29/6/18: Multilateralism and the Impossible Policy Trilemmas

"Global governance requires rules, because flexibility and goodwill alone cannot tackle the hardest shared problems. With multilateralism under attack, the narrow path ahead is to determine, on a case-by-case basis, the minimum requirements of effective collective action, and to forge agreement on reforms that fulfill these conditions."

Can Multilateralism Adapt?, Jean Pisani-Ferry.

International Political Trilemma applies to both monetary and fiscal policy dimension by making it impossible for modern societies to combine:

1. Monetary sovereignty in the form of free capital mobility, with international political stability and political autonomy of democratic systems. In simple terms, free capital mobility means that capital flows will reflect economic and demographic conditions prevailing in the specific society. If these conditions deteriorate, triggering capital outflows (perhaps due to monetary accommodation response to ageing population), the society can respond either through imposing capital controls (preserving its standing in international political institutions, and allowing its democratic institutions to remain robust) or it can pursue non0-democratic suppression of its own population (allowing capital to flow out of the economy and not imposing cost of resulting economic decline onto international partners). Alternatively, the country can continue allowing outflow of capital and retain democracy by blaming the external shocks and restricting its engagement with international political institutions.
2. Fiscal sovereignty in the form of free capital mobility, international political stability and autonomous fiscal policy. In simple terms, the above monetary sovereignty simply transfers democratic autonomy failure to fiscal policy failure.

To my students at TCD and MIIS, these are familiar from the following summary charts:

For more academically inclined readers, here is my paper summarising these Trilemmas and putting them into the context of the euro area harmonisation: Gurdgiev, Constantin, Euro After the Crisis: Key Challenges and Resolution Options (May 30, 2016). Prepared for: GUE/NGL Group, European Parliament, October 2015: https://ssrn.com/abstract=2786660.

It is, generally, not hard to find examples of the two trilemmas presence in a range of historical shocks in the past. More recent examples, however, are harder to come by due to time lags required to see these trilemmas in action. Pisani-Ferry's quote above hints at such.

During the 1990s, "After an eight-decade-long hiatus, the global economy was being reunified. Economic openness was the order of the day. ...The message was clear: globalization was not just about liberalizing flows of goods, services and capital but about establishing the rules and institutions required to steer markets, foster cooperation, and deliver global public goods."

As Pisano-Ferry argues, today, "Despite a decade of talks, the global trade negotiations launched in 2001 have gotten nowhere. The Internet has become fragmented and could break up further. Financial regionalism is on the rise. The global effort to combat climate change rests on a collection of non-binding agreements, from which the United States has withdrawn...  The very principles of multilateralism, a key pillar of global governance, seem to have become a relic from a distant past."

"...let’s face it: today’s problems did not start with Trump." In fact, the problems started with the above trilemmas. Or put differently, the problems are not an outrun of bad policies or choices, but the natural result of the impossibility of combining the conflicting policies objectives and institutions. "There is no shortage of explanations. An important one is that many participants in the international system are having second thoughts about globalization. A widespread perception in advanced countries is that the rents from technological innovation are being eroded precipitously... A second explanation is that the US strategy toward Russia and China has failed... neither Russia nor China has converged politically... Third, the US is unsure that a rules-based system offers the best framework to manage its rivalry with China. [and]... Finally, global rules look increasingly outdated. Whereas some of their underlying principles – starting with the simple idea that issues are addressed multilaterally rather than bilaterally – are as strong as ever, others were conceived for a world that no longer exists. Established trade negotiation practices make little sense in a world of global value chains and sophisticated services. And categorizing countries by their development level is losing its usefulness, given that some of them combine first-class global companies and pockets of economic backwardness."

In simple terms, the world became more complex and more fragile because we tried to make it less complex and more centralized (hegemonic positioning of the U.S. in Bretton Woods setting), while making it also more multilateral (through financial, economic, trade and human capital integration).

Pisano-Ferry offers a 50,000 feet level view on the solution to the problems: "the solution is neither to cultivate the nostalgia of yesterday’s order nor to place hope in loose, ineffective forms of international cooperation. International collective action requires rules... The narrow path ahead is to determine, on a case-by-case basis, the minimum requirements of effective collective action, and to forge agreement on reforms that fulfill these conditions." In other words, one cannot tackle trijemmas directly (correct view), but one can defuse them by limiting each node of the desired policies. E.g. less democracy here - to offset pressure from demographic of ageing, less capital mobility there - to reduce the speed of capital flows across the borders and lower volatility of financialized investment, less fiscal sovereignty - to provide better buffers for shocks arising in financial and economic systems, and less international institutions - to allow for more flexible rebalancing of monetary, trade and fiscal policies.

The problem with this is it requires for the hegemony (the U.S.) to put a hard stop to imposing its preferred solutions onto the rest of the world and international institutions. Or, put differently, the hegemony must stop being a hegemony. Good luck squaring that with American vision of the world a-la Rome 4.0.

29/6/18: Can, Foot, Road: EU 'Agreement' on Migration Crisis

The EU27 have a new 'deal'. This time, on revamping the block's migration strategies in the face of continued relentless wave of refugees fleeing to Europe from Syria and North Africa, propelled or aided to take desperate actions by the regime change doctrine of Washington. Migration numbers are down roughly 90 percent from their peak in 2015, and fell 45 percent y/y in the first half of 2018. But, voter revolt against the system that is perceived as "open borders" is still fuelling rise in political opportunism and extremism across Europe. The latest catalysts for the negotiations have been: (1) the rise of anti-immigrant parties in Germany that now threatens the uneasy governing coalition in Berlin, and (2) the arrival to power of the new, anti-immigration coalition in Italy. To be more precise, Italian Government has been asking for the EU to take "concrete steps" to share burden of accepting refugees with Italy for some time now. Other  catalysts have been governments of Hungary and the Czech Republic, where current political leadership has been opposing the EU policy of imposing automatic quotas for accepting migrants.

Earlier today, following almost nine hours of negotiations, the EU27 finally hammered out a compromise deal, immediately labeled in the media as 'political fudge' - something the EU has been very skilled at achieving for a good part of the last 20 years.

To prevent Italy from exercising a veto on the deal, the EU agreed to redistribute arriving migrants away from the country of their original landing to "control centres" spread across the EU. Centres locations are to be specified later. "Control centres", funded out of unspecified funds, but presumably payable by the joint resources of the EU, will de facto trade 'local jobs and euros' for communities accepting large scale migrants detention centres. This model works well with military bases and jails, and can be attractive to some poorer Eastern European countries, as well as countries like Greece and Italy. The key to this is that the detention centres will only be located in countries that volunteer to accept them. In simple terms, immigration policy is now a part of fiscal redistribution scheme, just what Italy wanted.

"Control centres" will function as a triage point, with “rapid and secure processing” separating economic migrants from those with a potentially legitimate claim to the asylum. Thereafter, successfully pre-screened asylum seekers will be distributed under the principle of solidarity (quotas), although, in a bow to Czech and Hungarian governments, solidarity principle will apparently be voluntary too. In other words, "rapid" processing will likely end up being a 'lengthy detention' in "control centres", as many Governments will simply refuse to take in asylum seekers, while other Governments will end up being swamped with applicants.

To restrict the numbers of those reaching the EU borders in the first place, the EU meeting agreed to provide more funds for Turkey and Morocco to act as buffers for refugees. Algeria, Egypt, Libya, Morocco, Niger and Tunisia are to get funding for setting up 'processing centres'. Or, put differently, the EU will be paying more to warehouse migrants offshore, something that is likely to lead to lengthy detention in questionable conditions.

As a support for embattled Angela Merkel, the agreement also states that the nation states can “take all necessary internal legislative and administrative measures” to stop refugees and migrants crossing Europe’s internal borders. Whatever this means for the Schengen agreement and borderless travel, time will tell.


My view: The migration agreement is nothing more than another kick to the proverbial can that was stuck in the cracks on the proverbial road toward addressing the migration crisis. It fails to address actual modalities of asylum process, the key being the length of the process, lack of alternatives to highly costly and questionable (in ethical and even international law terms) deportations of failed seekers, and the lack of clarity of rules and resources for allocating successful asylum seekers. It also failed in effectively dealing with migrants inflows: a 'buffer zone' on the southern shores of the Mediterranean simply increases costs of making the crossing, and thus increases the risk of crossing to migrants. It does not remove the incentives for making the journey. In the case of Libya and Egypt, there are questions about these states' capacity actually control their borders, primarily arising from the nature of the Government regimes in both countries. In case of Syria, ability to seal off inflows of refugees from the country hinges on stabilisation of the Assad regime, as no other participant in the Syrian civil war has any interest in controlling Syria's Mediterranean coast. In effect, the EU agreement does not tackle the main issue at hand: how to reduce the inflows of both economic migrants and refugees into Europe. Likewise, the EU agreement does not even touch upon the need to structure effective measures (legal and institutional) to improve integration of the successful migrants into the European societies.

In short, we will be back to this issue soon. Mark my words.

29/6/18: Debt Bubble: Staying the Course into Hurricane

In three and a half years, the world debt has gone from being a worry to a bubble. At the end of 2014, there were just under $44 trillion worth of corporate and government debt on issue with roughly 1.4 percent of these yielding negative rates. As of June 2018, there are now more than $49 trillion worth of corporate and public sector bonds in the markets, with ca $8 trillion of these (or 16 percent) trading at negative yields.

And this is just a part of the overall debt bubble picture. In April this year, the IMF report noted that non-bank funding for households and wholesale lending "is on the rise since the Lehman-crisis, and constitutes a major source of bank credit to the economy" (see https://www.imf.org/en/Publications/WP/Issues/2018/03/19/Leverage-A-Broader-View-45720). IMF estimates for non-bank funding for the U.S. banks alone, shown below, add $11.7 trillion to the debt system in 2016, against $10 trillion in 2008. Meanwhile, another roughly $8 trillion worth of non-bank debt is sitting in the dealer funds and hedge funds' pledged collateral exposures.

Meanwhile, in the U.S. alone, $6.3 trillion corporate debt bubble is now at a risk of rising interest rates. U.S. speculative-grade corporate borrowers are now at a new record-low cash-to-debt ratio of just 12 percent, below the 14 percent in 2008. Worse, per S&P report, more than 450 investment-grade companies that are not in the top 1 percent of cash-rich debt issuers, have highly risky cash-to-debt ratios of around 21 percent.

27/6/18: U.S. War on Drugs: The Unwanted Dividends

While the U.S. war in Afghanistan drags closer to marking 17th anniversary, and the U.S. war on drugs in Latin America rages into its fourth decade (the U.S. has spent more than 1 trillion dollars since the mid 1970s combatting narco-mafias in Latin America), global drugs trade is booming.

According to the data from The Economist, global drugs production has hit a new record high and most of this rise is accounted for by, you've guessed it, Afghanistan (for opium) and Latin America (for cocaine):

Source: https://www.economist.com/graphic-detail/2018/06/27/opium-and-cocaine-production-has-reached-record-levels.

For some background on disastrous fallout from the U.S. war on drugs cartels in Latin America, see https://www.theguardian.com/global-development-professionals-network/2014/feb/03/us-war-on-drugs-impact-in-latin-american.

For background on the U.S. policymakers' surprising inability to learn from their own failures: http://trueeconomics.blogspot.com/2018/05/12518-us-war-in-afghanistan-when.html.

25/6/18: Wilbur Ross: The MAGAlithic Cat Fish of Washington's Swamps?

The 'hero' of the Irish banking sector bailouts, Wilbur Ross, formerly of Bank of Ireland and Bank of Cyprus fame, a dude who would have made the podium in bottom-fishing were it ever designated an Olympic sport, and currently, the MAGAlithic U.S. Secretary of Commerce is now also a subject of the criminal and ethics complaints filed on June 22, 2018 by Citizens for Responsibility and Ethics in Washington (CREW) with the Department of Justice (DOJ) and OGE: https://www.citizensforethics.org/press-release/wilbur-ross/.

The guy is an Energizer Bunny when it comes to alleged ethics violations, tirelessly going where no Government official should be going at all...

The guy has been recently in the news with the following Forbes look at his fortune and pained efforts at divesting from it: https://www.forbes.com/sites/danalexander/2018/06/18/lies-china-and-putin-solving-the-mystery-of-wilbur-ross-missing-fortune-trump-commerce-secretary-cabinet-conflicts-of-interest/#78356eb97e87.  Which contains the following allegation:

Swimming in the cleaned up waters of the drained Washington Swamp, Mr. Ross, has actively sought to inject unwanted and unwarranted 'transparency' not into his own dealings and disclosures, but into... U.S. Census 2020, earning him another set of law suits: "In March, Ross ordered that the 2020 Decennial Census include a question about the citizenship of all U.S. residents for the first time since 1950 — leading to a slew of lawsuits around the country..." (see https://nypost.com/2018/06/06/wilbur-ross-sued-over-citizenship-question-on-2020-census/).

Mr Ross has been now accused of insider dealing in Bank of Ireland: http://www.businessinsider.com/wilbur-ross-accused-of-insider-trading-with-irish-bank-stake-2017-12, and his firm was fined by SEC for improper disclosures of fees it charged the investors: https://www.reuters.com/article/us-wlross-sec-idUSKCN10Z2YJ/ and was sued for overcharging: https://www.wsj.com/articles/wilbur-ross-sued-over-fees-by-firms-former-executives-1510793229.  Then, there are shady issues with Mr. Ross' past involving U.S. steel companies: https://theintercept.com/2018/03/05/steel-tariffs-wilbur-ross-pollution/.

And on... and on... and on... Often described as a Wall Street 'shark', the dude is really a giant cat fish, enjoying murky waters of the Washington's mud beds.

22/6/18: 'Skeptical' IMF tends to be over-optimistic in its U.S. growth forecasts

In recent weeks, the IMF came under some criticism for posting relatively gloomy forecasts for the U.S. economy, especially considering the White House rosy outlook that stands out in comparison. see for example, WSJ on the subject here: https://www.wsj.com/articles/imf-sees-u-s-potential-growth-at-half-the-pace-of-white-house-estimates-1528995732.

Which begs two questions:

1. Does IMF have any grounds to stand on its forecasts divergence from the White House? and
2. Are IMF forecasts for the U.S. economy actually any good?

Firstly, the grounds:

Per above chart, the IMF is not alone in being less than exuberant about forward growth forecasts for the U.S. In fact, it is White House that appears to be an outlier when it comes to 2020-2023 outlook.

Secondly, per the question above, I crunched through IMF's semi-annual forecasts releases from April 2013 on (period prior to 2013 is too volatile in terms of overall fundamentals to take any forecast errors seriously). The chart below summarizes these against the actual outrun:

On the surface, it appears that IMF forecasts in recent years carried massive errors compared to outrun. So I did a little more digging around. I took 1, 2, 3, and 4 years-ahead forecasts, averaged them over different forecast releases, and estimated 90 and 95 percent confidence intervals for these. Here is the resulting chart:

What does the data tell us? It says that IMF forecasts have, on average, overstated actual growth outrun. In other words, IMF forecasts have been over-optimistic, not excessively pessimistic, in the recent past. More that that, IMF's current (April 2018 WEO release) forecast for the U.S. GDP growth is even more optimistic than already historically optimistic tendencies of the Fund imply. In other words, even though the first chart above shows the IMF forecast for the U.S. growth to be pessimistic, compared to that of the White House, in reality, IMF's forecasts tend to be wildly optimistic.

Average error for 1 year ahead forecast for the U.S. in IMF releases has been 0.037 percentage points (very small), rising to 0.476 percentage points for 2 years ahead forecasts (more material error), and 0.867 percent for 3 years ahead forecasts. Augmenting data (to achieve larger number of observations to 2000-2006, 2011-2014 periods, 4 years ahead average forecasts has been 0.867 percentage points above the outrun growth. And so on.

So, to summarize:

1. IMF is not unique in being less optimistic on the U.S. economy than the White House;
2. IMF's history of forecast errors suggests that the Fund tends to be overly optimistic in its forecasts and that current official Fund forecasts are more likely to be reflective of significant over-estimation of future growth than under-estimation;
3. IMF's forecasts more than 1 year out should be treated with some serious caution - something that applies to all forecasters.

21/6/18: Weaker growth signals for the euro area

I have not updated Eurocoin dynamics and euro area growth forecasts for some time now, so here is the latests, from May data:

• Eurocoin, leading growth indicator for the euro area, has fallen significantly from the local high of 0.96 in February (the highest growth forecast since June 2000) to 0.89 in March, followed by continued decline to 0.76 for April and 0.55 in May
• May reading is the lowest since December 2016
• Growth forecasts consistent with Eurocoin dynamics indicate that, assuming revised 1Q growth remains at 0.4 percent, 2Q 2018 growth is likely to come in somewhere in the range of 0.35-0.55 percent

Chart below shows improving outlook for HICP (inflation) over the last 12 months through May 2018, just as the economy beginning to slow down:

On balance, we now have three consecutive months of declining Eurocoin-implied forecasts for euro area growth. It will be interesting to see eurocoin print for June, coming up in about a week, as well as July (coming out prior to the Eurostat growth estimates for 2Q 2018).

20/6/18: Irish Labour Force Participation Rate: Persistency of a Problem

With the latest CSO data reporting on labour force participation figures for 1Q 2018, time to update the chart showing secular decline in the labour force participation rate in the country since the start of 2010:

As the chart above shows, despite low and falling unemployment, Irish labour force participation rate remains at the lows established at the start of 2010 and is not trending up. In fact, seasonal volatility in the PR has increased on recent years (since 1Q 2016), while the overall average levels remain basically unchanged, sitting at the lowest levels since the start of the millennium.

Taking ratio of those in the labour force to those outside the labour force as a proximate dependency indicator (this omits dependency of children aged less than 15), over 2000-2004 period, average ratio stood at 1.685 (there were, on average, 1.685 people seeking work or employed for each 1 person not in the labour force). This rose to 1.895 average over 2005-2009 period, before collapsing to 1.630 average since the start of 2010. Current ratio (1Q 2018) sits at 1.600, below the present period average.

While demographics and education account for much of this, overall the conclusions that can drawn from this data are quite striking: per each person staying out of the labour force for various reasons, Ireland has fewer people working or searching for jobs today than in any comparable (in economic fundamentals terms) period.

17/6/18: ECB's Shift of Gears Presents Another Set of Risks

My article for Business Post from Friday covering ECB's latest announcements on QE and interest rates: https://www.businesspost.ie/opinion/ecbs-shift-gears-presents-another-set-risks-418797.

15/6/18: "Ripples in the Crypto World" - Our New Article on Systemic Risks in Cryptocurrencies

Our new article on dynamic properties and systemic risks of key cryptocurrencies is available at:

Gurdgiev, Constantin and Corbet, Shaen, Ripples in the Crypto World: Systemic Risks in Crypto-Currency Markets (June 15, 2018). International Banker, June 2018 https://internationalbanker.com/brokerage/ripples-in-the-crypto-world-systemic-risks-in-crypto-currency-markets/ . Ungated version: https://ssrn.com/abstract=3197351.

15/6/18: Italian High Yield Bonds and Markets Exuberance

Nothing illustrates the state of asset valuations today better than the junk bonds tale from Italy. Here is a prime example from the Fitch ratings note from June 7:

"...longstanding Italian HY issuer and mobile operator WindTre sequentially refinanced crisis-era unsecured notes at 12% coupons into 3% area coupons by January 2018, despite losing cumulative revenue and EBITDA of 30% and 25%, respectively, and re-leveraging from 4x to 6x."

Give this a thought, folks:

1. We expect rates to rise in the future on foot of ECB unwinding its QE, the Fed hiking rates and monetary conditions everywhere around the world getting 'gently' tighter;
2. Euro is set to weaken in the longer run on foot of Fed-ECB policies mismatch;
3. WindTre issues replacement debt, increasing its leverage risk by 50%, as its revenue falls almost by a thirds and its EBITDA falls by a quarter;
4. WindTre operates in the market that is highly exposed to political risks and in an economy that is posting downward revisions to growth forecasts.

And the investors are piling into the company bonds, cutting the cost of debt carry for the operator from 12 percent to 3 percent. 

Per FT (https://www.ft.com/content/31c635f4-64df-11e8-a39d-4df188287fff): "Lending to corporates rose 1.2 per cent in the year to February 2018, according to the Bank of Italy, and the average interest rate on new loans was 1.5 per cent — a historic low."

Say big, collective "Thanks!" to the folks at ECB, who worked hard to bring us this gem of a market, so skewed out of reality, one wonders what it will take for markets regulators to see build up of systemic risks.

9/6/18: Misinformed and wrong: President Trump's trade policy stance on the EU

I just posted on @twitter a short thread concerning the U.S.-EU trade and payments balances from 2003 through 2017 and a trend-based forecast for same out to 2021. The thread can be accessed here: https://twitter.com/GTCost/status/1005467563034152961.

The key problem is that in his trade policy strategy, President Trump appears to be oblivious to several key factors that materially determine the true extent of imbalances the U.S. trade with the EU, including:

1. Trade in services: while the U.S. is running a large (USD 153 billion dollars in 2017) deficit in goods trade with respect to the EU (and this deficit is persistent since 2003), the U.S. is running USD 51.3 billion surplus in services against the EU, and this surplus is rising (with some volatility).
2. When trade balance is augmented by transfer payments (accounting for profits of the U.S. companies earned in the EU, less profits of the EU companies earned in the U.S., plus net transfers from the US to EU residents, including pensions payments, etc), the U.S. was running a surplus of USD14.22 billion in 2017 with respect to the EU. In fact, the current account balance for the U.S. with respect to the EU has been in surplus (in favour of the U.S.) since 2009, with 2008 figure being statistically zero (balance).
3. U.S. net lending (+) or borrowing (-) from current- & capital-accounts vis-a-vis the EU has been in surplus every year since 2008.
4. In fact, the 'New Economy' (services, IP etc) have generated a huge surplus for the U.S. when trade and income flows with the EU are accounted for.
5. U.S. true exports to the EU are obscured by the U.S. multinationals accounting strategies that aim to minimise their tax exposures to the U.S. by engaging in extensive transfer pricing, shifting of tax base and complex offshoring of retained earnings. Were these factors taken into the account, the U.S.
6. Over 2009-2017 period, cumulative balance on trade in goods and services, plus primary and secondary income with the EU, stood at USD 57.3 billion in favour of the U.S. and cumulative net balance on capital and current account transactions basis was USD 112.7 billion in favour of the U.S.

Prior to the G7 Summit President Trump complained in a tweet that the U.S. was running a deficit of USD 151 billion with the EU. The official figure from the U.S. Department of Commerce, however, is USD 153 billion but this figure only covers trade in goods.

The dynamics of full net cumulated 2003-207 balance in payments and trade for U.S.-EU trade, including forecast out to 2021 (pure trend forecast, not accounting for other factors that favour the U.S.) is presented below:

In simple terms, President Trump's trade war on the EU is unwarranted, dangerous, damaging to both economies and a major negative for the U.S. standing in the global economy. It is also reflective of his deeply economically illiterate understanding of the complexities of national accounts.