Economics 27/11/2009: Euro area data signals near 2% growth in November

Updated

Eurocoin - a leading barometer of future economic activity in the Eurozone - increased to 0.55 in November, the third positive reading in a row up from 0.33 in October. The reading points to an underlying growth in the Euro area of slightly above 2% on a annual basis. Gains have been led by consumer and business confidence as the main drivers, the stock market and industrial production contributed to a lesser extent. We are now back to H2 2007 level in Eurocoin reading.

So here is the forecast, as promised:
Notice that my forecast assumes ca 1.1% growth q-o-q in Q4 2009 and a dip to ca 0.3-0.4% in January 2010. Not a W, but a moderation nonetheless, driven primarily by what I believe will be a very weak Christmas season across Europe. In Ireland, as always there is an issue of extreme volatility in growth, but I will be watching Christmas sales for signs of serious weakness - there is a distinct possibility of large shut downs on retail and restaurants trade side the other side of holidays into January. Let's hope I am wrong (and I have been wrong in the past - my previous forecast for Q3 2009 Euro area growth was -0.5-1% and it came out at a 0.8 percentage points swing from my closer end of the estimate).

On a less economic side of news:

EU Commissioner for Internal markets for the next 5 years will be one French MEP Michel Barnier. Barnier will take portfolio with responsibilities for financial services. Barnier had so far distinguished himself as trade protectionist with strong opposition to the so-called 'Anglo-Saxon' model of economic development. That is to say he is firmly in favor of rules-based regulation of financial services. This is a net negative development, as currently Brussels is in the process of drafting a massive volume of regulations relating to financial services and such a process of reform requires a very balanced and sector-specific approach. Barnier is hardly fulfilling such a description. On July 28 this year, Le Monde (Barnier's home paper) described the possible appointment of Barnier to the Internal Markets portfolio as equivalent to "entrusting the surveillance of a chicken coop to a fox".

Why a chicken coop & fox analogy? Not because Le Monde is that much concerned over Barnier's credentials as over-regulation driven finance tsar, but because Barnier will be running financial sector across the EU at the time when President Sarkozy has a clearly defined (and publicly expressed) objective to make Paris a bigger financial services centre than London. It will be interesting to see how the battle between Barnier-the-European-Federalist and Barnier-the-French-Politico will be unfolding.

Forbes reports (here): "One former official who worked with Barnier said: 'He has always been very close to the French conservatives. He was close to Chirac and now he is close to Sarkozy. He will know that he is in that position thanks to Sarkozy.'"

If there is any more to add here it is that Barnier was Minister for Agriculture in France between 2007 and 2009 - a post that saw him preside over the most subsidised, most protected and least 'common market' of all sectors in Europe in a country that holds second place only to Ireland in per-farmer subsidies. He now will oversee the most mobile and least protected sector across the EU. Spot the irony...


And since we are on news digest - here is the story that caught my eye. This goes to heart of the debate as to what makes a state a pariah state. After all, Soviet Union used in place its Nobel Prize winners into exile or under house arrest in a remote city closed-off to the rest of the world, it even forced one to turn down his Nobel Prize, but stealing it away from a person? New low for the state that the West is courting with bouts of friendly rhetoric. And what an irony for the Nobel Peace Prize Committee, which awarded President Obama's prize this year in part for his renewing dialogues with rogue states like... Iran (here)...

Economics 26/12/2009: International report on Irish Air Tax

So in few hours from now, Ryanair will launch a report commissioned by them, Aer Lingus and CityJet that comprehensively destroys any argument in favour of the Irish Travel Tax. Here are the exerts from the report - well ahead of all other media. Note: this research was carried out by consultants who earlier this year convinced authorities in Holland to revoke their own travel tax in order to improve economic performance of their air transport sector. My comments are in brackets below.

“Aer Lingus, Ryanair and CityJet, which account for 83% of total departing passengers from Irish airports, are currently endeavouring to persuade the Irish Government to withdraw the Irish Air Travel Tax (ATT), which has applied to flights out of Ireland since 30 March 2009. The ATT imposes a tax of € 10 per passenger on all flights from Irish airports to airports which are situated more than 300 kilometres from Dublin Airport. For flights from Irish airports to airports within this limit a reduced rate of € 2 applies.

“It is envisaged that the revenue of the ATT would have been approximately € 130 million per annum if no demand reduction had occurred as a result of the imposition of the ATT. However, economic theory and empirical evidence clearly demonstrates that passengers will react to higher travel costs, which will inevitably reduce demand for air travel.

“If airline capacity had been maintained at 2008 levels and the ATT was to be passed on in full to passengers in the form of higher fares, it is estimated that the total resulting demand reduction would be between 0.5 and 1.2 million departing passengers based on a price elasticity range of between –0.5 and –1.5. On this basis, ATT revenue would be between € 117 million and € 124 million but total revenue losses for airlines, airports and the tourist sector would range from a minimum of € 210 million up to € 465 million, dependent on the elasticities assumed While some revenue losses may be absorbed by the relevant sectors in the form of resulting cost savings, there will still be a significant adverse effect on the Irish economy. These losses are compounded further down the supply chain as companies purchase fewer goods and services.

“In particular, there will be a direct loss of jobs of at least 2,000 to 3,000 affecting airports, airlines and the tourism industry dependent upon the extent to which companies are willing to accept the inherent diseconomies of scale from a reduction in demand. The direct consequences of the reduction in passenger demand as a result of the ATT would give rise to significant reductions in government revenues in the following categories:
Less revenues from income tax (as well as higher unemployment costs)
Less revenues from corporate tax
Less revenues from sales tax (value added tax (VAT))

“While it is not possible to quantify the scale of these revenue losses, the level of expected job losses as a consequence of the ATT would, assuming that every lost job results in additional costs of approximately € 20,000 per annum to the Government in the form of reduced income tax and social welfare payments, give rise to an additional cost to the Irish government of the order of € 50 million or more. These costs are related to social welfare payments as jobs are unlikely to be replaced in the short to medium term. Over the longer term, as the economy recovers from the recession, the net loss of jobs may reduce as labour switches to less productive employment in a new economic equilibrium.

“In reality, airlines have not been able to pass on the ATT to passengers in the form of higher fares but have reacted by a combination of absorbing the tax by lowering fares and redeploying capacity outside of Ireland to locations where no travel tax is applicable. Consequently, actual revenue losses across the various sectors as a result of the ATT have been significantly higher than might have been expected due the impact of higher prices alone, estimated at between € 428 - € 482 million based on activity by Aer Lingus, CityJet and Ryanair alone, with ATT revenue estimated to be € 116 million. The resulting loss of revenue on the part of the Government will also be significantly higher as a result of the additional loss of jobs.

“Our analysis clearly demonstrates that the imposition of the ATT has resulted in a decline in revenue to specific sectors of the Irish economy of a far greater magnitude than the amount of tax likely to be collected. Based on the actions of airlines to date and the revenue impact on the airlines, who have had to absorb the tax in lower fares to maintain volumes, it is likely that the level of capacity will further reduce as airlines continue to redeploy their resources to lower cost markets in the European Union where no travel tax applies. This will have a further detrimental impact on the Irish economy and the tourism industry in particular. In addition, the resulting reduced airline network will reduce air service connectivity to Ireland, making it less attractive to visit and a less attractive place to do business, which may also serve as an impediment to economic regeneration more generally.”

[My comment: I have nothing to add, other than – I told you so months ago!

But let me ask this question - economics aside, why no one has questioned the ethical authority of this Government to levy an arbitrary tax on air travel? After all, air travel involves a voluntary transaction between a passenger and an airline. Use of airport infrastructure is already charged for. Vat and other taxes are already factored in. Income taxes were paid. What service does the state claim to provide to justify this surcharge? None. Not even in theory should the Government have a right to levy a tax that is so apparently ad hoc and serves solely the purpose of discriminating against one group of people (those undertaking overseas travel for personal or business reasons) in favor of generating cash revenue for general spending purposes. You disagree? Ok, should we have a marriage tax next? Or a tax on private libraries? X-box use surcharge? I-phone listening levy? Children walking assessment? Where does the abuse of power to tax stop?]

Economics 22/11/2009: News Flash - our taxes are already killing FDI

If you missed my today's article in Sunday Times, here is the unedited version below.

Before that, a quick news flash - my source close to DETE has informed me last week that in September-October this year three large multinational companies currently not present in Ireland have told our international investment development agency that they have no interest in locating in Ireland. These statements came after several months of negotiations to attract these companies into Ireland. Significantly, all three indicated that the upper marginal tax rate in Ireland, which inclusive of levies and charges rises to a whooping 56% of individual income was the main reason for them not to locate their European headquarters here, as they deemed this level of tax on executives' earnings to be prohibitive.

As Ireland is facing the prospect of one of its toughest Budgets in history, the debate about what to cut and by how much has firmly displaced all other issues on the news agenda. Different views, arguments and policy proposals abound. Virtually all side one way or the other with the idea that any reduction in public spending will be deflationary in this economic environment. Cut public deficit financing, say proponents of tax-and-spend or borrow-and-spend policies, and you will be cutting consumption, triggering a decline in GDP, and more layoffs.

This argument is not new. Many economists, let alone policy pundits, subscribe to it. But is it really true? If the Irish Government were to reduce public consumption or state wage bill today, will the Irish economy crash?

The debate centres on the question as to how large is the fiscal policy multiplier. To understand it, suppose that the fiscal multiplier is greater than 1, say 1.5. In this case, a €1.00 increase in government purchases raises the aggregate demand for goods and services in the economy by more than one euro, or in example above, by €1.50. If the original euro was borrowed at 5% per annum, then the net return to the economy is 42.9%. Sounds magical? If this indeed were true, economic prosperity for all can be achieved by simply endlessly running ever-rising deficits to finance more and more public spending. Enter SIPTU/ICTU/CPSU programmes for State spending. Clearly something is amiss in this logic.

But forget the theory, perhaps fiscal policy alchemy works in practice?

Well, even in the case of the US – the most thoroughly researched economy in the world - there is confusion as to what exactly deficit financing of public expenditure does in a recession.

In a recent research note Professor Christina Romer, Chair of President Obama’s Council of Economic Advisers, asserted for each $1 spent by the Federal Government in a recession, US economy grows by $1.95. So far so good – borrowing at, say 5% per annum and getting 51.3% return makes sense. So much so, that her own employer – the said Council of Economic Advisers – thought this paper was a grand candidate for publicly justifying President Obama’s stimulus package.

The problem, of course, was that Professor Romer’s estimates did not fully for the fact that the largest part of President Obama’s stimulus came in the form of tax cuts, not spending increases. The former accounted for roughly $66bn of the total spending of $151.4bn in March-August 2009, while conventional public spending accounting for just $30.6bn. The rest of stimulus was taken up by aid to the states ($38.4bn) much of which went to offset earlier local tax increases and Government investment ($16.5bn).

In response to Professor Romer, Professor Robert Barro of Harvard University argued in January 2009 that historically, US fiscal multiplier was very close to 1, suggesting that deficit-financed spending earns no real economic return. And Barro’s findings are echoed by an earlier study by Roberto Perotti of Bocconi University, Italy. Perotti looked at fiscal multipliers for the OECD countries between 1960 and 2001. His main conclusions were that post-1980 there is no evidence of fiscal multipliers being in excess of 1. Over time, with a 5% coupon on a 10-year Government bond, deficit financing for Ireland Inc today, under Perotti’s findings will end up costing our economy at least 62 cents on each euro spent net of any benefits we might receive from growth. Furthermore, Perotti found evidence that government spending stimuli hurt private consumption and investment, whereas tax cuts do not. This suggests that cutting taxes, although not necessarily more productive than a fiscal stimulus in the short run will at the very least be less costly to the economy in the longer term.

So dynamic effects of deficit-financed fiscal stimulus over time do matter. And here lies the crux of our debate: dynamic effects depend on country characteristics. Majority of studies on the matter of fiscal multipliers were carried in the US – a country that hardly resembles Ireland for several reasons. Firstly, it is a large and a relatively closed economy. Secondly, it has independent monetary policy, prints its own currency and has a global market for its bonds. Ireland, in contrast, is a small open economy, with no monetary policy independence, extremely tight and saturated markets for its bonds and with exchange rates that are flexible vis-à-vis its main trading and investment partners (the US, UK and the rest of the non-euro world).

And this brings us to the last point of our tour de force through the world of fiscal multipliers and deficit-financed state spending programmes. To make the most accurate assessment of the potential effects of the public sector cuts proposed for the Budget, we must consider empirical evidence for countries similar to Ireland. A recent (October 2009) study published by the Centre for Economic Policy Research looked at 45 countries (20 high-income and 25 developing), spanning 1960 through 2007. What the authors found confirms the results attained by Romer and Perotti, and paints a picture of just how dangerous the deficit financing myth can be for a country such as Ireland.

For a small open economy, like Ireland, the study found cumulative total fiscal multiplier starts with a negative (yes, a negative) -0.05 effect on economic growth and in the long run (over 6 years) reaches a negative -0.07. In no time does the average cumulative multiplier exceed 0.4%. Now, add to this a realisation that Irish economy operates in the world where the Euro is in a virtual free-float against the Pound Sterling and the US Dollar. The same study estimates that for economies with flexible exchange rates, the impact effect of fiscal stimulus is -0.04 and the cumulative long-run effect is -0.31.

This means that were we to pursue a policy of higher fiscal spending based on deficit financing, as the Men of the Liberty Hall suggest, we would be facing immediate losses of at least between 4-5 cents on each euro of the entire stimulus. Over time – say by around 2013-2015, these losses will accumulate to something in the neighbourhood of 31-40 cents on the euro per annum. And this is before the cost of financing these deficits is factored in.

Even were ICTU/SIPTU were right on our ability to raise funding without any cost to the real economy (although their proposals would imply severe tax hikes for ordinary men and women of this country), Irish economy would still be wasting money if transferring wealth from the so-called rich (aka pretty much everyone with a decent job) to public expenditure.

Love it or hate it, but real world economics simply has no room for our Social Partners’ latest ideas on fiscal management.

Box-out:

At a recent conference, a French colleague asked me if Ireland is a low tax and low public spending economy.

The only way to answer this question is to consider the overall size of the Government expenditure in Irish economy. Back in 2008, Irish Government spending accounted for approximately 48% of our GNP, or one percentage point above the EU average and about half a percentage point above the UK. Forget for a moment that the UK has a functional and a sizeable military.

Focus on 2009 numbers. Due to continued increases in public spending throughout
this year, and to a rapid decline in our GNP, Irish Government spending is likely to account for between 53% and 54% of our domestic economy. In other words, over half of all goods and services supplied in Ireland is being swallowed by the State.

To put this number into perspective, the heaviest taxed economy in Europe in 2008 was Sweden, where the ratio of public spending to domestic economy was just over 53%. Yet, navigating through the recession, Swedes cut their taxes in 2009 as we raised our. Thus, by December 31 this, Ireland will be the holder of the dubious title of the heaviest taxed economy in the EU.

Now, give a thought another fact. Top personal income tax rate in Denmark in 2008 was 59%, in Sweden - 56.4%. In Ireland it is 56% after April 2009 Budget. Thus, we now have the third highest income tax band in Europe.

All of this means that Ireland is heading for a grim Christmas sales season shackled not by low consumer confidence, but by a lack of after-tax disposable income.

Economics 21/11/2009: Public v private sector income inequality is up, again

Updated images files

There are many claims flying about our bearded men of Siptu and Ictu nowadays. None are more offensive than their claims that private sector has not been hit hard in terms of wages and earnings by the current crisis. Well, thanks to CSO's inability to collect timely and frequent data, we had to sit back for some time, tolerating these unionist claims. Alas, data for Q2 2009 is starting to show that those of us who said that private sector is suffering earnings declines while public sector is basking in the sunshine of rising earnings were right. Here are the numbers:

Table 1 reports actual average weekly earnings based on CSO data sets. Yep, that's right -public servants make more money than the average managerial, professional and clerical grade in every other sector except financial services and insurance. Note, I separated electricity, water supply and waste management sector into quasi-public sector because it is heavily dominated by massively inflated earnings in ESB and other state monopolies.

Next, consider average weekly earnings for professional and clerical grades and for public sector overall. The reason for this is that our unionists keep on droning that public sector workers are so superior to the average worker in the rest of economy that they must be compared with higher grades. Forgive my disbelief that, say, CIE's bus drivers are so productive and so highly skilled that they should be benchmarked against branch managers of Irish banks, but let us indulge the Siptu/Ictu crowd:
Yes, it says that: between Q2 2008 and Q2 2009 more categories of public sector workers started to earn in excess of private sector average earnings for managers, professionals and clerical workers. And this is at the time when Jack O'Connor and the rest of Unions' leaders are talking about rising tide of income inequality (oh, give me a sec and I will get back to that concept).

Now, chart above shows that wages have been rising across all (but one) public sector sub-sectors. Average public sector earnings are up 3.2% in a year to the end of Q2 2009, while average private sector wages are down 6.8% over the same time - a swing of 10 percentage points. Happy times for CPSU and the rest of the unions pack.

Of course, years ago, when we had fast growing private sector wages, the unions, CORI, the rest of the social pillar fringe were loudly bemoaning the rising tide of income inequality. So what can we say now? Check out the following table:
Yeps, that's right, applying Socialists' faulty economic logic, last year our Trade Unions' policies have led to a rise in income inequality between private and public sector in favor of higher income to public sector.

If anything, the latest CSO data suggests that the next month's Budget 2010 should open with a significant across the board cut in public sector wages by at least 10% (to simply undo income inequality that has been generated since 2008), and only then proceed to all other cuts. Have a pre-Budget Addendum on Public Sector Earnings Inequality first, before you cut education, health and even social welfare, Minister.

Economics 21/11/2009: Travel figures

Just the facts... so as not to be too controversial.

CSO's travel to Ireland data for September 2009 released yesterday:

Chart 1: 

The above shows a significant month-on-month fall in September. But it does not show the underlying trends:

The difference between trips to Ireland less trips from Ireland revels two things. First - a general downward trend in the series over time. Second, in terms of annual averages: a drop from pre-2008 average to 2008 average was followed by a further drop in 2009 average to date. If the correction was due to a recession, one would expect to see some stabilization in 2009, especially per summer months. This would have pulled the average line for 2009 above 2008 line. But it did not happen. Something other than a recession is working through our travel data. May be, just may be, it has to do with the overall cost of traveling here?.. If so, the Rip-off-Republic surely starts at the point of entry - the taxes and charges feeding into airfares (not airfares themselves, with or without baggage fees, Irish airfares are relatively cheap compared to other countries).

The same patterns are showing through in trips taken to Ireland by main countries of origins. Note that I did not show linear trend lines, but it is negatively sloped only for Great Britain, while sloping up for Other Europe and North America. The fact that current annual averages are completely out of line with general longer term trends and that 2009 represents continued deterioration on 2008 suggests once again that something more sinister than a recession is working through our figures.

I can't resist doing some analysis here. Chart below shows linear trends in travel data (difference between trips to Ireland and from Ireland) over time periods concerned.

So what do these lines tell us? The blue line reproduces the results from the second chart above - this is the historic trend toward secular decline in net trips from abroad to Ireland. Yellow and pink lines show linear trends for 2008 and 2009. These lines are parallel, but 2009 line is below 2008 line, which means that the rate of change in the number of trips to/from Ireland did not change between 2008 and 2009, but the intercept declined year on year. In other words, this deterioration in trips to/from Ireland has nothing to do with continuous recession (slope effect), but everything to do with a consistent travelers' selection against Ireland as a destination. The same is confirmed by comparison of the yellow line (2009 trend) against the green line (2008 & 2009 trend), as well as by comparison of pre-2008 trend line (blue) against the 2008&2009 trend line (green).

Economics 21/11/2009: State Directors Fees

Per RTE report (here), Anglo's 'Public Interest' directors are being paid handsomely for their gargantuan efforts to... do exactly what? Steer the bank out of trouble? Not really, Anglo is not any better today than a year ago. Carry out its ordinary business? Not really, Anglo is not doing any new business at all and is in effect sitting pretty until Nama cleans up the mess. Safeguard public 'investment'? Not really, for no one sane really expects any return from this 'investment'. So what exactly do these 'Public Interest' director do? No one dares to ask. 

In the mean time, Alan Dukes and Frank Daly - two, in my view fine individuals - collect public retirement pay and are receiving €99,360 each in fees from a publicly-owned Anglo. A figure more than six times the compensation for directors of other State bodies.

But things are not much better in BofI (where Tom Considine and Joe Walsh received total fees to €102,375 and Joe Walsh's to €78,750). AIB in contrast paid Dick Spring and Declan Collier €27,375 and also topped these with €3,000 for each committee meeting attended. IL&P's public guardians, Ray MacSharry (fees of €56,250) and Margaret Hayes (€63,500) were handsomely well off as well. At EBS, Tony Spollen and Ann Riordan both receive a basic fee of €29,000 each. State appointed noble folks of Nationwide, Rory O'Ferrall and Adrian Kearns, in line with a long-running tradition at the building society to behave like a secretive private bank, simply didn't disclose their earnings to the public.

Further irony: fully state-owned Anglo pays second highest rate to its non-execs, while the Irish Government is flustered with privately held banks (AIB & BofI and the rest of privately held 5) executives' remuneration. It looks like someone (Minister Lenihan?) can't control his own organization (Anglo), while trying to play tough with organizations he has little stake in. Oh, incidentally, the fees for Dukes & co were set on the 'recommendation' by the State own 'commission' - another state body that Minister Lenihan apparently cannot reign in.

Expected annual cost (inclusive of expected, but not disclosed fees) €760,000 plus.

After having a quick chat with few friends in academia, here is a bold proposal for the Minister for Finance - you can find at least 12 senior and experienced academics and industry practitioners, including my self, who would do these jobs for €10,000 per annum plus expenses. As a real exercise in our patriotic (Minister Lenihan's words from last Budget) duty.

How about it, Minister? You promise left right and center that you will save taxpayers money. Here is a chance to do so. Some €640,000 of taxpayers money!

Oh and while we are on the topic of silly/dodgy political news - there is a recent report in the US (here) that argues that President Obama evokes Jesus and God more frequently than his predecessor. Not that I have a problem with this myself, but I wonder what all the European 'Liberals' would make of this...

Economics 16/11/2009: Notes on Banks post-Nama & Eurozone recovery

There is an excellent issue on Financial Sector Regulation published tonight by The Economists' Voice of BE Press (free link here), it also contains a superb article by Rob Schiller of Yale on housing bubble.

Oh, and per today's Bloxham note: "...media speculation is suggesting that Anglo needs a €5.7bn capital injection if it is to continue lending. Finance Minister Lenihan said on November 13th that a second capital injection won't be needed, but reports now suggest that if Anglo is to form part of a new banking force in Ireland the eventual cost will be in the region of 5.7bn to meet international capital adequacy levels. Finally the report suggests that a wind down option is now believed to be gathering support in the Dept of Finance."

Hmmm, see my blogpost here. Two weeks ago I predicted this same exactly number - 5.7bn as the upper envelope of the capital demand from Anglo... Glad to see media now catching up...

Watch tomorrow's Mail for my comment on why Anglo can be wound up at a lower cost than continuing the sorry saga of the bank...


Now to news:


You all heard the news: five consecutive quarters of economic contraction later, and the euro area's economy finally grew by 0.4% in Q3 2009. Anemic (as in expectations were for 0.5%) but this does mark the region's exit from its worst recession since World War II.

Eurostat has yet to release a breakdown of the third quarter, but it looks like exports were the drivers for growth. Of course, the other side of the economic equation - European consumers - is still stalled in the quick sands and is now gearing up for higher taxes, lower incomes and permanently higher unemployment in years to come. All of this as the Euro area's debt to GDP ratio is now heading for 100% by 2014. For comparison, US National Debt today stands at around $11,996bn or 96.5% of GDP.

Back to Europe: France expanded by 0.3% (0.6% growth was expected by the markets), Germany grew by 0.7%, (against 0.8% expectation).

Now, Ireland's GDP was stagnant per Q2 2009, while GNP fell another 0.5%. Technicality might be that Ireland will post a positive growth in Q3 2009, but that would mean preciously little: Irish GDP is extremely volatile and another negative correction might be easily coming in Q4 2009 / Q1 2010. This volatility is driven by exports' mammoth share of the country GDP.

Lastly, there is a problem of European fiscal and monetary stimuli - both covered by me before. Once unwinding begins, even the stronger economies of Europe are not immune from a sudden growth reversal. what's there to say about Ireland, Spain and Greece?..


And on a separate note couple of thoughts concerning Nama's passage:

There is an excellent article in the October issue of the US version of Vanity Fair magazine about the legacy of TARP. To remind you - TARP is a US programme to help struggling banks that:

• started its life with an idea of purchasing distressed assets off the banks' balancesheets (just like Nama),
• ended up purchasing common and preferred equity in the banks;
• overpaid grossly (to the tune of 30%) for the equity bought (even though unlike in the case of Nama there was a ready and functioning market for these banks' shares); and
• like Nama promised to deliver easing of the credit crunch conditions.

Now, a year from its inception, we know that TARP:

• resulted in banks taking Government cash and parking it in Government bonds, lending out virtually nothing;
• was immediately followed by a severe tightening of existent lending contracts and revisions of performing loans to squeeze more cash out of households;
• has led to multiple defaults by cash-strapped students, homeowners and credit card holders as banks are going on with their business rebuilding profit margins.

Any idea now what we can expect from post-Nama Irish Banking sector? Or with that ESRI estimate of 300,000 households at risk of negative equity?

Economics 15/11/2009: When Ryanair gets serious...

Per my continued opposition to absurd tax measures, see the following statement from Ryanair and my comment below:

Apart from landing another rainy cloud on Mrs Coughlan's fine parade (after all it does call Tanaiste out as being somewhat disingenuous in her claims), this statement is worth looking at a bit closer:

If the Irish economy is losing €600mln in tourism revenue, the VAT on this loss will likely be ca €80-100mln (as some services bear reduced VAT). This is the first round of losses to the Exchequer.

But every euro spent by a tourist in this country goes to pay for goods and services here, which in turn generates banks deposits and payments to suppliers. These payments are then used to generate new economic activity, thus triggering a second round of tax receipts. And the merry-go-round then goes on to the third round and so on. 

Given the average OECD private spending multiplier is approximately equal to the M1/M3 multiplier, which is roughly 3.8-6 (depending on the range of years chosen, with the lower number coincidentally referring to the years of the most recent global markets boom), then these losses are indeed much greater than those claimed in Ryanair note. 

Back of the envelope calculation suggests the Exchequer will be foregoing some €120-250 million more in revenue on top of the first round losses. And this is before we factor in income taxes and other taxes, such as charges on fuel that foreign motorists might pay while touring Ireland.

So we are now back to the old equation: put a €10 tax in place, lose some €100-230 million in revenue. Good luck running the country with these mathematics...

Note: that article attacking my and Ryanair analysis of the travel figures that predicted the yet-to-materialise substitution effects of Irish travel tax is available from the Irish Times site (here).

Economics 14/11/2009: Irish Insitituional Accounts 2008

CSO is not the quickest of institutions when it comes to timely release of data, so when it comes to Institutional Accounts, all we have to go for now is 2008 end of year data released earlier this week. Here is my take on it.
Chart above shows broad GDP composition. The decline in GDP in 2008 is pronounced and it is relatively clear that Non-Financial Corporations lead the way in driving down our gross domestic product. To see this in more details, consider the decomposition below:
Absent real growth in private sectors, public sector becomes more pronounced. In other words, as overall economy decline, public spending picks up in relative terms. Everything else is tanking. Not surprising, really. But in percentage terms, this is throwing some additional insights (below):Now, the story of our economic downturn is very much in full view - productive part of domestic economy (non-financial corporations and households and financial sector) is in deep retreat. Non-productive public deficit financing of state consumption is swinging into positive. Also, note that household contribution fall off is pretty much in line with financial sector fall off. This is indicative of the fact that (as I have argued consistently before) our financial crisis was not caused by external forces of credit crunch, but by internal mountains of bad debts accumulated by corporates and households.

Another point from above is just how dire are the conditions in non-financial corporate sector. Only a fool would believe that this precipitous collapse in the relative share of GDP accruing to non-financial companies in Ireland can be repaired by injection of more debt into the system.
Chart above shows that Net National Income (NNI=GNI-depreciation, GNI=GDP+net receipts from abroad of wages and salaries and of property income), which by its definition nets out along with depreciation some of the effects of transfer pricing has fared pretty much in line with GDP. Interestingly, households contribution to NNI is in excess of their contribution to GNP, suggesting lower depreciation and potentially rising inflows of income from abroad when it comes to Irish households. It also reflects the outflow of foreign workers (either out of Ireland or onto unemployment benefits), reducing income outflow out of the country. General Government line shows clearly that net income multiplier of government spending is negative - which is logical when you consider the fact that the Government borrows from abroad to finance current spending at home.
Percentage contributions to NNI are equally revealing of the fact that Government spending cannot be seen as income-additive when it comes to net income accruing to this country. Remember - per earlier slides, Government spending was a positive contributor to GDP, but a negative contributor to NNI.
Gross operating surplus in the economy fell in 2008 across all private sectors and rose for Government sector. Why? Because while talking about the need to correct deficit, to cut spending and to take tough measures necessary to rebuild exchequer finances, our leaders were all too keen to actually pre-borrow as much as possible before 2009 hit. 'Do as I say, not as I do' is the motto...And thus net savings collapsed for Irish Exchequer as net borrowing soared. In contrast, households - scared first by rising joblessness and tanking stock markets and collapsed house prices, then by Leni's VAT measures and Government's inability to act - have moved early on into precautionary savings. Good for them - Irish non-financial corporations, in contrast decided to cut their savings - a sign of debt overhang in a recession. This means that overall, Irish corporations will emerge from this crisis with no spare cash to sustain restart of capital investment. This might be a good thing, given that over the last 10 years, most of Irish corporate 'investment' involved buying up competitors' firms at peak market valuations in a hope that if you make your company bigger, it will grow faster.

External balance has improved, but underlying it, trade flows to and from Ireland have come under pressure:
To nobody's surprise, net worth fell off the cliff in 2008 for the entire economy, although household savings allowed for a rise in their net worth position. 2008 marked the first year in modern history when Irish households net worth exceeded that of the Irish Government. Just think about it: the state dependent on taxpayers has had higher net worth than those who financed it... Spot anything here? How about 'fairness' idea our political leaders love waving around.Net lending positions (above) are also self-explanatory. But here is an interesting angle on CSO's data:
While Government share of GDP rose, its share of Net National Income declined. Even more dramatically, Government share of net disposable income fell even faster than that of NNI. Why? Because as Government deficit went through the roof, net disposable income fell -4.66% which is even faster than GDP (-4.18%). How? One word: Taxes!

Economics 12/11/2009: ECB's latest view

I will be blogging on the latest monthly bulletin from ECB published today, but here are few early previews:

One interesting snapshot showing just how silly is all the talk about decoupling in growth between emerging economies and the West:
Since mid 2008 there is absolutely no difference in leading indicators for two series. So anyone still thinks that emerging markets up 90% in a year is a good thing?

And here is a latent illustration of the trend I described some weeks ago using raw ECB data:
Of course anyone knows by now that money supply is not growing, despite the ECB vastly expanded liquidity pumping operations as banks hoard cash in capital reserves, while Government mop up all and any liquidity they can get into their vast deficit financing exercises. Clearly, M3 is showing that things are going swimmingly in the euro area economy.

Don't believe me? Well, here is another illustration:
So things are not getting much better on the credit markets side. The mountain of debt on private sector side is still intact, the mountain of debt on Governments' side is rapidly rising. Hardly a sound exit from the crisis.

Economics 11/11/2009: Lagging indicators and leading signals

McKinsey have published their review of the global economic conditions survey for November. Good read as always (here). Few snapshots of main results first:

"For the first time in a year, a majority of respondents—51 percent—say economic conditions
in their countries are better now than they were in September 2008.... [but] only 19 percent say an upturn has begun. This figure rises to a remarkable 33 percent, however, among respondents in Asia’s developed countries."

Cool, but... 49% state that economy either did not improve or worsened relative to September 2008. 64% expect their economy to be better than in September 2008 by the end of Q1 2010 (up from 61% reading in September 2009). So almost 50% believe that their economy is no better now than at the beginning of this recession (full 4 quarters ago) and some 36% believe that it won't come out of the recession even after 6 quarters of straight contraction.

"A larger share of executives also expects the good news to continue, with 47 percent expecting GDP growth to return to pre–September 2008 levels in 2010 or 2011, compared with 40 percent
six weeks ago." Key point here is that this is an improvement in the indicator, not the actual growth signal (which would require a reading above 50%).

"Although the global news is good, there are marked regional differences; executives in the developed countries of Asia are generally the most optimistic, and those in Europe are the least." This tell us what we all knew - European companies are suffering still through the remnants of old pains, banks are yet to suffer most of their pains, and households - well, households in Europe are in a perpetual pain given sticky unemployment and slow consumption growth and household investment. Thus: "Everywhere except Europe, more executives describe the economy over the next several months as “battered but resilient” than say it is frozen, stalled, or regenerated." (see pic below)So much for the European Century story.

But what are the causes of this pessimism in Europe / optimism in Asia scenario? One can speculate:

For example, despite all the crises, all public spending and monetary easing, business leaders worldwide still see Government regulation as one of top three problems (chart below).
What this tells me is that structural issues that have precipitated the current recession have not been addressed. Can one be out of crisis when the causes of crisis in the first place remain intact?

Another interesting issue - future profitability.
I am not sure how you feel about this, but it makes me very uncomfortable for several reasons:

1. Again, Europe acts as a global drag (just as it was before this crisis), and this is before the hefty tax increases necessary for underwriting recent profligate spending are factored in;
   
2. US - think of this as the indicator of future equity values and you can see just how massively is overbought the US equity market;
3. Overall, all countries which used large state reserves of liquidity to finance current crisis measures (India, China, Asia-Pacific) are on the tearing path for profitability relative to Europe and North America.
   

Now take the outlook for 12 months ahead:
Let's look at this closer:

1. Low customer demand for our products or services: the main driver for all types of firms - with profits at risk (66%), static (46%) and expected to rise (41%). Just think what this means for countries that like Ireland are staring at higher taxes into foreseeable future and destroyed households' net worth;
2. Loss of business to low cost competitors: do I need to say anything here in terms of threats to Ireland Inc? Well, let me put 5 cents in - think of wages path in this economy. While private sector did some cutting (and hardly enough to reach long run equilibrium wages) public sector did none and is unlikely to do much (the latest plan for 6.85% cuts is (a) insufficient, and (b) won't happen in real terms). So overall level of wages in Ireland is really stuck somewhere around 2006 levels.
3. Competition from new entrants is the worry for leaders in profitability, but it will also impact the developed world economies. Why? Because to counter such entry you need new investment and to have new investment you need capital. Currently, capital is mopped up by Governments financing their deficits through Central Banks' issuance of new cash. Later it will be cleaned out by higher taxes. Not a good prospect going forward.
4. Low levels of innovation - again go back to capital in (3) and the same investment cycle restart bottlenecks. Ditto for Inability to get funding - Number 7 on the list.
   

We can go on, but you can see where all this is leading us -

• our current fiscal and monetary policies will be haunting us down the line into the so-called recovery,
  
• while more frugal Governments in China, India (you get the irony here?), Asia and so on, having stayed pre-crisis off the path of unsustainable increases in public spending at rates much faster than growth in their real economies, were able to absorb the crisis with lesser burden of debts.

This is where optimism is now resting globally. We are, therefore, back to the paradigm of "Smaller Governments, Happier Economies"... and healthier households, one might add?

Economics 10/11/2009: Our Unique Path to Solvency

Updated: FX outlook (below)

And so two things come to pass in the last few days that will have a significant bearing on Ireland in years to come.

Issue 1: the ECB has firmly set its sight on exiting from money printing business sooner rather than later. Per ECB's statement last week, the bank will close off its 1 year discount window, cutting maturity of the loans available to the banking sector in the euro area from 1 year long term maturity to 3 months traditional maturity. This will mean two things for Irish banks who are the heaviest borrowers from the ECB by all possible measures (see here):

1. Irish banks will face much faster transmission of any rates increases into their cost of borrowing increases;
2. Irish banks will see higher cost of borrowing directly due to them being unable to access 3-12 months maturity instruments outside the interbank lending markets (currently they are collecting a handsome subsidy from the ECB’s discount window by borrowing at rates well below those offered in euribor).

And all of this will mean that our banks will once again see their margins squeezed by the credit markets, implying an even greater incentive for them to go after their paying customers with higher mortgage rates, credit cards rates and banking fees and costs.

Issue 2: earlier this week, the EU produced an estimate that the Union members’ total public debt could reach 100% of GDP by 2014 up from 66% in 2007. Last month, the Commission forecast that EU debt levels will rise to 84% in 2010 and 88.2% in 2011. Now, it says that not only the debt will top 100% of GDP in 2014, but that it will keep on rising after that. And the Commission named the row of culprits most responsible for fiscal debacle: Greece, Ireland, Latvia, Spain and the UK. This is linked to the earlier paper from the Commission that looked at long-term demographic challenges to deficit financing, where Ireland and other countries were presented as basket cases in terms of pensions liabilities and expected healthcare costs associated with ageing population.

This, of course means the following two things for Irish economy:

1. Despite all extension for 2013 deadline for Mr Cowen to deliver SGP-compliant budget for Ireland, the EU is going to put more pressure on Ireland to bring its house in order. Not doing so will risk derailing of stimulus exits and deficits rollbacks by the likes of Italy, followed by Austria, Spain, Portugal and France. This simply cannot be allowed for the fear of undermining euro’s credibility and with it any plans Brussels might have for the tidy earnings from reserve currency seignorage in the future;
2. Brussels will be pushing harder and harder for own tax revenue source – some sort of a unified federal tax – in order to divorce itself from the precarious and uncertain (i.e volatile) sources of state-level revenues.

The net effect of all of this – taxes will go up. To put this into perspective, should the EU allow us the deadline of 2014 to sort out our deficit, this will mean our debt will be up by another €20-22bn and our cumulative interest bill will rise (by the end of 2014) by another €5.5-7bn.

Alternatively, consider the annual bill for this debt – at 4.7-6% per annum (a reasonable range starting from today’s low rates and reaching into rates consistent with ca 1.75-2.0% base ECB rate), the new, shall we call it ‘delay the pain SIPTU’-debt, will cost us every year something to the tune of €940-1,320 million, or just about what Mr Cowen is now promising to shave off the public sector pay bill.

So do the math – accumulation of liabilities (interest only) of up to €1.3bn per annum and political process delivering promises of savings of €1.3bn after two years of the crisis… Path to solvency indeed.


Now, per one reader's request, here is my view on what this means for the euro:

Macro side: unwinding of deficits will mean a steep fall off in Government consumption and investment, so both - short term and longer term demand for euro will fall. This will be offset by the simultaneous unwinding of quantitative easing, so supply of euro will also decline. Three scenarios and paths are possible from there:

1. If the two offset each other, we are down to interest rate differences to drive currency pairs against the euro (more on this below);
2. If monetary tightening will be lagging fiscal constraints, then euro will be heading south vis-a-vis dollar but not by much as it is highly unlikely that Obama Administration will be able to sustain its own deficits for much longer;
3. If monetary tightening leads fiscal tightening, then euro might head further north vis-a-vis the dollar.
4. Interest rates effects are most likely to drive euro up for several reasons: the US Fed is likely to continue easing as fiscal stimulus runs out; the ECB has reputation building (re-building?) to do; US has higher tolerance for inflation.
5. Last issue to watch over is the financial sectors demand for liquidity. Here, the US is more likely to face smaller demand for liquidity than euro area and this will imply a net positive to the dollar upside.
   

So my view is that dollar-euro pair will remain volatile over some time, with some limited upside to the dollar in the medium term. Carry trades in dollar will be continuing especially as the BRICs and the rest of the world launch into a new investment cycle in early 2010. Depending on whether this will coincide with monetary/ fiscal tightening in the euro area, we might see temporary testing of $/€1.65 barrier.

Euro-sterling story is a different story. The UK will be unwinding fiscal stimulus, while continuing monetary easing (banks are still in need of capital and writedowns will remain pronounced), which means we shall see plenty excess supply of sterling. The pressure is to the downside here and parity can be approached once again (remember that 0.98 moment in December 2008?).