17/5/15: Public Debt, Private Debt… Someone Thinks There Might Be Consequences

Remember last year vigorous debate about whether debt (in particular real economic debt - as I call it, or non-financial debt - as officialdom calls it) matters when it comes to growth? Well, the debate hasn't die out… at least not yet. And some heavy hitters are getting into the fight. Òscar Jordà, Moritz HP. Schularick and Alan M. Taylor paper, "Sovereigns versus Banks: Credit, Crises and Consequences", Working Paper No. 3: http://ssrn.com/abstract=2585696

Ok, so some key preliminaries: "Two separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies." The problem is that the two 'narratives' "…may interact in important and understudied ways", most notably via debt and debt overhangs.

The authors examine "the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt."

Time for Krugmanites to pop some champagne? Err, not too fast: "However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression."

Wait, what? A state indebted to the point of losing its shirt (or rather default on pay awards to trade unionised workers and retirees) imposes cost on private sector that can be detrimental during private sector own deleveraging? Yeah, you betcha. It is called power of taxation. Just as during the current crisis the Governments world wide gave no damn as to whether you and I can pay kids schools fees, health insurance and mortgages, so it was thus before.

"We uncover three key facts based on our analysis of around 150 recessions and recoveries since 1870:

1. in a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; 
2. the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and 
3. the path of recovery is worse still when a credit-fuelled crisis coincides with elevated public debt levels. Recent experience in the advanced economies provides a useful out-of-sample comparison, and meshes closely with these historical patterns. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now."

Now, take a more in-depth tour of the changes in fiscal and private non-financial debt across 17 advanced economies since 1870s:

Oh, yeah… 1950s and 1960s public deleveraging was done by leveraging up the real economy. And it didn't stop there. It got much much worse… instead of deleveraging one side of the economy, both public and private sides continued to binge on debt. Through the present crisis.

So "what does the long-run historical evidence say about the prevalence and effects of private and public debt booms and overhangs? Do high levels of public debt affect business cycle dynamics, as the public debt overhang literature argues? Are the effects of either variety of debt overhang more pronounced after financial crisis recessions?"

So here are the results:

So the results provide "…a first look at over 100 years of the inter-relationships of private credit and sovereign debt. We end with five main conclusions":

1. "…while public debt has grown in most countries in recent decades, the extraordinary growth of private sector debt (bank loans) is chiefly responsible for the strong increase of total liabilities in Western economies. About two thirds of the increase in total economy debt originated in the private sector. ...Sovereign and bank debts have generally been inversely correlated over the long run, but have increased jointly since the 1970s. In modern times, the Bretton-Woods period stands out as the only period of sustained public debt reduction, both in expansions and recessions."
2. "…in advanced economies financial stability risks originate primarily in the private sector rather than in the public sector. To understand the driving forces of financial crises one has to study private borrowing and its problems. In the very long run, if we run a horse race between the impact of changes or run-ups in private credit (bank loans) and sovereign debt as a predictor of financial crisis and its associated distress, private credit is the more significant predictor; sovereign debt adds little predictive information. This fits with the events of 2008 well: with the exception of fiscal malfeasance in Greece most other advanced countries did not have obvious public debt problems ex ante. Of course, ex post, the fierce financial crisis recession would wreak havoc on public finances via crashing revenues and rising cyclical expenditures."
3. "…with a broader and longer sample we confirm that private debt overhangs are a regular feature of the modern business cycle. We find that once a country does enter a recession, whether it is an ordinary type or a financial-crisis type of recession, if it carries the legacy of a large private credit boom then the post-recession output path of the economy is typically adversely affected with slower growth."
4. "…our new data also allow us to see the distinct contribution of public debt overhangs. We find evidence that high levels of public debt matter for the path of economies out of recessions, confirming the results of Reinhart et al. (2012). But the negative effects of high public debt on the performance of the economy arise specifically after financial crises and in particular when private borrowing also ran high. While high levels of public debt make little difference in normal times, entering a financial crisis recession with an elevated level of public debt exacerbates the effects of private sector deleveraging and typically leads to a prolonged period of sub-par economic performance." In other words, not too fast on that champagne, Krugmanites… 
5. "…from a macroeconomic policy standpoint these findings could inform ongoing efforts to devise better guides to monetary, fiscal, and financial policies going forward…" blah… blah… blah… we can stop here.

Funny how no one can get the right idea, though - the reason public debt matters is because the state always has a first call on all resources. As the result, the state faces a choice at any point of deleveraging cycle:

• (A) leverage up the State to allow deleveraging of the real economy; or
• (B) tax there real economy to deleverage the State.

In the US, the choice has been (A) in 2008-2014. In Europe, it has been (B). The thing is: both Europe and US are soon going to face another set of fine choices:

• (Y) reduce profligacy in the long run to deleverage the State; or
• (Z) get the feeding trough of pork barrel politics rocking again.

No prizes for guessing which one they both will make… after all, they did so from 1970s on, and there are elections to win and seats to occupy...

17/5/15: Two Asias and the U.S. European Incentives

If you want to see the context to the ongoing geopolitical re-distribution of power that is threatening the world order, do not look at the margins of the European realm, like Ukraine. Look at Asia.

Here is an excellent discourse that supports the thesis of the emergence of two Asia:

• Asia dominated (already) economically by China; and
• Asia dominated (for now) military-wise and geopolitically by the U.S.

Read the full text here: http://belfercenter.ksg.harvard.edu/files/Summary%20Report%20US-China%2021.pdf and a summary here: http://www.businessinsider.com/major-change-in-world-order-china-us-economy-2015-5.

Europe has already decoupled with the U.S. on the issue of Chinese-led Asian Infrastructure Investment Bank, while BRICS have decoupled from the U.S. on a vast range of initiatives. But European signals of willingness to engage with the new Asia are going to continue being half-hearted, principally because of the second bullet point above - economic cooperation will not resolve the growing tension on geopolitical stage. Sooner or later, the U.S. dominance in Asia Pacific will be weakened to the point of the Western block playing a second (albeit not insignificant, by any means) role.

There are two levers for retaining direct and active links to the Asia Pacific centre of power that are currently available to Europe: India and Russia. Alas, both are lost to Europeans for now, one for the reason of perpetual neglect and the other for the reason of perpetual antagonisation.

Oh, and one last piece of 'food for thought' breakfast: as the U.S. is being squeezed in Asia Pacific, is it more or less likely that the U.S. will need to amplify cohesion of its allies around the Atlantic? And if you think the answer to this question is 'more likely' (as I do), what other means can the U.S. find to doing so other than by playing centuries old angsts across EU's Eastern borders? 

17/5/15: Irish Merchandise Trade: 1Q 2015

Irish trade in goods statistics - the ones responsible for the tax-induced economic dizziness in the National Accounts over 2014 - are back at posting more absurd numbers.

Take a look at data through March 2015:

• 1Q 2015 imports of goods stood at EUR14,819 million which represents an increase of 10.5% y/y and 18.6% cumulative rise over the last two years. Relative to 2000-2007 period average, Irish imports of goods are up 3.8%. These are pretty large numbers, even allowing for currency valuations. 
• 1Q 2015 exports of goods from Ireland stood at EUR24,957.6 million, which represents an increase of 17.4% y/y. Yep, apparently Irish exports outputs are growing at a rate that implies doubling of the entire export capacity every 4 years, plus a month or so. No, seriously, folks - at this rate of building manufacturing facilities and logistics parks to accommodate all this stupendous growth, there won't be any cranes and construction crews left in the entire UK and probably none in France either. All would have been busy adding new land to Ireland.
• Now, we can compute % change in exports per 1% change in imports as the latter are often inputs into production of the former. Even recognising that imports of goods are also growing on foot of improving domestic demand, current exports elasticity with respect to imports is the third largest - lagging behind only two out the last 25 years: 1992 and 2004. What happened back in 1992? Ah, yes, new FDI in ICT manufacturing sector pushed Irish exports by 16% y/y in one year off a low base. It took couple of years thereafter for imports to catch up with this tremendous 'value creation' by stuffing computers and software disks into boxes. And in 2004? Well, that arrived on foot of abysmal 2003, when exports sunk and trade surplus went into largest y/y decline on record. So here we have it: the miracle of Irish exports growth: more of 1992 (tax arbitrage) and less 2004 (post collapse bounce).

Now, take a look at some dizzying numbers for March:

As the above shows, March marked the third highest value of goods exports for any month on record. Year on year, imports of goods were up 14.21% in March after posting 12.08% growth in February. Meanwhile, exports of goods rose 20.85% y/y in March after posting 16.92% growth in February. Trade balance rose 32.61% y/y in March having grown 24.21% in February.

Put frankly, even Google's big data analysts would struggle connecting these numbers to any tangible reality.

Chart below shows shorter range for dynamics.

16/5/15: Russian Trade in Goods: 1Q 2015

Per BOFIT latest data, exports of Russian gas were down 10% y/y in 2014 with total of 175bn cubic meters (bcm) of gas exported. exports to Ukraine were down 44% to 15bcm, to Europe and Turkey down 9% to 126bcm. Russian LNG exports stood at around 14bcm in 2014, virtually unchanged on 2013.

Meanwhile, the latest figures for external trade, covering 1Q 2015 show exports of goods down 28% y/y (predominantly due to price effects - ruble devaluation and lower prices charged). Volume of exports actually rose across several categories, including crude oil (+13% y/y in volume), petroleum products (+24% y/y in volume), as well as exports of copper, fertilisers and grain. Share of oil and gas in overall exports remained largely unchanged at around 2/3rds.

Biggest volume of exports went to the EU, as usual, although value of exports shipped to the EU fell by roughly 1/3rd. Overall, EU received about 1.2 of Russian goods exports with APEC taking 20%.

On imports side, the opposite holds: APEC became the largest supplier of goods to the Russian market as imports from the EU dropped 44% y/y in 1Q 2015 more sharply than the overall imports decline of 37% y/y. Imports from China fell by 1/3rd, but China remained the largest single supplier to the Russian markets with 20% share of overall Russian imports of goods.

Ireland's bilateral trade in goods with Russia also suffered in 1Q 2015. Per latest CSO data, released this week, Irish merchandise exports to Russia totalled EUR78mln in 1Q 2015 against EUR157mln in 1Q 2014 - a 50% drop y/y. Irish merchandise imports from Russia totalled EUR52mln over the 1Q 2015, down only 1.6% y/y. As the result, trade balance (merchandise trade only) has deteriorated significantly: in 1Q 2015, Irish trade surplus vis-a-vis Russia stood at EUR104mln, this has now declined to EUR26mln (a drop of 75% y/y).

It is worth noting that in 2008-2009, Irish merchandise exports to Russia declined 30% y/y over 1Q-4Q period.

15/5/15: Irish Construction PMI: April Stronger PMI, but Overall Activity is Weak

Irish Construction Sector PMI for April was released by Markit earlier this week. Here are the main points:

Overall Activity Index in Irish construction rose to 57.2 in April from 52.9 in March, bringing index back to the levels of January 2015. Current 3mo average is at 54.0 against 3mo average through January 2015 at 61.2, showing a clear slowdown in activity growth over most recent three months.

All three components of the index posted increases in April, with Civil engineering Activity index reaching above 50 marker (to read 51.0) for the first time since January 2015.

It is worth noting that Construction Sector PMIs have been pretty much out of touch with actual construction sector activity. Current readings on PMIs side signal blistering growth in activity and this is sustained, on average from the start of Q2 2013. Yet, Irish construction sector remains the second worst performing sector in the EU since the start of the crisis:

You can see the disconnection between PMIs (these are quarterly averages) and Construction sector actual performance setting in post Q2 2013 here:

15/5/15: Monetary Titanic & Bubbles Troubles

Food for thought this morning - two links:

• HSBC's research warning that the monetary policies-based liquidity pyramid is shaky: http://finance.yahoo.com/news/hsbc-thinks-world-economy-titanic-120044852.html?soc_src=mediacontentstory&soc_trk=tw and that this time around, the shakes are systemic. Key point here: Central Banks are out of ammunition, while economy is not anywhere near being on solid footing.
• Meanwhile, MoneyWeek spots three bubbles (the UK-centric property bubble is not unique to London, but is present in a large number of economies, from Canada to Australia and beyond): http://moneyweek.com/three-bubbles-that-are-ready-to-pop/

Note, first link above cites low worker productivity. Here's a slide from my recent (this week) presentation on same: 

And here is my view on the Irish property bubble (in development, but not yet fully manifested):

What is interesting about the Irish property markets is that whilst price and activity levels are not yet at concern points, the rates of increases in commercial rents and declines in yields, and rates of rises in residential property prices in Dublin are clearly fuelling a massive hype by real estate agents and the media. This is hardly consistent with a 'healthy' market.

I will be speaking about the financial valuations bubbles, focusing on M&As and strategy for avoiding these, next week at http://rebel.alltech.com/ so stay tuned for slides on that next week.

15/5/15: Greece on a Wild Rollercoaster Ride

Greece has become a BitCoin of Europe in terms of volatility, and, man, things are soaring and crashing on a daily basis now. Here are three snapshots of Greek Credit Default Swaps:

End of last week:

Mid-week this week:

Closing yesterday:

Meanwhile, the entire financial system of Greece is now on a weekly timeline courtesy of the ECB approvals of ELA:

One move by ECB down on ELA or laterally on collateral requirements, and the house of cards can come crashing.

Note: Sources: CMA and @Schuldensuehner.

15/5/15: New Financial Regulation: Part 8: An Overconfidence Bias Awaits

My latest blog post on European Union innovations in financial regulation, continuing coverage of the European Banking Union is now available here: http://blog.learnsignal.com/?p=181

14/5/15: Expert Insight: Q1 results: Estonia

My contribution (and others') to economic outlook analysis for Estonia, via Euromoney Country Risk http://www.euromoneycountryrisk.com/Analysis/Expert-insight-%E2%80%93-Q1-results-Estonia

Here are the jpgs of the article:

14/5/15: The Happiest Deflationary Consumers of Ireland... April 2015 Data.

Good thing Consumer Confidence is booming in Ireland, cause otherwise we might get a wind that domestic demand for goods and services is going nowhere:

Now, how would we get such an idea. you might ask? Well, simples.com : take a look at consumer prices:

Spot the trend? That's right: CPI was down 0.7% y/y in April and down 0.6% on average over the last 3 months.

And in case you want to see what 'sustains' at least some semblance of non-totally-collapsing prices? Why here it is:

Well, the only reason we are not a complete basket case come inflationary dynamics is thanks to tobacco and alcohol (up whooping 26.5% over the pre-crisis average thanks to tax extraction by the State), and electricity and rents (pushing housing, water, electricity, gas etc up 7.1% over the pre-crisis levels - you might also call that tax extraction, for much of these increases goes to fund semi-states and quangos and soon-to-come Irish Water), Health (where much of the 'savage cuts' were just something masking the actual hikes in cost of services to those of us who pay for them), and Education (where state extraction of funds was so rampant as outpace by a factor of 10 overall inflation in the economy), and Restaurants & Hotels (where the cut in Vat did nothing to alleviate price pressures on consumers), and a bunch of state-related and regulated prices that went into Miscellaneous category.

And so just as with retail sales, deflation is now consistent with rising consumer confidence. Happiness attained, at last. Just never ask what happens to demand when prices (imported from the rest of the Euro area) start creeping up across all sectors... that is something polite Irish economy forecasters don't want to talk about...

13/5/15: Dublin Commercial Property Market 1Q: No Fireworks, yet...

CBRE's commercial property report for 1Q 2015 is worth reading. If only for the surprising sub-trends that go largely unnoticed in the overall frothy markets.

Let's start with the summary: "Office take-up in Dublin during Q1 2015 reached 38,359m2 in 64 individual lettings." And, "the highest number of lettings in a quarter since Q1 2008".

So we have a handy chart:

Do tell me this is somehow a sign of 'strong' performance - 1Q 2015 lettings are lower than 1Q 2013 and 1Q 2014.

"15 of the 64 transactions signed in Q1 were to US companies with a further 39 lettings to Irish companies"

Which is good, because up until recently, main new signees were MNCs and Irish public sector. But… "There were no large lettings of over 4,645m2 (50,000 sq. ft.) completed in Q1." Wait, there were no large lettings completed in 4Q 2015 either, as I recall. Which means no large lettings in at least 6 months.

"62% of office take-up in Q1 occurred in Dublin City Centre" which is lower than in 1Q 2014, but higher than in 1Q 2013. Which suggests no clear trend in terms of pick up outside Dublin City Centre. Actually, ex-Dublin City Centre, lettings completed are the lowest for 1Q period compared to 2013 and 2014.

"The overall rate of vacancy fell to 11.27% down from 11.84% at the end of 2014. The Grade A vacancy rate in Dublin 2/4 at the end of Q1 2015 was 1.78%." And "prime office yields now 4.75%". Which suggests that while the prime market is clearly over-heating, secondary market is not.

"2 of the ten largest lettings completed in Dublin during Q1 were expansions, while 5 were relocations and 3 were lettings to new entrants." Which is an improvement on 4Q 2014 when there were no new entrants at all.

So I dare say there is not that much of a 'revival' going on, compared to where we are relative to the pre-crisis activity. It is probably more accurate to describe 1Q 2015 as steady, gradual and potentially risky recovery. Cautious, except when it comes to pricing Grade A prime location properties - the trophy treasure of MNCs and Public Sector and Semi-States.

12/5/15: Behold the Digital (Paper) worth EUR415 billion

Yes, EU has a new proposal for a new White Elephant, named Digital Strategy and costed at EUR415 billion: https://euobserver.com/digital/128602...

And yes, unveiling it, the forward-looking modernist commissioner for everything Digital had to carry into the hearing a pile of... papers...

You can't make this up... but you can (if you are an EU Commissioner) make up a EUR415 billion new 'Lisbon Agenda'... this time for a Digital Union... to out digitalise every other Digital Economy in the world... using pencils and binders...