12/2/16: Deutsche Bank: Crystallising Europe’s TBTF Problems

This week was quite a tumultuous one for banks, and especially Europe’s champion of the ‘best in class’ TBTF institutions, Deutsche Bank. Here’s what happened in a nutshell.

Deutsche’s 6 percent perpetual bonds, CoCos (more on this below), with expected maturity in 2022, used to yield around 7 percent back in January. Having announced massive losses for fiscal year 2015 (first time full year losses were posted by the DB since 2008), Deutsche was under pressure in the equity markets. Rather gradual sell-off of shares in the bank from the start of 2015 was slowly, but noticeably eroding bank’s equity risk cushion. So markets started to get nervous of the second tier of ‘capital’ held by the bank - second in terms of priority of it being bailed in in the case of an adverse shock. This second tier is known as AT1 and it includes those CoCos.

Yields on CoCos rose and their value (price) fell. This further reduced Deutsche’s capital cushion and, more materially, triggered concerns that Deutsche will not be calling in 2022 bonds on time, thus rolling them over into longer maturity. Again, this increased losses on the bonds. These losses were further compounded by the market concerns that due to a host of legal and profit margins problems, Deutsche can suspend payments on CoCos coupons, if not in 2016, then in 2017 (again, more details on this below). Which meant that in markets view, shorter-term 2022 CoCos were at a risk of being converted into a longer-dated and zero coupon instrument. End of the game was: Coco’s prices fell from 93 cents to the Euro at the beginning of January, to 71-72 cents on the Euro on Monday this week.

When prices fall as much as Deutsche’s CoCos, investors panic and run for exit. Alas, dumping CoCos into the markets became a problem, exposing liquidity risks imbedded into CoCos structure. There are two reasons for the liquidity risk here: one is general market aversion to these instruments (a reversal of preferences yield-chasing strategies had for them before); and lack of market makers in CoCos (thin markets) because banks don’t like dealing in distressed assets of other banks. Worse, Asian markets were largely shut this week, limiting potential pool of buyers.

Spooked by shrinking valuations and falling liquidity of the Deutsche’s AT1 instruments, investors rushed into buying insurance against Deutsche’s default on senior bonds - the Credit Default Swaps or CDS. This propelled Deutsche’s CDS to their highest levels since the Global Financial Crisis. Deutsche’s CDS shot straight up and with their prices rising, implied probability of Deutsche’s default went through the roof, compounding markets panic.


Summing Up the Mess: Three Pillars of European Risks

Deutsche Bank AG is a massive, repeat - massive - banking behemoth. And the beast is in trouble.

Let’s do some numbers first. Take a rather technical test of systemic risk exposures by the banks, run by NYU Stern VLab. First number of interest: Systemic Risk calculation - the value of bank equity at risk in a case of systemic crisis (basically - a metric of how much losses a bank can generate to its equity holders under a systemic risk scenario).

Deutsche clocks USD91.623 billion hole relating to estimated capital shortfall after the existent capital cushion is exhausted. A wallop that is the third largest in the world and accounts for 7.23% of the entire global banking system losses in a systemic crisis.

Now, for volatility that Deutsche can transmit to the markets were things to go pear shaped. How much of a daily drop in equity value of the Deutsche will occur if the aggregate market falls more than 2%. The metric for this is called Marginal Expected Shortfall or MES and Deutsche clocks in respectable 4.59, ranking it 8th in the world by impact. In a sense, MSE is a ‘tail event’ beta - stock beta for times of significant markets distress.

How closely does Deutsche move with the market over time, without focusing just on periods of significant markets turmoil? That would be bank’s beta, which is the covariance of its stock returns with the market return divided by variance of the market return. Deutsche’s beta is 1.61, which is high - it is 7th highest in the world and fourth highest amongst larger banks and financial institutions, and it basically means that for 1% move in the market, on average, Deutsche moves 1.6%.

But worse: Deutsche leverage is extreme. Save for Dexia and Banca Monte dei Paschi di Siena SpA, the two patently sick entities (one in a shutdown mode another hooked to a respirator), Deutsche is top of charts with leverage of 79.5:1.

Incidentally, this week, Deutsche credit risk surpassed that of another Italian behemoth, UniCredit:

So Deutsche is loaded with the worst form of disease - leverage and it is caused by the worst sort of underlying assets: the impenetrable derivatives (see below on that).


Overall, Deutsche problems can be divided into 3 categories:

1. Legal
2. Capital, and
3. Leverage and quality of assets.

These problems plague all European TBTF banks ever since the onset of the Global Financial Crisis. The legacy of horrific misspelling of products, mis-pricing of risks and markets distortions by which European banks stand is contrasted by the rhetoric emanating from European regulators about ‘reforms’, ‘repairs’ and ‘renewed regulatory vigilance’ in the sector. In truth, as Deutsche’s saga shows, capital buffers fixes, applied by European regulators, have yielded nothing more than an attempt to powder over the miasma of complex, derivatives-laden asset books and equally complex, risk-obscuring structure of new capital buffers. It also highlights just how big of a legal mess European banks are, courtesy of decades of their maltreatment of their clients and markets participants.

So let’s start churning through them one-by-one.


The Saudi Arabia of Legal Problems

Deutsche has been slow to wake up and smell the roses on all various legal settlements other banks signed up to in years past. Deutsche has settled or paid fines of some USD9.3 billion to-date (from the start of the Global Financial Crisis in 2008), covering:

• Charges of violations of the U.S. sanctions;
• Interest rates fixing charges; and
• Mortgages-Backed Securities (alleged) fraud with respect to the U.S. state-sponsored lenders: Fannie Mae and Freddie Mac.

And at the end of 2015, Deutsche has provided a set-aside funding for settling more of the same, to the tune of USD6 billion. So far, it faces:

1. U.S. probe into Mortgages-Backed Securities it wrote and sold pre-crisis. If one goes by the Deutsche peers, the USD15.3 billion paid and set aside to-date is not going to be enough. For example, JP Morgan total cost of all settlements in the U.S. alone is in excess of USD23 billion. But Deutsche is a legal basket case compared to JPM-Chase. JPM, Bank of America and Citigroup paid around USD36 billion on their joint end. In January 2016, Goldman Sachs reached an agreement (in principle) with DofJustice to pay USD5.1 billion for same. Just this week (http://www.businessinsider.com/morgan-stanley-mortgage-backed-securities-settlement-2016-2) Morgan Stanley agreed to pay USD3.2 billion on the RMBS case. Some more details on this here: http://www.reuters.com/article/us-deutsche-bank-lawsuit-idUSKCN0VC2NY.
2. Probes into currency manipulations and collusion on its trading desk (DB is the biggest global currency trader that is yet to settle with the U.S. DoJustice. In currency markets rigging settlement earlier, JPMorgan, Citicorp and four other financial institutions paid USD5.8 billion and entered guilty pleas already.
3. Related to currency manipulations probe, DB is defending itself (along with 16 other financial institutions) in a massive law suit by pension funds and other investors. Deutsche says ‘nothing happened’. Nine out of the remaining 15 institutions are pushing to settle the civil suit for (at their end of things) USD2 billion. Keep in mind of all civil suit defendants - Deutsche is by far the largest dealer in currency markets.
4. Probes in the U.S. and UK on its alleged or suspected role in channeling some USD10 billion of Russian money into the West;
5. Worse, UK regulators are having a close watch on Deutsche Bank - in 2014, they placed it on the their "enhanced supervision" list, reserved for banks that have either gone through a systemic failure or are at a risk of such; a list that includes no other large banking institution on it, save for Deutsche.
6. This is hardly an end to the Deutsche woes. Currently, it is among a group of financial institutions under the U.S. investigation into trading in the U.S. Treasury market, carried out by the Justice Department. 
7. The bank is also under inquiries covering alleged fixings of precious metals benchmarks.
8. The bank is even facing some legal problems relating to its operations (in particular hiring practices) in Asia. And it is facing some trading-related legal challenges across a number of smaller markets, as exemplified by a recent case in Korea (http://business.asiaone.com/news/deutsche-bank-trader-sentenced-jail).

You really can’t make a case any stronger: Deutsche is a walking legal nightmare with unknown potential downside when it comes to legal charges, costs and settlements. More importantly, however, it is a legal nightmare not because regulators are becoming too zealous, but because, like other European banks, adjusting for its size, it has its paws in virtually every market-fixing scandal. The history of European banking to-date should teach us one lesson and one lesson only: in Europe, honest, functioning and efficient markets have been seconded to manipulated, dominated by TBTF institutions and outright rigged structures more reminiscent of business environment of the Italian South, than of Nordic ‘regulatory havens’.

CoCo Loco

CoCos, Contingent Convertible Capital Instruments, are a hybrid form of capital instruments that are designed and structured to absorb losses in times of stress by automatically converting into equity should a bank experience a decline in its capital ratios below a certain threshold. Because they are a form of convertible debt, they are counted as Tier 1 capital instrument ‘additional’ Tier 1 instruments or AT1.

CoCos are also perpetual bonds with no set maturity date. Banks can be redeemed them on option, usually after 5 years, but banks can also be prevented by the regulators from doing so. The expectation that banks will redeem these bonds creates expectation of their maturity for investors and this expectation is driven by the fact that CoCos are more expensive to issue for the banks, creating an incentive for them to redeem these instruments. European banks love CoCos, in contrast to the U.S. banks that issue preferred shares as their Tier 1 capital boosters, because Europeans simply love debt. Debt in any form. It gives banks funding without giving it a headache of accounting to larger pools of equity holders, and it gives them priority over other liabilities. AT1 is loved by European regulators, because it sits right below T1 (Tier 1) and provides more safety to senior bondholders on whose shoulders the entire scheme of European Ponzi finance (using Minsky’s terminology) rests.

In recent years, Deutsche, alongside other banks was raising capital. Last year, Credit Suisse, went to the markets to raise some CHF6 billion (USD6.1 billion), Standard Chartered Plc raised about $5.1 billion. Bank of America got USD5 billion from Warren Buffett in August 2014. So in May 2014, Deutsche was raising money, USD 1.5 billion worth, for the second time (it tapped markets in 2013 too). The fad of the day was to issue CoCos - Tier 1 securities, known as Contingent Convertible Bonds. All in, European banks have issued some EUR91 billion worth of this AT1 capital starting from 2013 on.

Things were hot in the markets then. Enticed by a 6% original coupon, investors gobbled up these CoCos to the tune of EUR3.5 billion (the issue cover was actually EUR25 billion, so the CoCos were in a roaring demand). Not surprising: in the world of low interest rates, say thanks to the Central Banks, banks were driving investors to take more and more risk in order to get paid.

There was, as always there is, a pesky little wrinkle. CoCos are convertible to equity (bad news in the case of a bank running into trouble), but they are also carrying a little clause in their prospectus. Under Compulsory Cancelation of Interest heading, paragraphs (a) and (b) of Prospectus imposed deferral of interest payments on CoCos whenever CoCos payment of interest “together with any additional Distributions… that are simultaneously planned or made or that have been made by the issuer on the other Tier 1 instruments… would exceed the Available Distributable Items…” and/or “if and to the extent that the competent supervisory authority orders that all or part of the relevant payment of interest be cancelled…”

That is Prospectus-Speak for saying that CoCos can suspend interest payments per clauses, before the capital adequacy problems arise. The risks of such an event are not covered by Credit Default Swaps (CDS) which cover default risk for senior bonds.

The reason for this clause is that European regulators impose on the banks what is known as CRD (Combined Buffer Requirement and Maximum Distributable Amount) limits: If the bank total buffers fall below the Combined Buffer Requirement, then CoCos and other similar instruments do not pay in full. That is normal and the risk of this should be fully priced in all banks’ CoCos. But for Deutsche, there is also a German legal requirement to impose an additional break on bank’s capital buffers depletion: a link between specified account (Available Distributable Items) balance and CoCos pay-out suspension. This ADI account condition is even more restrictive than what is allowed under CRD.

This week, DB said they have some EUR1 billion available in 2016 to pay on EUR350 million interest coupon due per CoCos (due date in April). But few are listening to DB’s pleas - CoCos were trading at around 75 cents in the euro mark this week. The problem is that the markets are panicked not just by the prospect of the accounting-linked suspension of coupon payments, but also by the rising probability of non-redemption of CoCos in the near future - a problem plaguing all financials.

DB is at the forefront of these latter concerns, because of its legal problems and also because the bank is attempting to reshape its own business (the former problem covered above, the latter relates to the discussion below). DB just announced a massive EUR6.8 billion net loss for 2015 which is not doing any good to alleviate concerns about it’s ability to continue funding coupon payments into 2017. Unknown legal costs exposure of DB mean that DB-estimated expected funding capacity of some EUR4.3 billion in 2017 available to cover AT1 payments is based on its rather conservative expectation for 2016 legal costs and rather rosy expectations for 2016 income, including the one-off income from the 2015-agreed sale of its Chinese bank holdings.

Earlier this week, Standard & Poor’s, cut DB’s capital ratings on “concerns that Germany’s biggest lender could report a loss that would restrict its ability to pay on the obligations”. S&P cut DB’s Tier 1 securities from BB- to B+ from BB- and slashed perpetual Tier 2 instruments from BB to BB-.

Beyond all of this mess, Deutsche is subject to the heightened uncertainty as to the requirements for capital buffers forward - something that European banks co-share. AT 1 stuff, as highlighted above, is one thing. But broader core Tier 1 ratio in 4Q 2015 was 11.1%, which is down on 11.5% in 4Q 2014. In its note cutting CoCos rating, S&P said that “The bank's final Tier 1 interest payment capacity for 2017 will depend on its actual net earnings in 2016 as well as movements in other reserves.” Which is like saying: “Look, things might work out just fine. But we have no visibility of how probable this outcome is.” Not assuring…

DB is also suffering the knock-on effect of the general gloom in the European debt markets. Based on Bloomberg data, high yield corporate bonds issuance in Europe is down some 78 percent in recent months, judging by underwriters fees. These woes relate to European banks outlook for 2016, which links to growth concerns, net interest margin concerns and quality of assets concerns.


Badsky Loansky: A Eurotown’s Bad Bear?

Equity and debt markets repricing of Deutsche paper is in line with a generally gloomy sentiment when it comes to European banks.

The core reason is that aided by the ECB’s QE, the banks have been slow cleaning their acts when it comes to bad loans and poor quality assets. European Banking Authority estimates that European banks hold some USD 1.12 trillion worth of bad loans on their books. These primarily relate to the pre-crisis lending. But, beyond this mountain of bad debt, we have no idea how many loans are marginal, including newly issued loans and rolled over credit. How much of the current credit pool is sustained by low interest rates and is only awaiting some adverse shock to send the whole system into a tailspin? Such a shock might be borrowers’ exposures to the US dollar credit, or it might be companies exposure to global growth environment, or it might be China unwinding, or all three. Not knowing is not helpful. Oil price collapse, for example, is hitting hard crude producers. Guess who were the banks’ favourite customers for jumbo-sized corporate loans in recent years (when oil was above USD50pb)? And guess why would any one be surprised that with global credit markets being in a turmoil, Deutsche’s fixed income (debt) business would be performing badly?

Deutsche and other european banks are caught in a dilemma. Low rates on loans and negative yields on Government bonds are hammering their profit margins (based on net interest margin - the difference between their lending rate and their cost of raising funds). Solution would be to raise rates on loans. But doing so risks sending into insolvency and default their marginal borrowers. Meanwhile, the pool of such marginal borrowers is expanding with every drop in oil prices and every adverse news from economic growth front. So the magic potion of QE is now delivering more toxicity to the system than good, and yet, the system requires the potion to flow on to sustain itself.

Again, this calls in Minsky: his Ponzi finance thesis that postulates that viability of leveraged financial system can only be sustained by rising capital valuations. When capital valuations stop growing faster than the cost of funding, the system collapses.

In part to address the market sentiment, Deutsche is talking about deploying the oldest trick in the book: buying out some of its liabilities - err… senior bonds (not CoCos) - at a discount in the markets to the tune of EUR5 billion across two programmes. If it does, it will hit own liquidity in the short run, but it will also (probably or possibly) book a profit and improve its balance sheet in the longer term. The benefits are in the future, and the only dividend hoped-for today is a signalling value of a bank using cash to buy out debt. Which hinges on the return of the markets to some sort of the ‘normal’ (read: renewed optimism). Update: here's the latest on the subject via Bloomberg http://www.bloomberg.com/news/articles/2016-02-12/deutsche-bank-to-buy-back-5-4-billion-bonds-in-euros-dollars

Back to the performance to-date, however.

Deutsche Bank's share price literally fell off the cliff at the start of this week, falling 10 percent on Monday and hitting its lowest level since 1984.

On bank’s performance side, concerns are justified. As I noted earlier, Deutsche posted a massive EUR6.89 billion loss for the year, with EUR2 billion of this booked in 4Q alone. Compared to 2014, Deutsche ended 2015 with its core equity Tier 1 capital (the main buffer against shocks) down from EUR60 billion to EUR52 billion.

Still, panic selling pushed DB equity valuation to EUR19 billion, in effect implying that some 2/3rds of the book of its assets are impaired. Which is nonsense. Things might be not too good, but they aren’t that bad today. The real worry with assets side of the DB is not so much current performance, but forward outlook. And here we have little visibility, precisely because of the utterly abnormal conditions the banks are operating in, courtesy of the global economy and central banks.

So markets are exaggerating the risks, for now. Psychologically, this is just a case of panic.

But panic today might be a precursor to the future. More of a longer term concern is DB’s exposure to the opaque world of derivatives that left markets analysts a bit worried (to put things mildly). Deutsche has taken on some pretty complex derivative plays in recent years in order to offset some of its losses relating to legal troubles. These instruments can be quite sensitive to falling interest rates. Smelling the rat, current leadership attempted to reduce bank’s risk loads from derivatives trade, but at of the end of 2015, the bank still has an estimated EUR1.4 trillion exposure to these instruments. Only about a third of the DB’s balance sheet is held in German mortgages and corporate loans (relatively safer assets), with another third composed of derivatives and ‘other’ exposures (where ‘other’ really signals ‘we don’t quite feel like telling you’ rather than ‘alternative assets classes’). For these, the bank has some EUR215 billion worth of ‘officially’ liquid assets - a cushion that might look solid, but has not been tested in a sell-off.


In summary: 

Deutsche’s immediate problems are manageable and the bank will most likely pull out of the current mess, bruised, but alive. But the two horsemen of a financial apocalypse that became visible in the Deutsche’s performance in recent weeks are worrying:
1) We have a serious problem with leverage remaining in the system, underlying dubious quality of assets and capital held and non-transparent balance sheets when it comes to derivatives exposures; and
2) We have a massive problem of residual, unresolved issues arising from incomplete response to markets abuses that took place before, during and after the crisis.

And there are plenty potential triggers ahead to derail the whole system. Which means that whilst Deutsche is not Europe’s Lehman, it might become Europe’s Bear Sterns, unless some other TBTF preempts its run for the title… And there is no shortage of candidates in waiting…



Links: 
DB’s 2015 report presentation deck: https://www.db.com/ir/en/download/Deutsche_Bank_4Q2015_results.pdf
DB’s internal memo to employees on how “ok” things are: https://www.db.com/newsroom_news/2016/ghp/a-message-from-john-cryan-to-deutsche-bank-employees-0902-en-11392.htm

10/2/16: Slon.ru: "Чем хуже, тем лучше"

My latest column “Чем хуже, тем лучше. Откуда у российской экономики все больше сил“ for Slon.ru is out at https://slon.ru/posts/63670 in Russian.

This time, I am covering the topic of how Russian economy deleveraging leads to a future uplift in its potential growth, before tackling the cost of such deleveraging that is driving Russian public opinion of policies and direction of the State in a follow up column.

10/2/16: Was Resource Boom a Boom for Commodities Exporters?

While everyone is running around with the collapsed oil prices, economists with an eye for cycles and history are starting to digest the aftermath of the passed commodities price boom that started around the beginning of the century and lasted until 2011-2012.

The issues relating to that boom are non-trivial. Commodities prices are cyclical and just as the boom turns to bust, so will the bust turn to boom. Therefore, one should really try to understand what exactly happens in both.

Andrew Warner of the IMF has a very interesting, actually fascinating, paper on the effects of the past commodities booms (the 1970s and the more recent one) on countries that are large-scale exporters of commodities. The paper relates naturally to so-called Resource Curse thesis.


A Quick Summary

So this is my summary of the main conclusions, relating to the most recent commodities boom.

Per Warner, “The global boom in hydrocarbon, metal and mineral prices since the year 2000 created huge economic rents - rents which, once invested, were widely expected to promote productivity growth in other parts of the booming economies, creating a lasting legacy of the boom years. This paper asks whether this has happened.”

Warner strips out growth in the commodities sectors in these countries and focuses on other sectors, trying to identify whether there was more rapid growth in these sectors during the boom compared to the periods before the boom.

Broadly-Speaking, he finds that “despite having vast sums to invest, GDP growth per-capita outside of the booming sectors appears on average to have been no faster during the boom years than before. The paper finds no country in which (non-resource) growth per-person has been statistically significantly higher during the boom years. In some Gulf states, oil rents have financed a migration-facilitated economic expansion with small or negative productivity gains. Overall, there is little evidence the booms have left behind the anticipated productivity transformation in the domestic economies. It appears that current policies are, overall, proving insufficient to spur lasting development outside resource intensive sectors.”


A bit more specifics

In general, across all commodities boom-impacted economies (identified by Warner as 18 countries) “…estimates of the change in growth during the boom period, [show] that the majority of countries, 11 of the 18, have seen lower growth during the boom period than before. One of these is statistically significant (Bolivia). The remaining 7 countries have seen higher growth during the boom but none of these are statistically significant. Therefore the [results show] that there is little compelling evidence to reject the null of no change during the boom period. …If the presumption was that the Natural Resource bonanza would spark an economic boom in the rest of the economy, this expectation has been disappointed, as there is no statistically significant case of higher per-capita growth during the boom years than before.”

This is quite interesting. Investment should have boomed on foot of rising revenues from commodities extraction and this should have at least trickled down to non-commodities sectors. It turns out investment did not produce growth. Why? Maybe timing is an issue? Lags in time to invest and build new capital?

Warner goes on to check.

“An alternative way to summarize this result is to aggregate across countries. The data for all countries were synchronized not by calendar years but by years since the start of the boom. … [Data] shows that although total GDP rose strongly during the boom period, GDP for the rest of the economy has been essentially flat over the boom period. …Furthermore, it is apparent …that there has been no tendency for growth in non-resource GDP to accelerate during the later years of the boom, as would be expected had there been a lagged impact of investments made during the boom period. If overcoming the curse hinges on raising productivity in the rest of the economy, the data suggest that countries are not, as a rule, successfully overcoming the curse.”

Ok, may be slower growth in non-commodities economy was simply down to that - a period of slower growth overall? Warner tests for this and finds that actually data does not support the thesis that slower growth in non-commodities sectors was caused by a general slowdown in the rate of growth.

“The data suggest that …it is simply rare to find a case of fast growth in the non-resource economy. …It emerges that only 5 of the 18 countries show growth over 2 percent per year. Hence slow growth in the rest of the economy continues to be the norm in resource-intensive economies, even during boom periods.”

Again, a paradox: greater revenues from commodities sectors should translate into greater savings rates, which should still trigger greater investment.

Warner “…examines the extent to which the previous findings can be attributed to a lack of saving, a lack of public or private domestic investment
effort out of the saving or a lack of economic return from the investment effort.”

Savings rose. “The evidence on saving rates shows that, for the 16 countries with available data, mean saving rates rose strongly in the boom period compared with the counterfactual period, from 16 percent of non-resource GDP to 27 percent. Furthermore, the current account shifted towards surplus by approximately 5 percentage points of GDP, so a significant part of the boom was saved in foreign assets.”

Investment rose (somewhat) too, in quantity: “Nevertheless, despite the rise in saving and particularly saving in foreign assets, domestic investment effort remained constant or even rose during the boom period. Focusing on the 16 countries with booms in the 2000’s, mean investment rates rose during the boom periods compared to the counterfactual periods from 22 to 27 percent of GDP. …Further, available evidence suggests that a large fraction of the investment effort during the booms in the 2000’s was domestic public investment. This is the investment that the state controls directly, and the evidence is that public investment rates remained roughly constant, rising slightly from a mean of 9 percent of GDP during the [pre boom] periods to 10 percent during the boom periods. Private investment also rose - from 14 to 18 percent of GDP. Since total GDP rose during the booms, this data suggests that, overall across the 16 economies, there remained a strong and significant effort to invest in the domestic economy.”

Conclusion? “Although investment data are not broken out [between commodities producing sectors and rest of the economy] it would be a rare occurrence if none of the extra investment fell on the non-resource economy. Therefore, although it is theoretically possible that the low impact on non-resource GDP growth is down to low investment rates, the available data do not support this view. They appear instead to point to low returns from the investment that was made.”

In other words: commodities boom revenues were wasted on poor quality investment projects that failed to boost non-commodities sectors productivity. And this includes public and private sectors investments.


Russia et al

As an aside, there is a fascinating discussion in Warner’s article about the specific group of commodities exporters - countries of the former USSR.

The reason this discussion warrants a separate treatment is the fact that “the resource-rich countries of the ex-Soviet Union require a method for testing for a curse that incorporates the special u-shaped pattern of GDP over time during the transition period. The u-shaped profile of total GDP is a natural outcome of a two-sector model in which one sector declines sharply (the state sector) while another rises gradually from a small base (the new private sector), as happened in all European post-socialist-planned economies.”

So Warner looks at Azerbaijan, Kazakhstan, Russia, and Turkmenistan. And finds that “against expectations, the results indicate that the five resource intensive countries experienced slower growth during their resource boom. Growth was statistically significantly slower than resource poor countries for all except Azerbaijan. This shows little evidence that the resource booms served to accelerate GDP growth above the levels experienced by other post-soviet economies. Based on this evidence it is difficult to claim that the resource booms served to raise the path of GDP above what it would have been without the booms.”

Wait a second. Common narrative, especially in the West, as it pertains to Russian and Kazakhstan, is that both countries have *only* grown because of higher commodities prices. This is what is normally used to explain the ‘Putin effect’ - rapid growth attained by Russia during the first two terms of the Putin Presidency. Alas, data, it seems speaks the opposite: rapid growth during the first two terms of the Putin Presidency is not consistent with the causality linked to the boom in commodities prices. And the actual boom period in commodities prices for Russia seems to be associated with slower, not faster growth, compared to non-commodities boom period (controlling for effects of economic transition) and to non-commodities exporting ex-Soviet counterparts.


You can read the whole paper here: Warner, Andrew, Natural Resource Booms in the Modern Era: Is the Curse Still Alive? (November 2015). IMF Working Paper No. 15/237: http://ssrn.com/abstract=2727182.

10/2/16: Ponzi Schemes? Bah! We've Got an ETP Problem, Roger...

An interesting story that Mark Markopolos of Madoff fame, via BusinessInsider, apparently unearthing a bunch of new Ponzi schemes on the Wall Street to rival Madoff's: http://www.businessinsider.com/harry-markopolos-ponzi-scheme-bigger-than-madoff-2016-2.

Several interesting and obvious things in the article. Assuming, of course, Markopolos is not talking about the Ponzi of all Ponzi Schemes, the 'fiat money' printers at the Central Banks. But one worth a note, the little piece relating to ETPs (Exchange Traded Products) that allegedly polluted the previously relatively clean universe of U.S. listed ETFs with the European disease of synthetics.

The crux of the issue is contained in this letter: https://www.sec.gov/comments/s7-16-15/s71615-60.pdf.

Choice quotes:

"With the mortgage-backed securities crisis... it was the bundled, flawed mortgage products that became a significant contributing factor to the negative financial events of 2008/2009. Some ETPs contain very similar characteristics to the illiquid mortgage-backed securities. Other ETPs are based on very risky trading and settlement processes that can produce systemic challenges to the ETP industry, thus the financial markets."

Dire stuff. We get more: "There has been an exponential growth rate in the number of ETPs since the financial crisis. Unfortunately, unlike mortgage-backed securities, which were sold to more professional investor classes, ETPs have been marketed on a large-scale to retail investors, their mutual and pension funds and financial advisors are advocating the products to even their retail customers." It's grannies and pensions, not Lehmans & Bears that are now at risk. Congratulations, folks: financial engineering, having plundered taxpayers and savers is now munching through retailers, aka ordinary folks, directly.

Worse: "...the most active ETPs are based on the important components of the U.S. capital markets, i.e. S&P 500 securities. A collapse or disturbance caused by these products could strike directly at the heart of the U.S. financial system during the next financial crisis through blue chip securities." Munching through ordinary folks requires levering more risks into core equities and asset markets too. So if you haven't bought the Killer White of risk yourself, via links to underlying equities and other retail assets,  the Killer White of risk bought you anyway.

What's the problem if they can just sell underlying and clear off the decks? Ah, that 'selling the underlying'. "The vast majority of ETPs have very low levels of assets under management and illiquid trading volumes. Many of these have illiquid underlying assets and a large group of ETPs are
based on derivatives that are not backed by physical assets such as stocks, bonds or commodities,
but rather swaps or other types of complex contracts."

Hello, Kitty... no wait... Kitty is a rabid tiger! Back in 2011 I wrote about these types of funds in relation to the European investors here: http://trueeconomics.blogspot.com/2011/08/14082011-warning-on-synthetic-etfs.html.

And the latest revelations are absolutely mirror image of the concerns raised in 2011: "Many of these products may have been designed to take what were originally illiquid assets from the books of operators, bundle them into an ETP to make them appear liquid and sell them off to unsuspecting investors. The data suggests this is evidenced by ETPs that are formed, have enough volume in the early stage of their existence to sell shares, but then barely trade again while still remaining listed for sale. This is reminiscent of the mortgage-backed securities bundles sold previous to the last financial crisis in 2008."

Garbage in. Balancesheet cleansed. You, retailer, holding the trash.

This can get very very ugly...

Note: in addition to the above letter, there are several other letters released by SEC detailing the problems in ETPs universe. Here are the links:

• http://www.sec.gov/comments/s7-11-15/s71115-19.pdf Letter S-7-11-15 (2015)
• https://www.sec.gov/comments/s7-16-15/s71615-60.pdf Letter S-7-16-15 (2015)
• http://www.regulations.gov/contentStreamer?documentId=FSOC-2014-0001-0015&attachmentNumber=1&disposition=attachment&contentType=pdf Cover Letter from March 2015
• https://www.sec.gov/comments/265-29/26529-49.pdf Letter 265-29
• And there is a good post on the subject here: http://prograssing.com/news/as-madoff-airs-on-tv-two-anonymous-whistleblowers-are-pounding-on-the-secs-door-again/.

10/2/16: IMF to Ukraine: Sort Thyselves!

IMF on Ukraine (and it is narsty):

The only surprising bit is the tone. It is quite frankly unbelievable to think that the IMF were rationally expecting substantial and visible progress on such a tough and 'sticky' issue as corruption to be delivered within such a short span of time. Their key concern is, of course, warranted. But the sharpness of the tone suggests IMF is entering into an internal political dogfight between Ukrainian Presidency and the Government and it is siding, seemingly, with the President.

9/2/16: Currency Devaluation and Small Countries: Some Warning Shots for Ireland

In recent years, and especially since the start of the ECB QE programmes, euro depreciation vis-a-vis other key currencies, namely the USD, has been a major boost to Ireland, supporting (allegedly) exports growth and improving valuations of our exports. However, exports-led recovery has been rather problematic from the point of view of what has been happening on the ground, in the real economy. In part, this effect is down to the source of exports growth - the MNCs. But in part, it seems, the effect is also down to the very nature of our economy ex-MNCs.

Recent research from the IMF (see: Acevedo Mejia, Sebastian and Cebotari, Aliona and Greenidge, Kevin and Keim, Geoffrey N., External Devaluations: Are Small States Different? (November 2015). IMF Working Paper No. 15/240: http://ssrn.com/abstract=2727185) investigated “whether the macroeconomic effects of external devaluations have systematically different effects in small states, which are typically more open and less diversified than larger peers.”

Notice that this is about ‘external’ devaluations (via the exchange rate channel) as opposed to ‘internal’ devaluations (via real wages and costs channel). Also note, the data set for the study does not cover euro area or Ireland.

The study found “that the effects of devaluation on growth and external balances are not significantly different between small and large states, with both groups equally likely to experience expansionary [in case of devaluation] or contractionary [in case of appreciation] outcomes.” So far, so good.

But there is a kicker: “However, the transmission channels are different: devaluations in small states are more likely to affect demand through expenditure compression, rather than expenditure-switching channels. In particular, consumption tends to fall more sharply in small states due to adverse income effects, thereby reducing import demand.”

Which, per IMF team means that the governments of small open economies experiencing devaluation of their exchange rate (Ireland today) should do several things to minimise the adverse costs spillover from devaluation to households/consumers. These are:

1. “Tight incomes policies after the devaluation ― such as tight monetary and government wage policies―are crucial for containing inflation and preventing the cost-push inflation from taking hold more permanently. …While tight wage policies are certainly important in the public sector as the largest employer in many small states, economy-wide consensus on the need for wage restraint is also desirable.” Let’s see: tight wages policies, including in public sector. Not in GE16 you won’t! So one responsive policy is out.
2. “To avoid expenditure compression exacerbating poverty in the most vulnerable households, small countries should be particularly alert to these adverse effects and be ready to address them through appropriately targeted and efficient social safety nets.” Which means that you don’t quite slash and burn welfare system in times of devaluations. What’s the call on that for Ireland over the last few years? Not that great, in fairness.
3. “With the pick-up in investment providing the strongest boost to growth in expansionary devaluations, structural reforms to remove bottlenecks and stimulate post-devaluation investment are important.” Investment? Why, sure we’d like to have some, but instead we are having continued boom in assets flipping by vultures and tax-shenanigans by MNCs paraded in our national accounts as ‘investment’. 
4. “A favorable external environment is important in supporting growth following devaluations.” Good news, everyone - we’ve found one (so far) thing that Ireland does enjoy, courtesy of our links to the U.S. economy and courtesy of us having a huge base of MNCs ‘exporting’ to the U.S. and elsewhere around the world. Never mind this is all about tax optimisation. Exports are booming. 
5. “The devaluation and supporting policies should be credible enough to stem market perceptions of any further devaluation or policy adjustments.” Why is it important to create strong market perception that further devaluations won’t take place? Because “…expectations of further devaluations or an increase in the sovereign risk premium would push domestic interest rates higher, imposing large costs in terms of investment, output contraction and financial instability.” Of course, we - as in Ireland - have zero control over both quantum of devaluation and its credibility, because devaluation is being driven by the ECB. But do note that, barring ‘sufficient’ devaluation, there will be costs in the form of higher cost of capital and government and real economic debt.It is worth noting that these costs will be spread not only onto Ireland, but across the entire euro area. Should we get ready for that eventuality? Or should we just continue to ignore the expected path of future interest rates, as we have been doing so far? 

I would ask your friendly GE16 candidates for their thoughts on the above… for the laughs…

9/2/16: We've Had a Record Year in M&As last... next, what?

Dealogic M&A Statshot for the end of December 2015 showed that global M&A volumes have increased for third year running, reaching USD5.03 trillion in 2015 through mid-December. Previous record, set in 2007, was USD4.6 trillion.

• 2015 annual outrun was up 37% from 2014 (USD3.67 trillion) 
• 2015 outrun was the first time in history that M&As volumes reached over USD5 trillion mark.
• 4Q 2015 volume of deals was the highest quarterly outrun on record at USD1.61 trillion, marking acceleration in deals activity for the year
• There is huge concentration of deals in mega-deal category of over USD10 billion, with 69 such deals in 2015, totalling USD1.9 trillion, more than double USD864 billion in such deals over 36 deals in 2014.
• Even larger, USD50 billion and over, transactions accounted for record 16% share of the total M&As with 10 deals totalling in value at USD798.9 billion.
• Pfizer’s USD160.0 billion merger with Allergan, officially an ‘Irish deal’, announced on November 23, is now the second largest M&A deal in history (see more on that here: http://trueeconomics.blogspot.com/2016/01/28116-irish-m-not-too-irish-mostly.html)

The hype of M&As as the form of ‘investment’ in a sales-less world (see here http://trueeconomics.blogspot.com/2016/02/9216-sales-and-capex-weaknesses-are-bad.html) is raging on and the big boys are all out with big wads of cash. Problem is:

• M&As are not that successful as a strategy for corporate growth (http://trueeconomics.blogspot.ie/2015/05/21515-global-m-and-economic-fundamentals.html), 
• They are pretty terrible deal for organic capital investment (http://trueeconomics.blogspot.com/2015/11/141115-more-evidence-us-capex-cycle-is.html), and
• They are usually jobs subtractive, rather than jobs additive. 

The former, however, is trouble for investors, not management. The latter two are trouble for us, mere mortals, who want well-paying jobs. which brings us about to 'What's next?' question.

Given lack of organic revenue growth and profitability margins improvements, and given tightening of the corporate credit markets, one might assume that M&As craze will abate in 2016. Indeed, that would be rational. But I would not start banking on M&A slowdown returning companies to real capital spending. All surplus cash available for investment ex-amortisation and depreciation and ex-investment immediately anchored to demand growth (not opportunity-creating investment) will still go to M&As and share support schemes. And larger corporates, still able to tap credit markets, will continue racing to the top of the big deals. So moderation in M&As will likely be not as sharp as moderation in corporate lending, unless, of course, all the hell breaks loose in the risk markets.

9/2/16: Sales and Capex Weaknesses are Bad News for U.S. Jobs Growth

In a note from February 4, Moody Analytics have this two key messages about the U.S. economy, none pleasant:

• Business sales are ‘mediocre’ outside energy sector, so that jobs growth singled by business sales outside energy sector should be slowing; and
• Capex slowdown is about to smack jobs growth even further to the downside.

Take their numbers with a gulp of some oxygen.

Point 1: Business sales

The old-fashioned statistics don’t quite fudge stuff as well as the more modern hoopla about users, unique visits and signups deployed in the ICT sector. So here we go:

“Don’t fall into the trap of believing all is well outside of oil & gas. According to Bloomberg News, the 52% of the S&P 500 that has reported for 2015’s final quarter incurred over-year setbacks of -4.9% for sales and -5.7% for operating income. To a considerable degree, the declines were skewed lower by annual plunges of -34.2% for the sales and -64.2% for the operating profits of the latest sample’s 18 energy companies. For the 53% of the S&P 500’s non-energy companies that have reported for Q4-2015, sales barely rose by 0.6% annually, while the 2.6% increase by operating income fell considerably short of long-term profits growth of 6.5%.”

You’ve heard it right: in a recovery the U.S. is having, sales are up 0.6% y/y. Know of any real business that lives off something other than sales? I don’t.

Based on the Commerce Department broad estimate of business sales “that sums the sales of manufacturers, retailers and wholesalers. …even after excluding sales of identifiable energy products, what I refer to as core business sales posted annual increases of merely +2.1% for 2015 and +1.0% for Q4-2015”.

“…payrolls have been surprisingly resilient to the slowest growth by business sales excluding energy products since Q4-2009.” But, based on 3-mo average payrolls correlation with 12-mo average business sales data (estimated by Moody’s at 0.87), 2015 figures for sales suggest “…the average increase of private sector payrolls may descend from 2015’s 213,000 new jobs per month to 42,000 new jobs per month. Unless core business sales accelerate, 2016’s macro risks are most definitely to the downside.”

A handy chart:

Point 2: Capex headwind for jobs growth

“Business outlays on staff and capital spending are highly correlated. Over the past 33 years, the yearly percent change of payrolls revealed a strong correlation of 0.84 with the yearly percent change of real business investment spending.”

So, based on 2015 yearly increase in capital spending private sector payrolls “should have approximated 0.8% instead of the actual 1.9%. In other words, Q4-2015’s 1.6% yearly increase by real business investment spending favored a 91,000 average monthly increase by 2015’s payrolls, which was considerably less than the actual average monthly increase of 221,000 jobs.”

All of which puts into perspective what I wrote recently about the U.S. non farm payroll numbers here: http://trueeconomics.blogspot.com/2016/02/5216-three-facts-from-us-labor-markets.html

You really have to wonder, just how long can the U.S. economy continue raising the bar on additional bar staff hiring before choking on shortages of sales and capital investment?

9/2/16: Echoes of 2011 at Deutsche?

Almost 4 and a half years ago, I wrote about the systemic weaknesses in the Deutsche Bank balancesheet: http://trueeconomics.blogspot.com/2011/09/13092011-german-and-french-banks.html, And now we are seeing these weaknesses coming to the front.

It is not quite Europe's Lehman Moment, yet, but if Deutsche goes to the wall at the rates implied by its CDS, we are into more than Lehman-deep pool of the proverbial...

Source: @Schuldensuehner 

7/2/16: You Gotta Have Some Heart: Baltic Dry Index

As the global growth prospects are apparently and allegedly improving, and the world is busy printing money left right and centre with currency devaluations rounds stimulating the fabled 'competitiveness', the world trade indicators are no longer flashing red. They are, frankly, in a free fall.

Remember Baltic Dry Index? The one that reflects volumes of goods trade flows? And the one that was testing new record lows almost daily around the end of December 2015 through January 2016?

Behold the latest record: Baltic Dry is now below 300

H/T to @soberlook

Time for IMF eagles to fly some forecasting models to tell us things are just going fine at 5% annual global growth click... Yes, yes... that is, to repeat gain, Baltic Dry at its lowest level in its history.

PS: Ireland's exports are, of course, insulated from all this global nonsense... because when times get tougher in the markets, tax optimisation becomes even more important to MNCs.

6/2/16: Down the Ruble Hole? Russian Opinions & Russian Economy

Latest Russian figures on wages and earnings, rounding up 2015, are pretty horrific. In USD terms, average wage is now down more than 30 percent in a year through December, falling to around USD560 per month at year end.

Wages Woes?

In Ruble terms, things are more palatable. Nominal wages are up 4.5 percent to RUB34,000, which means that real wages have fallen roughly 9.5 percent in 12 months through December. The average salary was down to RUB30,311 (USD381) per month, from end of September average of RUB32,911 (USD463). Rate of real wages decline accelerated in December compared to full year averages to 10 percent compared to December 2014.

However, average real incomes excluding wages, but including private business income and state payments, were down 4% y/y in 2015. One sign of the fiscal policy direction is that President Putin signed off on a minimum wage hike for 2016 that raised (as of January 1st) the minimum wage to RUB6,204 (USD87) a month, up on RUB5,965 or USD84 per month in 2015.

Beyond this, underlying labour markets trends, despite sharp cuts to employment reported in all surveys of PMIs for Services and Manufacturing over the last 24 months, official unemployment remains benign at 5.8 percent. This masks vast regional variation. In the Central Federal District, which includes Moscow, unemployment is below 4 percent, against, per BOFIT data, 12 percent in North Caucasus. BOFIT reports figure for Inigushetia at  30 percent. Unemployment rate for under-20 years of age is at around 20 percent.

2016 is expected to be another hard year for wage earners, as Korn Ferry — Hay Group forecast that Russian companies will increase salaries on average by only 7 percent in 2016. Given expected inflation in 14.6 percent range this will entail another 7.5 percent cut to real wages.

Feeding Rising Cutbacks by Households

Notably, economy, salaries and inflation have been identified as the main economic concerns in this week’s survey by state-run pollster VTsIOM. Low salaries were raised as concern by 13 percent of respondents in January survey. 12 percent of Russians were concerned about rising inflation in December 2015 and this rose to 20 percent in January data. Another 12 percent of respondents said they were concerned about unemployment.

These trends are feeding into decline in consumer demand. Based on state-run VTsIOM poll published earlier this week, as of the end of December 2015, some 63 percent of Russians have cut back purchases of goods over the last 6 months. 59 percent are substituting in favour of cheaper goods and 26 percent are dipping into personal savings to make ends meet.

In another poll, published at the end of December, covering the period of mid-December, VTsIOM, Russians are reporting lower social well-being with the welfare Self-Estimate Index reporting own conditions of the respondents falling to the lows of 2009 and 24 percent of Russians estimating their own financial situation as being “bad”. The Social Optimism Index was showing that only 27 percent of Russians think their lives are going to improve in 2016, and 33 percent of Russians said the economic situation in the country was bad.

That said, for now at least, 45 percent of Russians positively assess country’s overall development path and only 17 percent of respondents disagree with this view.

Still, based on yet a third poll (also from December and also by VTsIOM), if in August 2014 introduction of the food imports embargo against the Western countries was opposed by only 9 percent of Russians, by mid-November 2015, some 20 percent of respondents expressed opposition to the embargo. Still, as shown by the poll results, the majority of Russian citizens continue to support the ban on food imports, although the number of those supporting it falling from 84 percent to 73 percent since the introduction of the embargo. In line with this, fewer Russians consider the food embargo to be an effective measure: down from 80 percent in August 2014 to 63 percent mid-November 2015.

And Touching the Values Systems

In a way, all of this translates into some serious fodder for political analysts (apart from us, economists). You see, much of Russian system legitimacy rests on two factors: immense economic gains over the period of 2000-2012 or 2013 (depending on timings of the crisis) and national (not quite nationalist) aspirations for a historical revival.

Back in July 2015, Levada Centre - probably Russia’s most reputable polling organisation - found that 42 percent of Russians said they preferred "decent" wages and pensions over the freedom of speech and the opportunity to travel abroad. 49 percent, though said they won’t. The results in July 2015 (data was collected in June) were similar to those in 2013 survey (43 percent preferred financial stability over the opportunity to travel abroad and the right to free speech, against 46 percent who opposed such  trade off). But this still marked a big change on 2008 when only 35 percent of Russians were willing to trade freedoms for income and 54 percent of Russians opted for freedom of speech and travel ahead of pensions and salaries.

While the above figures suggest that large share of population is closely anchored to financial and economic fortunes of the country, there are preciously few signs that those adversely impacted by the crisis are willing to take up the issue with authorities. Levada Centre July poll found that 69 percent of Russians would tend to avoid any interactions with the authorities and only 23 percent were determined to press authorities to deliver on promises. Not surprisingly, 60 percent of Russians do not believe that people can hold authorities to account and 22 percent believe they can. Subsequently, only 18 percent of the Russian population thought that mass protests are likely to arise as the result of the ongoing crisis and only 14 percent of respondents expressed willingness to participate in protests.

Yet, for all their imperfections, opinion polls are showing some tremors in the facade of the public support for state policies and institutions.

Obshchestvennoye Mnenie Foundation poll published on February 5th showed that 54 percent of Russians see economy as being in a crisis. 41 percent said the economic situation in Russia is satisfactory and only 3 percent of the participants said that the economy is in a good state. The number of Russians that have a negative view on the state of the economy is increasing, and rapidly so: just 43 percent of the respondents in December last year felt the economy was in bad shape and only 30 percent did so in May of 2015. And 58 percent now think that the economic situation in the country is worsening, while a month ago this answer was given by 41 percent of people. Which flies in the face of many analysts and the Government view that the economic crisis has bottomed out. Note: it is worth noting that in general, public opinion on timing of bottoming out of the recessions lags actual underlying numbers. Still, for a ’stabilising’ economy, only 9 percent of Russians currently believe that the economic situation is improving.

Levada Centre poll published at the end of January found that 45 percent of Russians believed that the country was “moving in the right direction”, down from 64 percent in June 2015, and from 56 percent in December 2015. January marks the first time for over a year that the state policy approval rating fell below 50 percent mark. Meanwhile, those who feel that the country was on a “wrong route” rose to 34% in January poll compared to 22 percent back in June 2015 and to 27 percent in December 2015.

President Putin's personal approval rating fell to 82 percent in January, compared to a record high of 89 percent in June 2015 and to 85 percent in December 2015. The proportion of respondents who named him among the politicians they trust also declined. This currently stands at 58 percent, down on 64 percent in June 2015 and 60 percent in December 2015.

What Does All of This Mean?

All of the above adds up to a picture in which the country is sliding gradually toward becoming un-anchored from the key driver for social cohesion: economic normalisation (compared to the 1990s) delivered during the so-called Putin Era. While the ongoing geopolitical revival still compensates for the negative economic momentum, that compensation is starting to fade.

One reason for it - cumulative losses on the economy front. Key responses to the crisis have been: devaluation of the Ruble, push toward imports substitution and conservative push back against the pressures on capital account side. All were necessary and rather successful. But all of them also transferred large amounts of pain onto the shoulders of the households and SMEs working in the private sector. Public sector employment and wages have been better shielded from the crisis, but there too, strains are starting to appear. As the result, real, tangible and compounded pain is now feeding through to the ordinary folks.

The other reason is the weakening of the geopolitical dividends perceived by the ordinary Russians. Crimea was the high point of 'return to roots' in Russian psyche - a point of reversal of perceived historical injustice inherent from the Soviet times and a point of a payback for years (since 1991) of virulent anti-Russian rhetoric across the majority of the former USSR states, including Ukraine. These were perceptions of the average Russian (do not confuse them with my own views). The conflict spillover into Eastern Ukraine was already a step away from the Crimean narrative, but it was a proximate one. And hence it had weaker, but nonetheless significant, support on the ground in Russia. But Russian push into Syria has completely divorced the country geopolitical strategy from the hearts-and-minds of the Russians on the ground. Syria is a foreign land, with alien religious strife and probably more reminiscent of Chechnya to an average Russian, than of the traditional spheres of Russian interest.

The twin factors: increased economic pressures and weakening geopolitical dividends, are now working through public perceptions. The outcome of these is far from predictable. Current lack of serious discontent is likely to persist over time: Russia is not Ukraine and it will not opt (socially) for the convulsions of knee-jerk 'revolutions' . But, if the economic crisis continues unabated, there will be political 'blood'. One way or the other.



A note to the above: Surveys in Russia — even those conducted by reputable pollsters such as Levada Center — need to be taken with a pinch of salt. Reliance on polls is a tricky thing, especially for polls in societies highly skeptical of social researchers and authorities, like Russia. Here is a good article on some problems identified in some recent polls: http://www.themoscowtimes.com/news/article/what-do-russians-really-think-the-truth-behind-the-polls/558537.html.

5/2/16: Ifo Economic Climate Index for Euro area: 1Q 2016

Ifo Economic Climate Index in the Euro Area has posted another contraction at the start of 1Q 2016 marking the third consecutive quarter of declines and reaching the lowest level since 1Q 2015. IFO Economic Climate Index (the headline index for the series) for the Euro area fell to 118.9 in 1Q 2016 from 122.0 in 4Q 2015. Activity signalled by the index, however, remains above the historical average at 107.5 an well above downturns-consistent average of 84.8.

The chart below shows index trends:

As highlighted in the chart above, EU Commission own sentiment index for economic activity is also pointing to weakening growth conditions in 1Q 2015. The EU Commission Sentiment Index was un a divergence to the Ifo index since the start of 2015.

Two core components of the Index also moderated in 1Q 2016. Present Situation sub-index fell from 153.8 for 4Q 2015 to 151.0 in 1Q 2016, marking the first quarter of contraction after four consecutive quarters of increases. The sub-index remains firmly ahead of the historical average of 127.5.

Perhaps the most worrying is the decline in Expectations for the next 6 months sub-index which fell from 103.3 in 4Q 2015 to 100.0 in 1Q 2016. This marks third consecutive quarter of declines in expectations and the index level currently is closer to the historical average of 95.8.

Overall, the gap between expectations forward and present conditions assessment has declined. Gap index (my own calculation) is now at 66.2 for 1Q 2016 against 67.2 in 4Q 2015. This suggests that weaker expectations are now starting to feed through to weaker present assessments.

A chart below illustrates the trends for sub-indices:

Per Ifo release: “Assessments of the current economic situation were most negative in Greece and Finland, but the current economic situation also remains strained in France, Italy and Cyprus. The situation was only slightly better in Spain, Portugal and Austria; but assessments for Austria were far less negative than last quarter. The sharpest recovery was seen in Ireland, where survey participants assessed the current economic situation as very good. In Germany the economic situation is considered to be good, although assessments were somewhat less favourable than last quarter.

The six-month economic outlook remains positive nearly everywhere. Economic expectations brightened in Austria, France, the Netherlands, Estonia and Latvia. In the other countries the outlook either remains unchanged, or is somewhat less positive. WES experts were only slight pessimistic about Greece, Portugal and Spain.”