21/5/16: Euro Area Income per Capita: Is the Crisis Finally Over?

Has euro area recovered from the crisis on a per-capita basis? 

Let’s take a look at the latest data available from the Eurostat, covering the period through 4Q 2015.

Looking at the Nominal gross disposable income per capita first: in 4Q 2015, income per capita in the euro area stood at +6.67 percent premium over the pre-crisis peak (measured as an average of 4 highest pre-crisis quarters) and at +3.86 percent premium to the overall highest pre-crisis quarter reading. This is not new: the measure attained its pre-crisis peak within 6 quarters following the peak quarter (3Q 2008). So by this metric, the answer to the above question is ‘Yes’.

Now, consider Real gross disposable income per capita: in 4Q 2015, real income per capita in the euro area was still down 0.57 percent on pre-crisis peak (based on 4 quarters pre-crisis peak average) and down 0.72 percent on pre-crisis peak quarter. Given the peak quarter was in 1Q 2008, we are now into 31 quarters of a crisis and counting. Notably, due to deflation at the height of the crisis, real disposable per capita income actually reached above the pre-crisis peak in 3Q 2009, and as of 4Q 2015, real disposable income per capita in the euro area is down on that reading some 1.31 percent. So by real (inflation-adjusted) metric, the answer to the above question is ’No’.

Lastly, consider Real actual final consumption per capita: in 4Q 2015, real consumption per capita in the euro area was 0.25 percent below pre-crisis peak (for peak measured as an average of four quarters including the peak quarter); and it is down 0.52 percent on pre-crisis peak quarter. As with real income per capita, we now into 31 quarters of below-peak real consumption, so the crisis goes on, judging by this metric.

Here’s a chart to illustrate:

21/5/16: Banks Deposit Insurance: Got Candy, Mate?…

Since the end of the [acute phase] Global Financial Crisis, European banking regulators have been pushing forward the idea that crisis response measures required to deal with any future [of course never to be labeled ‘systemic’] banking crises will require a new, strengthened regime based on three pillars of regulatory and balance sheet measures:

• Pillar 1: Harmonized regulatory supervision and oversight over banking institutions (micro-prudential oversight);
• Pillar 2: Stronger capital buffers (in quantity and quality) alongside pre-prescribed ordering of bailable capital (Tier 1, intermediate, and deposits bail-ins), buffered by harmonized depositor insurance schemes (also covered under micro-prudential oversight); and
• Pillar 3: Harmonized risk monitoring and management (macro-prudential oversight)

All of this firms the core idea behind the European System of Financial Supervision. Per EU Parliament (http://www.europarl.europa.eu/atyourservice/en/displayFtu.html?ftuId=FTU_3.2.5.html): “The objectives of the ESFS include developing a common supervisory culture and facilitating a single European financial market.”

Theory aside, the above Pillars are bogus and I have commented on them on this blog and elsewhere. If anything, they represent a singular, infinitely deep confidence trap whereby policymakers, supervisors, banks and banks’ clients are likely to place even more confidence at the hands of the no-wiser regulators and supervisors who cluelessly slept through the 2000-2007 build up of massive banking sector imbalances. And there is plenty of criticism of the architecture and the very philosophical foundations of the ESFS around.

Sugar buzz!...

However, generally, there is at least a strong consensus on desirability of the deposits insurance scheme, a consensus that stretches across all sides of political spectrum. Here’s what the EU has to say about the scheme: “DGSs are closely linked to the recovery and resolution procedure of credit institutions and provide an important safeguard for financial stability.”

But what about the evidence to support this assertion? Why, there is an fresh study with ink still drying on it via NBER (see details below) that looks into that matter.

Per NBER authors: “Economic theories posit that bank liability insurance is designed as serving the public interest by mitigating systemic risk in the banking system through liquidity risk reduction. Political theories see liability insurance as serving the private interests of banks, bank borrowers, and depositors, potentially at the expense of the public interest.” So at the very least, there is a theoretical conflict implied in a general deposit insurance concept. Under the economic theory, deposits insurance is an important driver for risk reduction in the banking system, inducing systemic stability. Under the political theory - it is itself a source of risk and thus can result in a systemic risk amplification.

“Empirical evidence – both historical and contemporary – supports the private-interest approach as liability insurance generally has been associated with increases, rather than decreases, in systemic risk.” Wait, but the EU says deposit insurance will “provide an important safeguard for financial stability”. Maybe the EU knows a trick or two to resolve that empirical regularity?

Unlikely, according to the NBER study: “Exceptions to this rule are rare, and reflect design features that prevent moral hazard and adverse selection. Prudential regulation of insured banks has generally not been a very effective tool in limiting the systemic risk increases associated with liability insurance. This likely reflects purposeful failures in regulation; if liability insurance is motivated by private interests, then there would be little point to removing the subsidies it creates through strict regulation. That same logic explains why more effective policies for addressing systemic risk are not employed in place of liability insurance.”

Aha, EU would have to become apolitical when it comes to banking sector regulation, supervision, policies and incentives, subsidies and markets supports and interventions in order to have a chance (not even a guarantee) the deposits insurance mechanism will work to reduce systemic risk not increase it. Any bets for what chances we have in achieving such depolitization? Yeah, right, nor would I give that anything above 10 percent.

Worse, NBER research argues that “the politics of liability insurance also should not be construed narrowly to encompass only the vested interests of bankers. Indeed, in many countries, it has been installed as a pass-through subsidy targeted to particular classes of bank borrowers.”

So in basic terms, deposit insurance is a subsidy; it is in fact a politically targeted subsidy to favor some borrowers at the expense of the system stability, and it is a perverse incentive for the banks to take on more risk. Back to those three pillars, folks - still think there won’t be any [though shall not call them ‘systemic’] crises with bail-ins and taxpayers’ hits in the GloriEUs Future?…


Full paper: Calomiris, Charles W. and Jaremski, Matthew, “Deposit Insurance: Theories and Facts” (May 2016, NBER Working Paper No. w22223: http://ssrn.com/abstract=2777311)

21/5/16: Voters selection biases and political outcomes

A recent study based on data from Austria looked at the impact of compulsory voting laws on voter quality.

Based on state and national elections data from 1949-2010, the authors “show that compulsory voting laws with weakly enforced fines increase turnout by roughly 10 percentage points. However, we find no evidence that this change in turnout affected government spending patterns (in levels or composition) or electoral outcomes. Individual-level data on turnout and political preferences suggest these results occur because individuals swayed to vote due to compulsory voting are more likely to be non-partisan, have low interest in politics, and be uninformed.”

In other words, it looks like there is a selection bias being triggered by compulsory voting: lower quality of voters enter the process, but due to their lower quality, these voters do not induce a bias away from state quo. Whatever the merit of increasing voter turnouts via compulsory voting requirements may be, it does not appear to bring about more enlightened choices in policies.

Full study is available here: Hoffman, Mitchell and León, Gianmarco and Lombardi, María, “Compulsory Voting, Turnout, and Government Spending: Evidence from Austria” (May 2016, NBER Working Paper No. w22221: http://ssrn.com/abstract=2777309)

So can you 'vote out' stupidity?..

20/5/16: Business Owners: Not Great With Counterfactuals

A recent paper, based on a “survey of participants in a large-scale business plan competition experiment, [in Nigeria] in which winners received an average of US$50,000 each, is used to elicit beliefs about what the outcomes would have been in the alternative treatment status.”

So what exactly was done? Business owners were basically asked what would have happened to their business had an alternative business investment process taken place, as opposed to the one that took place under the competition outcome. “Winners in the treatment group are asked subjective expectations questions about what would have happened to their business should they have lost, and non‐winners in the control group asked similar questions about what would have happened should they have won.”

“Ex ante one can think of several possibilities as to the likely accuracy of the counterfactuals”:

1. “…business owners are not systematically wrong about the impact of the program, so that the average treatment impact estimated using the counterfactuals should be similar to the experimental treatment effect. One potential reason to think this is that in applying for the competition the business owners had spent four days learning how to develop a business plan… outlining how they would use the grant to develop their business. The control group [competition losers] have therefore all had to previously make projections and plans for business growth based on what would happen if they won, so that we are asking about a counterfactual they have spent time thinking about.”
2. ”…behavioral factors lead to systematic biases in how individuals think of these counterfactuals. For example, the treatment group may wish to attribute their success to their own hard work and talent rather than to winning the program, in which case they would underestimate the program effect. Conversely they may fail to take account of the progress they would have made anyway, attributing all their growth to the program and overstating the effect. The control group might want to make themselves feel better about missing out on the program by understating its impact (...not winning does not matter that much). Conversely they may want to make themselves feel better about their current level of business success by overstating the impact of the program (saying to themselves I may be small today, but it is only because I did not win and if I had that grant I would be very successful).”

The actual results show that business owners “do not provide accurate counterfactuals” even in this case where competition awards (and thus intervention or shock) was very large.

• The authors found that “both the control and treatment groups systematically overestimate how important winning the program would be for firm growth… 
• “…the control group thinks they would grow more had they won than the treatment group actually grew”
• “…the treatment group thinks they would grow less had they lost than the control group actually grew” 

Or in other words: losers overestimate benefits of winning, winners overestimate the adverse impact from losing... and no one is capable of correctly analysing own counterfactuals.


Full paper is available here: McKenzie, David J., Can Business Owners Form Accurate Counterfactuals? Eliciting Treatment and Control Beliefs About Their Outcomes in the Alternative Treatment Status (May 10, 2016, World Bank Policy Research Working Paper No. 7668: http://ssrn.com/abstract=2779364)

20/5/16: Migrating Extremism: Long Run Impact on Voters Preferences

What happens when there is a systemic pattern of migration across borders and geographies that captures migration by political extremists?

This is neither a trivial question nor an esoteric one. It is non-trivial, because, to the best of my knowledge, we are yet to have a good understanding of what happens in the aftermath of military and political efforts to curb extremism. Curbing extremism pushes some of it into underground, but if attempts to curb extremism are not uniform across various geographies, it also incentivises selective migration of large numbers of extremists to those locations, where the efforts to curb their ideologies and behaviour are less strong. If so, when such a migration is feasible on large enough scale, asymmetric treatment of extremists across two geographies can lead to a concentration of extremists in that geography where they are treated more leniently.

This is the logic. What about the evidence?

Here is a fascinating study by Ochsner, Christian and Roesel, Felix, titled Migrating Extremists (March 10, 2016) published so far as a CESifo Working Paper (Series No. 5799: http://ssrn.com/abstract=2763513).

Quoting their abstract (emphasis is mine):

• "We show that migrating extremists shape political landscapes toward their ideology in the long run. 
• "We exploit the unexpected division of the state of Upper Austria into a US and a Soviet occupation zone after WWII. Zoning prompts large-scale Nazi migration to US occupied regions. 
• "Regions that witnessed a Nazi influx exhibit significantly higher voting shares for the right-wing Freedom Party of Austria (FPÖ) throughout the entire post-WWII period, but not before WWII. 
• "We can exclude other channels that may have affected post-war elections, including differences in US and Soviet denazification and occupation policies, bomb attacks, Volksdeutsche refugees and suppression by other political parties. 
• "We show that extremism is transmitted through family ties and local party branches. We find that the surnames of FPÖ local election candidates in 2015 in the former US zone are more prevalent in 1942 phonebook data (Reichstelefonbuch) of the former Soviet zone compared to other parties."

This is pretty much nuclear. Migration of individuals holding extremist beliefs, when systematically biased in favour of a specific location, does lead to concentration of extremist voters and such concentration is robust over time. Big lessons to be learned for today's migration regulation and institutional environment, as well as the systems of incentives and pressures that drive the migrant selection mechanisms.

17/5/16: US Earnings Recession: Four Quarters Long... but How Much Longer?

Recently, I have been highlighting in my Risk & Resilience course for MBAs at MIIS and on this blog the perils of corporate earnings gaming, including the rather worrying trend toward companies posting negative net cash flows (basically using debt to fund shares repurchases).

Here are two of my lecture slides from two weeks ago:

And to add to the pile of evidence, as 1Q 16 earnings rolled in, the numbers were coming in at a frankly put brutal squeeze: we had the fourth consecutive quarter for the S&P 500 earnings running in the red, with 1Q 16 decline being the steepest since 2008-2009 at 6.3%:

However, some interesting insight on the matter of forward earnings guidance was recently published by the Deutsche Bank Research and here is a link to the article discussing it: http://www.valuewalk.com/2016/05/earnings-q1-marks-darkest-hour-just-dawn-says-db/.

Yes, DB's model for earnings for S&P500 is an interesting one. No, without seeing actual standard econometric tests, I can't tell if it makes any sense in reality or not (just because it has high R-sq means diddly nada without knowing how the residuals behave). And no, I am not sure I am buying the idea of 'all factors in favour' arguments presented by DB Research. I am, however, pretty certain that probabilistically a bet should be for more moderate earnings performance in 2Q compared to 1Q, which of course will prompt DB Research lads cheering confirmation of their own model. So I am skeptical, but... still, the article is worth a read.

17/5/16: Euro Area Exports of Goods Down in 1Q 2016

Euro area trade in goods data for 1Q 2016 is out today and the reading is poor.

On annual basis (not seasonally-adjusted figures), extra-EA19 exports of goods were down in 1Q 2016 to EUR485.8 billion from EUR492.0 billion a year ago, a decline of ca 1% y/y. Imports - sign of domestic demand and investment - dropped 3%. As the result, EA trade balance for goods trade only rose from EUR46.8 billion in 1Q 2015 to EUR53.9 billion in 1Q 2016.

Out of the original EA12 countries, Ireland was the only one posting an increase in extra-EA19 exports in 1Q 2016 compared to 1Q 2015 (+3%), while the largest decrease was recorded by Greece (-20%) and Portugal (-17%).

On a seasonally-adjusted basis (allowing for m/m comparatives), exports extra-EA19 fell from EUR167.3 billion in February 2016 to EUR165.1 billion in March 2016, reaching the lowest point in 12 months period. Due to an even sharper contraction in imports, trade balance (extra-EA19 basis) rose to EUR22.3 billion from EUR20.6 billion.

More details here: http://ec.europa.eu/eurostat/documents/2995521/7301989/6-17052016-AP-EN.pdf/70c12e75-2409-44f5-9403-fdb3eb816d1a 

17/5/16: Village May 2016: Buzz Wrecked

My article for Village magazine highlighting some longer-term risks for the Irish economy: http://villagemagazine.ie/index.php/2016/05/buzz-wrecked/.

Plenty of opportunities to the upside, but risks are material and require careful policy balancing between fiscal prudence, institutional supports for domestically-anchored companies and entrepreneurs, with a concerted effort to move away from the FDI-or-bust policies of the past 30 years.

16/5/16: 1Q 16 GDP growth and other recent stats on Russian Economy

Russian GDP (preliminary estimate) shrunk 1.2% y/y in 1Q 2016, with the rate of contraction in the economy moderating from 3.7% for the full year 2015 and from 3.8% drop recorded in 4Q 2015. So the economy is still shrinking, albeit at a slower pace, and slower, yet, than consensus annual forecast for the decline of 1.7%.

Some interesting developments on inflation front too.

April CPI was up 0.4% m/m and 2.5% y/y which is well below m/m and y/y inflation recorded in April 2015 at 0.5% and 7.9%, respectively. Food inflation was running at 5.3% y/y in April 2016 against 21.9% registered in April 2015. January-April 2016 y/y inflation in food prices was 'only' 6.5% which compares against 22.2% inflation in food prices registered in January-April 2015. HICP inflation for April 2016 was 7.6% y/y and January-April 2016 period HICP inflation was 8.8% y/y, against corresponding figures for April 2015 and January-April 2015 at 17.5% and 16.6%, respectively. Amongst food products: Meat and poultry (-0.2% y/y for the first four months of 2016), Sugar (refined) (-0.2%) and Fruit & Vegetables (-1.9%) registered deflation in prices over the first four months of 2016 compared to 2015. During the corresponding period of 2015, all categories of food products registered double-digits inflation.

Consumer price index evolution in 2015 and 2016 by month

Source: State Statistics Committee http://www.gks.ru/

Trend toward much more subdued inflation continued in the first ten days of May 2016, based on preliminary data.

Meanwhile, imports substitution policies are starting to finally show some positive payoffs (albeit, helped heavily by massive ruble devaluations of the recent 18 months):

• Beef production rose 4.34% in 2015 compared to 2010-2013 average;
• Pork production was up massive 73.6%
• Meat products are up 18.8%
• Fish & sea food however shrink 5.82% in 2015 compared to 2010-2013 average;
• Milk and milk products output was up 5.99% in 2010-2013 average.

16/5/16: Earnings Surprises and Share Price Impact

A very interesting summary graph from Factset on the impact of earnings performance relative to consensus expectations on share prices

In basic terms, upside to consensus is systemically rewarded, while downside impact decays over time. The chart reflects 5 years worth of data, so capturing the period of declining earnings, where positive surprises should naturally be priced at a premium. The question the data above raises is whether coincident or subsequent shares repurchases provide support to the upside for underperforming firms and/or for outperforming firms.

Remember, recent McKinsey research showed that deviations from consensus forecast do not matter that much when it comes to underwriting longer term returns:

16/5/16: Another Top 100 for Trueeconomics

Just got a note that TrueEconomics is ranked 72nd in Top 100 Economics Blogs for 2016 by the IntelligentEconomist.com : https://www.intelligenteconomist.com/top-economics-blogs-2016/

15/5/16: Don't Rush the Cheers for Eurozone Growth, Yet

Remember record-busting 0.6% preliminary flash estimate of the first estimate GDP growth figure for Euro area released back in April? Well, it sort of was true, sort of...

Eurostat now puts 1Q 2016 growth at 0.5% q/q in its updated estimate released today - 0.1% lower than the April estimate. This figure is tied jointly for highest q/q growth figure since 1Q 2011 when it hit 0.8%.

Sounds good? Brilliant - the euro area outperformed both the U.S. and the UK. But when one looks at annual rates of growth... things are not as shiny.

In annual terms, growth rate actually fell in 1Q 2016, from 1.6% in 2Q 215 through 4Q 2015 to 1.5% in 1Q 2016. You won't be jumping with joy on that. And as the euro area lead growth indicator, Eurocoin suggests, rates of growth have been declining over the last three months through April 2016, dropping from cyclical high of 0.48 in January 2016 to a 13-months low of 0.28 in April 2016:

There is a strong smell of smoke from the Eurostat figures. Demand side of the economy is apparently booming. Despite the fact that retail sales are tanking:

Meanwhile, external trade is also underperforming (on foot of euro appreciation from November 2015 lows against both the US dollar and British pound):

Euro bottomed out at around 1.057 to the dollar at the end of November, and steadily gained against the USD every month since, with current valuation around 1.13-1.14 range. This hardly supports European exports to the U.S. Controlling for volatility, similar trend is against British Pound. About the only thing going the euro way today is yen and it is immaterial to the Euro area’s economy.

So euro zone economic growth appears to be loosing momentum since the start of 2Q 2016. And there are both short term drivers for this and long term ones.

Short term drivers, as outlined above suggest that current risks environment appears to be titled to the downside:

• Eurozone Composite Output Index by Markit posted 53.0 in April against March 53.1. Statistically-speaking, the rate of growth effectively remained static. 
• German Composite PMI was at 53.6, which is an 11-months low, French Composite index reading was 50.2 (barely above the 50.0 line, but still at 3mo high), while Italian Composite PMI in April came in at 53.1, also 2 months high. 
• Importantly, the euro zone PMI indices have been moving out of step with the Global PMI readings. In April, while eurozone PMI declined marginally compered to the end of 1Q 2016, Global PMI reading marginally picked up, rising from 51.5 in March to 51.6 in April. 
• The ongoing stagnation in France continued, while solid expansions were noted in Germany, Italy, Spain and Ireland.
• Developed markets saw all-industry output rise at the fastest pace in three months during April. However, the rate of increase still one of the weakest registered during the past three years. Growth remained only modest in both the US and the UK (UK growth slowed to its weakest pace since March 2013). This puts pressure on demand for eurozone exports and, in turn, pressures profit margins and investment.
• Given 1Q growth estimate at 0.5% (q/q growth) from the Eurostat, current level of Eurocoin suggest quarterly growth slowdown to around 0.4%. 
• Ifo’s Economic climate indicator for the Euro area has now been on a clear declining trend since mid-2015 and is now at its lowest levels since 1Q 2015 and second lowest reading in two-and-a-half years.
• In Germany, consensus estimates put gross domestic product growth at 0.3 percent in the current quarter and 0.4 percent in 3Q and 4Q, with full year growth of around 1.5 percent.

My view: we might see 2Q growth coming in at 0.3-0.4 percent, if April trends continue into the rest of 2Q. Overall, I expect 2016 growth to be around 1.4-1.5 percent which is just about to the downside on current consensus estimate of 1.5 percent.


Long term drivers for structural euro zone growth weakness: Even with positive 1Q 2016 print on growth side, it is fairly clear that euro zone lacks serious growth catalysts.

Everyone is talking about Brexit referendum and the renewal of the Greek crisis as key threats. Put frankly - this is a smokescreen. When it comes to longer term euro zone growth prospects both are irrelevant. Growth within the euro area has nothing to do with the UK. And Greece has been effectively removed from the markets and economic agents' considerations - the country is no longer commanding any serious media attention (with markets fatigued by the never-ending 'crises'). With ESM / EFSF /ECB now seemingly the sole bearers of Greek debt (with IMF likely to take back seat in the Bailout 3.0 as per http://trueeconomics.blogspot.com/2016/05/11516-71-steps-guide-to-greek-crisis.html) Greek funding issues and any risk of a default are unlikely to trigger Grexit. Put more directly, even if Greece were to exit the Euro, no one will bat an eyelid over such an event.

Meanwhile, the real long term problems for the euro area are:

• Capex remains subdued across the entire euro area, including Germany, Italy, France. 
• Fiscal policy is currently largely neutral and it is hard to see how the euro area can find any significant capacity to increase fiscal spending. 
• ECB stimulus is working in the financial markets, but not on the ground - there is still too much debt and too little prospect for a return on capital. Quality borrowers are not rushing to take on loans for capex. And the banks are not too eager to lend to borrowers with legacy leverage problems. 
• Eurozone banking is still a mess: capital and loans restructuring is sporadic, rather than systematic, negative rates taking a bite out of margins, but even if this headwind is taken out, markets volatility is not helping. 

And there are even bigger structural headwinds:

1. Lack of agility in the structurally over-regulated and sclerotic economy: technological innovation is weak, adoption of technological innovation is weak, labour force quality is deteriorating, so productivity growth has collapsed. Entrepreneurship is weak. Employment is sluggish and of deteriorating quality. That’s supply side.
2. Demand side is improving due to a short term boost from the post-Great Recession cyclical recovery. But, legacy issues of debt across corporate and household sectors and public finances are still present.
3. On financial side: banks-intermediated funding model for capex is a drag on growth and there is zero momentum on equity and direct debt issuance sides. Even with ECB going into another round of TLTROs, issuance of new bonds has spiked primarily because of larger corporates issuance, not because of market deepening.
4. On policies front, there is total and comprehensive paralysis. EU is malfunctioning, torn apart by crises of European making. National governments have lost capacity to legislate because of delegation of so much decision making to Brussels in the past. Political discontent is rising everywhere. We now have growing proportions of core European countries’ populations - the Big 4s - wanting to reexamine the entire EU.

Europe has been Japanified. And there is little that it can do to avoid this stagnation trap. There is no hope that  fiscal policy can do what monetary policy has failed to deliver - the great hope of Keynesianistas. And with that, both the monetary and the fiscal sides of European growth equation are out. What's left? Endless low interest rates (with a risk of policy error, should Germans rebel against Draghi's uncountable puts) and endless painful quasi-deflating (through low demand) of debt. Aka, pain.