13/2/2012: Now - a Greece comparative that doesn't work in our favor

Sometimes those 'We are not Greece' comparatives work our way, sometimes (fortunately enough rarely) they take us in the opposite direction. Take a look at the following two charts from DB Research (hat tip to Zero Hedge). Note: you might want to click on the charts to enlarge.

Chart one clearly shows Ireland's impressive performance with low interest rates, bubble-fueled domestic growth. The chart below shows Ireland's disastrous growth performance since the bubble burst. What's the point, you ask? Ok, half of the period of our rapid decline has been the period of exports boom, the period of our growth has been the period of domestic growth. Irish exports have been on the tear since quarter  9 in the second chart. And yet, the miracle is not happening - the exports-led recovery is still not here.

And look at Greece. And Portugal. And Spain. And Italy. And compare to Ireland. Scary? Glance back at chart 1 above and spot the fall we've taken. Some might say as the consolation that we are still ahead of all the PIIGS in actual national income (do keep in mind - the above charts are GDP, not much more adversely impacted GNP). Ok, let's put it in simpler terms: Greece has fallen from the 10th floor to the 5th floor balcony. We have fallen from the 20th floor to the 10th floor roof terrace. We are still five stories above Greece, but, man it has to hurt more.

13/2/2012: Sunday Times 12/2/2012: The perils of long-term unemployment

This is an unedited version of my article in Sunday Times, 12 February, 2012.

The conflicting nature of the most recent data on unemployment in Ireland paints the picture of an economy bouncing at the bottom of the Great Recession. However, underlying trends in long-term unemployment represent the single greatest threat to our growth potential in years to come.

The latest Live Register figures reflect two months of consecutive and robust declines in the numbers drawing unemployment assistance. In December 2011, seasonally-adjusted Live Register dropped 3,600 (the third largest monthly decline since the beginning of the crisis). This was followed by a 3,200 decline in January 2012, marking the fourth biggest downward adjustment in the series since January 2008. Yet, January 2011 Live Register total remains just 2.1% below the peak of 449,200 attained in September 2010.

Since 2009, net emigration form Ireland totalled some 76,400 and gross emigration amounted to 236,800 according to CSO. Absent the officially registered emigration, Irish Live Register would have been closer to 522,900 in January 2012. In other words, the Live Register improvements now conceal, not reveal, the true extent of joblessness and underemployment in the country.

In contrast to the Live Register data, more direct evidence on the job markets conditions is provided by the monthly Purchasing Managers Indices (PMI) surveys published by NCB Stockbrokers. These make for a rather depressing reading. January Services PMI employment conditions registered a deeply contractionary 44.5, exacerbating declines posted in December 2011. January marked the sharpest rate of decline in the services sectors employment in 21 months. In Manufacturing employment index rose in December to 50.5 before falling again to a contractionary 49.5 in January 2012. Manufacturing employment index is now 4.1% below January 2011, marking the fourth drop in the past five months.

These are the short-term signs of the labour market that remains in continued distress. And further deterioration in the underlying jobs and employment dynamics can be expected in the medium term.

Firstly, dramatic increases in the cost of laying off workers under Budget 2012 are likely to translate into an overall stabilization of the Live Register figures at a cost of the deterioration in the quality of jobs (wages and bonuses, and promotional opportunities losses) and hours of work as employers will be seeking cuts to their cost bases through lower pay and fewer billable hours. Budget 2012 makes it less likely that employers will be taking on new workers any time soon.

Secondly, the already rampant rise of the long term structural unemployment will continue unabated. Here Ireland is in the league of its own when compared to other European economies. In Q3 2011 our long-term unemployment stood at 8.8% - the third highest in the EU27. Over the period covered we have experienced a sharpest increase in long-term unemployment in Europe.

Matters are even worse when it comes to very long-term unemployment – defined as unemployment spells in excess of 24 months. With a rate of 5.4% in Q3 2011 we are now the second worst performer in Europe in terms of overall very long-term unemployment rate, and we are the absolute worst in the EU27 in terms of increases in very long-term unemployment since the beginning of the crisis.

Long-term unemployment exacts tremendous social and economic tolls. International research shows that long-term spell out of work leads to reduced life-time earnings (with estimates of up to 20% loss in earnings years after the return to the job market), higher probability of future unemployment (in some studies reaching over 2.3 times higher probability of unemployment that average), and rapid and profound deterioration in human capital of the unemployed. These effects also hold for those entering the workforce during the periods of elevated long-term unemployment, such as the current Irish graduates.

In today’s environment, rising long-term unemployment in Ireland, threatens to reinforce already adverse future trends in productivity growth. A study by the European Commission from 2006 has shown that across EU27, over the next 25-30 years, ageing workforce will require greater use of skills-driven productivity growth. The last thing we want is to lose the skills of the current generations of young workers and students to long-term unemployment.

In terms of timing of the policy responses to the long-term unemployment, therefore, it is critical that we do not delay the necessary structural reforms.

Most of the research on the policy solutions to this problem is focused on the structural and institutional aspects of the labour markets. A number of recent studies from the UK, Italy, and the US, as well as more broadly-focused studies across the advanced economies show that long duration strong unemployment protection, and high cost of hiring and laying off workers, along with rigid systems of wage setting can act as structural barriers to dealing with the long-term unemployment. This point has been most recently flagged in the case of Ireland by the OECD report from June 2011. High minimum wage and strong collective bargaining have been linked to segmentation of the labour force and increased job instability for the younger and less-skilled workers. Systemic reforms of social welfare and wages-setting mechanisms are clearly an extremely painful, but necessary part of the comprehensive solution.

On the enabling side of the policy equation, the focus should be on enhancing the human capital of the unemployed and incentives for private sector jobs creation, not public investment-driven policies.

Immediate labour market measures should be developed for the long-term younger unemployed. The Government, consistent with the advice from the IMF and OECD is pursuing so-called active labour market programmes in this area. These are primarily represented by the ‘push’ policies designed to force young people off the unemployment benefits and into state-run training programmes. According to the Nobel Laureate James Heckman training schemes designed to de-list people from the unemployment rosters had zero effect on labor markets outcomes in the 1990s. More recent research for European countries experiences prior to 2008 confirms the same. In Ireland the real impact of FAS programmes on long-term unemployment both before and during the crisis has been negligible.

OECD data very clearly shows that Ireland spends more than the Nordic countries as well as high income EU countries on direct jobs creation and state training. In total, Ireland spent 0.87% of GDP or 1.10% of GNP in 2010 on all active labour markets programmes, compared against 1.06% in the Nordic countries and 0.70% in the rest of the high income EU states. It is clear that we are simply not getting a good value for money out of this expenditure.

Instead of relying on active labour markets programmes alone, Ireland should focus on facilitating formal education access for long-term unemployed, especially to undergraduate and MSc programmes closely aligned with business and industry interests and featuring large component of direct industry-related teaching. Retraining grants and supports can be linked with mobility grants to assist mobility of those moving off unemployment benefits.

For the very young at-risk of future unemployment, financial incentives to stay in school can be developed via social welfare systems.

There is strong evidence to support the view that private sector jobs creation can be assisted through carefully targeted tax breaks and deferrals. These require extremely close monitoring, strict conditionality and enforcement, while assuring that there is no older workers displacement. Another significant measure would be to suspend minimum wage for all workers under-25 years of age, but this policy cannot be expected to generate sustainable, higher quality jobs.

Reducing USC rates for self-employed below those for PAYE workers to reflect the reality of their restricted access to social benefits would provide some support for early-stage entrepreneurship and skills-based self-employment.

The last thing the Government should do in the current environment is to use scarce taxpayers cash on direct physical capital investment as such measure would subsidise capital-intensive, not skills-enhancing activities which will cease the minute Government cash dries up once again.

Both the IMF and the OECD provide very clear-cut suggestions as to the core composition of the structural labor markets reforms based on three pillars: welfare reforms, labour markets reforms and activation systems enhancement. Augmenting these with more direct measures to incentivise private sector jobs creation mentioned above would be a net benefit in combating long-term unemployment.

Table: Spending on active labour market programmes, 2010, % of GDP

	Ireland (GDP)	Ireland (GNP)	Nordic Countries	Other OECD Europe	OECD non-Europe
Public employment service and administration	0.18	0.23	0.30	0.17	0.07
Training	0.37	0.47	0.26	0.22	0.09
Direct job creation	0.26	0.33	0.03	0.08	0.05
Other active measures	0.06	0.08	0.46	0.23	0.07
Active Labour Market Programmes, total	0.87	1.10	1.06	0.70	0.28

Source: OECD, Employment Outlook 2011, table 3.2

Box-out:

As the farcical show of Greek negotiations and austerity talks continued its merry-go-round through this week, the ECB has caused some excitement by opening up the discussion on allowing some writedowns of the Greek bonds it holds. The EFSF bonds swap would see ECB converting Government bonds the Central bank bought in the markets, for higher rated EFSF bonds, writing down its purchase discount, which in the case of Greek bonds stands around 31% of the face value of debt bought. The move has been gathering momentum and driving the bond prices up since the mid-week in a hope it will be extended to other peripheral bonds. Yet, no one in the markets seemed to notice a simple paradox. In order to create any real lasting effect on bond yields, such monetization would require a de facto injection of hundreds of billions in cash into the Euro area economy. The upside of this would be further cheapening of the credit for the peripheral states. The downside will be an even greater liquidity trap via EFSF and a sharp rise in the future interest rates on Euro denominated debt of the ordinary households and companies. With 4-4.5% ECB rates on offer and double-digit retail rates on banks loans, ECB would be robbing Paul and Jane to pay off Governments across the EU weakest states. This we now call Europe’s greatest hope for salvation?

12/2/2012: A road map to a cooperative solution for Greek crisis

Papandreou: 'this is a battle between the markets and democracy'.

Greek political discourse - mirroring the received wisdom of the crowds has been reduced to a blatant, and populist lie.

The battles in Greece today are between democracy and European/ECB dogma of preserving the status quo of existent statist system, of which patronage by the State of some markets participants is just an element. Here's why:

1. The markets did not impose ANY conditions on Greece - EU/ECB did. The markets simply refuse to be conned any longer into subsidizing the Greek state through cheap credit. This is the basic right of any participant in the markets - to refuse investing or lending to anyone, just as it is the right of any baker to refuse selling bread to someone with no money and no desire to pay on credit.
2. The markets investors are the injured party - excluding the bottom-fishing hedge funds who bought Greek bonds very recently at hefty discounts. The investors are the only ones who were first deceived by the Greek Governments cooking books and fudging numbers in official statistics. The investors should have known better, but that is not a valid defense of the case against them - they were deceived by fraudulent data reporting by the Greek State (yes, right - politicians, Governments, civil servants). The markets/investors are also the only ones who have to take any writedowns. The ECB and the European Union are taking no writedowns on Greek bonds, and are, in fact, lending Greece 'rescue funds' at a profit. 

I am pointing this not to prevent imposition of losses on Greek bonds investors. They deserve to lose and they should lose more than 70-75% of the face value of their investments in Greek bonds.

I am writing this to point that the battle we are facing in Athens today is between people pushed to a breaking point by the policies of the Governments past, and the EU/ECB.

And there is a way out, folks. Here's what should be done:

1. Impose full losses on Greek bondholders to bring debt/GDP ratio in Greece to 75%. Do same for banks bondholders in Ireland and Spain, and combine these sovereign and banking measures to achieve the same in Portugal and Belgium. Seniority under these arrangements should be as follows: private sector debt holders take the first hit, followed by the public debt holders.
2. All PIIGS bonds held by the ECB are to be transferred into a separate holding fund. This fund is to run between 2012 and 2021. Bonds are to be held in the fund not at face value, but at purchase value to instantaneously reduce debt overhang in these countries. Note: this imposes no loss on ECB until the fund is wound up.
3. The ECB Special Fund (outlined in (2) above) is to monitor the conditions of compliance with real (not the currently identified) reforms aiming to restructure PIIGS economies to put them on the path of private sector-driven growth and fiscal sustainability over 10 years horizon.
4. No coupon payments or principal repayments to be accepted by the ECB on these bonds between 2012 and 2021 to reduce debt overhang drag on the participating economies and improving their fiscal capacity to implement reforms.
5. The bonds held in the ECB fund are to be automatically written down to zero face value in 2021 as long as the participating country meets conditions of implementing the reforms.

The above proposal will eliminate or severely restrict the problem of moral hazard, as countries participating in the programme will be subject to strict reforms programme implementation. The plan will also reduce the burden of repayment of debt on the countries that do stick to the conditions of the reforms. The plan will also bring, gradually, these countries economies to more competitive institutional, fiscal and regulatory environment. In other words, the proposal contains both the sticks (under items (2), (3) and conditionality) and the carrots (items (4) and (5)).

In other words, the fund, as outlined above, would satisfy core objectives of the crisis resolution framework:

• Allow for meaningful change and reforms
• Create an incentive to participate actively in reforms for the countries engaged with the fund
• Reduce moral hazard problem
• Help to establish popular support for reforms by providing real, tangible improvement in the economies ability to sustain reforms

We can't keep fighting battles driven by noble objectives, but based on faulty logic that simply serves the very same elites that have created this crisis. We need to find a cooperative solution to the problems we face.

11/02/2012: Labor Productivity - some cross-EU comparatives

There has been much of talk about Euro area (and EU27) competitiveness trends recently in the media. Some of the commentary I've seen references the issue of decoupling in competitiveness across EU states. In light of this, I decided to take a look at productivity trends. Using eurostat data, I was able to:

1. Take eurostat main series for per person aggregate (total) productivity index that sets 2005=100
2. Rebase the index to Q1 2000=100 and recompute entire set of EU27 countries, plus EA17 and EU27 aggregates
3. Obtain via (1) and (2) above new set of productivity indices that reflect dynamics in per person productivity since Q1 2000 through Q3 2011
4. Note: data is seasonally adjusted and I am only reporting countries where data is hours adjusted as well.

Here are the core charts (I added Ireland and EU 27 average in every chart):

So few trends are apparent:

• Ireland performs - since the beginning of the crisis extremely well in terms of productivity improvements and levels - much due to the massive destruction of its employment base (I commented on this effect a number of times before). Overall - this is remarkable performance albeit at huge cost.
• Spain has posted some significant increases as well, mostly due to destruction of employment - much more so than Ireland.
• Italy is performing poorly as does Greece. In fact, Greece is the third worst performer in the entire EU27 in terms of productivity growth since the beginning of the crisis (Q1 2008).
• Portugal improvements appear to be largely consistent with the pattern for Spain.
• Finland clearly leads the pack (after Ireland) in the group of Small Open Economies (SOEs)
• Strong trends in growth in East-Central Europe (ex Hungary and Slovenia) 

Now, let's take a look at cumulative growth in productivity since the beginning of the crisis - note: green boxes mark countries that outperform EU27 average by more than 1/2 STDEV, while red boxes mark those countries that underperform the EU27 average by more than 1/2 STDEV:

And similar analysis for cumulative growth in productivity since Q1 2000:

 So is there 'decoupling' going on in terms of labor productivity? Not really. Here's what's happening:

• Spain shows highest gains in total productivity since Q1 2008 but weak (roughly average) gains since Q1 2000
• Ireland shows second highest gains since Q1 2008 and above average (6th highest in EU27) gain since Q1 2000
• Slovakia doing spectacularly well, albeit, of course, from low levels, as is Estonia (though not too great during the crisis period)
• During the crisis, Belgium, UK, Greece, Hungary, Italy, lux & Sweden all posted below average (more than 1/2 STDEVs) performance
• Since Q1 2000, Italy and Lux were the only two statistical underperformers.

So unless we go beyond Q1 2000 (the period for which we don't really have coherent comparable data) there is no 'decoupling' going on in labor productivity. There is shallow growth in it on average, but no dramatic 'decoupling'. In other words, much of core Europe is pretty poor in terms of labor productivity growth, while East-Central Europe and Ireland are performing pretty well.

11/02/2012: Globe & Mail 9/02/2012

Here's the link to my latest article for Economy Lab with Canada's Globe & Mail.

10/2/2012: Two charts for a Friday night pint

Two charts for some Friday night thinking instead of (or even while) drinking. One courtesy of Lorcan Roche Kelly flagging it on twitter (link here):

No, it's not Nouriel Roubini references that are of import in the above - entertaining as they might be - it's the likely pending reversal in the series that some techies have noticed. Hope you are not too long into the weekend...

Second chart is my own. I took a simple ratio (expressed in %) of General Government Deficit to Structural Deficit to highlight the extent of the spending related to excess over structural imbalances, in other words - to show some pro- and counter-cyclicality. Underlying data came from IMF WEO.

Some points worth noting: US has been running expansionary (in excess of structural) deficits since 2007 and these have peaked in 2009. UK started slightly later - in 2009 and will be running these through the entire forecast period. Here's an interesting thing - for all the austerity claims in the UK, ordinary deficits are expected to run above structural deficits all the way through 2016. 

10/2/2012: Few thoughts on the global policy crisis

What makes me really concerned nowdays is not the ongoing crisis, but the logical and numeric impossibility of the mounting policy "solutions' to the crisis. Here's a quick synopsis. Take a look around the world:

• Bank of England repeated QE rounds in the face of £1 trillion+ debt pile is a strategy for growth via debasement of the currency
• Fed's continued unrelenting QE is much the same
• ECB has been debasing any real connection between banks, real economy and banks profits via uninterrupted injection of cash into banks - giving a license to earn free profits on interest margins while monetizing already excessive Government debts. Real economy, of course, gets hammered by sterilization via reduced real credit flows. The end game - moral hazard of massive proportions in the financial sector across Europe
• EU itself is hell-bent on debasing real incomes and wealth of its citizens by implementing the Fiscal Compact as the sole policy tool for dealing with the crisis
• Obama Administration is debasing, in contrast with EU, the future generations' wealth and income by continuing to spend Federal dollars like a drunken sailor arriving in a casino
• Ireland's Government is actively debasing the entire domestic economy, oblivious to the reality that households and businesses deleveraging is being prevented by banks and Government deleveraging - all for the sake of grand posturing of "We will pay all our debts" variety
• Japan is engaged in an active pursuit of debasing Government balancesheet as the debt bubble spreads to Japanese Government bonds - now in negative yields
• China is debasing its monetary and fiscal policies to deliver a 'soft landing' to the massive train wreck of its vastly bubble-like property and banking sectors

Close your eyes and think - how will the world be able to reverse out of these disastrous desperate policies in years ahead without completely shutting off growth via high interest rates, destabilized savings-investment links and in the presence of ever-rising public, private and corporate debts? What levels of inflation will be required to 'inflate' out of this mess? What degree of real wealth destruction has to be imposed on the ordinary people to sustain these gambles without a structured, orderly and coordinated restructuring of debts? What asset class and geography hedge can protect you from this avalanche of disastrous policy choices by the Western leaders?

9/2/2012: Interesting chart on Euro area deposits

Here's an interesting chart from Credit Suisse via zerohedge:

Now, it's not the blue line that worries me and the others (EAP5=Euro Area Periphery states or PIIGS). It's the massive dip in the grey line. Given there's little deleveraging of consumers and corporates in France and Germany and that there is little it terms of concerns for stability of German banks (whether or not this sense of security is justified or not), the chart suggests that deposits are flying out not just in fear of local banks risks, but in fear of the euro risks.

The link to zerohedge post is here.

9/2/2012: What can ECB do?

In relation to the recent statements from Minister Noonan and Taoiseach Kenny on their expectations that ECB involvement in Greece should be matched by ECB extending assistance to Ireland:

What can ECB provide in relief for Ireland:

1) ECB can do a swap of Irish higher coupon bonds for cheaper EFSF/ESM bonds at current or even reduced (via suitable averaging) market value, saving interest charges and reducing outstanding principal of Irish debt. This will not be a credit event, as the transaction will be purely contained within ECB balancesheet.

2) ECB can give a green light to the Central bank of Ireland not to sterilize ELA returns under the promisory notes, effectively rebating the funds back to the Exchequer.

3) ECB can also consent to restructuring of ELA (partial form of (2) above)

So there are a few things ECB can do, but all will de facto open ECB to a major risk of other countries coming to it with similar demands.

Regardless of the outcome, the Taoiseach and Minister Noonan are correct in demanding ECB step forward with solutions to the problems in Ireland that have been created in the first place by ECB policies of the past.

9/2/2012: Few bothers

Today's mid-day CDS spreads (courtesy of CMA):

This should bother few sovereigns:

 and few banks:

And is likely linked to Greek bailout costs falling on: France, Netherlands, and Finland while doing nothing good to over-indebted Belgium and Italy and leading to a slowdown in Norway and Denmark... while taking a bite out of the balancesheets of few big banks. And that comes on top of markets already expecting the fallout from the Greek deal...

9/2/2012: ECB rate decision

So we have ECB keeping rates at 1%... which relates to:

1) growth:

So with growth leading indicator stuck for the 4th month in a contraction territory, 1% repo rate is a bit too high, given we are now into the second leg of recession judging by leading indicators.

2) inflation:

So with inflation still anchored well ahead of 2% bound, that 1% repo rate is a bit too low for the ECB mandate, unless the ECB expects rapid de-acceleration of prices.

And in case you wonder, the pull on policy side comes from divergent growth/inflation dynamics:

And thus we have: ECB latest decision is inconsistent with either inflationary or growth signals. You might say that on average, that makes ECB policy balanced. Or you might want to say that this mismatch reflects monetary union internal inconsistency. Or both... take your pick.

8/2/2012: A more pleasant Sovereign arithmetic

And for a rather more pleasant sovereign arithmetic, here's an interesting table from the Global Macro Monitor (link here) summarizing yoy movements in 5 year CDS:

Frankly speaking, all of this suggest some severe overshooting in CDS and bonds markets on upward yield adjustments over time followed by repricing toward longer term equilibrium. What this doesn't tell us whether we have overshot equilibrium or not... Time will tell.

7/2/2012: An unpleasant risk arithmetic

Here's the guys Irish authorities trust so much on risk assessment, they contracted them to do banks stress tests - PCARs - back in 2010-2011. Note: this is a statement of fact, not an endorsement by me. The Blackrock folks produce quarterly report on sovereign risks and this the summary chart from the latest one - Q1 2012. Negative numbers refer to higher risks:

So Greece leads, Portugal follows, Egypt and Venezuela are in 3rd and 4th place worldwide of the riskiest nations league and then, in the fifth place is Ireland, followed by Italy. And here's the summary of the euro area ratings:

Yes, bond yields have been improving significantly, including due to both fundamentals and banks liquidity steroids, which is a good news. The bad news, yields have been declining for other countries as well and investors' relative sentiment is not improving as much as the absolute levels of yields declines suggest.

Today, one of the Irish Stuffbrokerages claimed in a note that: "The country’s success in meeting its targets under an EU/IMF bailout without social or political unrest and its export-focused economy has enabled it to dodge the recent Eurozone downgrades by S&P and Fitch and distance itself from fellow bailout recipients Greece and Portugal. " Distancing we might be, but the neighborhood we are lumped into is not changing as the result of this distancing. At least not for now.

Please note, the assessments above are consistent with CMA analysis based on CDS spreads, covered here.

6/2/2012: Fiscal Compact Treaty - Sunday Times 05/02/2012

This is an unedited version of my Sunday Times article from February 5, 2012.

In medical analogy terms, this week’s Fiscal Pact signed by the 25 EU Member States, is equivalent to a misdiagnosed patient (the euro area economy) receiving a potent cocktail of misprescribed medicines.

In other words, the Fiscal Pact is neither a necessary, nor a sufficient solution to the ongoing crisis of the euro area insolvency. Moreover, it saddles the euro area with a choice of only two equally unpalatable alternatives. The first choice is compliance with the Pact that will lead to a situation whereby a one-policy-fits-all monetary framework will be coupled with an equally mismatched one-policy-fits-all fiscal framework. The second choice is business as usual, with continued reckless borrowing, internal and external imbalances and ever deepening links between the sovereign finances, the ECB and the banking sector balancesheets. In other words, there is a choice of either pushing Euro area down the deflationary, stagnation-inducing deleveraging spiral, or leaving it in the current modus operandi of reckless borrowing.

Both alternatives are internecine for Ireland, and both increase the probability of an eventual collapse of the euro over the next 5-10 years.

Suppose the EU member states, opt for the first alternative. As a whole, to comply with the Pact parameters, the Euro area economy will have to shrink by some €535-540 billion every year between now and 2020 – an equivalent of reducing euro area growth by a massive 3.9% annually. Just for the purpose of comparison, during the 2009 recession, Euro area experienced a real decline of overall income of 4.25%.

Ireland will be one of the worst impacted economies in the group courtesy of our excessively high structural deficits, debt to GDP ratio and cyclical deficits. In 2012, Ireland is forecast to post a structural deficit in excess of 5.5% of potential GDP – the highest structural deficit in the entire Euro area. To cut our structural deficit to 0.5% will require reducing annual aggregate demand in the economy by some  €7-8 billion in today’s terms. Debt reductions over the period envisioned within the pact will take an additional €12 billion annually. For an economy with huge private sector debt overhang, paying some 12% of its GDP annually to adhere to the Fiscal Pact is a hefty bill on top of the already massive interest bill on public debt.

Ireland’s fiscal performance under the Fiscal pact constraints, 2012

Sources: author estimates based on the combination of data from the Department of Finance, Budget 2012, IMF World Economic Outlook database, and author own forecasts

Crucially, the idea of the Fiscal Pact as a tool for resolving the structural crisis faced by the Euro area is equivalent to doing more of the same and expecting a different outcome.

The crisis arose because the Euro area combined vastly heterogeneous and complex economies under a one-policy-fits-all monetary umbrella. This has meant that no matter what policy the ECB pursued, interest rates and money supply will never be in synch with all economies within the Euro. The modern economic theory suggests that fiscal transfers can act as automatic stabilizers, correcting for monetary policy disequilibrium.

In European case, this theory is a pipe dream. Firstly, fiscal transfers cannot happen with the same timing as monetary policy changes, especially given the bureaucratic nature of the EU and its institutions’ detachment from the member states’ realities. Take one example – Ireland and other euro areas have been experiencing severe unemployment problems since 2009. Yet, only this week did the EU wake up to the problem and thus far, there are no tangible plans for dealing with it. Automatic stabilizer of fiscal policy will never be timely and responsive enough to undo damages caused by the unsuitable monetary policy. Secondly, fiscal transfers are an imperfect substitute for private sector adjustments to dislocations that monetary policy generates. No need to go beyond the current crisis to see this with aggressive monetary policy interventions since 2008 yielding not an ounce of real economic impact on the ground. Which means that the theoretical stabilizers are not really that effective in stabilizing the economic disruptions caused by monetary policy misfiring. Lastly, neither the current Pact, nor any other institutional arrangements within the Union provide for any automatic fiscal transfers.

Yet, when it comes to the penalties that apply to member states breaching the Pact conditions the new agreement are automatic and very tangible. This imbalance – with the Pact being all stick and no carrot – risks destabilizing economic systems struggling with shocks.

Take for example a country like Ireland. Suppose ECB policy in the future leads to high interest rates – a scenario consistent with the current monetary policy developments. This would imply that our terms of trade will deteriorate, reducing our exports and driving our economy into an external deficit. Simultaneously, slowdown in the economy will put pressures on our fiscal balance. This deterioration will not be consistent with a cyclical recession, implying that we are likely to simultaneously breach the twin deficits targets under the Fiscal Pact, triggering automatic penalties. Economy brought to its knees by the monetary policy mismatch will be forced to pay additional price through fiscal penalties.

In other words, the Pact is now attempting to create another policy system that will risk further detaching fiscal policies within the Euro area from the monetary policy.

When it comes to dealing with the current crisis, the new Pact contains no tools for achieving structural reforms required to arrive at sustainable public finances. Paying down the debts and cutting back deficits requires simultaneously running surpluses on the Exchequer side and the current account side. In other words, both external and internal surpluses must be achieved simultaneously. As international research shows, the likelihood of any state moving from long-term external imbalances to a sustainable current account surplus is extremely low.

Matters are worse when it comes to both fiscal and external balances. My own research based on the Euro area data shows that during 1990-2008, only two euro countries – Finland and Malta – have complied with the Fiscal pact criteria more than 50% of the time. The rest of the member states, including Germany and France, have run sustained deficits more than 60% of the time. Once a euro state found itself stuck in twin current and fiscal deficits in one decade (the 1990s), transitioning to a twin current account and fiscal surplus in the next decade (the 2000s) was virtually impossible. For example of all states in EA17 who were in current account deficit throughout the 1990s, only 2 have managed to achieve current account surpluses during the following decade. Only one country that experienced fiscal deficits in the 1990s has managed to generate fiscal surpluses over the following decade. No country has been successful in restoring fiscal and external balances after a decade of twin deficits.

The Fiscal Pact implies even less flexibility in adopting structural reforms necessary to achieve an already highly unlikely economic transition to the long-term sustainability path for many euro area states, including Ireland.

Consider for example two economies currently in a crisis – Ireland and Portugal. Portugal requires severe and substantial cuts in all public spending and then deep reforms in the private sectors of its economy. The country does not need a debt restructuring, but it needs huge capital injections to put it onto the path of capital investment convergence with the euro area average.

In contrast, Ireland needs restructuring of the private sector debts, deep reforms on the current expenditure side of the Irish exchequer, and more gradual reforms in the private sectors. Ireland has a functional exports generating economy, it has achieved current account surpluses on external side and balance on its Government spending side in the past. During the adjustment, Ireland needs structural reductions in the current spending best timed to start concurrently with the pick up in private sector jobs creation to offset adverse effects of these reforms on the most vulnerable – the unemployed. Ireland also needs to boost its after tax returns to human capital in the medium term – something that Portugal has no need for at this point in time.

There is nothing within the Pact that would facilitate either Portuguese or Irish economic stabilization and recovery. Neither will the Pact improve the chances of Spain, Belgium and Italy ever reaching real growth paths that imply sustainability of fiscal and external balances. In short, the Pact our Government so eagerly subscribed to is at the very best a continuation of the status quo. At its worst, Ireland and other member states of the Euro are now participants to a fiscal suicide pact, having previously signed up to a monetary straightjacket as well.

Box-out:

Last two weeks marked two significant milestones on Ireland’s economic performance front. Despite the adverse newsflow on the real economy side, Irish bond yields for 5 year bonds have dipped below 6% mark last week for the first time since the beginning of the crisis. This week, spreads on the 5 year Credit Default Swaps (the cost of insuring Irish bonds) also fell below 6% mark. For the first time since the crisis began our implied cumulative probability of default (CPD) – the probability that the Irish Government will default on its debt at some point over the next 5 years has touched 40%, down from over 46% at the end of 2011. Although the CPD is a mechanical function of CDS yields and not a statistical estimate of the true risk of the Government default, the CPD is an important metric for the markets. The significant decline in our CDS spreads this week, was prompted by the Irish banks buying into longer maturity bonds in the recent NTMA-led bond swap, plus the overall improving sentiment for sovereign debt in the euro area markets. The later itself was driven by the artificial forces, such as the ECB extending €497 billion to the banks in 3 year money. Nonetheless, our bond yields and CDS spreads declines are starting to show some improvement in overall markets risk-pricing for the Irish Government debt – a much needed stabilization and a moment of respite from the relentless crisis dynamics of the recent past.

6/2/2012: An interesting (non-scientific) poll

Here's an interesting set of results - note, sample size is small for the duration of this survey to draw any serious conclusions, so don't... but from the top of the results provided, and given this is the official site of the President of the European Parliament, with all the selection biases possible in terms of audience it attracts, the results would be unsettling:

The site for the poll is: http://www.martin-schulz.info/index.php?link=6&bereich=1#

5/2/2012: Irish Consumer Confidence - a bounce in January?

I have noticed that ESRI and KBC Bank are very enthusiastic about the latest reading for their consumer confidence barometer reading for January 2012. Absent the retail sales data for January, we can only speculate as to what the latest increase means. But here's a somewhat scientific method for doing this.

Chart below shows dynamics in Consumer Confidence index and historical and forecast values for two core retail sales indices. The forecasts are based on trend dynamics for each index from January 2008, accounting for the correlation between Consumer Confidence and specific retail sales index and accounting for the latest reading for Consumer Confidence index.

The chart above shows my own Retail Sector Activity Index with the forecast for January 2012 based on the above estimates shown in the first chart.

Here's what is clear from the above exercise. Assuming the Consumer Confidence index reading for January is to be trusted (see below on that), we can expect:

• Index of retail sales value to rise 7.4% qoq and 6.3% mom to the level of 101.8 or 4.1% ahead of where the index reading was 12 months ago. This would put the value index at the levels not seen since July 2009.
• Volume index of retail sales can be expected to rise 5.4% qoq and 3.4% mom. The index reading would reach 104.3 which is 2.6% ahead of where it was 12 months ago and the level not seen since April 2010.
• Of course, Consumer Confidence index now stands at 56.6 up on 49.2 in December 2011.
• My Retail Sector Activity Index, consistent with the current reading in the Consumer Confidence index would be around 110.5 - the level that is 1.6% ahead of where it was 3 months ago, 7.4% ahead of the previous month reading and 6.4% ahead of where the index stood 12 months ago. This reading - were it to materialise - will bring my index to the levels unseen since July 2010.

All of this, of course, is rather academic. The problem with the ESRI Consumer Confidence is that it has only weak relationship with both the Value Index of Retail Sales and the Volume Index of Retail Sales, as the charts below illustrates. Please note: this does not mean in any way that Consumer Confidence Index contains little relevant information, just that it is, in itself, a very weak predictor of the retail sales activity.

I wouldn't be holding my breath waiting for a big Retail Sales bounce in January-February this year.

5/2/2012: Irish Labour Productivity - some latest trends

Chart of the Week, folks, comes courtesy of the ECB database on labour productivity. It contains the full set of productivity indices for Ireland by sector, reported on the basis of productivity per person employed. And it speaks volumes of the myths we hear in the media.

So the Chart of the Week is:

Now, what does it tell us? (And please, no protests - I am decomposing the above chart into some interesting trends using as illustrations more charts).

• Irish productivity - overall, across all sectors - has been rising during the crisis 
• Although as I pointed out so many times, much of this rise in Ireland's overall productivity is due to jobs destruction in retail, construction and other sectors, not to some intrinsic rises in real productivity. Jobs destruction concentrated in less productive sector helps overall total productivity. Despite the fact that it causes massive unemployment and other problems. See chart below for evidence on this.

• Another interesting feature of the data is the rapid, continuous decline in productivity in the broadly-defined public sector, arrested around Q3 2010 and now running basically flat. But historically, public sector productivity has contributed negatively to overall productivity performance of the economy.

• Overall, so far, our labour productivity is 5.2% ahead of the EA17 and 4.7% ahead of EU27 in Q3 2011. Year on year, EA 17 labour productivity is up 1.04%, EU27 is up 1.34% and Irish total labour productivity is up 2.28%. This is a strong performance for Ireland, compared to EU and EA averages. As already mentioned above, Construction sector productivity declined in Q3 2011 some 15.2% yoy and productivity in Information & Communication sector fell 8.15% yoy. Productivity grew in Financial and Insurance Activities sector by 3.11%, in Agriculture and associated sub-sectors by a very impressive 24.8% (although this is largely due to higher commodities prices and exchange rates effects, as well as continued robust inflows of CAP money into Ireland). In Public Administration and the rest of the public sector sub-sectors, productivity grew 2.6% year on year in Q3 2011.

And to summarize the emerging new (crisis-period post Q1 2008) trends, here is a chart plotting correlations between productivity index performance for Ireland overall, against EU27, EA17 and specific sectors of the economy: