18/08/2011: VIX signals crunch time for the crisis

Summary:


Few charts on VIX - hitting historic, second highest ever, 1-day dynamic semi-variance range:
VIX itself above and intraday range below:

3mo dynamic STDEV showing emerging and reinforced trend up on semi-variance side:
And same for straight volatility (symmetric)
This, folks is a crunch time.

The reasons I bothered with this are here.

16/08/2011: Euro area and German growth Q2 2011

Two quick updates on some economic data released today.

Germany posted virtually zero rate of growth with GDP in Q2 2011 adjusted for seasonal effects up just 0.1 percent on Q1 2011. Q1 2011 quarterly growth rate was revised to 1.3 percent. German GDP growth was 2.6% yoy in Q2 2011, down from 4.6% in Q1 2011.

France data released last week showed economy stagnated in the three months through June with zero growth rate qoq and 1.6% growth rate yoy in Q2 2011, down from 2.1% expansion in Q1 2011. Italy reported data on August 5th showing its GDP growing 0.3% qoq in Q2 2011, 0.8% yoy, down from 1.0% yoy growth in Q1 2011. Spain’s economy expanded by just 0.2 percent in Q2 2011 (qoq) and 0.7% yoy, against 0.8% expansion in Q1.

And so on... until eurostat posted euro area-wide growth rate of 0.2% qoq in Q2 2011, down from 0.8% qoq in Q1 2011. Year on year growth rate fell to 1.7% in Q2 2011 from 2.5% in Q1 2011. Exactly the same growth rates were recorded in EU27, showing that the ongoing slowdown is now spreading across non-euro area member states as well. The EU27 and the euro area growth rates are now below those in the US (+0.3% qoq).

Summary table courtesy of the eurostat:

The overall disappointing growth in the euro area was entirely predictable, given that the leading indicators were pointing to it for some time now (see here), the industrial output data (here), etc.

However, here's an interesting chart suggesting that months ahead are not going to be easy for German economy:
Pay especially close attention to the yellow line showing business expectations for economic activity in months ahead. The data above is through July 2011, the latest we have and it firmly shows that business expectations have now dropped to the lowest level since January 2010, marking as fifth month of consecutive declines. The index stood at 105.0 in July 2011, down from the Q1 2011 average of 110.1 and Q2 2011 average of 107.1.

Euroarea leading economic indicator is now slipping since the beginning of July and this confirms continued weakness in the growth series.

16/08/2011: EU's pearls of wisdom

As far as the cartoonish characters go, European leadership provides fertile ground for rich pickings. And as the crisis continues to spread from one Euro area country to the next, there is hardly any respite from their brilliant pearls of wisdom being showered on unsuspecting European public and the markets.

On August 9th, Olli Rehn, European Monetary Affairs Commissioner, issued letter to the European parliament in which he objected to the experts opinion of the ECB as the 'bad bank' on the back of the ECB purchases of distressed Government bonds from Italy and Spain. Apart from making up the claim that the ECB bonds purchases programme is compatible with the EU Lisbon Treaty – the fabrication to which he managed himself to admit in his interview with Bild newspaper today – Olli really struck the golden vein of wisdom in his comments on the ECB programme. As brilliantly put by the zerohedge blog (link here):

"Where you should prepare to have your frontal lobe turn to jelly is the following: in defending why the expanded SMP program, which may soon hit hundreds of billions in onboarded toxic bonds, Rehn said the central bank's investments are safe because "the bonds are purchased in the secondary market at market price -- i.e. the credit risk is already factored in," according to a response dated yesterday to a query by an EU lawmaker. We will repeat this.... because it bears repeating: there is no risk of loss to the ECB's loan portfolio because they are purchased in the open market. In other words, if you, or a central bank, or an alien from Uranus, buys something in the open market, it is a risk free transaction."

What can one add to that? Not much, unless you are Olli – the inexhaustible fountain of wisdom on the markets, finance, macroeconomics and all things concerned. Yesterday, in the interview published by German Bild newspaper, Olli told the world that Spain, Italy and France won't need a rescue.

Of course, Olli managed to put his foot into his mouth so many times with respect to the EU rescues that one begins to wonder if he ever actually takes the said foot out of the said mouth at all. Rehn assured investors that Greece won't need a rescue package 1 and then rescue package 2 just weeks before the country was sent into the EFS/ESM/IMF/ECB 'safe' house. He did the same with Ireland – a week before the IMF/EU/ECB troika arrived into Dublin. Olli was also bullish on Portugal not requiring assistance shortly before it went to the wall. Olli also consistently denied any plans for the EU bailouts in all of the above cases, even while the Commission ardently labored behind the scenes to push them through.

And, as the above instance with his deep grasp of risk considerations in financial investment clearly indicates, he is also deeply confused as to whether subsidized purchases of Italian and Spanish bonds by the ECB last week (and before that) constitutes a rescue measure. According to the ECB and Olli's own bosses in the Ecofin, it does. According to Olli, it does not. Go figure how this man made it to be a Monetary Affairs Commissioner when his grasp of both finance and macroeconomics (the two core components of the monetary policy) is so bizarre, he couldn't probably even get a job as a junior bank loans administrator.

But Olli 'La-La" Rehn is hardly the only serial gaffer in the top circles of Brussels elites. Close to him in these dubious accomplishments it the President of the European Council, Herman "Frompy" Van Rompuy.

Usually busy with his war against Europe's 'other' President – the Commission chief Jose Manuel "Grabosso" Barosso for the title of the Presidency (please, keep in mind that Europe has three (!) Presidents, including Frompy, Grabosso and Jean-Claude "Junky" Juncker who is the President of the Euro Group of Finance Ministers), Frompy took some time back in July to share with us, the mere mortals, his wisdom on the global value of Europe (aka, the EU, for apparently non-EU members of Europe do not warrant to be called European).

"Europe is still sexy," declared President Frompy. "As long as a club attracts new members," he added, "it is in good shape."

That, of course, is exactly what the Ottomans were saying to themselves in the 18th century before switching to congratulating their rulers for keeping the empire going in the 19th century. Never mind they were presiding over the 'Sick Man of Europe' all along.

15/08/2011: Italian "reforms" 2011

So Mr Berlusconi's plan for Italy is now clearly outlined, but as usual with Italian government, it remains to be seen if:

1. There will be effective government push to implement it, and
   
2. There will be a government to implement it.

Italy's new austerity budget is the country only political and macroeconomic response to the increase in bond spreads and its reliance on ECB purchases of the Government paper. In a clear concession to the emergency of the situation, the new budgetary measure were passed by decree, and are now subject to a 2 months-long debate and amendments by the Parliament. Which, of course, is risk number one – the Parliament amendments can significantly reduce the bill effectiveness.

Overall, the bill plans for budgetary savings of €20bn in 2012, and €25.5bn in 2013.

Majority of the reductions will be driven by higher taxes, which means:

• They will have a longer-lasting adverse impact on growth, and
• Cannot be seen as permanent or even long-term, as point (1) above implies that for an already heavily taxed economy (with General Government total revenue accounting for 45.5-46% of the country GDP in 2010-2011 against G7 average of 35.2-35.4%), Italy will have to come off higher tax path sometime in the near future.
  

Given that the country already runs low rates of economic growth (with IMF latest projections for the average growth of under 1.3% per annum in 2011-2016), low personal income base (with GDP per capita adjusted for price differentials expected to return to pre-crisis levels some time in 2013 – the latest of all Big-4 Euro area economies), high unemployment (8.6% in 2011 against G7 average of 7.6%), the gross government debt of 119% this year, and the worst current account deficit of 3.4% this year amongst the Euro area Big-4 economies, it is hard to imagine that the country can actually master these tax increases.

Overall, based on IMF data, the estimated impact of the budgetary plan announced yesterday will take out roughly €1,980 per working person in new taxes and spending cuts, which amounts to 9.3% reduction in the per capita income, adjusted for price differentials. Accounting for this, IMF projections for Italy suggest that Italian real disposable incomes will not return to their pre-crisis peak anytime before 2016. And this is based on IMF's rather rosy assumptions for growth in 2011-2013, which were compiled prior to the onset of the recent economic slowdown.

Of course, in a typical Italian fashion, the new plan is virtually devoid of the structural spending cuts and reforms on the spending side. Overall spending cuts include:

• Central government ministries cuts of €6bn in 2012 and €2.5bn in 2013.
• Savings on the funds allocated to town councils, regions and provinces of €6bn in 2012 and €3.5bn euros in 2013.
• State pension system savings of €1bn in 2012 alongside the increase in retirement for women in the private sector by 5 years to 65. In addition, there will be restrictions on retirement funds for public sector workers who retire early.
• Burden sharing with senior politicos was achieved by restricting MP's reimbursements for flights only to the economy class costs.
• All public bodies with fewer than 70 employees will be abolished (excluding economics and finance functions).
• Provincial governments with less than 300,000 inhabitants and covering less than 3,000 square kilometres will be abolished. Town councils with less than 1,000 inhabitants will be merged. It is estimated this will mean the abolition of up to 29 of Italy's 110 provincial governments.

In terms of revenue increases:

• There is a new "solidarity tax" on high earners, to be levied for three years from this year, as an additional 5% on income above €90,000 per year and 10% on income above €150,000
• Increase in taxation of income from financial investments from 12.5% to 20% - which is a regressive measure for Italy, where investment is running at 19.9% of GDP this year, down from the average of 21.6% of GDP in pre-crisis years
• Increases on a so-called "Robin Hood" tax on energy companies
• Increase in the base rate for corporation tax
• Higher tax on lotteries and betting and higher excise duties on tobacco – the latter being a personal blow to the devotees of the Italian MS (aka Morto Sicuro) cigarettes, like myself
• Further curbs in tax evasion – a set of policies that has been promised more often than the Italian Governments' went to elections, and yet to be delivered in any meaningful measure. Of course, the tax increases above are only going to add incentives to evade taxes in the future, and
• Finally, in a silly season way, all non-religious public holidays will be celebrated on Sundays, to reduce their disruptive effects on national output (note to Berlusconi - outlawing Italian siesta hours in services would do some marvels to output too).
  

According to the IFC Paying Taxes 2011 report, Italy's total tax rate stands at 68.6%, compared to the EU rate of 44.2% and the world-wide average rate of 47.8%. The country ranks 128 in the world in Ease of paying taxes, 49th in the world in terms of Tax payments, 123rd in the world in terms of the time cost of complying with the tax codes and 167th in the world in total tax rate burden. (www.pwc.com/payingtaxes)

The only structural reform promised by Berlusconi emergency measures is, as of yet completely unspecified liberalisation of national labour contracts.

Good luck to all who would go long Italy on the back of these 'measures'. In my opinion, there is about 25% chance of the Italian Government actually delivering on revenue raising targets from this package and about 10% chance we will see noticeable reductions in the costs of the state sector in Italy, with one slight exception – the local and regional reforms. However, there is a good 75-90% chance that Italy will slide into a recession in Q3-Q4 2011 and its 2011-2016 average growth rate will likely slide from 1.31% projected by the IMF back in April 2011, to ca 1.02%. Which, of course, will mean that its debt will top 120% of GDP mark in 2012 and is
unlikely to alter the path set out for it in the IMF projections.

Here are few charts:

14/08/2011: A warning on synthetic ETFs class

An interesting, much overlooked working paper from the Bank for International Settlements, shines some light on recent innovations in financial engineering. It also contains a warning of the rising probability of the next asset class meltdown.

BIS Working Paper Number 343 (available here) “Market structures and systemic risks of exchange-traded funds” by Srichander Ramaswarmy starts from some historical stylized fact from finance.

“Crisis experience has shown that as the financial intermediation chain lengthens, it becomes complicated to assess the risks of financial products due to a lack of transparency …at different levels of the intermediation chain.”

Despite the crisis, however, the appetite for structured credit products is now growing, especially amongst the institutional investors with access to low cost funding (courtesy of the lax monetary policies). The problem, according to Ramaswarmy, is finding higher risk and higher returns products to beef up institutional portfolia returns – the very same problem identified back in 2002-2003 when, following the collapse of ICT bubble, tech stocks (high risk, high return products of the late 1990s) were wiped out.

“This time, financial intermediaries have responded by adding some innovative features to existing plain vanilla …exchange-traded funds (ETFs)... The structuring of these funds initially shared common characteristics with that of mutual funds. In particular, the underlying index exposure that the ETF replicated was gained by buying the physical stocks or securities in the index.”

As a result, of investors appetite for higher returns while simultaneously desiring high liquidity, “ETFs have moved away from being a plain vanilla cost- and tax-efficient alternative to mutual funds to being a much more complex and diverse array of products and replication schemes…” using derivative products. “As the volume of such products grows, such replication strategies can lead to a build-up of systemic risks in the financial system.”

Here are some interesting facts – all from Ramaswarmy:

• As of end-2010, there were close to 2,500 ETFs offered by around 130 sponsors and traded on more than 40 exchanges around the world.
• Global ETF assets under management rose from $410 billion in 2005 to $1,310 billion in 2010 (Chart left hand side panel) roughly 5.7% of the global mutual fund industry.
• “Almost all of the ETFs that are benchmarked against fixed income or equity indices in the United States are plain vanilla structures that involve” physical holding of securities that comprise the underlying index. “In Europe, roughly 50% of the ETFs are plain vanilla types, and the rest are replicated using synthetic structures (Chart, centre panel).”
• “Regulatory rules …encourage the adoption of plain vanilla structures in the United States [including notification, stress-testing and control over derivatives held, especially over-the counter derivatives]… The UCITS regulations that apply in Europe, on the other hand, permit exchange-traded as well as over-the-counter derivatives to be held in the fund…”
• As the result of more lax regulation in Europe, a significant share of more risky ETFs benchmarked to emerging market assets is “domiciled in Luxembourg or Dublin… ETFs benchmarked to emerging market assets now total $230 billion (Chart, right-hand panel).”
  

Synthetic ETFs replicate the index using derivatives such as unfunded total return swaps or the funded swaps as opposed to owning the physical assets.

The former type of a swap is a transaction between two counterparties to exchange the return arising from an asset for periodic cash flows. Under this swap system:

• ETF can end up holding physical securities / assets that are completely different from the benchmark index that the ETF is supposedly replicating.
• Underlying securities can incorporate potential conflicts of interest between the funding counterparty and the securities it pledges.
• “The composition of the assets in the collateral basket can change daily... Under UCITS regulations, the daily NAV of the collateral basket, …should cover at least 90% of the ETF’s NAV...”
  

An alternative is the funded swap under which, “the ETF sponsor transfers cash to the swap counterparty, who then provides the total return of the ETF index replicated. This transaction is collateralized… [usually to 110-120% of the NAV, using a system that] can potentially lead to delays in realising the value of collateral assets if the swap counterparty fails…”

These synthetic ETFs, per Ramaswarmy “transfer the risk of any deviation in the ETF’s return from its benchmark [the tracking error risk] to the swap provider... However, there is a trade-off: the lower tracking error risk comes at the cost of increased counterparty risk to the swap provider.”

In addition, many synthetic ETFs are at a risk of non-transparent “possible synergies that might exist between the investment banking activities of the parent bank and its asset management subsidiary or the unit within the parent bank that acts as the ETF sponsor. These synergies arise from the market-making activities of investment banking, which usually require maintaining a large inventory of stocks and bonds that has to be funded. When these stocks and bonds are less liquid, they will have to be funded either in the unsecured markets or in repo markets with deep haircuts. By transferring these stocks and bonds as collateral assets to the ETF provider sponsored by the parent bank, the investment banking activities may benefit from reduced warehousing costs for these assets…”

In other words, if ETF sponsor is cross-linked to the funding bank, the cost savings to the investment bank from synthetic ETF collateral are directly and inversely linked to the quality of the collateral held by the ETF – the lower the quality, the higher the savings. As Ramaswarmy puts it, “for example, there could be incentives to post illiquid securities as collateral assets.”

Furthermore, liquidity regulation, “such as the standards now proposed under Basel III, may also create incentives to use synthetic replication schemes” to artificially reduce the run-off rate on short maturity assets. This can be used to allow banks “to effectively keep the maturity of the funding short” and inflate bank’s liquidity positions.

All of the above benefits can yield short-term gains to ETF investors, but they come at a cost of:

1. increased risk to financial markets stability
2. lack of transparency in the quality of collateral held and liquidity positions
3. decreased transparency on ETF leverage and composition,
4. decreased liquidity of the ETF collateral can be further compounded by securities lending, and etc
   

Ramaswarmy summarizes these as follows: “Drawing on [the 2000-2008] experience, there are a number of channels through which risks to financial stability could materialise from ETFs, especially when product complexity and synthetic replication schemes grow in usage. They include:

1. co-mingling tracking error risk with the trading book risk by the swap counterparty could compromise risk management;
2. collateral risk triggering a run on ETFs in periods of heightened counterparty risk;
   
3. materialisation of funding liquidity risk when there are sudden and large investor withdrawals; and
4. increased product complexity and options on ETFs undermining risk monitoring capacity.”

Core ETFs’ risk minimisation mechanism – overcollateralisation – “might provide little comfort, as crisis experience has shown that collateral quality tests and collateral coverage tests designed by rating agencies for structured products did not protect senior tranche holders from losses.”

And there is a warning note to the investors: “by employing a variety of markets and players to replicate their benchmark indices, ETFs complicate risk assessment of the end product sold to investors. There is little transparency and no investor monitoring of the index replication process when this function is taken over by the swap counterparty. Financial innovation has added further layers of complexity through leveraged products and options on ETFs.”

13/08/2011: The Swiss Franc dilemma

If you are wondering why Swiss Central Bankers are growing increasingly alarmed at the precipitous rise of the Swiss Franc, consider the following charts based on the real effective exchange rate (REER).

Take first a look at the historical relationship between the Swiss REER and the peer rates:
According to chart above, which is based on the data from the Bank for International Settlements and takes us through June 2011, Euro area REER stood at 106.49 in June 2011, up from 101.53 in January and from 100.83 in June 2010. Euro area REER index was at 105.96 in January 2010. In contrast, Swiss REER stood at 122.60 in June 2011, up from 115.36 in January 2011, 106.80 in June 2010 and 104.9 in January 2010. That means since January 2010, Swiss REER index rose 16.87% while Euro index rose just 0.5%.
Using historical (1965-present) time trends, Swiss REER should be at 109.95 in June 2011 against the actual 122.60 level - an over-valuation on trend of 11.51%. At the same time, Euro REER should be at 99.95 against 106.49 actually posted in June 2011 - an overvaluation of 6.54% on long-term trend. Again, the problem is in the Swiss side of the court.

Taking a shorter horizon look: from 2000-present - Swiss REER should be currently around 104.12 - implying an overvaluation of 17.75%, while the Euro should be at 112.32, implying Euro undervaluation of 5.19%. Hence, Swiss problem is even greater over more recent period of time. In reality, trends since 2000 clearly show that Swiss franc should be competitive vis-a-vis the Euro. And of course, it's strength means it is not.

Next, consider the gap between the euro and the other REERs for the countries in direct competition with Switzerland for trade and investment. Charts below summarize historical trends:
In some periods in the past, countries above acted as 'safe havens' for Euro area tribulations. Let's take a look at where these countries stand today compared to Euro REER:

• Australia's REER is now at a premium of 23.15% on the Euro, down from January 2011 premium of 26.12%. Australia did not act as a safety zone vis-a-vis the Euro in the 1990-2006, but started acting as a safe haven since 2006 and currently leads the pack of safe havens in terms of absolute premium on the Euro REER.
  
• Canada REER stands at 10.41% premium on the Euro REER and this premium has declined from 15.31 in January 2011, but is up on January 2010 premium of 0.36%. Canada acted as strong safe haven against the Euro in the recession of the early 1990s, low range safe haven in the slowdown of 2001-2002 and a decent safe haven against Euro performance in 2006-2008. It is now the 4th strongest safe haven for the Euro since June 2011 and amongst top four safe havens since 2010.
• Hong Kong is a historically strong safe haven for the Euro, but is currently at a discount on the Euro REER of 17.63% - the discount that has been growing in size since June 2010 when it stood at 3.27%, although the change is marginal on the discount of 15.96% back in January 2010. Hence, Hong Kong is not a safe haven for the Euro at this point in time.
• Japan is a weak safe haven for the Euro REER today with a premium of 3.64%, down from a stronger premia in January 2011 (+10.86%), June 2010 (9.81%), but up on the discount of 5.87% in January 2010.
• Korea's REER index is currently at 17.00% discount on Euro's index and the discount is consistently high since January 2010 when it stood at 21.23%. Korea acted as a strong safe haven for the Euro in all periods since mid 1990, although it was relatively weak in the early 1990s recession.
• New Zealand currently has REER at a 5.59% discount on the Euro REER index, but the discount was much weaker at 1.69% in January 2011 and is now down from the high discount of 13.55% in January 2010. New Zealand is not a safe haven for the Euro historically since 1965.
• Norway, despite being a perceived as a safe have for nominal bilateral exchange rate is not a safe haven for the Euro in terms of REER. It's discount on Euro REER of 4.85% in January 2010 moved to a premium of 3.90% in June 2010 which remained at a premium of 3.33% in January 2011. Currently, it is back at a discount, albeit shallow, of 1.23%. Norway did act as a safe haven,even a strong safe haven, in the past episodes of Euro area instability, so the current departure from this pattern can be temporary.
• Singapore is now at 19.43% premium on the Euro REER index and this premium is consistent since June 2010 when it stood at 21.15%, although January 2010 reading for the premium was just 4.45%. Singapore is now the second strongest safe haven for the Euro area REER movements after Australia.
• Switzerland is now one of the top 4 strongest safe havens for the Euro with the premium of 15.13% on Euro REER. More importantly, it is the second best safe haven over the period of 1990-present after Singapore and the same is true for the broader range of periods, from the 1980s through today.
• Both the UK (discount of 22.86% today, and 25.45% in January 2010) and the US (discount of 16.51% today and 14.83% in January 2010) fail to act as safe havens for the Euro REER in the current crisis, although in previous periods between 1965 and 2007 they did act as safe havens against the Euro REER.

Chart summarizing current safe havens vis-a-vis Euro REER index:
Lastly, equally important is the factor of risk / volatility. As the two charts below clearly show, Switzerland is not only one of the strongest 4 safe havens in the world when it comes to hedging REER risk on the Euro area, it is also one of the historically less volatile (since 1990s - second in quality only to Singapore and least volatile since 1965). In fact, since about 1982 on it is less volatile than Euro area as a whole.
This, therefore, is the dilemma faced by the Swiss Central Bank today: debase the currency in terms of its value (less controversial, though still hard to attain for a small open economy - see a post on this here), plus debase the stability of the CHF (an even harder and more painful thing to achieve), or continue experiencing deteriorating competitiveness on exports side.

13/11/2011: What do PIIGS tell us about EU's economic convergence thesis

Working with the industrial production indices today, I found it interesting to compare the PIIGS in terms of their respective industrial performance over the years. The chart below does exactly that, but first few numbers, using annual averages of monthly data for 1990-present

• Annualized production index in the Euro area had risen from 85.95 in 1990 to 105.58 in the first 6mo of 2011 - a rate of increase in the sector of 0.94% annually
• Irish industrial production over the same period rose from 31.54 to 146.43 an increase of 7.23% annually on average. We are currently at the historic peak in terms of annual averages of 146.43 slightly above 2010 level of 145.53 when our industrial activity surpassed the pre-crisis peak of 145.43 attained in 2007.
  
• Spain's industrial output index rose from 80.63 in 1990 to 85.97 in 2011 (though H1 so far) an increase of 0.29% per annum on average. Spain's industrial production peaked in 2007 at 108.79.
  
• Italy's industrial production dropped from 85.59 in 1990 to 85.48 in 2011 so far, in effect the rate of growth just below zero on average annually. Italy's industrial activity peaked in 1992 and has been declining since then.
  
• Greece's data only goes as far back as 1995 and from that base the country industrial production shrunk from 79.12 to 74.16 over the 1995-present, an annualized rate of decrease in production of 0.4%. In fact, Greek industrial output activity peaked in 2000 and has been on decline since then.
• Portugal's data is available only since 2000 and within the span of 2000-present, Portuguese industrial output index fell from 100 to 85.55 - an annualized rate of decline of 1.3%. Portuguese output maxed-out back in 2002 at less-than-impressive 102.05 or just 2.05% above 2000 level.

Now, another interesting issue is just how much was the crisis responsible for in terms of derailing any potential convergence in industrial activity between the PIIGS and the Euro area average. In all of the countries concerned, and in the Euro area 17 aggregate data, the crisis is marked by the contraction of industrial activity in 2008. Re-based to 2007=1000, data shows that:

• EU 17 remains at 93.40% of 2007 operating levels
• Ireland has exceeded 2007 peak production levels by 0.69% in H1 2011
• Greece remains at 25.35% below peak 2007 capacity and the situation is worsening
  
• Spain has seen a slight improvement on 2010 levels in H1 2011, but is still suffering a 21% decline in industrial capacity relative to pre-crisis peak
• Italy's industrial output recovered only slightly off the cyclical low, reaching the average of 84.33 in H1 2011, some 15.67% below pre-crisis levels
• Portugal's industrial activity fell in 2008, and 2009, rebounded slightly in 2010 and is now falling again. As of the end of H1 2011, industrial output index stood at 11.3% below the pre-crisis levels.
  

So overall, the data suggests that despite extremely anemic growth in the Euro area in terms of industrial production since 1990, no PIIGS country other than Ireland was on convergence path to the Euro area levels of activity. The gap in industrial performance between the countries and Euro area has grown in Greece, Italy and Portugal, and failed to converge in Spain (where growth rate was more than 3 times slower than in the Euro area).

Ireland stands alone as the economy where the much hyped convergence thesis (one of justifications for the Euro area and indeed the EU overall existence) holds. Irony has it, in Ireland this convergence was achieved, of course, almost exclusively due to MNCs. So the EU can say thank you to the US, UK, some EU and ROW investments for proving the convergence thesis in just one out of 5 examined economies.

12/08/2011: Industrial Output - Euro area June 2011

European industrial production indices released today show that through June 2011, core Euro area economies have slowed down significantly their industrial and manufacturing output growth. This outcome, well flagged earlier by PMIs and eurocoin leading indicator of economic activity, implies that in all likelihood, Euro area growth for Q3 2011 is going to show if not an outright contraction, at the very least flat-line performance.

For Ireland (we have data through July now - see PMI data analysis for manufacturing and services, plus additional analysis of exporting activity and industrial turnover and volumes) this trend is now fully established with either contraction signals remaining persistent over recent months or flat-line trend being established on more volatile industrial production data for some 12 months now.

But what about the rest of the EU and the Euro area? Here is the data.

Industrial production index showed a decline from 101.63 in May to 100.94 in June for the first time since September 2010 (against 2008 average of 106.6, 2009 average of 90.88, 2010 average of 97.66 and 2011 average to-date of 101.18) driven, primarily by:

• Germany index falling from 111.7 in May to 110.8 in June, with current 2011 average to-date standing at 110.37, up on 2010 average of 103.48, 2009 average of 93.46, but below 2008 average of 111.73
• Greece contracting from already recessionary 75.68 in May to 74.02 in June - the worst performance since 1994 when the series began
• Spain posted a decline from 84.97 to 84.26 between May and June this year. This compares poorly against the running average for 2011 to-date of 84.87, 2010 average of 84.68 and 2008 average of 99.55. However, the index is still above 2009 average of 83.97
• France also recorded a decline in industrial activity from 94.80 in may to 93.20 in June with current average for 2011 to-date standing at 93.93, ahead of 2010 level of 91.49 and 2009 level of 86.95, but below 2008 average of 99.40.
• Italy recorded a decline from 90.00 in May to 89.5 in June with current 2011 average to-date remaining ahead of 2009 and 2010 averages, but well below 2008 average of 102.00
• Netherlands, Denmark, Portugal and Finland showed declines in their indices in June
• Ireland and the UK were the two countries in the series to show an increase in the index, while Belgium, Austria and Sweden did not report data for June.
• Poland showed a slowdown in the sector from 143.7 in May to 140.6 in June with current 2011 average to-date standing at 140.77, still significantly up on 2010, 2009 and 2008 averages
• The UK posted a marginal increase in the index from 89.57 in may to 89.58 in June with current 2011 to-date average running at 90.09 - ahead of 2010 average of 89.99 (marginally) and 2009 average of 87.74, but below 2008 average of 97.58.

Charts to illustrate (note: SOEs refers to Small Open Economies):

On Manufacturing side: Denmark, Germany, Greece, Spain, France, Italy, the Netherlands, Poland, Portugal, Finland and the UK all showed declines in output activity. Only Ireland posted a rise in June.
Euro area manufacturing activity overall fell from 102.76 in May to 101.67 in June and is now below 2011 average to-date of 102.32, although still running ahead of the annual averages for 2009 and 2010. 2008 annual average was 107.27, well ahead of the activity levels to-date.

New orders also came in disturbingly lower at 104.64 in June down from 105.74 in May. New orders index now running below its 2011 to-date average of 104.77 and below 2008 average of 110.09, thaough still well-ahead of 2010 and 2009 averages.
Again, as before, new orders fell in Denmark, Germany, Greece, Spain, France, the Netherlands, Poland, Portugal, Finland and the UK. The New Orders sub-index rose in June in Ireland and Italy.

Capital goods production declined significantly in the Euro area from 107.05 in may to 105.5 in June and now stands below 105.55 running 2011 average to-date, ahead of 2009 and 2010 averages, but below 2008 average of 113.52.
In terms of individual countries, capital goods output fell in Denmark, Germany, Ireland, Greece, Spain, France, the Netherlands, Poland and Portugal. Output rose in Italy, Finland and the UK.

12/08/2011: US Economy - Consumers' quiet rejection of Obama-nomics

The University of Michigan Consumer Confidence survey for August released to day pushed the index reading to the lowest level since May 1980 in a clear sing that despite all the "Yes we can" rhetoric from the US Administration, American consumers are simply not buying into the Obama-nomics. Or, perhaps, it's the Obama-nomics that is not trickling down to the US households still overloaded with debt and expecting massive future tax increases courtesy of the US Governments' handling of the fiscal spending side.

Historical average Consumer Confidence reading now stands at 85.8 against the Crisis period average (since January 2008) of 67.6. Jimmy Carter Presidency average for Consumer Confidence was 69.9. Barak Obama's tenure in office so far averages 69.3. The new low for Obama presidency is on par with Jimmy Carter's lows, which takes some doing.

Here's the chart mapping the course of Consumer Confidence from November 2008 cyclical low of 55.3 to today's abysmal reading of 54.9. Short of the Irish banks shares, I have not seen anything that scary, folks.

To me, the above picture reinforces my view that the US economy is now on a firm track to hit recession in Q3-Q4 2011. Unless, of course, the Fed steps in with US$1.5-2 trillion of fresh cash to, this time around, bailout actual American households.

11/08/2011: Exchequer balance for July 2011

Staying on the topic of Exchequer performance - the theme is (see earlier post here) "The dead can't dance". This, of course, refers to our flat-lined economy and the ability of the Government to extract revenue out of collapsing household incomes, wealth and dwindling number of solvent domestic companies.

Let us now briefly cover the remaining parts of the Exchequer equation: spending and overall balance position.

Overall, the Exchequer deficit at end-July 2011 was €18.894bn compared to a deficit of €10.189bn in the first seven months of 2010. The increase reflects a number of things.

The Government has issued back in March this year some €3.085bn worth of bank promisory notes to the larks of Irish banking: Anglo, INBS and EBS, all of which have since ceased to exist. On top of that the Government showered some €5.241bn of taxpaers cash onto the elephants of the Irish banking system: AIB (the Grandpa Zombie) and BofI (the Zombie-Light). To top things up, the Exchequer pushed some €2.3 billion of taxpayers funds into IL&P (the msot recent addition to the Zombies Club).

Controlling for banks measures, 2011 deficit through July stands at €8.241bn which represents savings of €1.449bn on same period of 2010. So, now recall - tax receipts went up by €1.48bn in total. Ex-banks deficit shrunk by €1.45bn in total... which, of course, strongly suggests that the "Exchequer stabilisation" so much lauded by our Government was achieved largely not due to some dramatic reforms or austerity, but due to old-fashioned raid on taxpayers' pockets.


Aptly, folks, austerity is not to be found in the aggregate figures. Per DofF own statement, "total net voted expenditure at end-July, at €25.7 billion, was €224 million or 0.9% up year-on-year. Net voted current spending was up €813 million or 3.5% but net voted capital expenditure was €589 million or 26.4% down. Adjusting for the reclassification of health levy receipts to form part of the USC which has the effect of increasing net voted expenditure, it is estimated that total net voted expenditure fell 2.6% year-on-year." Hmm... ok, there seems to be some austerity, but on capital spending side.

The main culprit for this is the continuous rise in Social Protection spending and low single-digit decreases in spending in some other departments. Hence, unadjusted for changed composition:

• Communications, Energy and Natural Resources spending declined just 8.1% on 2008 levels for the period January-July 2011
• Education and skills - by just 8.2%
• Health - by only 4.3%

While Social Protection spending rose 49.7% on 2008 levels and Department of Taoiseach is up 1%.

It is worth noting that lagging in cuts departments account for ca 49.12% of the total spending by the Government, while Social Protection accounts for 30.07%.

We might not want to see the above areas cut severely back, but if we are to tackle the deficit, folks, we simply have to. Why? Because our debt is rising and this debt is fueled largely by the deficit.

And this means that our debt servicing costs are also rising. Total debt servicing expenditure at end-July, including funds used from the Capital Services Redemption Account was just over €3 billion. Per DofF statement, "Excluding the sinking fund payment which had been made by end-July in 2010 but which has not yet been made in 2011, debt servicing costs to end-July 2010 were some €21⁄4 billion. The year-on-year increase in comparative total debt servicing expenditure therefore was €3⁄4 billion." One way or the other, we are paying out some 12% of our total tax receipts in debt interest finance. That is almost double the share of the average household budget that was spent on mortgages interest financing back at the peak of the housing markets craze in December 2006 - (6.667%).

11/08/2011: Irish Exchequer receipts July 2011

August is a silly season, so forgive me for avoiding digging too deep into silly data. This includes the data on Exchequer spending and tax receipts. They are silly. Why? Because the shambolic rearranging of chairs on the deck of the proverbial Titanic - the so-called reforms of the Departments - has made historical references invalid. We no longer are able to check what the Government is really doing and instead are forced to rely on what the DofF is telling us that the Government is doing.

This means two things for this blog. One, I will still be updating the datasets on spending, but will do this over longer time horizon spans than monthly. And I will still be updating tax receipts figures, which are, at least, more consistent than spending figures.

Here are the latest figures for August.

Total tax revenues for January-July 2011 was €18.633 billion which is €1.48 billion or 8.63% higher than in the same period last year. According to the DofF note, "This year-on-year increase was due primarily to higher income tax receipts, arising from the Budget 2011 measures, including the introduction of the USC. Excise duties, corporation tax, customs duties and stamp duties all recorded year-on-year increases also."


Overall, income tax rose to €7,277mln in 7 months of the year on 5,81mln collected in the same period of 2010 - a 25.1% increase. Again, as mentioned above, this includes USC measures. Income tax receipts are now up 14.5% on same period of 2009 and in fact are ahead of the same period of 2007, but again, this is surely due to transfer of USC.
Sadly, enough, they wouldn't tell us just how much of this increase was organic (out of old tax revenues) and how much due to USC. The note on spending attributes €604mln to USC on the side of the expenditure adjustments. So carrying the same over to tax receipts side implies that non-USC related tax measures in Budget 2011 have lifted tax revenue by €876mln so far in the year or annualized rate of tax increases of ca €1.5 billion. This arithmetic suggests that income tax receipts in Jan-Jul 2011 were around €6,673mln or still below 2008 and 2007 levels.

Adjusting total tax receipts for the above estimate of USC puts total receipts at €18,029 - a level 5.1% ahead of 2010 and 3.53% below 2009 figures. Not exactly a spectacular improvement in the 4th year of the crisis and after 3 years of austerity budgets. And not exactly spectacular improvement given that officially, per our Government claims, we are out of the recession now since Q4 2010.

The Government loves targets, even if the objectives they set are unambitious enough to be able to deliver on them. In this department, we are doing ok. Tax revenues were €263 mln (1.4%) above target. Income tax was €160 mln or 2.2% above target at end-July, but, per DofF own admission, "excluding the beneficial impact of earlier than expected DIRT payments, both in April and July, income tax was a little below target in the first seven months. That said, the underlying performance of income tax in recent months has been encouraging, with the targets for both June and July marginally bettered."

Enough said about targets. Back to data.

Vat came in below 2010 levels at January-July 2011 receipts of €6,399mln against 2010 period receipts of €6,478. The shortfall now stands at 8.07% on 2009 and 1.22% yoy. So as the chart below shows, Vat is trending along the worst year on history - 2010.

Corporate tax revenues were €1,648mln which is a vast improvement of a whooping €23mln (what the Dail spends on expenses, roughly) yoy (+1.42%). Corporation tax is now down 12.57% on same period 2009 which was the best year for this line of tax receipts in 2007-present period.

Excise duties recorded a €101mln (4.05%) surplus in the first seven months of the year relative to 2010, which translates into 0.54% increase on the same period of 2009.

The rest of the tax heads were all over the shop. Stamps improved by 23.9% yoy, but remain marginal and the improvement was due to timing factors. CGT and CAT are both down (and both are extremely marginal in size), suggesting that capital investment in the economy remains on downward trajectory. Customs were up 9.9% yoy - potentially due to increased improting activity in May-June 2011 as MNCs beefed up their stocks of inputs.

So overall picture on tax receipts side suggests:

1. Extremely poor performance on Vat and capital taxes - implying no domestic consumption or investment pickups;
2. Lackluster performance on income tax (ex-USC), with receipts stable around 2008-2009 levels
3. Mediocre performance on corpo tax, despite strong production activity in the MNCs-dominated exporting sectors
4. Transactions taxes running within 2009-2010 performance readings.

Things are, therefore, stable - in a 'the dead can't dance' way.

11/08/2011: Another 'black eye' for services supporting our 'knowledge economy'

Here's a disturbing story (hat tip to @BriMcS via Twitter) about the trials and tribulations of the Irish 'knowledge economy' arising from the traditional sectors market structure.

I wrote before about the abysmal quality of water supply - a key infrastructure input into 'knowledge economy' both in terms of pharma and biotech sectors, but also in terms of quality of life considerations that impact decisions by highly mobile and highly skilled 'knowledge'-intensive sectors workers to locate in the country.

I also wrote before about the poverty of Irish electricity supply (in terms of low quality and high cost) with ESB (state-owned dominant electricity market player) and Irish Regulator presiding over the generation and supply systems that routinely lead to electricity supply warnings in Trinity College, Dublin (Dublin city centre).

Here is another episode, this time directly impacting our Ireland-based 'knowledge economy' giants - Amazon and Microsoft:

• The report of a 5-hour long (!) interruption of energy supply to Amazon and Microsoft’s cloud computing services based at Citywest (full report here). let me make 2 comments on this. Firstly, cloud computing services are targeted by the Irish Government for flagship development in Ireland, with hopes that cloud computing clusters can be created here by attracting foreign MNCs and building on their platforms domestic expertise and entrepreneurship. Secondly, the uo to 5 hours disruption was reported originally by the ESB Networks as a 1 hour disruption, which begs a question - does the industrial behemoth have a capacity to even accurately time in real time the extent of disruption to its services. Even a taxi company would be able to tell if their customers couldn't get their services for 1 hour or 5 hours.
• Additional report (see here) cites another incident whereby on the same day another "knowledge economy" centre experienced "a voltage dip which lasted for less than one second".
  

The report above also cites Marguerite Sayers, Head of Asset Management at ESB Networks saying (emphasis is mine): “I can certainly confirm that this was an unexpected fault situation, with absolutely no advance warning, which did result in a voltage dip for many customers, in addition to supply loss for approximately 100 customers.” Which makes me wonder - does Irish ESB categorize fault situations into

1. "Unexpected" as in the ones they cannot do anything about even in theory, and
2. "Expected" as in the ones that can be prevented?

If so, how can a faul that is expected take place? By failure to prevent that which is preventable?

All of this is academic, of course. The hard fact is that while incidents do occur, there is something inherently incongruous in having an economic development policy that focuses on building 'knowledge economy' while retaining the market structure that cannot even assure basic quality of supply of energy and water to both residential and industrial users.