough, the documentary cites me as a Chairman of the IRBA (which I was at the time). It is worth repeating again that I never speak on behalf of any organisation I am involved with and the IRBA never had a corporate opinion on any policy-related issues. I only express my own personal views.

1/2/16: BRIC Manufacturing PMI January: A Test of Stagnation?

I covered China Manufacturing PMI in an earlier separate note here: http://trueeconomics.blogspot.com/2016/02/31116-china-manufacturing-pmi-its-at.html with core conclusion that Chinese Manufacturing PMIs have been now running second worst in the BRIC’s group since July 2015, staying above only Brazil’s - a country that is in an outright recession. PMI index came in tat 48.4 in January, marginally up on 48.2 in December 2015, marking 11th consecutive month of sub-50 readings. 3mo average through January 2016 is now at 48.4 against 3mo average through October 2015 at 47.6. Current 3mo average is down significantly on 49.8 3mo average through January 2015. Last time Chinese Manufacturing posted statistically significant expansion (as measured by PMI reading above 51.46 - the statistically significant growth marker - was back in July 2014.

India Manufacturing PMI posted a rise to 51.1 in January from 49.1 in December, with January reading being highest in 4 months. This sounds like good news, expect it is not. The reason is that at 51.1, the PMI is well below historical average of 54.5. And it is below January 2015 level of 52.9. 3mo average through January 2016 is at zero growth mark 50.0, which compered poorly to 3mo average through October 2015 at 51.4 and worse relative to 53.6 which is 3mo average through January 2015. Market release was quite upbeat on India numbers, however, noting that “the industry recovered following the contraction seen at the end of last year. Alongside a resumption of output at some firms impacted by December’s flooding, manufacturers also benefited from rising inflows of new business from domestic and export clients.” The sectoral breakdown of the index is also concerning. Again per Markit, “The consumer goods subsector remained the principal growth engine at the start of the year, seeing substantial expansions of both output and new orders. In contrast, producers of investment goods saw output and new orders fall, while production volumes stagnated in the intermediate goods category.”

Russian PMIs were covered in a stand alone post here: http://trueeconomics.blogspot.com/2016/02/1216-russian-manufacturing-pmi-january.html with core conclusion that although Russia retained its's position as the second strongest performing economy by Manufacturing PMIs in the BRIC group in January, the latest reading puts Russian Manufacturing in a stagnation zone too close to 50.0 to call it a full-blown contraction. This has meant that over the last 3 months, Russian Manufacturing PMI averaged 49.7, a reading nominally below 50.0, although an improvement on 49.1 average for 3 months through October 2015, and on 49.4 3-mo average through January 2015. In simple terms, Russian Manufacturing continued to contract in 3 months through January 2016, but the rate of contraction was virtually indistinguishable from zero growth.


This leaves us to cover Brazil Manufacturing PMI. Brazil Manufacturing index posted a rise in January, hitting an 11-mo high of 47.4. By all normal metrics, this is a disaster territory reading, consistent with rather sharp deterioration in trading conditions. But for Brazil - this was an improvement, especially as output and news orders both were contracting at slower rates in January. Per Markit: “The downturn in the Brazilian manufacturing sector continued at the start of 2016, with levels of production and new orders contracting for the twelfth successive month. This continued to filter through to decisions relating to staff hiring, stock holdings and purchasing activity, all of which also declined during the latest survey month.”  On the positive (sort of) side, “output declined at weaker rates in each of the three production categories (consumer, intermediate and investment) covered by the survey. Underlying the latest decrease in output was a further reduction in the level of incoming new orders. The latest drop in inflows of new work received was mainly centred on the domestic market, as the volume of new export business expanded for the second straight month in January.” On a 3mo average basis, 3mo average through January 2016 is at 44.5, which is worse that 3mo average through October 2015 (45.6) and 3mo average through Ja
nuary 2015 (49.9). In simple terms, Brazil remains the basket case of BRIC economies, leading the group to the downside on Manufacturing.

Chart and table below summarise the BRIC’s outlook:

So, overall, BRIC Manufacturing side of the economy is still in a woeful shape. India's return to growth is relatively weak, while contractionary conditions prevail in Brazil (strong, albeit moderating on the end of 2015), Russia (very weak contraction, closer to stagnation) and China (where PMI data has been at serious odds with official national accounts data for some time now). The net result for the global growth is not exactly encouraging.

1/2/16: Russian Manufacturing PMI January 2016: Stagnation Looms

Russian Manufacturing PMI rebound in January compared to December slump, rising from 48.7 in December (the lowest reading since August 2015, to 49.8. Still, January reading was nominally below 50.0, signalling second consecutive month of contraction in country manufacturing activity. In statistical significance terms, January reading is basically singling zero growth.

Per Markit, this means that “Russian manufacturing sector edgeed closer to stability during the first month of 2016” with “both output and incoming new orders return to growth territory”. However, overall, “survey data for the first month of 2016 remained disappointing for Russian manufacturers, as the sector stayed in contractionary territory. Although there were marginal increases in volumes of both production and incoming new orders, job shedding was still evident. Meanwhile, average cost burdens increased at a marked pace, while a more moderate rise in output charges was reported”.

On sectoral basis,”production volumes grew at Russian goods producers during January, having contracted in the final month of 2015. Anecdotal evidence suggested the expansion in output was linked to an increase in
incoming new orders. Job cuts were still evident in the manufacturing sector of Russia in January, continuing a trend that began in July 2013. The rate of job shedding accelerated to a four-month high and was solid overall.”

All of the expansion in new orders was contained within domestic economy, “as new export orders contracted. Falling new business from abroad has been reported in every month since September 2013.”

On a 3mo average basis, Manufacturing PMI for 3 months through January 2016 was 49.7 - below 50.0, although an improvement on 49.1 average for 3 months through October 2015, and on 49.4 3-mo average through January 2015. In simple terms, Russian Manufacturing continued to contract in 3 months through January 2016, but the rate of contraction was virtually indistinguishable from zero growth.

As shown above, Russia retained its's position as the second strongest performing economy by Manufacturing PMIs in the BRIC group.

31/1/16: China Manufacturing PMI: It's at Recession Levels, Folks

China manufacturing PMI signalled another month of deterioration in operating conditions for January 2016. Per Markit, “with both output and employment declining at slightly faster rates than in December. Total new business meanwhile fell at the weakest rate in seven months, and despite a faster decline in new export work.’

Overall, PMI index came in tat 48.4 in January, marginally up on 48.2 in December 2015, marking 11th consecutive month of sub-50 readings. 3mo average through January 2016 is now at 48.4 against 3mo average through October 2015 at 47.6. Current 3mo average is down significantly on 49.8 3mo average through January 2015. Last time Chinese Manufacturing posted statistically significant expansion (as measured by PMI reading above 51.46 - the statistically significant growth marker - was back in July 2014.

Interestingly, Markit is using very ‘diplomatic’ language in their release, saying that “Production at Chinese goods producers fell for the second successive month in January. Though modest, the rate of contraction was the fastest seen in four months. According to panellists, relatively weak market conditions and fewer new orders had led firms to cut production.” In simple terms, this means that the Manufacturing sector in Chine is not growing slower, but is contracting. Which, of course, is vastly inconsistent with official GDP growth data. Over the last 15 months, Chinese Manufacturing managed to hit PMI >50.0 on only one month. One month. How this can be consistent with an economy growing at 6.9 percent is anyone’s guess.

And Chinese companies are now appearing to be deep in revenue recession too. per Markit: “Weaker client demand led manufacturers to discount their prices charged again in January, thereby extending the current sequence of deflation to 18 months (although the rate of reduction was the slowest seen since June 2015). Lower selling prices were supported by a further fall in average input costs at the start of the year.”

In fact, Chinese Manufacturing PMIs have been now running second worst in the BRIC’s group since July 2015, staying above only Brazil’s - a country that is in an outright recession.

I mean you getting any signs of the 6.8-6.9 percent growth anywhere here? No? Well, in general, Services PMIs are also in a tanking mode, but more on this separately.

31/1/16: Why is Inflation so Low? Debt + Demand + Oil = Central Bankers

One of the prevalent themes in macroeconomic circles in recent months has been what I call the “Hero Central Banker” syndrome. The story goes: faced with the unprecedented challenges of dis-inflation, Heroic Central Bankers did everything possible to induce prices recovery by deploying printing presses in innovative and outright inventive ways, but only to see their efforts undermined by the falling oil prices.

Of course, the meme is pure bull.

Firstly, there is no disinflation. There is a risk of deflation. Let’s stop pretending that negative growth rates in prices can be made somewhat more benign if we just contextualise them into a narrative of surrounding ‘recovery’. Dis-inflation is deflation anchored to an invented period duration of which no one knows, but everyone assumes to be short. And there is no hard definition of what 'short' really means either.

Secondly, there is no mystery surrounding the question of why on earth would we have ‘dis-inflation’ in the first place. Coming out of the Global Financial Crisis, the world remains awash with legacy debt (households) and new debt (corporates and governments). This simply means that no one, save for larger corporations and highly-rated governments, can borrow much in the post-GFC world. And this means that no one has much of money to spend on ‘demanding’ stuff. This means that markets are stagnating or shrinking on demand side. Now, the number of companies competing for stagnant or shrinking market is not falling. Which means these companies are getting more desperate to maintain or increase their market shares. Of these companies, those that can borrow, do borrow to fund their expansions (less via capex and more via M&As) and to support their share prices (primarily via buy-backs and further via M&As); and the same companies also cut prices to keep their effectively insolvent or debt-loaded customers. slow growing supply chases even slower growing (if not contracting) demand… and we have ‘dis-inflation’.

Note: much of this dynamic is driven by the QE that makes debt cheaper for those who can get it, but more on this later.

Thirdly, we have oil. Oil is an expensive (or used to be expensive) input into producing more stuff (more stuff that is not needed, by the companies that can’t quite afford to organically increase production for the lack of demand, as explained in the second point above). So demand for oil is going down. Production of oil is going up because we have years of investments by oil men (and few oil women) that has been sunk into getting the stuff out of the ground. We have falling oil prices. Aka, more ‘dis-inflation’.

Note: much of this dynamic is also driven by the QE which does nothing to help deleverage households and companies (supporting future demand growth) and everything to support financial sector where inflation has been all the rage until recently, and in Government bonds continues to-date.

Fourth, when Heroic Central Bankers drop policy rates and/or inject ‘free’ cash into the economy. Their actions fuel  borrowing in the areas / sectors where there either exists sufficient collateral or security of cash flows to borrow against or there is low enough debt level to sustain such new borrowing. You’ve guessed it:

• Financials (deleveraged using taxpayers funds and sweat with the help of the "Heroic Central Bankers" and protected from competition by the very same "Heroic Central Bankers") and 
• Commodities producers (who borrowed like there is no tomorrow until oil price literally fell off the cliff). 

When the former borrowed, they rolled borrowed funds into public debt and into financial markets. There was plenty inflation in these 'sectors' though they didn't quite count in the consumer price indices. For a good reason: they have little to do with consumers and lots to do with fat cats. However, part of the inflows of funds to the former went to fund ‘alternative’ energy projects - aka subsidies junkies - which further depresses demand for oil (albeit weakly). Both inflows went to support production of more oil or distribution of more oil (pipelines, refineries, export facilities etc) or both.

Meanwhile, inflows from the financial institutions to the markets usually went to larger corporates. Guess where were the big oil producers? Right: amongst the larger corporates. Thus, cheap money = cheaper oil, as long as cheap money does not dramatically drive up inflation. Which it can’t because to do so, there has to be demand growth at the household level, the very level where there is no cheap money coming and the debts remain high.

Now, take the four points above and put them together. What they collectively say is that the risk of deflation in the euro area (and anywhere else) is not down to oil price collapse, but rather it is down to demand collapse driven by debt overhang in the real economy (corporates and households and governments). And it is also down to monetary policy that fuels misallocation of credit (or risk mispricing). Only after that, risk of deflation can be assigned to oil price shock (in so far as that shock can be treated as something originating from the global economy, as opposed to from within the euro area economy). And across all these drivers for deflation risks up, there are fingerprints of many actors, but just one actor pops up everywhere: the "Heroic Central Banker".

A recent paper from the Banca d’Italia actually manages to almost grasp this, albeit, written by Central Bankers, it just comes short of the finish line.

Antonio Maria Conti, Stefano Neri and Andrea Nobili published their “Why is Inflation so Low in the Euro Area?” in July 2015 (Bank of Italy Temi di Discussione (Working Paper) No. 1019: http://ssrn.com/abstract=2687105). They focus on euro area alone, so their conclusions do treat oil price change as an exogenous shock. Still, here are their conclusions:

• “Inflation in the euro area has been falling steadily since early 2013 and at the end of 2014 turned negative. 
• "Part of the decline has been due to oil prices, but the weakness of aggregate demand has also played a significant role. …
• "The analysis suggests that in the last two years inflation has been driven down by all three factors, as the effective lower bound to policy rates has prevented the European Central Bank from reducing the short-term rates to support economic activity and align inflation with the definition of price stability. Remarkably, the joint contribution of monetary and demand shocks is at least as important as that of oil price developments to the deviation of inflation from its baseline.” 

Do note that the authors miss the QE channel leading to deflation and instead seem to think that the only thing standing between the ECB and the return to normalcy is the need to cut rates to purely negative nominal levels. In simple terms, this means the authors think that unless ECB starts giving money away to everyone, including the households (a scenario if nominal rates turn sufficiently negative) without attaching a debt lien to these loans, there is no hope. In a sense, I agree - to get things rolling, we need to cancel out household debts. This can be done (expensively) by printing cash and giving it to households (negative nominal rates). Or it can be done more cheaply by simply writing down debts, while monetising write-offs to the risk-weighted value (a fraction of the nominal debt).

I called for both measures for some years now.

Even "Heroic Central Bankers" (for now within the research departments) now smell the rotten core of the QE body: without restoring balancesheets of the households and companies, there isn't much hope for the risk of dis-inflation abating.