18/9/2014: Quite a disappointing TLTRO round 1

So ECB's first tranche of TLTROs allotted at EUR82.6 billion - which is disappointing to say the least. Announcement is here: http://www.ecb.europa.eu/press/pr/date/2014/html/pr140918_1.en.html

Prior to the allotment, the following were forecast:

• Credit Agricole: EUR100 billion (EUR200 billion into December tranche)
• Goldman Sachs: EUR200-260 billion in September and December TLTROs and EUR720-910 billion in overall programme
• Morgan Stanley: EUR250 billion in September & December TLTRO tranches and EUR100-400 billion for tranches 3-8
• Nomura EUR115 billion in September and EUR165 billion in December
• JPMorgan EUR150 billion in September
• Barclays EUR114 billion in September and EUR154 billion in December.

My own view on the subject as follows (from a comment given yesterday for international publication).

Note that the take up today has been disappointing for all above expectations (my own included), suggesting that traditional LTROs roll-overs dominated decision on TLTRO demand. This means that going into AQR reviews by the ECB the banks are reluctant to expand their corporate lending balance sheets and the loading now is on much heavier take up of TLTROs in December. In the mean time, low take up in this tranche can put some added pressure on ECB to deploy its ABS purchasing programme.


TLTROs vs LTROs

The key difference between TLTROs and LTROs is in the targeted nature of TLTROs. Conventional LTROs (despite the fact that term 'conventional' can hardly apply to these rather exceptional instruments) are unrelated to the balancesheet exposures of the banks and are designed to simply inject medium-term and long-term liquidity into the banking system as a whole. Thus, in the environment of deleveraging and uncertainty with respect to future losses, LTRO-raised funds flow to government securities with lower / zero risk-weighting and high liquidity. The effect is to reduce yields on Government securities, without providing any meaningful uplift in lending to the real economy. De facto, LTROs helped alleviate the sovereign debt crisis on 2010-2011, but also resulted in increased credit markets fragmentation and did nothing to reduce credit supply pressures in the real economies of the euro area countries. TLTROs - via targeting levels of real credit exposures to non-financial corporations - are holding a promise to shift funds into credit markets for companies, with weighting formula favouring banks with greater exposures to such lending. If successful, TLTRO programmes can incentivise banks to lend on the basis of risk-return valuations, which can, in theory, also alleviate the problem of financial markets fragmentation by attracting euro area banks into lending in the so-called 'peripheral' economies.

At this stage, both demand and supply of credit in the majority of the euro area economies are well outside the fundamentals-determined levels. The financial markets are severely fragmented and the ongoing deleveraging of the banks and companies balancesheets still working through the credit markets. This means that any forecast for TLTROs uptake and effectiveness are subject to huge uncertainty. My view is that we are likely to see rather cautious take up of the TLTRO funds in the first round, with many lenders dipping into the funding stream without full commitment. We are looking at the take up of around EUR100-150 billion in Thursday TLTROs. One reason for this is that the first tranche of TLTROs is likely to go into replacing maturing 3-year LTRO funds rather than new expansion of the banks balancesheets. To-date, banks repaid some EUR649 billion of LTROs, with EUR370 billion outstanding. Close-to-redemption LTRO funds need replacement and TLTROs are offering such an opportunity, albeit at a cost (TLTROs are priced 10bp higher than LTROs but offer longer maturity). All-in, the banks are likely to go for roughly EUR300 billion of TLTROs (with total potential allotment of EUR400 billion available, the cost will be the main factor here), with under half of this coming in September and the balance in December. Another reason pushing TLTROs demand into December, rather than September, is the ongoing ECB review of the banks (AQR analysis).

TLTROs, ABS and QE

ABS measures are going to aim to address the size of the ECB balancesheet, while providing support for effective yield on loans to the real economy. In this, well-structured ABS purchasing programme can provide support for TLTROs by increasing incentives for the banks to lend funds to corporates. However, excessive focus in the ABS programme on quality of assets and risk pricing can posit a risk of increasing fragmentation in the markets, as such focus can drive a significant wedge in pricing between corporate yields in the core economies of the euro area and the 'periphery'.

I do not see the ECB deploying traditional QE programme at this point in time. The reason for this is simple: yields convergence in the Sovereign markets is ongoing, levels of yields are benign, and demand for sovereign assets remains strong. However, if TLTROs and ABS programmes prove to be successful, we may see banks exits from low-yielding sovereign debt (core euro area) and from high yield, but now significantly repriced peripheral debt (profit taking). Unlikely as this might be at this point in time, if such exits prove to be aggressive, the ECB will have to provide support for sovereign yields and a small-scale QE can be contemplated in this case.

In general, however, it is clear from Mr Draghi's recent speeches and statements that he sees two key problems plaguing the euro area economies: the problem of high structural and cyclical unemployment and the problem of low private investment. Both of these problems continue to persist even as the sovereign debt yields have fallen dramatically, suggesting that government spending stimulus and investment programmes are unlikely to repair what is structurally a longer-term set of weaknesses in the economy.

17/9/2014: Belarus v Ukraine: Income per Capita

Someone just asked me a question as to what is the relative income in Belarus vs Ukraine. Here is the data on GDP per capita basis (PPP-adjusted to reflect exchange rates and price levels differences) for main CIS countries (click to enlarge):

Note: as Ukraine is now a programme country for the IMF, forecasts end at 2014.

Sorted. Enjoy.

On related note, here are some other comparatives including Belarus and Ukraine: http://trueeconomics.blogspot.ie/2014/09/992014-russias-risks-are-up-but-still.html see table at the bottom of the post.

17/9/2014: Letting Go Ireland's Tax Arbitrage Model Will be a Painful Process

OECD has put forward their proposals for new international tax rules that, in theory, could eliminate tax-optimisation structures that have allowed many multinational companies (such as Google, Apple, Pfizer, Amazon, Yahoo and numerous others) to cut billions of dollars off their tax bills. The proposals were prompted by the G20 request issued last year and the measures announced this week have already been agreed with the OECD’s Committee on Fiscal Affairs (44 countries).

The proposals form just a part of the overall international tax reforms package called “Action Plan on Base Erosion and Profit Shifting” that will be unveiled in 2015 and is commonly known as BEPS.

There are two pillars in the current announcement.

The first pillar addresses only some of the abuses of dual-taxation treaties that generally aim to prevent double taxation of companies trading across the borders. The OECD is proposing to make amendments to its model treaty package that would prevent cross-border transactions from availing of tax treaty reliefs whenever the principal reason for the transaction is to avoid tax liability. This is a principles-based change, recognising the spirit or the principle of the dual-taxation treaties. De facto, the aim is to prevent the situation where preventing dual taxation leads to the scenario of dual non-taxation.

As with all principles-based reforms, the devil will be in the fine print of the actual regulations and economist's mind is not the best guide for sorting through these. From the top, were the measures to succeed, profits shifting via the likes of Ireland to tax havens will be if not fully stopped, at least significantly impaired. The result will be putting at risk tens of billions of economic activity booked via Ireland. In some cases, practically, this will mean that activity will be re-domiciled to other jurisdictions, where it really does take place. In other, however, it will become subject to tax in the country that stands just ahead of the tax haven in the pecking order of revenues flows. Ireland might actually benefit here, since our tax regime is still more benign than that offered in other countries.

To support the first pillar, however, the OECD also wants to restrict the amount of profits that a company can report in its intra-company accounts when these are based offshore. In effect this will put a cap on how much of their activity companies can attribute to the intra-company transactions or to force companies to redistribute profits generated by intra-company divisions across the entire group.

This is likely to undermine our ability to gain from re-allocation of revenues mentioned above. For example, suppose a company has a division based in Ireland that holds the company IP. The division is highly profitable, despite being very small: revenues it earns from other parts of the company operating around the world are covering the alleged cost of IP. If these profits were capped and/or required to be redistributed around the world to other divisions of the same company, the incentive for the company to retain its IP in tax optimising location, such as Ireland, will be gone no matter what our tax rate is.


The second pillar relates to the rules on tax residency. In particular, the OECD said that the existent rules that allow companies to operate facilities in a country without registering tax residency there should be abolished. The result, if adopted, will be to force companies like Google, Apple and Amazon to pay taxes on activities carried out in larger European states in these states by removing the channel for profit shifting to Ireland and other countries. The OECD is explicit about this by insisting that companies with 'significant digital presence' in the market should be forced to declare tax residence in that country.

Ireland's official response to this threat is that majority of MNCs trading from here do have significant presence here in form of large offices and big employment numbers. This is a weak argument for two reasons. One: Irish operations are relatively small for the majority of MNCs, compared to their global workforce. Two: majority of Irish operations of MNCs are sales, sales-support, marketing and back office. In other words, these support larger markets workforce.


The first pillar of the proposal is likely to impact sectors such as phrama and tech, where significant profits are generated by IP, trademarks and patents and these are often held off-shore in what are de facto shell subsidiaries not registered for tax purposes in the countries where actual activities of the company are based.

The second pillar is even more damaging to smaller open economies such as Ireland, because it mirrors the old EU proposal for CCCTB basis of corporate taxation. This pillar will likely push activities that are registered in countries like Ireland back into the countries where actual transactions take place, favouring larger economies over smaller ones.

For example, take a US company running sales support centre in Ireland servicing Spain. This activity is supplied by Spanish-speaking, largely non-Irish staff that has been imported into Ireland not because they are more productive here or have better human capital or face lower costs of employing, but because their presence in Ireland allows the company to book sales in Spain into Ireland. In fact, absent tax arbitrage, it would probably be cheaper for the company to employ these workers in Spain.

Back in 2013, Reuters reported that 3/4 of the largest US MNCs in tech sector channeled their revenues from sales across the EU into Ireland and Switzerland, avoiding reporting these activities in the countries where actual customers resided.

If OECD proposals are implemented to reflect the spirit of the reforms, the tax arbitrage bit of the abnormal return on locating labour-intensive activities in Ireland will be gone. This, by itself, may or may not be enough to put those jobs on the airplanes back to Spain, Italy, Germany, France and elsewhere. But if other countries start making themselves more competitive in labour costs, tax and regulatory regimes, defending Ireland's competitive proposition will be harder and harder.

This process - of erosion of Irish competitive advantage - will be further accelerated by the OECD proposals on tax data sharing and clearance which envisages massive increase in the data reporting burdens on the multinational companies. The cost of compliance and audits this entails will be large and increasing in complexity of companies' structures, leading to more incentives for them to rationalise and streamline their operations worldwide. A tiny market, like Ireland, much more efficiently serviceable via the larger economy like the UK, is unlikely to win in this race.


OECD proposals can have a pronounced effect on economic growth, employment and financial health of a number of countries, including Ireland, Luxembourg, Switzerland, and the Netherlands because the proposals will force MNCs to change their global operations structures and move jobs out of tax optimisation states toward the states where real activity takes place.

From Ireland's point of view, closing off of the loopholes can have a dramatic effect on the ground if it is accompanied by other trends, such as renewed corporate tax rate competition that can challenge our attractive headline rate of 12.5%, erosion of Irish regulatory and supervisory regimes competitiveness, increase in cost inflation and other inefficiencies. Instead of competing on being a tax arbitrage conduit, Ireland will have to start competing on the basis of real economic fundamentals, such as skills, public policy, public goods and services, private markets efficiencies, etc.

Ironically, the threat of the elimination of tax arbitrage opportunities can result in Ireland becoming more competitive and more successful over time, assuming the Governments - current and subsequent - play it smart.

16/9/2014: Mapping Uncertainty Across Industries

A very interesting post on HBR Blog (http://blogs.hbr.org/2014/09/the-industries-plagued-by-the-most-uncertainty/) mapping technological uncertainty against demand uncertainty across major industries.

Two charts:

16/9/2014: Allegedly, Irish Consumers Have Pulled Back Spending in August

It is with some puzzlement that I read the following tweet:

Being aware that there has not been any new data on retail sales or consumer demand issued today, I opened the link: http://www.independent.ie/business/irish/irish-households-pull-back-in-spending-last-month-new-figures-show-30590499.html

It turns out that the 'pulling back' of 'spending' is really a 'pulling back' of consumer confidence.

And indeed, as chart below shows, Consumer Confidence reported by the ESRI fell from a very high reading of 89.4 in July to 87.1 in August:

Now, we do not have August data for retail sales yet. And these may or may not have fallen. But Consumer Confidence decline has preciously little to say about the actual household spending or consumer demand or retail sales. Especially in the medium (3 months and over).

Take a look at data we do have:

• In January 2014, Consumer Confidence rose m/m strongly, but seasonally-adjusted retail sales barely rose in value terms and strongly shrunk in volume terms.
• In February 2014, Consumer Confidence rose again strongly, but seasonally-adjusted retail sales remained unchanged in volume terms and fell strongly in value terms.
• In March 2014, Consumer Confidence moderated significantly, and retail sales fell in volume and value terms.
• In April 2014, Confidence rose dramatically and both volume and value indices of retail sales rose as well. 
• In May 2014, Confidence indicator tracked both retails sales indices to the downside.
• In June 2014, Confidence tracked volume and value of retail sales to the upside.
• In July 2014, Confidence rose dramatically, but retail sales shrunk in both volume and value terms.

So in last 7 months, Consumer Confidence changes tracked changes in actual consumer demand in 4 and did not track demand in 3. That is hardly a record to base any conclusions on. But historically things are even worse.

The chart above shows that Consumer Confidence historically shows a weak relationship with the Volume of Retail Sales and a very weak relationship with the Value of Retail Sales. Worse, these weak relationships fall to nil - or vanish completely - for quarterly readings:

So whatever KBC lads might say, ESRI Consumer Confidence does not indicate that households pulled back their spending in August. It might, however, suggest that consumer are not expressing same levels of enthusiasm about their current prospects and this might mean they could have pulled back spending. 

16/9/2014: Ukraine Passes Far-Reaching Law on Eastern Regions Decentralisation

After ten days of ceasefire, the Ukrainian Parliament (Rada) ratified a very significant new bill, introduced by President Poroshenko, that

• guarantees a "special status" based on a degree of self-rule for the self-proclaimed separatist territories, the Donetsk and Luhansk "People's Republics", for a period of 3 years
• allows for policing by local militias in specially designated areas of self-rule
• provides protection (yet to be defined) for Russian language
• permits local governments' autonomy in establishing and strengthening of "good neighbourly relations" with Russia
• promises Kiev funding to rebuild the regions (not specified amount and/or conditions)
• sets the date for local elections: December 7

A separate bill guarantees amnesty for "participants of events in the Donets and Lugansk regions", which implies three things of note:

1. the bill does not reference separatists as terrorist - a major departure from past practices; and
2. grants symmetric amnesty to both sides, including the volunteers fighting on the side of the Ukrainian forces; and
3. provides no exceptions on the basis of citizenship - so all foreign fighters on both sides are, presumably, included in the amnesty.

It is worth noting that the amnesty does not cover those responsible for the shooting down of the MH17 as well as rebels accused of other "grave" crimes (per BBC report).

In my view - this is a major and very positive departure from the past policies for President Poroshenko which is made even more significant by the fact that Ukraine is going into acrimonious and challenging political campaign for the new parliamentary elections. It took some guts and political will for President Poroshenko to push this through. For example, Yulia Tymoshenko, the former prime minister and presidential candidate, labelled the bill a "complete surrender". As quoted in the Telegraph, she stated that "This decision legalises terrorism and the occupation of Ukraine".

It must be reiterated again, President Poroshenko deserves huge credit for taking this major reconciliatory step and the bill, in my opinion, provides a very good roadmap for securing longer-term dialogue between all parties on how to rebuild the region within the united Ukraine. It is my sincere hope that the separatists will fall fully behind this process.

Signals from the separatists are, however, quite mixed. Igor Plotnitsky who heads Luhansk separatists, as reported in the Telegraph, said the bill met several of his demands and that "a peaceful resolution has been given its first chance". In contrast, Andrei Purgin, the so-called deputy prime minister of the Donetsk People's Republic, said that the bill only offers a possible starting point for discussions. This is unfortunate.



Sources:

http://www.telegraph.co.uk/news/worldnews/europe/ukraine/11099126/Ukraine-separatists-granted-self-rule-and-amnesty-as-Kiev-agrees-EU-pact.html

http://www.bbc.com/news/world-europe-29220885

16/9/2014: If China Growth Fall-off is Structural... Who's Going to Drive Global Growth?..

BOFIT published their revised forecasts for Chinese economic growth 2014-2016 and the numbers are just not pretty... not quite ugly, but not pretty. 2014-2015 forecast is for 7% growth - which is a 'psychological' bond for growth in China as it entails a 10-year doubling horizon and is alleged to be supportive of demographic changes. 2016 growth forecast is for 6% - or sub-7% magic number.

All in, 2014-2016 are expected to show slowest growth since the start of the millenium and these come on foot of two previous years of growth below 8%. So far, H1 2014 posted growth of 7.5%, down from 7.7% growth in 2013.

Interestingly, BOFIT note: "If the indicative data showing a relatively good employment picture are credible, even growth lower than forecast here may be suffi-cient to satisfy the needs of the Chinese society. China’s traditional official growth targets, crystallised in a single number, have outlived their purpose. They fail to guide market ex-pectations and policies in a way that reflect economic fundamentals."

The drivers of Chinese economy slowdown appear to be very similar to those impacting Russian economy: exhaustion of the investment boom. "The current slowdown in growth is quite natural given the size of China’s economy, its resource demands and increased level of development, but there are also other factors con-tributing to the slowdown. In the wake of a decade-long investment boom, new investment no longer delivers the same “bang for the buck” it did earlier. A corollary to China’s aging population is the decline in the number of work-age people. Vast environmental degradation comes with hefty costs that are already eroding growth. Finally, short-term growth will be subdued by high indebtedness that limits the government’s room to manoeuvre in the fiscal and monetary policy spheres."

The Big Hope has always been that falling investment will be offset by rising consumption. Which is what provides upside support to BOFIT forecasts. But one must ask a simple question: if debt is already a problem, who will be paying for this increasing consumption?

In case you wondered, that 'soft landing' meme is still around, but it is now being increasingly questioned: "A controlled “soft landing” for economic growth is by no means a given at this point. Remaining on the appropriate glide path will require strong economic and reform policies. The rising indebtedness of firms and local governments remains a top challenge for China’s multi-tiered economic policy matrix. Worryingly, the credit boom in China this decade tracks several earlier credit booms in other countries that ended in crisis. Darkening the mood further is an impending correction in the real estate sector. While Chinese financial markets have been relatively calm in recent months compared to a year ago, the shadow-banking sector continues to grace the headlines with stories of defaults and other problems. "

Key point is that China is not expected to support significant upside to global growth through 2016. And this leaves global growth dependent on G7...

Full forecast is available here: http://www.suomenpankki.fi/bofit_en/seuranta/kiina_ennuste/Documents/bcf214.pdf

16/9/2014: More of a Risk, Less of a Bubble: Irish Property Prices in Q1 2014

An interesting BIS paper on House Prices data across a number of advanced economies (http://www.bis.org/publ/qtrpdf/r_qt1409h.htm). A key chart:

Data is through Q1 2014 and is based on the aggregate of 8 data sets for Ireland. It is worth noting that data is for Ireland overall, not Dublin.

In the nutshell, in Q1 2014 Irish property prices were still at the lower end in terms of price/rent ratio and price/income ratio.

An interesting contrast to other peripheral and advanced economies in terms of dynamics:
"Year-on-year residential property prices, deflated by CPI, rose by 9.5% in the United States and 6% in the United Kingdom. Real house prices also grew, by 7% in Canada, 7.7% in Australia and 2.2% in Switzerland, three countries that were less affected by the crisis, as well as in some countries that were severely affected by the crisis, such as Ireland (+7.2%) and Iceland (+6.4%).  Real price growth remained in negative territory in Japan (–2.6%) and was generally weak or negative in continental Europe. Prices rose in Germany (+1.2%) and the Nordic countries (+1.7% in Denmark and +4.8% in Sweden), but continued to fall in the euro area’s southern periphery (Italy, –5%; Spain, –3.8%; Portugal, –1.2%; and Greece, –6%). "

So as I noted before, two points of concern and two points of solace:

• Dynamics of prices, not levels, are signalling serious problems in the markets;
• Dublin is the core driving factor for this with the rest of the country barely showing much of an improvement;
• Levels of prices remain benign in relation to incomes and to rents, especially outside of Dublin;
• Compared to other peripherals, we are witnessing much faster recovery supported by significant past falls in prices relative to income (note similar levels of prices in Iceland, although prices recovery and dynamics are more concerning there than in Ireland).

16/9/2014: World's top 35 Military Powers

Quite superficial, but nonetheless a ranking of military systems around the world:

Source: Centre for Arms Control and Non-Proliferation

15/9/2014: OECD Economic Outlook: It's Worse than the Cover Says...

Keeping in mind that the OECD is a cooperative international body (aka not known for taking strong positions on anything, save lunch menu), here's Paris-based boffins' latest outlook for the global economy in 2014:

Everyone is downgraded, save India. Poor Italy got blasted - forecast for 2014 growth is now 0.9 percentage points lower than back in May and the 'powerhouse' of the euro area, Germany, is expected to grow by just 1.5% this year despite booming current account.

2015 is not going to be much better either:

OECD expects euro area to grow at 1.1% in 2015, which is slower than its forecast for the common currency area for 2014 produced back in May 2014. In other words, the expected 'new' recovery is worse than expected 'old' current outlook.

And world trade slowdown is now pretty much structural:

Domestic demand is likely to stagnate just as external demand, especially in the euro area as jobs creation remains anaemic and wages growth is nowhere to be seen, even at low inflation rates:

What the OECD has to say on the euro area reads like a description of a full-blow Japanization:
"The recovery in the euro area has remained disappointing, notably in the largest countries:  Germany, France and Italy. Confidence is again weakening, and the anaemic state of demand is reflected in the decline in inflation, which is near zero in the zone as a whole and negative in several countries. While the resumption in growth in some periphery economies is encouraging, a number of these countries still face significant structural and fiscal challenges, together with a legacy of high debt. "

Meanwhile, door knobs of European policymaking are calling for raising domestic demand to combat debt overhang. Now, definition of Domestic Demand is: Personal Consumption of Goods & Services + Net Expenditure by Local & Central Government on Current Goods & Services + Gross Domestic Fixed Capital Formation = Final Demand. Add to Final Demand Value of Physical Changes in Stocks and you have Total Domestic Demand.

Take a look at the above components:

• Personal Consumption of Goods & Services is subject to significant downward pressures due to tax increases, cost of government-supplied / controlled goods & services increases and household debt overhang. To increase this without increasing debt overhang for households requires shifting some of the Government burden off shoulders of the households. Which will only add to Government debt pile.
• Net Expenditure by Local & Central Government on Current Goods & Services is held back by Government debt overhang and large deficits. To stimulate this will require heavier debt overhang or more taxation of households, which will only increase their debt overhang and depress their demand. 
• Gross Domestic Fixed Capital Formation is held back by corporate debt overhang and broken credit system (down to banks debt overhang). Stimulating investment - aka fixed capital formation - will either require companies to increase their debt overhang (more credit issuance) or increase Government spending (see above) or dilute equity in companies.

In short, there is not such thing as a debt-neutral 'stimulus' when debt overhang is present across all sectors of the economy, as in euro area periphery, and in a number of other euro area states.

Boffins from the OECD have this to say on euro area's alleged malaise Numero Uno: low inflation. "Inflation has been falling steadily in the euro area for nearly three years. As demand strengthens, inflation is expected to turn back up and gradually converge on the EBC’s target range. But the succession of downward surprises has increased the risk that inflation remains far below the ECB’s target for a more extended period or declines further. Excessively low inflation makes it more difficult to achieve the relative price adjustments that remain necessary to rebalance euro area demand without having to endure a prolonged period of slow growth and high unemployment. Inflation near zero also clearly raises the risk of slipping into deflation, which could perpetuate stagnation and aggravate debt burdens."

In my view, this is just plain bollocks, pardon my language. Why? 

Because low inflation only exacerbates debt burden in ratios to GDP, not in real terms and even then  only for the Governments. Low inflation means low interest rates, which reduce cost of debt servicing for all actors in the economy: households, governments and corporates. Higher inflation equals higher interest rates, which means that you are killing households and companies in order to drive that debt/GDP ratio down for the Government. Meanwhile, economy's cost of servicing the debt levels, not ratios, is rising. This is why deflation with low growth are unpleasant but bearable in debt overhang scenarios (see Japan) while stagflation (low growth and high inflation) is a disaster. 

Need more convincing? Suppose inflation reaches ECB target of 2%. Suppose we post real growth of 3% pa. Which makes our nominal growth in the economy around 5% (simplifying things, but only marginally). What happens to interest rates? Why, they go toward historical averages. Say benign 2.5%. What happens to legacy mortgages rates? They more than double for trackers and rise by at least 2.5 percentage points for ARMs. What happens to mortgages arrears? What happens to household consumption? What happens to household investment? If growth of 5% is driven, as currently, predominantly by external sectors (exports and foreign investment, including in property markets), what happens to earnings and wages that are supposed to pay for the household debts and purchase domestic companies' goods and services? And what happens to Government yields and with them debt-servicing costs?.. 

OECD rather cheerfully presents the following outlook for inflation:

Which suggests we are heading for mean reversion (increases) in interest rates on 5-10 year horizon. Fingers crossed by then foreign investors will be snapping homes in Ireland at prices close to 2005-2006 peak so we can at least foreclose on them without much of negative equity overhang...

14/9/2014: WLASze: Weekend Links of Arts, Sciences and zero economics

This is WLASze: Weekend Links of Arts, Sciences and zero economics. Enjoy.


Couple of 'firsts' this week. The first supernova spotted by the ESA Gaia that repeatedly scans the skies in order tod etect emerging anomalies: http://www.redorbit.com/news/space/1113233469/supernova-first-for-esa-gaia-observatory-091414/

The thing is hardly visually dramatic. Earlier, Hubble took an actual image of a distant supernova exploding and
http://www.redorbit.com/images/pic/61042/hubble-snags-one-of-the-farthest-exploding-stars/

And as impressive as it was in imaginary and scientific terms, visually the whole thing is a bit more like 'Meh!'… Closer up, things are much more impressive, as this NASA’s Chandra X-ray Observatory image of January 21, 2014, explosion of supernova in the Messier 82, or M82, galaxy suggests

Source: http://www.redorbit.com/images/pic/89147/universe-chandra-images-supernova-explosion-081514/


Another win for ESA is the image of the post-supernova remnants, showing the destructive results of a powerful supernova explosion "in a delicate tapestry of X-ray light, as seen in this image from NASA’s Chandra X-Ray Observatory and the European Space Agency's XMM-Newton": http://www.redorbit.com/images/pic/89219/universe-x-ray-view-of-supernova-remains-puppis-a-091214/#g1ypXAI5OHo5MlIY.99

Technology is a winner in the above… But it can also be a loser.

Behold NY Times Magazine's daft and boring exercise in neo-tech-classicism: http://6thfloor.blogs.nytimes.com/2014/09/10/under-cover-how-we-turned-lena-dunham-into-a-neoclassical-bust/?smid=tw-nytimes
In summary, they took an old sculpture by Canova and using a bunch of tech tricks copied it into a rendition of Lena Dunham (an actress and director). Expensive, elaborate and full of hype, this was just an attempt to prove to us that in the 21st century, with much of tech thrown its way we can make something similar to what Canova did in 1805-1808 with Pauline Bonaparte presented as Venus Victrix without any fancy tech, a team of 'specialists' and NY Times cameras and marketing machines running.

Cutesy, over-conceptualised and boring…

The cover story itself is worth reading, though: http://www.nytimes.com/2014/09/14/magazine/lena-dunham.html although the NY Post nails it by saying: "On the matching column of life (or art), one would never connect Bonaparte, an Imperial French princess and sister of Napoleon, with Dunham. The insistence on raising the “Girls” co-creator to the level of high art seems peculiar and a silly stretch at the very least. There’s nothing highbrow or particularly artful about her show — it’s a personality-driven vehicle that is sometimes funny and sometimes not, depending on your tolerance for self-referential irony and those bathing suit scenes." (http://nypost.com/2014/09/12/why-lena-dunhams-nyt-mag-cover-is-all-wrong/)


Let's stay for the moment with technology and its value. As the above suggests, some is for 'keepers' some is for 'undertakers'. Something similar to the taxonomy of knowledge here: http://www.farnamstreetblog.com/2014/09/the-book-of-trees-manuel-lima/ albeit not as elegantly expressed...

Dunham's 'bust' is for the latter. Here's an example of tech history for the former: http://www.aspeninstitute.org/about/blog/national-geographic-channel-features-time-capsule-found-at-aspen-meadows. Back in September 2013, some historians of technology dug up the time capsule deposited in 1983 by a bunch of techies. It contained some seriously epochal pieces of hardware, like Lisa Mouse - the first prototype of the computer mouse used by Steve Jobs.

In the link above, you can hear Jobs' speech at the conference back in 1983, where he mentions voice recognition, office and household networking, wifi connectivity, extension of networked computers into our lives to squeeze out the role played by cars, portability of computers "an incredibly great computer in a book that you can carry around with you that you can learn how to use in 20 minutes" and how the musical record industry will be transformed by software, erasing traditional music stores.


Moving on from stars, tech, science and all things geeky, onto matters aesthetic. Here's an absolutely stunning building design by emerging studio Zeller & Moye and overseen by Mexican architect and gallery founder Fernando Romero
http://www.dezeen.com/2014/02/18/fernando-romero-fr-ee-archivo-gallery-raw-exoskeleton-building/
Dramatic slicing of space, shifting and rotating of perspectives is, nonetheless, deeply integrated into its surroundings. A truly fantastic design, albeit the one that will in the end be neutered by health-and-safety requirements of any public building.

So here you have it: random and yet interconnected links... just as WLASze supposed to be... Enjoy!

14/9/2014: Pound, Scotland and Ireland's Risks

There are many arguments pro and against Scottish independence. And there are many arguments pro and against Scottish independence from various perspectives, including non-Scottish/UK ones. Not to try replicate these or to pretend to provide a comprehensive list of these, let me touch upon a couple points as viewed from Ireland's position vis-a-vis independent Scotland or Scotland remaining a part of the UK.

Take the fate of the British pound were Scotland vote for independence. Most likely this will be higher in value vis-a-vis the euro in the short run due to simple short-term risk valuations, usually known as a knee-jerk reaction. However, once the markets fully factor in the disappearance of Scottish GDP and demand from the UK markets, the value of the pound will have to come down vis-a-vis the euro. There is a problem with this from the point of view of Ireland as it entails:

1.  falling competitiveness of Irish goods and services exports to the UK; and
2.  falling attractiveness of retaining UK banks' presence in Ireland.

Let's look at the first point. As sterling falls in value against the euro, Irish exports to the UK will become more expensive. At the same time, Scotland itself is likely to undergo currency devaluation (direct, assuming it opts for its own currency or indirect - aka internal - if it pegs to sterling or stays in a currency union with the UK). Which means that both areas will cut purchases from Ireland, with Scotland cutting these more dramatically than the rest of the UK. Symmetrically, our imports from the UK and Scotland will become cheaper, which means we will tend to buy more of these. The end result: our trade balance with the UK and Scotland is going to fall. And it is the trade balance (not exports alone) that determines external trade's contribution to GDP.

Meanwhile, lower value of sterling (and/or Scottish currency) will lead to revaluation of returns on investment for UK and Scottish banks and firms made in Ireland. In simple terms, interest rates will rise faster and higher in the UK with weaker currency. Which means higher returns for UK banks in the UK than in Ireland. Meanwhile, with devaluation of the pound, funding Irish divisions losses will be more expensive for the UK and Scottish banks. Which means lower returns and higher costs of losses for UK banks in Ireland. Sign a 'bye-bye' note to RBS' Ulster Bank.

At the same time, the thriving financial services 'outsourcing' industry of the IFSC, currently serving numerous UK-based firms from Dublin will be looking at rising sterling cost of providing these services. Just at the time when independent Scotland is devaluing (lower cost in sterling terms) and attempting to lure these services into its own thriving back office services centres. If Scottish authorities play it right, there can be a double-incentive for some back office activities to re-domicile out of Ireland into Scotland.

Stronger euro relative to sterling is also going to carry over to tax arbitrage by the ICT services companies, which are currently booking billions of revenues from the UK into Ireland. As the values shrink expressed in euro terms, profits declared here for tax purposes, small as they already are, are going to get even smaller. For MNCs using Ireland as a cost (transfer pricing) centre, the same effect will be to reduce the transfer pricing margin in euros. Again, this will not play well with their GDP-linked activity.

All of which implies quite a risk from Irish economy's point of view.

None of the above should be treated as a comprehensive list of positive and/or negative effects of the possible Scottish 'yes' vote, nor should it be treated as supporting either 'yes' or 'no' camp. I am simply providing one small exercise of thinking about the possible effects of a 'yes' vote.

14/9/2014: Update: Sanctions Round 4: Russian Banks, Stocks & RUB

Updating my chart on Russian stock market performance:

A very interesting set of statements from Sberbank Chairman, German Gref on the impact of sanctions on Russia's largest bank. Two source articles for this are: http://www.vedomosti.ru/finance/news/33360751/sberbank-ne-isklyuchil-rosta-stavok and http://www.vedomosti.ru/finance/news/33332871/sberbank-doveli-do-singapura?utm_source=vedomosti&utm_medium=widget&utm_campaign=vedomosti&utm_content=link

Some quotes from the above:

1. External funding markets are already de facto closed [for Sberbank] - including markets for debt under 90 days (recall, debt over 90 days is directly restricted under the sanctions). De facto, per Gref, sanctions are much tighter than de jure. Hard currency liquidity position of the banks is severely disrupted. 
2. Impact is significant: Sberbank has 28 outstanding euro debt issues in the markets: 22 of these are denominated in USD, 3 in CHF, 1 in Euro, 1 in Turkish lira and 1 in rubles. Prior to the EU sanctions (round 3), Sberbank placed USD1 billion in 10 year 5.5% coupon euro-debt in February 2014.
3. Russian banks are seeking new avenues for raising debt and equity. Per Gref, Sberbank is looking to re-list some of the existing equity, currently trading in US and European markets in other markets. Singapore is one potential platform, with Sberbank considering following in the footsteps of Gasprom which re-listed some shares in Singapore in June 2014. Sberbank is looking at Singapore as a new platform for both equity and debt. Currently, Sberbank shares are traded in London (LSE: September 10 daily volume traded is USD64.1 million), Frankfurt (Xetra: daily volume is insignificant at USD77,453 million), over the counter in the NY (volume is also small at USD0.95 million) and in Moscow (volume RUB6.8 billion or USD181.3 million). Moving into Singapore can provide significant access to new markets for Sberbank and open, simultaneously, access to new debt issuance.
4. Gref expects that the CBR will raise deposit rates on foreign currency deposits to increase funding pool.
5. There are no serious issues with ruble-denominated liquidity, although share of ruble funding coming via the Central Bank is relatively high and rising. State funding is now the main source for growth in credit supply since July as CBR funding rose by RUB223 billion to RUB5.6 trillion, Federal and regional budgets funding is up RUB87 billion to RUB624 billion, and funding via Finance Ministry is up RUB36 billion to RUB656 billion. Share of state funding in the banking system is now at a record of RUB7.1 trillion (13.7% of total banking sector liabilities).

In a related statement, another sanctioned bank, Rosselkhozbank also noted that new sanctions have zero material impact on its access to foreign liquidity, as debt markets de facto froze on foot of the third round of sanctions.

As a reminder, Sberbank, VTB, Gazprombank, VEB and Rosselkhozbank were hit by the fourth round of sanctions announced this Friday. The new round extends July 2014 3rd round of sanctions and prohibits EU investors from trading in new equity and debt instruments issued by these banks with maturity in excess of 30 days (previous round banned trading in instruments with maturity over 90 days).

Note: As covered on this blog, the CBR has de facto allowed free float of the RUB in advance of its pre-commitment to do so starting from January 2015. The CBR stopped interventions in the FX markets back in June 2014 and non-intervention continued through August and into the first two weeks of September. Prior to June, the CBR actively intervened in the FX market to support RUB. Over the last 6 years, the longest period of non-intervention in the FX markets was just 3 days.

13/9/2014: Ukraine's economy newsflow: from bad to worse

A small digest on Ukrainian economy - mostly news, less analysis.

Some grim stats on Ukrainian economy here: http://slavyangrad.org/2014/09/08/statistics-tell-the-tale-irreplaceable-losses-for-the-ukrainian-economy/
A very comprehensive survey, despite some politically loaded statements. Read it for the stats and ignore all political ravings.

Meanwhile, the prospect of Ukraine dipping into gas deliveries destined for Europe is looming as Naftogaz debt continues to rise: http://en.itar-tass.com/economy/747187 and as winter draws closer and closer. The fabled 'reversed flows' from Eastern Europe are not materialising (predictably) and reserves are bound to be running out faster as coal production is all but shut. Per Vice PM Volodymyr Hroisman, ukraine is facing a shortfall of some 5 million tonnes of coal by the end of 2014 and gas shortages are forecast at 5 billion cubic meters. As the result, Ukraine is now forced to buy coal abroad, with one recent agreement for shipments of 1 million tonnes of coal signed with South Africa.

Electricity exports from Ukraine are suffering too, primarily as domestic production falls and demand rises. In January-August 2014, electricity exports are down 6% y/y

National Bank of Ukraine governor, Valeria Hontareva, has been reduced to talking up the markets by delivering promises that the Government will not default on its bonds and Naftogaz bonds. She had to admit this week that hryvna devaluation has now hit 60% y/y (by other calculations, depending on the currency basket chosen it is just above 40%) and inflation is running at 90%. Recall that on September 2, the IMF assessment of the economy which reflected the updates to risks and latest forecasts. Revised programme forecasts now see real GDP shrinking 6.5% y/y in 2014, but growing by 1% in 2015 and 4% in 2016. Hontareva said this week the GDP can fall by 9% this year alone. End of year CPI is expected to come in at 19% in 2014 (which has now been exceeded by a massive 71 percentage points, based on Hontareva statement) and 9% in 2015 before declining to 6.9% in 2016. Hryvna devaluation vis-a-vis the USD was expected to run around 50.6% y/y which is already too conservative compared to the reality, and by another 6.4% in 2015 falling to a devaluation of just 0.8% in 2016. Needless to say, Hontareva's statement suggests that the IMF forecasts, published only 10 days before she spoke, are largely imaginary numbers.

And the streets are voting for this verdict too: in January-August 2014 net purchases of foreign currency were up 6.6 times than in the same period of 2013, while households' deposits in foreign currency fell 13.3%. This suggests that people are stockpiling foreign currency in the safety of their own homes, rather than in the banks. Consumer confidence latest reading, published last week showed a drop of 10.4 points to 54.7, while inflation expectations rose 2.8 points to 188.7 and devaluation expectations were up 22.1 points to 147.8.

Meanwhile, the Government is yet to catch up with the ugly realities. Last week, the Government approved macroeconomic forecasts for 2015-2017 which show expected real GDP growth of 0.3%-2% in 2015, rising to 2.5-4.5% in 2016. Good luck to them...

None of this is cheerful. The country is economically in a tailspin and the Government is currently unable to address multiple and still mounting problems. New elections for the Rada are due, with effectively a caretaker Government in place. The conflict, currently in a fragile ceasefire, is destroying the economy (not to mention lives and society).

Country political crisis is starting to push the anti-Russian and anti-Eastern Ukrainian rhetoric to new highs (e.g. http://www.bloomberg.com/news/2014-09-12/u-s-widens-sanctions-on-russian-banks-energy-defense-firms.html) which is not helping President Poroshenko, who is effectively held hostage by his pre-election promises to bring back Crimea and restore Kiev control in Donbas and the need for pragmatic de-escalation. The President seems to have embraced the latter, but the rest of Ukraine's Government, facing fresh elections, is going on the solo run of beating the anti-Russian drums.

PM Yatsenyuk's ravings are dangerous, although they are also amusing, precisely because they represent blatant political posturing. Last week he went so far as to suggest that Europe cannot exist without Ukraine as a member of the EU (despite the simple fact that no one in the EU ever offered Ukraine a prospect of membership) and that Moscow wants to restore the entire Soviet Union (despite the fact that parts of the Soviet Union today are firmly members of the Nato, while some other former republics are basket cases so poorly run, Russia would have to go bankrupt to accommodate any sort of union with them).

Ukrainian exports to Russia are now expected to fall 35% in 2014 and a further 40% in 2015. And it is not all down to agrifood and heavy machinery trade that is suffering. Take for example insurance sector. In H1 2013, Russian reinsurance companies provided cover for 32.9% on Ukrainian insurance companies (UAH270.2 million). In January-June this year this was down 42% to UAH157 million, with Russian reinsurance share of the Ukrainian market down to 22.1%. Substitute cover was sought instead in Germany and the UK - both markets trading in currencies not offering hryvna any hedging against devaluations, unlike falling ruble. Which means cover is now more expensive.

13/9/2014: Irish tax System: Less Balance, More Burden

Remember the booming tax receipts and corporate tax returns? So what is really booming in the Exchequer accounts in Ireland?

Chart above shows that:

1. As proportion of total tax receipts, Income Tax and Levies now account for 42.84% of all tax receipts (data for January-July 2014) against 42.52% in 2013. This is the third highest proportion (in 1987 it reached 43.48% and in 1988 it was 43.62%) on record since 1984.
2. VAT, also predominantly paid by consumers (or households) now accounts for 31.76% of the total, up from 27.34% in 2013.
3. Meanwhile, booming corporate tax receipts accounted for just 9.48% of total tax take in the seven months of 2014, down from 11.30% in 2013. Controlling for timing of taxes, and thus excluding the result for 2014 to-date, 2013 marked the second lowest year for corporation tax receipts since 1995 (the lowest was 2011 at 10.34%). So far, through July, 2014 corporation taxes as a share of total tax paid in the country are at their lowest levels since 1992.

So as Irish media lauds Government efforts to rebuild the Exchequer balancesheet as some sort of a great achievement for the economy, keep it in mind - mortgages arrears, anaemic domestic demand, low household investment, pensions under-provisions, health insurance drop outs, utilities arrears, defaults on car and road taxes, and a myriad of other problems are being made worse by the fact that we have prioritised taxing families as the means for achieving the necessary objective of 'fiscal stability'.

12/9/2014: Bank of Russia Leaves Rates Unchanged

So Bank to Russia decided to maintain its benchmark rate at 8% today. The announcement is here http://www.cbr.ru/eng/press/pr.aspx?file=12092014_133319eng_dkp2014-09-12T13_29_04.htm. This was expected by majority of analysts: 17 expected no hike, 7 expected a 50bps hike and 1 expected a 25bps hike. My own view - tweeted out yesterday - that the decision could have gone in favour of a hike.

My rationale was (and remains the same for the next two-three months):

1. Russian sanctions against Western exports of food pushed up inflation and inflationary expectations. I wrote about this before on a number of occasions. As far as we know, early September CPI accelerated upward momentum. In July, when inflation shot up to 7.5% (well ahead of 5% annual target), the CBR responded with a hike and the Government revised its outlook for inflation (July decision raised rates from 7.5% to 8%). August figures (through September 8) suggest inflation has increased to around 7.7% and core inflation hit 8.0%.
2. Ruble weaknesses persist: the currency is now down roughly 5% on end-of-July figures. CBR's reluctance to intervene aggressively in the FX markets means the pressures are still building up.
3. Government policy favours higher inflation: the Government is pushing for a hike in VAT and for an introduction of a regional sales tax (ca 3%) on top of that. On the related, PM Dmitri Medveded held a meeting between cabinet ministers and a panel of Russian economists discussing various options for addressing fiscal risks. The group of economists invited was unanimously against the introduction of a regional sales tax, preferring to increase VAT instead.

Nonetheless, the CBR is clearly watching for any effects of July hike on inflation. As noted in the release, money supply growth fell off the cliff: down from 17.1% a year ago to 6.5% this year.

The CBR is also clearly concerned with the deposits situation in the banks, noting that higher rates create incentives for raising savings. This represents a policy of switching as much as possible of the lost funding from international markets (sanctions) into deposits funding.

The CBR has also revised its economic outlook which is now much gloomier than that of the Government. Utilisation capacity remains high, but labour productivity growth is sluggish, per CBR, which suggests that the CBR is more pre-occupied with structural weaknesses in the economy. The CBR now expects the economy to shrink by -0.2% y/y in Q3 2014 and expand by just 0.4% in 2014 overall. CBR outlook for 2015 is pretty dire too: GDP growth of just 0.9-1.1%.

With the above points in mind, it is pretty clear that CBR will have to continue raising rates in months ahead, so the current pause is just a temporary 'hold-back and watch' scenario. 

Meanwhile, the Economics Ministry stepped up its criticisms of the CBR - an open warfare that has been going on over the summer. CBR July hike was uncoordinated with the Government and was in a direct response to the CBR outlook forward, reflecting inflationary pressures on foot of trade sanctions and the risks arising from planned tax hikes. Worse, CBR deputy chairwoman Ksenia Yudayeva openly criticised the government for failing to take into the account the inflationary risks inherent in the proposed tax policies. The Government and the Economics Ministry are clearly unhappy with monetary tightening which comes amidst decelerating investment in the economy and at the time when Western sanctions have already severely restricted major banks' access to international funding markets. These restrictions are feeding through into retail rates and choking off already fragile credit growth.

Back in August, President Putin visibly backed the Economics Ministry in the fight with the CBR when he accepted the Economy Minister Alexei Ulyukayev's proposal that future inflation targets be set by jointly by CBR, his ministry and the Ministry of Finance. This comes on top of the already established consultative representation for the two ministries at the CBR board. So far, the CBR stuck to its medium term target structure based on inflation target of 4%+/-1.5%. And in today's note the CBR confirmed this target as still standing.

12/9/2014: Irish Risk Ratings Comeback

Euromoney article on Ireland's improved risk ratings http://www.euromoney.com/Article/3379641/Category/14091/ChannelPage/8959/Irish-comeback-offers-a-safer-eurozone-bet.html

12/9/2014: Q2 2014 Employment Growth in the Euro Area

Eurostat latest figures on employment growth in the EU are worrying, despite some positives in quarterly comparatives.

In q/q terms, employment growth slightly accelerated in Q2 2014 to 0.2% from Q1 2014 0.1% reading. And y/y growth also accelerated from 0.1% in Q1 2014 to 0.4% in Q2 2014.

Still, at current rates of growth, it will take euro area some 9 years to return to the pre-crisis levels of employment.

Looking at the countries data, Ireland posted relatively healthy readings in y/y growth terms (1.7% in Q2 2014), but average in q/q terms (0.2% in Q2 2014 up on 0.1% in Q1 2014, identical to the euro area as a whole). In trend terms, things are more worrying. In H2 2013 Ireland managed to expand employment at an annual rate of 3.2% and an average quarterly rate of 0.7%. In H1 2014, the same rates of growth fell to 2% for y/y growth and 0.15% for q/q growth.

In quarterly growth terms, Ireland ranked 4th in the EU28 in employment growth in Q3 2013, 6th in Q4 2013, 16th in Q1 2014 and 10th in Q2 2014. In y/y terms, we ranked 2nd in Q3 and Q4 2013 and 4th in Q1 2014 and Q2 2014. So deterioration in Irish conditions is in part related to the y/y trends in the euro area, but is more pronounced and idiosyncratic in quarterly trends.

Two charts to illustrate:

Ireland still stands in a better condition compared to other so-called 'peripheral' countries. In contrast to Ireland,

• Greece posted an H2 2013 average q/q decline in employment of 2.75% followed by an average q/q decline of 0.5% in H1 2014. In y/y terms, H2 2013 saw a decline of 0.25% in employment against zero growth in H1 2014.
• Spain posted q/q average decline rate of 2% in H2 2013 and returned to employment growth of 0.4% on average q/q in H1 2014, which outperformed Ireland's growth rates for the same period. In y/y terms Spain's employment grew 0.1% in H2 2013 and 0.35% in H2 2014. The latter figure is better than Ireland's performance, but comes on foot of much shallower growth in previous 6 months.
• Italy continued on the trend for falling employment with H2 2013 q/q average decline of 1.95 moderating to a 0.9% drop in H1 2014. In y/y terms, Italian employment averaged decline of 0.1% in H2 2013 and this switched to growth of 0.1% in H1 2014.
• Cyprus was the worst performer of all 'peripheral' states. The economy posted an average rate of employment decline q/q of 5.05% in H2 2013 and followed up with an average rate of decline of 2.4% in H1 2014. Year on year employment dropped on average by 0.6% in H2 2013 and declined further by 0.25% in H1 2014.
• Portugal, however, showed some significant gains. Average q/q growth rates in H2 2013 were negative -0.85% but turned strongly positive at +1.5% in H1 2014, outperforming Ireland. In y/y terms, Portugal's employment averaged growth of 0.5% in H2 2013 and this slipped to +0.3% in H1 2014.

11/9/2014: Some Recent Links on Ukrainian Conflict

Here is an interesting compendium of academic and analysts' voices dissenting from the prevalent Nato/US rhetoric on the long-term prospects for Nato's role in Ukraine.

Note: some of the links come via RIA Novosti, a Russian news agency, which is hardly surprising, given the consistent spin in the opposite direction that we get from the traditional Western media.

Another note: this collection of links is not a comprehensive reflection of the reality. It is not designed to be such. In reality, nothing is/can be comprehensive, especially when it comes to the conflict in Ukraine. My point is that much of what we are bombarded with in the social media and traditional media is one-sided. Here is a different side to the same stories.


Ukraine and Nato:

"The world could plunge into a new Cold War with Russia and China emerging as a new financial centers, unless the West changes the existing financial structures, a professor at University of California, Davis Wing Thye Woo said ...at the discussion at the Johns Hopkins School of Advanced International Studies.
“I think that if changes do not occur in the international [financial] institutions of today, I think that we are basically encouraging a China-Russian alliance to formulate an alternative center to the US,” Woo said." http://en.ria.ru/analysis/20140807/191797049/International-Financial-Shake-Up-Contributing-to-New-Cold-War--.html

Note: I highlighted this possibility in the context of the UK proposal for barring Russian banks' access to SWIFT system: http://trueeconomics.blogspot.ie/2014/08/2982014-while-new-financial-sanctions.html

University of Chicago University political scientist John Mearsheimer: “There’s no question that Ukraine is interested in becoming part of NATO and be protected by the United States and the West more generally, and who can blame them? But the fact of the matter is that this is a prescription for disaster. …The West should have told Ukraine that incorporating Poland or the Baltic states into NATO was possible, but trying to incorporate Ukraine and Georgia was a bridge too far. We ended up precipitating a crisis and that crisis would lead to the destruction of Ukraine – and that’s obviously not in Ukraine’s interests… We should have stopped NATO expansion, given up the idea of incorporating the Ukraine into the West and instead said that we’re interested in maintaining a neutral Ukraine that effectively serves as a buffer state with NATO on one side and Russia on the other.”
http://en.ria.ru/analysis/20140905/192649988/Scientist--Ukraine-NATO-Membership-Prescription-For-Disaster.html

Note: I agree. And it looks like majority of the Nato members agree too: http://uk.reuters.com/article/2014/09/04/uk-nato-summit-ukraine-idUKKBN0GZ0SI20140904 Nonetheless, Ukrainian Government is keen on reviving its bid to join Nato: http://en.ria.ru/world/20140906/192681097/NATO-Pretends-Ukraine-Membership-Request-Never-Happened.html


Azov Battalion: 

In other news, an interesting article in the NY Review of Books: http://www.nybooks.com/blogs/nyrblog/2014/sep/05/ukraine-catastrophic-defeat/ that covers the aftermath of last weeks' fighting in Eastern Ukraine, summing it up as "the devastation suffered by Ukrainian forces in southeastern Ukraine over the last week has to be seen to be believed. It amounts to a catastrophic defeat and will long be remembered by embittered Ukrainians as among the darkest days of their history."

The article also contains a passing reference to something that is being increasingly whitewashed in the Western Media, the role of the neo-Nazis in backing Kiev's military operations: "As we sped away from the “Russians” we could see a column of black smoke rising from the sea. When we got to the Ukrainian checkpoint the men told us that it was a coastguard cutter that had been hit, they thought by a tank. They were from the Azov Battalion, one of the Ukrainian volunteer militias. On their vehicles and their arm flashes they had the “wolfsangel,” a neo-Nazi symbol, which is their insignia and which tells you much of what you need to know about their background."

In a related news, NBC report on German channel showing a video of Azov soldiers with nazi insignias on their helmets: http://www.nbcnews.com/storyline/ukraine-crisis/german-tv-shows-nazi-symbols-helmets-ukraine-soldiers-n198961

The Guardian article on Azov's central role in Ukraine's Government campaign: http://www.theguardian.com/world/2014/sep/10/azov-far-right-fighters-ukraine-neo-nazis

And on related, an Amnesty International USA post on the "on-going abuses and war crimes by pro-Ukrainian volunteer forces": http://www.amnestyusa.org/news/news-item/ukraine-must-stop-ongoing-abuses-and-war-crimes-by-pro-ukrainian-volunteer-forces

This has to be an uncomfortable reality for the US and EU politicians: Azov was formed on foot of a large number of Maidan 'activists' and represents the strongest pro-Ukrainian force that, in part, has influence with Kiev and business elites. Azov is not the only (but is the most notorious) regiment of similar nature. Explicit US and EU support for Maidan and post-Maidan interim Government is clearly tarnished by the Azov abuses and neo-Nazi base.

Note, personally, I doubt that President Poroshenko or PM Yatsenyuk welcome or support these extremists. I suspect they fear their impact and are concerned about the spread of the Azov-styled groupings in parts of Ukraine. But they have little room to clamp down on these groups in the current environment when the post-Maidan activism is still shaping internal Ukrainian policies to some extent. It is their tragedy as much as the Ukrainian tragedy that Azov is so prominently featuring as a symbol Ukrainian nationalism.


US Public Opinion vs US Political Elites:

Another interesting post is via Politico, covering American public vs political elites' opinions on various topics, including Russia as a threat: http://www.politico.com/magazine/story/2014/09/the-politico-50-survey-110555.html#.VAy5erywJ9m


Historical Map of Russian Expansionism:

Last, but not least, a good info graphic tracing out evolution of the Russian borders from the IXth century AD through the beginning of the 2000s: http://en.ria.ru/valdai_mm/20100906/160481013.html

11/9/2014: Russian Equities and the Crisis: Update

An update of the event study on the impact of the Ukrainian crisis on Russian equities - through yesterday's close.

A chart for two main indices: MICEX (Ruble denominated) and RTS (USD denominated):

And a summary table of % changes in the indices (reed cells mark cumulative declines, green mark increases). Two indices impacts and changes are diverging due to Ruble devaluations vis-a-vis USD:

You can see very clearly that MH17 and subsequent third round of sanctions had the most dramatic impact effect (short-term shock), with most of the impact and longer-term effect accruing to the MH17 event, rather than sanctions. However, in terms of the long-term impact, Yanukovich's flight and replacement by interim Government in Kiev had the most dramatic effect on Russian markets.

Overall crisis impact is fully captured by two factors:

1. Russian markets effectively saw downgrading of the pre-crisis (pre-January 1, 2014) trends (so there is a loss of potential growth that would have happened if there was no crisis, assuming pre-crisis trend would have been sustained - a tall assumption, given the economy slowdown was well underway before the crisis hit); and
2. Devaluations of the Ruble since January 1 (not all of these devaluations were driven by the crisis, as I explained in numerous notes before, as the Central Bank was already moving toward a free float for the Ruble for some years now and set a target for the free flow back in the mid-2013).

9/9/2014: Creative Destruction and Individual Well-Being

Here's a very interesting paper by Philippe Aghion, Ufuk Akcigit, Angus Deaton, and Alexandra Roulet, titled "Creative Destruction and Subjective Well-Being" (April 7, 2014, http://isites.harvard.edu/fs/docs/icb.topic1259555.files/Papers%20Spring%202014/AGHION%20April%202014.pdf)

The paper looks at "the effect of Schumpeterian creative destruction on subjective well-being. We
highlight theoretically the two opposite forces that creative destruction has on well-being: a negative
force through the higher risk of displacement and a positive one through higher growth expectations."

The displacement comes from the entry by an 'innovator' that displaces currently employed worker(s). The new technology is only enabled when a new worker is hired, and this results in higher output thereafter. So "more turnover translates into a higher probability of becoming unemployed which in turn reduces life satisfaction". But higher turnover means higher growth and this implies higher future earnings which "enhances life satisfaction."

Beyond this, the authors distinguish two types of workers, and as the result derive two different net effects.
"A second prediction is that higher turnover has a less positive (or more negative) effect on life satisfaction for more risk-averse individuals."

Applying the model to data, "Empirically, we find evidence supporting the existence of these two effects. We measure subjective well-being … [and] also use a measure reflecting individuals’ current ”worry”. For creative destruction we use establishment and job turnover following Davis et al (1996). The turnover data are MSA-level panel data from the Business Dynamics Statistics."

In more details: "We find that the effect of creative destruction on life satisfaction is unambiguously positive when we control for MSA level unemployment, less so when we do not. The magnitude of the effect is similar than that of the unemployment rate (but of opposite sign) and stronger when focusing on anticipated well-being (the growth expectation effect); yet creative destruction is also associated with increased worry (the displacement risk effect). Consistent with our model, we also find that creative destruction has a more positive effect on life satisfaction in states with a more generous unemployment insurance policy."


Note: Thanks to Liam Delaney for spotting this one earlier on twitter.

9/9/2014: Russia's Risks are Up, but Still Vastly Outperforming Ukraine's

Earlier today I tweeted about the drop in the drop in the credit risk score for Russia in the Euromoney Country Risk survey. As always, one has to look at the scores in both time series context and comparative to the peer economies.

Here is the Russian score in time series context:

It is worth noting that Russian score has declines rather steadily over time, but remains well ahead the regional average for the Eastern and Central Europe. Part of Russian score decline is driven by the ECE trend, but part is idiosyncratic.

Here are the main components of the score and the direction:

The sea of read arrows is what is of greater concern - scores dropping across all categories surveyed except one: debt indicators.

For comparative, the chart below shows evolution of Ukraine score, which is much less benign than that of Russia and remains deep under-performer in the Eastern and Central Europe:

Table below (click to enlarge) shows cross-countries comparatives for score and main components for Russia's main non-EU neighbours:

At the bottom of the above table, I list countries that are in 'credit risk' proximity to Russia, Ukraine, Belarus and Moldova. One thing is clear: Russia is comparing favourably to Eastern European countries that are EU members. Ukraine, Belarus and Moldova - do not. Their proximates are least-developed countries of the region.