15/12/16: US Economic Policies in the Era of President Trump

My article on likely President-elect Donald Trump's economic policies for Manning Financial: https://issuu.com/publicationire/docs/mf_winter_2016__1_?e=16572344/41835605

15/12/16: Long-Term Fed Path May Force ECB to Act

My post-mortem analysis of the U.S. Fed's FOMC meeting and policy changes announcements for Sunday Business Post: https://www.businesspost.ie/opinion/constantin-gurdgiev-positives-ireland-feds-move-373461.

Hint: It's about longer term game and the neutral federal funds rate... and traces back to August...

11/12/16: Legal Frameworks Relating to State-led Cyber Attacks

This is a blog about economics and finance, not politics. Alas, geopolitical risks do impact economic risks and they materially influence financial markets. I am trying to stay out of the political analysis and hence offer little in terms of my own thinking on the matter. But that does not mean I should not share with you other analysts' views that I find informative, interesting or thought-provoking. I do so on Twitter, without endorsing (via retweets or 'likes' or shares) any given position, so I shall be able to do the same here, on the blog.

So here is an interesting piece of analysis, from an insightful source, relating to the allegations of Russian State influencing the U.S. election 2016: https://www.project-syndicate.org/commentary/kremlin-cyber-attacks-american-election-by-joseph-s--nye-2016-12?referrer=/xmGEziA4LU. In my opinion, this analysis is particularly valuable because it offers a calm assessment of the treaties and legal frameworks relating to cyber attacks.

Worth a read.


Update 12/12/16: Another take on the legal aspects of alleged intervention here: https://www.bloomberg.com/view/articles/2016-12-12/how-u-s-could-respond-to-russian-intervention-in-trump-election. 

10/12/2016: Austerity: Three Wrongs Meet One Euro

"Is it the 'How' or the 'When' that Matters in Fiscal Adjustments?" asks a recent NBER Working Paper (NBER Working Paper No. w22863). The authors, Alberto Alesina, Gualtiero Azzalini, Carlo A. Favero and Francesco Giavazzi ask a rather interesting and highly non-trivial question.

Much of recent debate about the austerity in the post-GFC world have focused on the timing of fiscal tightening. The argument here goes as follows: the Government should avoid tightening the pursue strings at the time of economic contraction or slowdown. Under this thesis, austerity has been the core cause of the prolonged and deep downturn in the euro area, as compared to to other economies, because austerity in the euro area was brought about during the downturn part of the business cycle.

However, there is an alternative view of the austerity impact. This view looks at the type of austerity policies being deployed. Here, the argument goes that austerity can take two forms: one form - that of reduced Government spending, another form - that of increased taxation.

There is some literature on the analysis of the effects of the two types of austerity compared to each other. But there is no literature, as far as I am aware, that looks at the impact of austerity across different types, while controlling for the timing of austerity policies implementation.

The NBER paper does exactly that. And it uses data from 16 OECD economies covering time period of 1981 through 2014 - allowing for both heterogeneity amongst economic systems and cycles, as well as full accounting of the most recent Great Recession experiences.

The authors "find that the composition of fiscal adjustments is much more important than the state of the cycle in determining their effects on output." So that the 'How' austerity is structured is "much more important" in determining its effects than the 'When' austerity is introduced.

More specifically, "adjustments based upon spending cuts are much less costly than those based upon tax increases regardless of whether they start in a recession or not." This is self explanatory.

But there is an added kicker (emphasis is mine): the overall "results appear not to be systematically explained by different reactions of monetary policy. However, when the domestic central bank can set interest rates -- that is outside of a currency union -- it appears to be able to dampen the recessionary effects of tax-based consolidations implemented during a recession." Now, here is a clear cut evidence of just how disastrous the euro has been for the real economies in Europe during the current crisis. As the authors note, correctly, "European austerity... was mostly tax based and implemented within a currency union". In other words, Europe choose the worst possible type of austerity (tax-based), implemented in the worst possible period (during a recession) and within the worst possible monetary regime (common currency zone).

In allegorical terms, the euro zone was like a food-starved runner starting a marathon by shooting himself in a knee.

10/12/16: Roads to Polluting Hell Outside the Electric Vehicles' Backyard

The old adage that the road to hell is commonly paved with good intentions, taken through the prism of economic analysis, can often be sharpened by modifying it. In truth, more often then not, the road to hell for some is often paved with good intentions and fortunes of the others.

For an example of such modification, consider a recent NBER paper, titled "Distributional Effects of Air Pollution from Electric Vehicle Adoption" (NBER Working Paper No. w22862) by Stephen P. Holland, Erin T. Mansur, Nicholas Z. Muller and Andrew J. Yates.

In the paper, the authors looked at the distribution of gains and losses in the form of air pollution arising from the adoption of electric vehicles in the U.S. To do so, the authors employed "...an econometric model to estimate power plant emissions and an integrated assessment model to value damages in air pollution from both electric and gasoline vehicles." The authors also used the registration location of electric vehicles.

The key findings are:

1. "...people living in census block groups with median income greater than about $65,000 receive positive environmental benefits from these vehicles while those below this threshold receive negative environmental benefits" For the want of better description, the better off are dumping their pollution onto the less better off via electric vehicles.
2. "Asian and Hispanic residents receive positive environmental benefits, but White and Black residents receive negative environmental benefits. In multivariate analyses, environmental benefits are positively correlated with income and urban measures, conditional on racial composition. In addition, conditional on income and urbanization, separate regressions find environmental benefits to be positively related with Asian and Hispanic block-group population shares, negatively correlated with White share, and uncorrelated with Black share." Which means that re-allocation of pollution shifts negative externality toward urban (not rural) poor.
3. "Environmental benefits tend to be larger in states offering purchase subsidies. However, for these states, an increase in subsidy size is associated with a decrease in created environmental benefits." Or put more simply: the greater the subsidies to purchases of the electric vehicles, the lower are the benefits from electric vehicles. Although we have no idea if the associated redistributed costs of these vehicles are any less worse.

The results are pretty intuitive. To power all these Teslas and BMW i-models and the rest of the electric cars lot, one has to generate electricity. Power plants (even those based on renewables, although their social and environmental costs are not factored in the study) are based in areas where those using electric vehicles do not tend to live. So when an executive in Silicon Valley drives her/his Tesla to work, the air pollution around her/him is reduced. But the air around a power generating plant gets worse, because a plant somewhere has to burn some natural gas or captured methane etc to power that Tesla, and that somewhere ain't in the area where the Tesla-driving hipster lives or, even, works.

Hipster's good fortune is a polluting hell for someone who can't afford living outside the industrially intensive areas where hipster's Tesla gets its electricity from. Oh... and one more thing: unlike in normal cases of externalities, there is no mechanism to compensate the losers in this game, because the hipsters get tax subsidies on their Teslas. There is nothing being raised from the beneficiary of the externality to compensate the loser from the externality. Even in theory, someone loses when someone gains.

9/12/16: Trumpismo and the U.S. Economy

My Village column on the outcome of the U.S. Presidential election and the economic implications of Trumpismo : http://villagemagazine.ie/index.php/2016/12/trumpslump/

8/12/16: Democratic Party: The Eraser of Middle Class Vote?

More of the same didn't cut it for the American middle class this November, ... and so the Obama voters went to the Republicans, as Hillary Clinton failed to impress onto the middle class any sort of vision they can relate to.

Per Pew Research, out of 57 'solidly middle-class areas' examined, "In 2016, Trump successfully defended all 27 middle-class areas won by Republicans in 2008. In a dramatic shift, however, Hillary Clinton lost in 18 of the 30 middle-class areas won by Democrats in 2008."

So the "deplorables" turned out to be middle-class voters and they clearly heard Hillary Clinton applying a new descriptive term to them. The term they did not quite embrace.

Now, if I were an adviser to the Democratic Party, I would start by putting its leaders in front of a mirror and ask them to point out every little wrinkle and crease in their faces that makes them so publicly loath middle-class as to endorse a candidate that called them 'deplorables'. Step one of the multi-year journey toward rebuilding the party will then be accomplished.

Rest of Pew Research analysis here.

7/12/16: Bloomberg Blows the Cover on Apple's Irish Tax Dodge, Again

So you know the $13 billion that Apple, allegedly, owes Ireland?.. It really never did owe Ireland much. Instead, it owes the money to taxpayers outside Ireland - in countries where actual business activities took place and in the U.S., where Apple tax avoidance scheme starts, ends and start again. Here's how Bloomberg explains it: https://www.bloomberg.com/graphics/2016-apple-profits/

Oh, yeah, you are reading it right: "a popular corporate tax haven"... that'll be Ireland (per Bloomberg). expect loud protests from Dublin to Bloomberg offices and, potentially, a re-drawing of the scheme to alter the wording...

But you do get an idea: 10 years, at, say $600 million payments, that'll be almost half the $13 billion 'owed to Ireland' that is really U.S. taxpayers cash...

13/11/16: Oil Prices: Still in the Whirlpool of Uncertainty

This is an unedited, longer, version of my article for the Sunday Business Post covering my outlook for oil prices.


Traditionally, crude oil acts as a hedge and a safe haven against currencies and bond markets volatility. Not surprisingly, during the upheaval of the U.S. Presidential election this week, when dollar went into a temporary tailspin, equity markets sharply contracted and bonds prices fell, all eyes turned to the risk management staples: gold, oil and, on a more exotic side of trades, Bitcoin. Gold and Bitcoin did not surprise, staunchly resisting markets sell-offs and gaining in value. But oil prices tanked. The old, historically well-established correlation did not apply. Instead of rising, U.S. oil futures fell in the immediate aftermath of Donald Trump’s surprise victory, and then, in line with the stock markets, futures rose. Within the day, U.S. crude futures prices were back at USD45.27 a barrel on the New York Mercantile Exchange, while Brent rose back USD46.36 marker. More broadly, the S&P 500 Energy Sector Index rose 1.5 percent within 12 hours of the election results announcement.

This breakdown in historical patterns of correlations between crude and financial assets prices underlines the simple reality of the continuous oil markets slump: we are in the new normal of systemically low oil valuations underpinned by the very same driving forces that precipitated the crude price collapse from over USD100 per barrel to their mid-to-high 40’s today. These forces are three-fold, comprising reduced demand for energy, reduced demand for oil as a source of energy, and increased supply of oil.

Prices and Stocks

Currently, oil prices are rebounding from the eight-week lows, but prices remain sensitive to any signals of changes in demand and supply. The reason for this is the excess stockpile of oil stored in tankers, ground facilities and at refineries. Most recent U.S. federal data showed oil stockpiles swelling well ahead of the markets expectations, as producers continue to pump oil unabated.

U.S.-held inventories of oil were at 2.43 million barrels at the beginning of November, based on the data from the U.S. Energy Information Administration. American Petroleum Institute puts total stocks of oil in storage and production at 4.4 million barrels - more than 1 million barrels in excess of the seasonally-adjusted forecast for demand. And at the end of October, the U.S. posted a 34-year record in weekly increases in crude and gasoline stocks - at 14.4 million barrels.

The U.S. is no exception to the trend. OPEC recently revised its outlook for oil price recovery for the next three years based on the cartel’s expectation that current levels of production will remain in place for longer than anyone anticipated. Per OPEC latest forecast, we won’t see oil hitting USD60 per barrel until 2020. Only twelve months ago, OPEC forecast for 2020 was USD80 per barrel.

Similar forecasts revisions were produced a month ago by the IMF. In its World Economic Outlook forecast, the IMF revised its outlook for 2016 crude prices from USD50.54 per barrel forecast in October 2015 to USD 42.96 per barrel. 2017 full year price forecast moved from USD55.42 in October 2015 to USD50.64 in October 2016. If in 2015 the IMF was predicting oil prices to hit USD60 marker by mid-2018, today the Fund is projecting oil prices remaining below USD58 per barrel through 2021.

Both, the OPEC and the IMF forecast lower global economic in 2016 and 2017. The IMF outlook is based on world GDP expanding by just 3.08 percent in 2016 and 3.4 percent in 2017, well below post-Crisis average of 3.85 percent and pre-crisis average of 4.94 percent. OPEC forecast for oil prices is based on similarly pessimistic growth outlook for 3.4 percent average growth over the next six years, down from 3.6 percent forecast issued in October 2015.

Alternative Energy: Rising Substitutes

As demand for energy in general remains weak, alternative sources of energy are starting to take a larger bite out of the total energy consumption. Solar power capacity has almost tripled in the U.S. over the last 3 years. Renewables share of the U.S. power supply rose from around 4 percent of total power generation in 2013 to 8 percent this year, on its way to exceed 9 percent in 2017. Solar energy supply is now growing at a rate of almost 40 per annum, spurred on by the Federal solar tax credits, extended by the Congress in early 2016. In Germany, following the Government adoption of Energiewende policies — a strategy that aims to move energy supply away from oil and uranium — renewables now provide almost 30 percent of electricity, on average. And Gwermany’s upper chamber of parliament, the Bundesrat, has passed a resolution calling on the EU to create a system of harmonised taxation and vehicle duties that can ensure that only emission-free cars will be registered in Europe by 2030. On the other side of the spectrum, in the OPEC member states and Russia, renewables energy production is currently standing at below 5 percent of total energy demand. While the number is relatively low, it is rising fast and countries from Saudi Arabia to United Arab Emirates to Russia - all have significant ambitions in terms of lifting non-oil based energy output. In Abu-Dhabi, a recently approved solar energy project will deliver electricity at a cost below coal-fired power plants, at 2.42 US cents per kilowatt-hour, setting world record for the cheapest solar energy supply. Dubai plans to get 25 percent of its energy needs from renewables by 2030. The target is to reach 75 percent by 2050. Even Iran is opening up to use of renewables, with wind and solar investments in 2016-2017 pipeline amounting to close to USD12 billion. In Jordan, just one wind farm - a 38-turbine strong Tafila - is supplying 3 percent of country electricity, since production began in 2015.

All-in, globally, estimated 7 percent of oil demand decline over the last 5 years is accounted for by energy sources substitution. The key drivers for this trend are new environmental agreements, putting more emphasis on alternative energy generation, local environmental pressures (especially in China), and the desire to shift oil production to export markets, away from domestic consumption. Another incentive is to use clean power to reduce domestic subsidies to fossil fuels. According to the IMF report published earlier this year, Middle East, North Africa and Central Asia account for almost one half of the total worldwide energy subsidies. Since the onset of the oil price shock, UAE, Egypt, Oman and Saudi Arabia have been cutting back on fossil fuels subsidies and bringing retail prices for energy closer to market standards.

The second order effect of the above changes in energy composition mix is that moving away from subsidised fossil fuels improves markets transparency and reduces corruption. It also compensates for declines in oil prices in terms of exports earnings.

Drilling at These Prices?

As slower global growth and increasing substitution away from fossil fuels are suppressing demand for oil, supply of the ‘black gold’ is showing no signs of abating. Per latest OPEC statement, oil producers, especially in North America, surprised markets analysts by failing to curb production volumes in response to weak prices.  OPEC members have been running production volumes near historical records through out the 3Q 2016. And in the U.S., the Energy Department raised its production forecasts for both 2016 and 2017. However, U.S. crude output this year is unlikely to match the 2015 levels - the highest on record since 1972. All in, the Energy Department now estimates that 2016 average daily production will be around 8.8 million barrel per day (bpd), which is lower than 9.5 million bpd delivered in 2015, but more than forecast for 2016 back in September. Likewise, for 2017, the Energy Department revised its September forecast from 8.57 million bpd to just over 8.7 million bpd in October. Through the second and third quarters of 2016, North American drillers actually increased drilling activity as prices improved relative to late 2015. The number of active oil rigs operating in the U.S. is now up by more than 130 compared to May counts and the rate of new rigs additions is remaining high, rising to 2 percent last week alone.

Russia and Iran

A combination of stagnant or even declining demand, and expanding production means that the only change in the flat trend in oil prices over the next 6-12 months can come only from a policy shock on the supply side. For OPEC, Iran and Russia such a shock is unlikely to happen. Majority of oil exporting economies have either fully (as in the case of Russia and Iran) or partially (as in the case of Saudi Arabia) adjusted their economic policy frameworks to reflect low price of energy environment.

I asked, recently, Konstantin Bochkarev of Forex-BKS, who is one of the leading financial markets analysts working in the Russian markets for a comment on the current state of play in Russian economic policies in relation to oil prices. In his view, “It looks like the worst is over for the Russian economy in terms of adaptations to low oil prices, Western sanctions, geopolitical risks and other challenges of last two years. Sub-50-55 USD oil or even $40 is the new reality and it doesn’t scare any more. On the other hand low efficiency of the economic policy in Russia (due to a lot of constraints like the lack of reforms and the will to change anything before the President election in 2018) means that there’s rather huge cap for the Russian GDP growth which can be limited by 1%-1.5% at 40-55 USD oil.” Overall, “the «crisis policy» which was rather successful during this recession and led to the stabilization of the macroeconomic situations. The recapitalization of the Russian banking system, free float of the Russian ruble, higher interest rates, the transparency of the CBR policy and rather tight budget policy. All these measures finally led to 6% inflation by the end of 2016, rather sufficient decrease in volatility of the Russian ruble and less correlation with oil prices.” And moving away from the petroleum-dominated economy has had even deeper impact. Per Bochkarev, “Oil can’t solve all your problems any more whether it’s 40$ or 100$, because changing social and business environment, external and internal challenges demand something more than budget without deficit or stable cash flow. Still low oil prices can accelerate changes in the Russian economy and society and lead to some necessary reforms or unpopular measures.”

In a sense, Russian experience shows the direction that many oil exporting economies are heading in the age of low oil prices: the direction of accelerated fiscal and monetary responses and gradual structural economic reforms. In some areas, Russia took its medicine first and in a larger dose, but other big producers, including Iran and Saudi Arabia, as well as UAE are also traveling down the same path.

As an aside, it is worth noting that Iranian production is growing ahead of expectations. Per Bloomberg report:  “Output at the fields west of the Karoun River, near Iran’s border with Iraq, rose to about 250,000 barrels per day from 65,000 barrels in 2013, the Oil Ministry’s news service Shana reported Sunday, citing President Hassan Rouhani at a ceremony to formally open the project. Iran had expected to reach that output target by the end of the year, Mohsen Ghamsari, director for international affairs at the National Iranian Oil Co., said in September.” (http://www.bloomberg.com/news/articles/2016-11-13/iran-pumps-more-oil-as-saudi-minister-calls-for-opec-output-cuts)

Since the easing of the sanctions, starting with end of January 2016, Iran’s output rose from just around 2.82 million bpd to ca 3.65 million bpd.

Russian producers are also hardly feeling a pinch. According to Bochkarev, “Tax system plays a much more important role in the Russian oil companies production decisions than the rise or fall in oil prices. Whether oil is $40 or $100 per barrel majors are generating generally the same financial results. Besides almost oil majors are stable even at $30 oil. The decreases in oil prices are easily compensated by the fall in the ruble exchange rate. So cost control or cost cutting plays much more important role in other sectors of the Russian economy.”

Still, Russia and Iran might be heading into a direct competition in the European markets, where geopolitics and legacy contracts are changing the playing field away from simple price competition. This new - since January 2016 - competitive dynamic may be a longer term, rather than a current issue, however, according to Bochkarev. “It doesn’t look like that Iranian oil is huge challenge for Russian majors next several years. Numerous consumers who stopped buying the oil from Iran due to sanctions made some changes to their refinery or productions lines and equipment. So Iran has to offer some kind of bonus or lower oil prices to make them return to its oil. Probably it’s much easier for Iran to deal with China, India and other countries in Asia in order to find export markets for its oil. Iran can try to restore market share in Europe but the other hand of such policy can be lower oil prices or necessary discounts. LNG Imports from the US as well as the bigger role of Qatar and Iran in the future are already evident in European markets. The unique status of Gazprom is probably now a matter of the past but the more competitive market can finally make Gazprom more competitive.”

Trump Cards

Which means that economic policies shocks that can alter the current flat growth trend for oil prices are unlikely to come from the OPEC+ countries. Instead, the key to the near-term future variation in oil price trend will most likely come from the U.S. The markets are still assessing the full impact of Mr. Trump’s victory on his foreign and energy policies - the two key areas that are likely to alter the supply side of oil equation, as well as his economic policies that might influence the demand side and inflation. Starting with the latter, if - as promised during the election - the new White House Administration deploys a significant infrastructure and spending stimulus across the U.S. economy, we can expect both the demand for oil to firm up, clearing out some, but not all of the excess supply currently available in the markets. A stimulus to the U.S. growth is also likely to trigger higher inflation. With oil generally being a historical hedge against inflationary pressures, the likely outcome of improved growth performance across the U.S. will be a rise in oil prices from the current range of mid-40s to mid-50s and upper-50s, slightly above the IMF forecasts for 2017 and well ahead of the current market prices.

On the other hand, President-elect has promised to shift Federal supports away from alternative energy toward ‘clean coal’, oil and gas sectors. If he gets his way, the impact will be more American oil flowing to exports and higher excess supply, with lower prices. Mr. Trump’s election is likely to see the Republicans-controlled Congress moving to approve more export-driven pipelines, reducing the cost of oil transport from shale oil rich regions, such as Ohio and Pennsylvania, as well as North Dakota, and increasing incentives to boost production levels. Beyond stimulating production of the U.S. oil, Trump Administration is also likely to green light Keystone XL pipeline that will connect Canadian oil sands to exports terminals in the Gulf of Mexico. This will further expand supply of cheaper oil in the global markets.


Combining the two factors, it appears that the current IMF and OPEC outlook for 2017 for oil prices may be rather optimistic.

Barring a significant surge in global (as opposed to the U.S. alone) growth, and absent supportive cuts to production by the OPEC and other major producing countries, in all likelihood we will see oil prices drifting toward USD52-55 per barrel range toward the second half of 2017. Until then, any significant repricing of oil from USD47-48 per barrel price levels up will be a speculative bet on strong economic growth uptick in the U.S.

11/11/2016: Europe's 'Convincing' Recovery

Europe's strong, convincing, systemic recovery ... the meme of the European leaders from Ireland all the way across to the Baltics, and save for Greece, from the Mediterranean to Arctic Ocean comes to test with reality in the latest Pictet Quarterly and if the only chart were all you needed to see why the Continent is drowning in populist politics, here it is:

As Christophe Donay and Frederik Ducrozet explain (emphasis is mine):

"Since 2008, the world’s main central banks have used a vast array of transmission channels: currency weakening to reboot exports; reflation of asset prices to boost confidence; a clean-up of banks’ balance sheets to boost the credit cycle. But, ultimately, all these measures have failed as economic growth remains subdued. Indeed, the belief that countries have become trapped in suboptimal growth and that developed economies, especially in Europe, look set to complete a
‘lost decade’ of subpar growth (see graph) since the financial crisis forms the third strand of criticism of monetary policy."

Whatever one can say about the monetary policy, one thing is patently obvious: since the introduction of the Euro, the disaster that is European economy became ever more disastrous.

Enter Trumpist successors to characterless corporatist technocrats... probably, first for worse, and hopefully later, at least, for better...

9/11/16: Bitcoin vs Ether: MIIS Students Case Study

Following last night's election results, Bitcoin rose sharply in value, in line with gold, while other digital currencies largely failed to provide a safe haven against the extreme spike in markets volatility.

In a recent project, our students @MIIS have looked at the relative valuation of Bitcoin and Ether (cryptocurrency backing Ethereum blockchain platform) highlighting

1. Fundamental supply and demand drivers for both currencies; and
2. Assessing both currencies in terms of their hedging and safe haven properties

The conclusion of the case study was squarely in line with Bitcoin and Ether behaviour observed today: Bitcoin outperforms Ether as both a hedge and a safe haven, and has stronger risk-adjusted returns potential over the next 5 years.

See the case here: http://www.economist.com/whichmba/mba-case-studies/investment-case-study-competition-2016/middlebury-institute-international-studies and please, give your vote to the team of our students. 

3/11/16: CFR: A Tax Cure for American Monetarism

My article for the Cayman Financial Review on tax reforms required to bring U.S. corporate tax system to an internationally competitive standard: http://www.caymanfinancialreview.com/2016/11/01/a-tax-cure-for-sisyphean-american-monetarism/