17/4/16: Start Ups, Manufacturing Jobs and Structural Changes in the U.S. Economy

In the forthcoming issue of the Cayman Financial Review I am focusing on the topic of the declining labour productivity in the advanced economies - a worrying trend that has been established since just prior to the onset of the Global Financial Crisis. Another trend, not highlighted by me previously in any detail, but related to the productivity slowdown is the ongoing secular relocation of employment from manufacturing to services. However, the plight of this shift in the U.S. workforce has been centre stage in the U.S. Presidential debates recently (see http://fivethirtyeight.com/features/manufacturing-jobs-are-never-coming-back/).

An interesting recent paper on the topic, titled “The Role of Start-Ups in Structural Transformation” by Robert C. Dent, Fatih Karahan, Benjamin Pugsley, and Ayşegül Şahin (Federal Reserve Bank of New York Staff Reports, no. 762, January 2016) sheds some light on the ongoing employment shift.

Per authors, “The U.S. economy has been going through a striking structural transformation—the secular reallocation of employment across sectors—over the past several decades. Most notably, the employment share of manufacturing has declined substantially, matched by an increase in the share of services. Despite a large literature studying the causes and consequences of structural transformation, little is known about the dynamics of reallocation of labor from one sector to the other.”

“There are several margins through which a sector could grow and shrink relative to the rest of the economy”:

1. “…Differences in growth and survival rates of firms across sectors could cause sectoral reallocation of employment”
2. “…differences in sectors' firm age distribution could affect reallocation since firm age is an important determinant of growth or survival behavior” 
3. “…the allocation of employment at the entry stage which we refer to as the entry margin could contribute to the gradual shift of employment from one sector to the other.”
4. “…because the speed at which differences in entry patterns are reflected in employment shares depends on the aggregate entry rate, changes in the latter could affect the extent of structural transformation.”

Factors (1) and (2) above are referenced as “life cycle margins”.

The study “dynamically decomposed the joint evolution of employment across firm age and sector”, focusing on three sectors: manufacturing, retail trade, and services.

Based on data from the Longitudinal Business Database (LBD) and Business Dynamic Statistics (BDS), the authors found that “…at least 50 percent of employment reallocation since 1987 has occurred along the entry margin.” In other words, most of changes in manufacturing jobs ratio to total jobs ratio in the U.S. economy can be accounted for by new firms creation being concentrated outside manufacturing sectors.

Furthermore, “85 percent of the decline in manufacturing employment share is predictable from the average life cycle dynamics and the early 1980s distribution of startup employment across sectors. Further changes over time in the distribution of startup employment away from manufacturing, while having a relatively small effect on manufacturing where entry is less important, explain almost one-third of the increase in the services employment share.”

Again, changed nature of entrepreneurship, as well as in the survival rate of new firms created in the services sector, act as the main determinants of the jobs re-allocation across sectors.

Interestingly, the authors found “…little role for the year-to-year variation in incumbent behavior conditional on firm age in explaining long-term sectoral reallocation.” So legacy firms have little impact on decline in manufacturing sector jobs share, which is not consistent with the commonly advanced thesis that outsourcing of American jobs abroad is the main cause of losses of manufacturing sector jobs share in the economy.

Lastly, the study found that “…a 30-year decline in overall entry (which we refer to as the \startup deficit) has a small but growing effect of dampening sectoral reallocation through the entry margin.”

These are pretty striking results.

The idea that the U.S. manufacturing (in terms of the sector importance in the economy and employment) is either in a decline or on a rebound is not as straight forward as some political debates in the U.S. suggest.

Reality is: in order to reverse or at least arrest the decades-long decline of manufacturing jobs fortunes in America, the U.S. needs to boost dramatically capex in the sector, as well as shift the sector toward greater reliance on human capital-complementary technologies. It is a process that combines automation with more design- and specialist/on-specification manufacturing-centric trends, a process that is likely to see accelerated decline in lower skills manufacturing jobs before establishing (hopefully) a rising trend for highly skilled manufacturing jobs.

17/4/16: Human Capital, Management & Value-Added

The value of management to a given firm rests not only in more efficient use of physical resources and financial capital, as well as corporate / business strategy, but also in the ability of the firm to identify, hire, retain and enable high quality human capital. This is a rather common sense conclusion that might be drawn by any analyst of management systems and any business student.

However, the question always remains as to how much of the firm value-added arises from managerial inputs, as opposed to actual human capital inputs.

Stefan Bender, Nicholas Bloom, David Card, John Van Reenen, and Stephanie Wolter decided to attempt to quantify these differences. In their paper “Management Practices, Workforce Selection and Productivity” (March 2016, NBER Working Paper No. w22101: http://ssrn.com/abstract=2752306) they note that “recent research suggests that much of the cross-firm variation in measured productivity is due to differences in use of advanced management practices.”

“Many of these practices – including monitoring, goal setting, and the use of incentives – are mediated through employee decision-making and effort. To the extent that these practices are complementary with workers’ skills, better-managed firms will tend to recruit higher-ability workers and adopt pay practices to retain these employees.”

The authors then use a survey data on the management practices of German manufacturing firms, as well as data on earnings records for their employees “to study the relationship between productivity, management, worker ability, and pay”.

Per authors: “As documented by Bloom and Van Reenen (2007) there is a strong partial correlation between management practice scores and firm-level productivity in Germany. In our preferred TFP [total factor productivity] estimates only a small fraction of this correlation is explained by the higher human capital of the average employee at better-managed firms. A larger share (about 13%) is attributable to the human capital of the highest-paid workers, a group we interpret as representing the managers of the firm. And a similar amount is mediated through the pay premiums offered by better-managed firms.”

Human capital value-added is neither uniform across types of employees, nor is it independent of the management systems, which means that increasing the value of human capital in the economy requires more emphasis on the structure of the overall utilisation of talent, not just acquisition of talent. This is exactly consistent with the C.A.R.E. framework for human capital-centric economy that I outlined some years ago, here http://trueeconomics.blogspot.com/2013/11/14112013-human-capital-age-of-change.html, the framework of Creating, Attracting, Retaining and Enabling human capital.

The study also confirms that “looking at employee inflows and outflows, … better-managed firms systematically recruit and retain workers with higher average human capital.”

Overall, the authors concluded that “workforce selection and positive pay premiums explain just under 30% of the measured impact of management practices on productivity in German manufacturing.”

These results should add to questions about the ability of the Gig-economy firms, e.g. online platforms providers for labour utilisation, such as Uber, to significantly improve productivity in the economy. The reason for this is simple: contingent workforce talent pool is at least one step further removed from management than in the case of traditional employees. As the result, it is quite possible that contingent workforce productivity does not benefit directly from management quality. If so, that sizeable, ‘just under 30% of the measured impact’ in terms of improved productivity, arising from better management practices, workforce selection and pay premiums can be out of reach for Gig-economy firms and their contingent workers.

Again, as I noted repeatedly, including in my recent presentation at the CXC Global “Future of Work” Summit (see here: http://trueeconomics.blogspot.com/2016/04/7416-globalization-and-future-of-work.html), the key to developing a productive and sustainable Gig-economy will be in our ability to develop institutional, regulatory and strategic frameworks for improving management of human capital held by contingent workforce.

17/4/16: Peer Effects in Classroom: The Value of Better Discipline?

In workplace, as well as in education, peer-pressure and competition, peer-linked cooperation and collaboration and other peer-linked effects of have been important contributors to work- and learning-related outcomes. Ditto for entrepreneurship, as collaborated by the effects of clusters, such as the Silicon Valley. However, we tend to think of peer effects as arising from more mature, adult-level interactions in either third level education, or career-linked workplaces.

As noted by Scott Carrell, Mark Hoekstra and Elira Kuka in their paper “The Long-Run Effects of Disruptive Peers” (February 2016 as NBER WP No. w22042: http://ssrn.com/abstract=2739567), “there is relatively little evidence on the long-run educational and labor market consequences of childhood peers.”

So the authors examined “administrative data on elementary school students” and students’ “subsequent test scores, college attendance and completion, and earnings” to identify any potential effects of childhood peers on educational outcomes.

“To distinguish the effect of peers from confounding factors, we exploit the population variation in the proportion of children from families linked to domestic violence, who were shown by Carrell and Hoekstra (2010, 2012) to disrupt contemporaneous behavior and learning.”

The end results show that “exposure to a disruptive peer in classes of 25 during elementary school reduces earnings at age 26 by 3 to 4 percent. We estimate that differential exposure to children linked to domestic violence explains 5 to 6 percent of the rich-poor earnings gap in our data, and that removing one disruptive peer from a classroom for one year would raise the present discounted value of classmates' future earnings by $100,000.”

These are striking numbers. Accumulated over life-cycle of employment, gains from reducing classroom-level disruptive behaviour of peers can lead to a significant uplift in both, economic welfare and individual financial wellbeing. It can also, potentially, help closing the income inequality gaps. The question, however, is how does one achieve such an outcome in the real world, where even disruptive students have a right to education.

15/4/16: Tech Sector Finance: Gravity of Gravy

Previously, having posted on disconnection between S&P500 market valuations and basic corporate finance (earnings and distributions) - see that post here: http://trueeconomics.blogspot.com/2016/04/15416-corporate-finance-s-and-bubble.html - it is time to remind us all what a popping bubble looks like.

Earlier this month, I was in San Francisco, the epicentre of the corporate finance-free world of tech. Not surprisingly, few smoke breaks and few chats over a glass of wine with some tech folks revealed a very interesting insight: every single one tech CEO/CFO/COO (but not CTO) I spoke to was concerned with evaporating funding in the markets for non-public equity financing around the Silicon Valley.

Need confirmation? Here is a chart through 1Q 2016 on Tech IPOs trends:

Source: https://www.theatlas.com/charts/Nkk4jHLCe

And a note from the WSJ: http://www.wsj.com/articles/startup-investors-hit-the-brakes-1460676478 on same with a handy graph:

And the numbers of deals? Why, off the cliff too:

Source: https://www.theatlas.com/charts/Vk8_bYUAl

There is not panic, yet, but there is panic already in works: techies are retrenching on new hiring and there are rumours of some layoffs in younger companies. Meanwhile, states-sponsored agencies seeking to lock start ups and existent players into relocating to their countries or landing in the countries with regional HQs are still shopping around, as if money will always be there to rent plush offices and the case-styled furniture for those whiz kids who make up apps with little cash flow behind them...

It all might be temporary. Or it might be the beginning of the real thing. But one thing is certain: on a long enough timeline, one can defy gravity of basic corporate finance only as long as the interest rates defy gravity of risk pricing.

15/4/16: Corporate Finance, S&P500 and Bubble Trouble...

Classical corporate finance tells us that companies should be valued on their earnings with past earnings being indicative of future earnings (predictive component). Which is tosh. In today's world that is.

Q4 2016 saw highest payouts to shareholders (combined cash dividends and share repurchases) in over 10 years (couple of slides from my course presentation):

And yet... yet... earnings have hit the brick wall back in Q3 2014 and have been trending down ever since:

You really can't call S&P500 anything but a sail-in-the-Fed-wind. There are no fundamentals sustaining it above 1600-1650 range. At least, not corporate fundamentals.

Unless, of course, one expects the recent extraordinary payout performance to remain indefinitely present in the future. Which only a sell-side analyst or a lunatic can...

15/4/16: Slovakia v France: Risk Divergence

I love it when the good guys lead: "Slovakia leaps ahead of France, reveals country risk survey

Full article available here: http://www.euromoney.com/Article/3545875/Slovakia-leaps-ahead-of-France-reveals-country-risk-survey.html?copyrightInfo=true

My full comment on the matter:

"From macroeconomic perspective the two economies appear to be heading in the opposite direction.

While France is experiencing weakening growth momentum with forecast real GDP growth rates for 2016-2017 at around 1.55 percent on average and declining (1H 2015 compared to current, a forecast swing of around 0.05 percentage points), Slovakian economy is gaining speed, with current forecast growth rate at around 3.57 percent for 2016-2017, representing an upgrade of around 0.3 percentage points.

Much of this is accounted for by differences in investment (rising in Slovakia, as a share of GDP, while relatively stagnant in France), as well as growth in exports of goods and services (with Slovakia expected to outperform France in terms of growth in exports in both 2016 and 2017 - a reversal on 2015 outrun).

In fiscal policy terms, both countries are expected to post modest reduction in total burden of Government in the economy, reflected in the declining ratio of Government revenues to GDP over 2016-2017. However, in France, this forecast is less certain due to political cycle and ongoing lack of progress on both structural reforms and fiscal targets. In contrast, Slovakia already runs relatively lean, strongly value-for-money focused public spending policies. As the result, even under relatively rosy projections, France will continue to post greater Government deficits than Slovakia through 2017. Crucially, even with negative Government yields on French debt, France is currently running deeper primary deficits than Slovakia, which suggests that the French fiscal space is much thinner than headline difference between the two countries suggest.

The above dynamics also point to continued divergence between the two countries' paths in terms of external balances. Slovakia's current account surplus in 2016-2017 is likely to average at around 0.15 percent of GDP. In contrast, France's current account deficit is expected to be around 0.37 percent of GDP.

In simple terms, diverging macroeconomic and political risks paths do warrant risk repricing in the case of both Slovakia (to the downside of risks) and France (to the upside in terms of risks assessment) into 2016, and possibly into 2017."

The risk trends are indeed showing counter-movement:

15/4/16: Of Breakeven Price of Oil: Russia v ROW

There has been much confusion in recent months as to the 'break-even' price of oil for Russian and other producers. In particular, some analysts have, in the past, claimed that Russian production is bust at oil prices below USD40pb, USD30pb and so on.

This ignores the effects of Ruble valuations on oil production costs. Devalued Ruble results in lower U.S. Dollar break-even pricing of oil production for Russian producers.

It also ignores the capital cost of production (which is not only denominated in Rubles, with exception of smaller share of Dollar and Euro-denominated debt, but is also partially offset by the cross-holdings of Russian corporate debt by affiliated banks and investment funds). It generally ignores capital structuring of various producers, including the values of tax shields and leverage ratios involved.

Third factor driving oil break-even price for Russian (and other) producers is ability to switch some of production across the fields, pursuing lower cost, less mature fields where extraction costs might be lower. This is independent of type of field referenced (conventional vs unconventional oils).

Russian Energy Ministry recently stated that Russian oil production break-even price of Brent for Russian producers is around USD 2 pb, which reflects (more likely than not) top quality fields for conventional oil. Russian shale reserves break-even at USD20 pb. In contrast, Rosneft estimates break-even at USD2.7 pb (February 2016 estimate) down from USD4.0 pb (September 2015 estimate).

Here is a chart mapping international comparatives in terms of break-even prices that more closely resembles the above statements:

Here is another chart (from November 2015) showing more crude averaging, with breakdown between notional capital costs (not separating capital costs that are soft leverage - cross-owned - from hard leverage - carrying hard claims on EBIT):

Another point of contention with the above figures is that they use Brent grade pricing as a benchmark, whereby Russian oil is priced at Urals grade, while U.S. prices oil at WTI (see here: http://oilprice.com/Energy/Crude-Oil/Will-Russian-Urals-Overtake-Brent-As-The-Worlds-Oil-Benchmark.html). All three benchmarks are moving targets relative to each other, but adjusting for two factors:

• Historical Brent-Urals spread at around 3.5-4 USD pb and
• Ongoing increase in Urals-like supply of Iranian oil

we can relatively safely say that Russian break-even production point is probably closer to USD7.5-10 pb Brent benchmark than to USD20pb or USD30pb.

Another interesting aspect of the charts above is related to the first chart, which shows clearly that Russian state extracts more in revenues, relative to production costs, from each barrel of oil than the U.S. unconventional oil rate of revenue extraction. Now, you might think that higher burden of taxation (extraction) is bad, except, of course, when it comes to the economic effects of the curse of oil. In normal economic setting, a country producing natural resources should aim to capture more of natural resources revenues into reserve funds to reduce its economic concentration on the extractive sectors. So Russia appears to be doing this. Which, assuming (a tall assumption, of course) Russia can increase efficiency of its fiscal spending, means that Russia can more effectively divert oil-related cash flows toward internal investment and development.

During the boom years, it failed to do so (see here: http://trueeconomics.blogspot.com/2016/02/10216-was-resource-boom-boom-for.html) although it was not unique amongst oil producers in its failure. 

Note: WSJ just published some figures on the same topic, which largely align with my analysis above: http://graphics.wsj.com/oil-barrel-breakdown/?mod=e2tw.

Update: Bloomberg summarises impact of low oil prices on U.S. banks' balancesheets: http://www.bloomberg.com/news/articles/2016-04-15/wall-street-s-oil-crash-a-story-told-in-charts.

Update 2: Meanwhile, Daily Reckoning posted this handy chart showing the futility of forecasting oil prices with 'expert' models

15/4/16: Banking Union, Competition and Banking Sector Concentration

One of the key changes in recent years across the entire U.S. economy has been growth in market concentration (lower competition) and regulatory burden increases in a number of sector, including banking. A good summary of the matter is provided here: http://www.americanactionforum.org/research/market-concentration-grew-obama-administration/ .

However, an interesting chart based on the U.S. Fed data, shows that even with these changes U.S. banking sector remains relatively more competitive than in other advanced economies:

Source: @HPSInsight

Interestingly, European banks are also becoming more regional, as opposed to global, players as discussed here: http://www.nakedcapitalism.com/2016/03/the-us-is-beginning-to-dominate-global-investment-banking-implications-for-europe.html

Chart next shows market shares of the European Investment Banking markets accruing to banks originating in the following jurisdictions:

Source: @NakedCapitalism

As an argument goes: “Deutsche Bank and Barclays are the only Europeans left in the top seven for the EMEA market. But they are likely to lose their positions because Deutsche Bank is currently undergoing a major reorganisation and Barclays is in the process of executing the Vickers split. In the investment banking field, the only pan-European banks will all soon be American. This has the corollary, for good or bad, that European national and EU-level authorities, such as the European Commission, will have rather less direct control over them. A key part of the European financial system is slipping out of the grasp of the European authorities.”

Which begs two questions:

Does Europe need more regulation-induced consolidation in the sector, aiming to make TBTF European banking giants even bigger and even less diversified globally, as the European Banking Union and European Capital Markets Union, coupled with increasing push toward greater regulatory constraints on Fintech sector are likely to do?

Or does Europe need more disruptive and more agile, as well as risk-diversified, smaller banking systems and more open innovation culture in banking and financial services?


Note: you can see my analysis of the European Capital Markets Union here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2592918

12/4/16: Look, Ma... It's [not] Working: IMF & the R-word

A handy chart from the IMF highlighting changes over the last 12 months in forecast probability of recession 12mo forward across the global economy

Yes, things are getting boomier... as every major region, save Asia and ROW are experiencing higher probability of recession today than in both October 2015 and April 2015, and as probability of a recession in 2016 is now above 30 percent for the Euro area and above 40 percent for Japan.

In that 'repaired' world of Central Banks' activism (described here: http://trueeconomics.blogspot.com/2016/04/12416-imf-rip-growth-update-risks.html) we can only dream of more assets purchases and more government debt monetizing, and more public investment on things we all can't live without...

Because, look, it's working:

12/4/16: IMF (RIP) Growth Update: Risks Realism, Policy Idiocy

IMF WORLD ECONOMIC OUTLOOK update out today (we don’t yet have full data set update).

Top line forecasts published confirm what we already knew: global economic growth is going nowhere, fast.  Actually, faster than 3 months ago.

Run through top figures:

• Global growth: In October 2015 (last full data update we had), the forecast for 2016-2017 was 3.6 percent and 3.8 percent. Now, it is 3.2 percent and 3.5 percent. Cumulated loss (over 2016-2017) of 0.725 percentage points in world GDP within a span 6 months.
• Advanced Economies growth: October 2015 forecast was for 2.2% in 2016 and 2.2% in 2017. Now: 1.9% and 2.0%. Cumulated loss of 0.51 percentage points in 6 months
• U.S.: October 2015 outlook estimated 2016-2017 annual rate of growth at 2.8 percent. April 2016 forecast is 2.4% and 2.5% respectively, for a cumulative two-years loss in growth terms of 0.72 percentage points
• Euro area: the comatose of growth were supposed to eek out GDP expansion of 1.6 and 1.7 percent in 2016-2017 under October 2015 forecast. April 2016 forecast suggests growth is expected to be 1.5% and 1.6%. The region remains the weakest advanced economy after Japan
• Japan is now completely, officially dead-zone for growth. In October 2015, IMF was forecasting growth of 1% in 2016 and 0.4% in 2017. That was bad? Now the forecast is for 0.5% and -0.1% respectively. Cumulated loss in Japan’s real GDP over 2016-2017 is 1.005 percentage points.
• Brazil: Following 3.8 contraction in 2015 is now expected to produce another 3.8 contraction in real GDP in 2016 before returning to 0.00 percent growth in 2017. Contrast this with October WEO forecast for 2016 growth at -1% and 2017 forecast for growth of +2.3% and you have two-years cumulated loss in real GDP of a whooping 5.08 percentage points.
• Russia: projections for 2016-2017 growth published in October 2015 were at -0.6% and 1% respectively. New projections are -1.8% and +0.8%, implying a cumulative loss in real GDP outlook for 2016-2017 of 1.41 percentage points.
• India: The only country covered by today’s update with no revisions to October 2015 forecasts. IMF still expects the country economy to expand 7.5% per annum in both 2016 and 2017
• China: China is the only country with an upgrade for forecasts for both 2016 and 2017 compared to both January 2016 and October 2016 IMF releases. Chinese economy is now forecast to grow 6.5% and 6.2% in 2016 and 2017, compared to October 2015 forecast of 6.3% and 6.0%.

Beyond growth forecasts, IMF also revised its forecasts for World Trade Volumes. In October 2015, the Fund projected World Growth to expand at 4.1% and 4.6% y/y in 2016 and 2017. April 2016 update sees this growth falling to 3.1% and 3.8%, respectively. And this is without accounting for poor prices performance.

In short, World economy’s trip through the Deadville (that started around 2011) is running swimmingly:

Meanwhile, as IMF notes, “financial risks prominent, together with geopolitical shocks, political discord”. In other words,we are one shock away from a disaster.

IMF response to this is: "The current diminished outlook calls for an immediate, proactive response… To support global growth, …there is a need for a more potent policy mix—a three-pronged policy approach based on structural, fiscal, and monetary policies.” In other words, what IMF thinks the world needs is:

1. More private & financial debt shoved into the system via Central Banks
2. More deficit spending to boost Government debt levels for the sake of ‘jobs creation’, and
3. More tax ‘rebalancing’ to make sure you don’t feel too wealthy from (1) and (2) above, whilst those who do get wealthy from (1) and (2) - aka banks, institutional investors, crony state-connected contractors - can continue to enjoy tax holidays.

In addition, of course, the fabled IMF ‘structural reforms’ are supposed to benefit the World Economy by making sure that labour income does not get any growth any time soon. Because, you know, someone (labour earners) has to suffer if someone (banks & investment markets) were to party a bit harder… for sustainability sake.

IMF grafts this idiocy of an advice onto partially realistic analysis of underlying risks to global growth:

• “The recovery is hampered by weak demand, partly held down by unresolved crisis legacies, as well as unfavorable demographics and low productivity growth. In the United States, ..domestic demand will be supported by strengthening balance sheets, no further fiscal drag, and an improving housing market. These forces are expected to offset the drag to net exports coming from a strong dollar and weaker manufacturing.” One wonders if the IMF noticed rising debt levels in households (car loans, student loans) or U.S. corporates, or indeed the U.S. Government debt dynamics
• “In the euro area, low investment, high unemployment, and weak balance sheets weigh on growth…” You can’t but wonder if the IMF actually is capable of seeing households of Europe as still being somewhat economically alive.

But the Fund does see incoming risks rising: “In the current environment of weak growth, risks to the outlook are now more pronounced. These include:

• A return of financial turmoil, impairing confidence. For instance, an additional bout of exchange rate depreciations in emerging economies could further worsen corporate balance sheets, and a sharp decline in capital inflows could force a rapid compression of domestic demand. [Note: nothing about Western Banks being effectively zombified by capital requirements uncertainty, corporate over-leveraging, still weighted down by poor quality assets, etc]
• A sharper slowdown in China than currently projected could have strong international spillovers through trade, commodity prices, and confidence, and lead to a more generalized slowdown in the global economy. 
• Shocks of a noneconomic origin—related to geopolitical conflicts, political discord, terrorism, refugee flows, or global epidemics—loom over some countries and regions and, if left unchecked, could have significant spillovers on global economic activity.”

The key point, however, is that with currently excessively leveraged Central Banks’ balance sheets and with interest rates being effectively at zero, any of the above (and other, unmentioned by the IMF) shocks can derail the entire wedding of the ugly groom with an unsightly bride that politicians around the world call ‘the ongoing recovery’. And that point is only a sub-text to the IMF latest update. It should have been the front page of it.

So before anyone noticed, almost a 1,000 rate cuts around the world later, and roughly USD20 trillion in various asset purchasing programmes around the globe, trillions in bad assets work-outs and tens of trillions in Government and corporate debt uplifts, we are still where we were: at a point of system fragility being so acute, even the half-blind moles of IMF spotting the shine of the incoming train.

10/4/16: The Real 'Panamas' Of Tax Havens... Are Not In Central America

The story of the Panama Papers leak has brought, on a 3.6 terabyte scale, the issue of money laundering and tax evasion back to the forefront of the mainstream media. However, quietly, and unnoticed by the majority of the punters, tax optimisation and tax evasion have been moving closer and closer to the homesteads of the Governments so keen on reducing it elsewhere, beyond their own borders.

Here are just a couple of links worth checking out on the matter:

1. The role of Nevada (yes, one of the U.S. states) as an emerging tax haven of choice: http://www.bloomberg.com/news/articles/2016-01-27/the-world-s-favorite-new-tax-haven-is-the-united-states
2. The role of the UK (yes, another - alongside the U.S. - leader in BEPS process and the driver of the G20 push to close down ‘other nations’’ tax havens) : http://www.mirror.co.uk/news/uk-news/london-now-worlds-capital-money-7729809

Of course, the shocker no one wants to highlight when it comes to Panama Papers is that Panama became a tax haven conduit for the world on foot of U.S.-approved and / or U.S.-tolerated policies choices that stretch decades after decades after decades.

Panama’s first dappling with tax haven status was in 1927, when the country accommodated first registrations of foreign ships in a move designed to shield Rockefeller's Standard Oil from U.S. taxmen. The law allowed foreign owners to set up tax-free, anonymous corporations with little disclosures, including no requirement to disclose beneficial owners.

By 1948, the country set up its first ‘free trade zones’. One of these - the Colon FTZ - became the largest free trade zone (or tax free zone) in all of the Americas, a hit spot for trading for narcos and black marketeers.

By 1980s, Panama was saturated with offshore accounts schemes and by 1980s these started to attract large volumes of drug money. By the late 1990s, the former were pushed deeper into secrecy and the top trade became politicians, wealthy individual investors and others.

A good summary of Panama's tax haven history is available here: http://www.theguardian.com/world/2016/apr/10/panama-canal-president-jp-morgan-tax-haven.

The U.S. always knew this. And the U.S. knew this when in penned and subsequently implemented the 2011 Free Trade Agreement (with both Presidents George W. Bush and Barak Obama being behind that pearl of ‘free trade’ wisdom). One side of the coin was that FTA required Panama to enter into a separate tax information exchange treaty with the U.S., on the surface, implying improved transparency. But behind the scenes, Panama gained effectively an ‘all-clear’ sign from the U.S., making the country officially ‘compliant’. This meant that Panama could operate even more brazenly in the global markets, as long as it satisfied minimal U.S. requirements on disclosures.

Worse, until February 2016, the Financial Action Task Force (FATF), an international body responsible for setting and monitoring anti-money laundering rules, had Panama on its "blacklist" of non-compliant countries. Something the U.S. knew too. It was removed from the list because the Government passed some new laws designed to curb inflows of outright criminal funds into its financial system

In February 2014, the IMF carried out review of Panama’s regulatory and enforcement regimes relating to FATF regulations. Here is the first line conclusion from the IMF: “Panama is vulnerable to money laundering (ML) from a number of sources including drug trafficking and other predicate crimes committed abroad such as fraud, financial and tax crimes” (see full report here: http://www.imf.org/external/pubs/ft/scr/2014/cr1454.pdf).

When it comes to money laundering (ML), the IMF states that “According to the [Panamanian] authorities, the largest source of ML is drug trafficking. Other significant but less important predicate offenses and sources of ML are cited to include: arms trafficking, financial crimes, human trafficking, kidnapping, corruption of public officials and illicit enrichment. With respect to predicate crimes committed outside of Panama, the authorities indicate that these would include activities related to financial crimes, tax crimes (tax evasion is not a predicate crime for ML in Panama) and fraud. These foreign offenses are likely to be linked with Panama’s position as an offshore jurisdiction. It is believed that ML related to these crimes is conducted electronically through the use of computers and the internet using new banking instruments and systems both in Panama and internationally. The authorities indicated that the diversity of foreign predicate crimes has been increasing in recent times.”

Overall, Panama laws still do not cover, even under the U.S. ‘enhanced transparency’ regime actions of lawyers, accountants, insurance companies, notaries, real estate agents or brokers dealing in precious metals and stones.

This all is now coming as a shocker for the U.S. and UK and European authorities in the wake of the Panama Papers leak? Give me a break!

The co-founder of Mossack Fonseca, Ramon Fonseca, recently accused the BEPS-leading countries, the U.S. and UK of hypocrisy. "I assure you there is more dirty money in New York, Miami and London than there is in Panama," he told the New York Times (see: http://www.bbc.com/news/business-35998801). And just in case you wonder, here are top 30 countries in terms of financial secrecy laws:

Source: http://www.financialsecrecyindex.com/introduction/fsi-2015-results

Yep. USA - Number 3... and so on...

10/4/16: Russian Bonds Issuance: Some Recent Points of Pressure

Catching up with some data from past few weeks over a number of post and starting with some Russian data.

First, March issue of Russian bonds. The interesting bit relating RUB22.8 billion issuance was less the numbers, but the trend on issuance and issuance underwriting.

First, bid cover was more than four times the amount of August 2021 bonds on offer, raising RUB22.8 billion ($337 million) across

• fixed-rate notes (bids amounted to RUB47 billion on RUB11.5 billion of August 2021 bonds on offer)
• floating-rate notes (bids amounted to RUB25 billion on issuance of RUB9.33 billion of December 2017 floating coupon paper) and 
• inflation-linked securities (amounting to RUB2.01 billion)

This meant that Russia covered in one go 90 percent of its planned issuance for 1Q 2016, as noted by Bloomberg at the time - the highest coverage since 2011. With this, the Finance Ministry will aim to sell RUB270 billion in the 2Q 2016.

Bloomberg provided a handy chart showing as much:

Now, in 2011, Russian economy was still at the very beginning of a structural slowdown period and well ahead of any visibility of sanctions.

Sanctions are not directly impacting sales of Russian Government bonds, but the U.S. has consistently applied pressure on American and European banks attempting to prevent them from underwriting Moscow's Government issues (http://www.wsj.com/articles/u-s-warns-banks-off-russian-bonds-1456362124). Prior to the auction, Moscow invited 25 Western banks and 3 domestic banks to bid for USD3 billion worth of Eurobonds (the first issuance of Eurobonds by Russia since 2013). Despite the EU official statement that current sanctions regime does not prohibit purchases or sales of Government bonds, Western banks took to the hills (at least officially).

The point of the U.S. pressure on the European banks is a simple threat: in recent years, the U.S. regulators have aggressively pursued European banks for infringements on sanctions against Iran and other activities. In effect, U.S. regulatory enforcement has been used to establish Washington's power point over European banking institutions. And the end game was that, despite being legal, sale of Eurobonds was off limits for BNP Paribas, Credit Suisse, Deutsche Bank, HSBC, and UBS, not to mention U.S.-based Bank of America, Citi, Goldman Sachs, JP Morgan Chase, Morgan Stanley and Wells Fargo.

Another dimension of pressure is the denomination of the Eurobond. Moscow wanted Eurobond issued in dollars. However, dollar-issuance requires settlement via the U.S., enhancing U.S. authorities power to exercise arbitrary restriction on a deal that is legal under the U.S. laws (as not being officially covered by sanctions).

Beyond underwriters, even buy-side for Russian Government bonds is being pressured, primarily by the U.S., with a range of European and American investment funds getting hammered: http://www.bloomberg.com/news/articles/2016-03-24/russia-loses-buyside-support-for-eurobond-after-banks-balk.

Russian Government bonds (10 year benchmark) are trading at around 9.26-9.3 percent yield range, well down on December 2014 peak of over 14.09 percent, but still massively above bonds for countries with comparable macroeconomic performance statistics.

Interestingly, there is a huge demand in the market for Russian Eurobonds, as witnessed by mid-March issuance by Gazprom of bonds denominated in CHF (see: http://www.bloomberg.com/news/articles/2016-03-16/gazprom-taps-switzerland-with-russia-s-first-eurobond-this-year).

It is worth noting again that Russian Government bonds are not covered by any sanctions and are completely legal to underwrite and transact in.

Beyond this, the Western sanctions were explicitly designed to avoid placing financial pressures on ordinary Russians. Government bonds are used to fund general Government deficits arising from all lines of Government expenditure, including healthcare, social welfare, education etc, but also including military spending, while excluding supports for sanctioned enterprises and banks (the latter line of expenditure is linked to funds being sourced from the SWF reserves). Given this, the U.S. position on bonds issuance represents a potential departure from the U.S.-stated objective of sanctions and can be interpreted as an attempt to directly induce pain on ordinary Russians (the more vulnerable segments of the population, such as the elderly, children and those in need of healthcare, or as they are termed in Russian - budgetniki - those whose incomes depend on the Budgetary allocations).

This is a sad turn of events from markets and U.S. policy perspectives - placing arbitrary and extra-legal restrictions on transactions that are perfectly legal is not a good policy basis, unless the U.S. objective is to fully politicise financial markets in general. Neither is the U.S. position consistent with the ethical stance de jure adopted under the sanctions regime.