Economics 13/06/2010: Mapping Dublin's weight in economy

Here is an interesting set of data for some of the world's leading cities in terms of their contributions to country GDP and their share of total population. Sizes of the bubbles reflect the ratio of contribution to GDP to share of population. Greater Dublin is taken as per CSO: Dublin plus Mid-East region.
To me, this really does put into perspective the necessity for continued investment in the Greater Dublin region and the futility of our serial National Spatial Development Strategies.

We hear so much about the massive urbanization in the emerging economies, especially in the East. This process, in fact, is very much a reality. But what we do not hear about is urbanization of our own economic activity. The fact that Dublin stands out amongst the most urbanized zones, relative to the rest of the country, in the world is telling me that Ireland should focus more attention on developing the Greater Dublin region to reflect the reality of demand of the firms' and workers' for its location.

Updated: see the same chart with Dublin only:
Note: per CSO "The Mid East region (Kildare, Meath and Wicklow) and the Dublin region are affected by a substantial proportion of their workforce living in one region and commuting to work in another." That's as much of a 'definition' as we get to reflect the most likely fact that vast majority of commuters are to Dublin...

And here are the inputs that went into the above charts:
And the source for Dublin figures: National Accounts, regional incomes:
Notice that Dublin City's overall relative weight in the economy (ratio of share of GVA to share of population) rises relative to Greater Dublin, as expected, in line with the evident 'bedroom communities' nature of Mid-East region. Just look at the CSO figure for Mid-East share of GVA.

Economics 11/06/2010: What's going up might be also going down

Irish retail sales have surprised on the positive side, posting a 0.3% increase yoy for sales ex-motors in April 2010. Sounds impressive, especially considering this was the first yoy increase since March 2008, or over some 25 months now. But hold on to that thought of a recovery signal. Check out the charts:
Things are still very much up in the air as to whether retail sales are actually on a mend or not. The figures above plot seasonally adjusted series ex-motors. More importantly, sales in the categories that are correlated with overall household investment activities - household equipment (down 3.1% in value mom, and down 1.2% in volume mom), electrical goods (-3.2% in value mom and 2.3% in volume mom) and Furniture & Lighting (down 5% in value and 6.2% in volume) - all signal no growth in the core leading indicator of a recovery - improved domestic investment. Only Hardware, Paint & Glass category related to investment showed increases of 2% and 4.2% in value and volume in mom terms.

Interestingly, Ireland bucked the EU-wide trend in April:

Economics 11/06/2010: Private Sector Credit data

Central Bank data released yesterday show Private Sector (non-financials) credit fell 9.3% in Q1 2010, to €355 bn. Total outstanding mortgages volume fell €1.2 bn to €146.4 bn. Two thirds of the total amount of credit decline came from writedowns on existing loans, which means that there is continued pressure on loans (keep in mind that Nama transfers are not yet in the data). Charts below update, as usual:
Aggregates first
Notice the rise of securitizations - banks shifting stuff off their balance sheets at an aggressive rate.
Chart above shows monthly flows. There is some improvement here, but absent seasonality corrections it is hard to say what exactly is going on. However, it does appear that the latest monthly transactions uptick is not in line with pre-crisis dynamics for Non-Financial Corps, but in line for Households:Year on year changes:
Clearly, yoy things remain bleak, although the rate of contraction is getting reversed for households. This is a seasonally consistent result, so I would not be reading too deeply into it.

Economics 10/06/2010: CPI & Industrial Production

Host of stats released today point to continued recessionary dynamics in the Irish economy and no turnaround in sight.

First, on consumer prices side. While the usual cheerleaders' squad of 'in-house' economists are singing the swan song of 'deflation is almost over', take a closer look at the composition of CPI changes and you can see that contrary to their claims, prices in categories that represent leading indicators for an uptick are still falling, month on month.

Per CSO: the most significant monthly price changes were

• increases in Housing, Water, Electricity, Gas & Other Fuels (+2.9%), Transport (+0.8%) and Food & Non-Alcoholic Beverages (+0.4%); and
  
• decreases in Clothing & Footwear (-1.1%) and Furnishings, Household Equipment&Routine Household Maintenance (-0.2%).

Detailed sub-indices show that:

• Education rose 9.1% in 12 months to the end of May, 2010
• Housing, Water, Electricity, Gas & Other Fuels was up 3.7%
• Transport was up 4.9%

So the return of inflation in Ireland - a turnaround sign for some - is driven by such hugely value-additive activities as:

1. Hikes in mortgages rates by the banks rebuilding margins (mortgage interest was up 6.1%);
   
2. Liquid fuels price hikes (+8.5% mom) due to our great Government idea of imposing a new tax on fuel which came in effect in May;
3. Higher cost of natural gas, courtesy of our regulated state-owned utility that is now offering competition in electricity markets, while jacking up prices in its core activities;
4. Cost of air transport (up 14% amidst collapsing demand)
5. Higher cost of petrol and diesel;
6. In Recreation and Culture group, there was a 4.1% mom increase in the state-controlled cost of cultural admittance;
7. In education, as numbers of students continue to rise, and as unemployed folks are dreaming about retraining, while financially stretched parents are seeking the ways to cut costs of raising children, our wonderfully accommodating state has ratcheted prices up by 9.1% yoy.

Oh yes, that does really suggest that "demand is improving" and "the economy is turning the corner".

All in, Ireland has now enjoyed an unprecedented 17 months of deflation. In statistical terms, we've hit the bottom and are now returning to positive price inflation territory, slowly but surely, But in economic terms, price increases are driven not by demand, but by the state diktat. desperate to claw as much as possible out of the economy into its own coffers, our state is inventing ever more elaborate schemes to get to our pockets. And with it, the banks too are getting bolder by the day. Instead of a turnaround, all of this smacks of a threat of a renewed pressure on household incomes, and, thus, on the economy.


And, of course, there isn't much of sunshine in the industrial production data released today either. Overall, Irish industrial production was don 11.8% mom in April in terms of production index and up 2.6% in terms of turnover index. Of course, Irish industrial production is the most volatile in the OECD so one must not be tempted to read too deeply into these figures. However, what is clear is that with such dramatic rate of decline, there isn't any signs of an uptick on industrial production side either.

Which, of course, means I am not changing my earlier forecast for GDP growth of -0.3-0.7 in 2010 and GNP growth of -1.0-1.2%. No matter what Ibec or anyone else says...

Economics 07/06/2010: My points from CPA conference

The following is a quick transcript of the main points of my speech at CPA Ireland annual conference last Friday, with some of additional points in brackets.

Friday, June 4, 2010

Ireland is ten quarters into twin crises of credit contraction and house price declines which [can be expected] last for 33 quarters unless radical policy changes are made according to Dr Constantin Gurdgiev. Dr Gurdgiev was speaking at the annual national conference of the Institute of Certified Public Accountants (CPA) in Carton House, Maynooth, today.

Dismissing optimistic reports of an imminent recovery Dr Gurdgiev said: “Since May 2009, we’ve been “turning corners” to a recovery more often than Michael Schumacher on a World Grand Prix circuit.”

According to Dr Gurdgiev, Ireland’s combined Government and economy-wide debt is the worst of any of the other so-called PIIGS (Portugal, Ireland, Italy, Greece and Spain) states and the other three EU member states which he groups with them in terms of economic difficulties – Belgium, Austria and the Netherlands (BAN).

“The structure of our fiscal spending is working against us”, Dr Gurdgiev told the conference. “Fiscally we have excessive structural deficits of 50-60% of the total deficit and, courtesy of the banks we are now accumulating off balance sheet structural deficits. Our deficits are the worst in BAN-PIIGS group.”

Ireland’s asset bubble implosion is also set to continue for some time. “Asset bubble crashes last longer than our policies anticipate”, he said. “The OECD average is 10 quarters of credit busts for 18% average contraction and 19 quarters of house price falls for a 29% average price decline. Ireland’s bubble of a 60% decline in credit supply implies 33 quarters of credit contraction and our 50% house price fall implies 33 quarters of price declines. We are currently roughly 10 quarters into these twin crises.”

Compounding these crises is the fact that Ireland has the least competitive economy in the BANPIIGS group in terms of relative unit labour costs. “We haven’t been competitive since at least the mid-1990s”, Dr Gurdgiev contended. “While the latest data from the Irish Central Bank provides some grounds for optimism on the competitiveness front, regaining our overall competitiveness compared to other small open economies around the world will require more hard choices on public sector reforms and restructuring of our public utilities and semi-state service providers.” [You can see more on these points here]

On the other hand, Ireland does have a healthy exporting sector dominated by multinational companies. “But it is struggling against uncompetitive capital, public services and utilities markets, has no credit support and is suffering from capital flight and assets downgrades. Our exporting sector alone cannot carry this economy out of the hole. We are in for a structural recession; unemployment will remain high and employment will continue to fall.” [Notice, I am stressing the word ‘alone’ – it is naïve to believe that we can move out of the crisis on the back of exports. In the longer run, exporting activities will have to dominate the overall economic structure, but we are very far away from this being a reality. More importantly, our exports are being held back – at the indigenous firms’ level – by uncompetitive domestic economic structures, with some of the most pressured areas relating to semi-state companies operations].

Looking at the international picture he claimed there will be decreased pool of foreign direct investment and portfolio investment for Ireland to compete for and there will also be a decreased appetite among investors globally for an ‘Irish story’; “Firm fundamentals will matter in future. In addition, competition for foreign direct investment and portfolio investment amongst the smaller EU states will heat up and as investment diversification becomes more important the flight of capital from Ireland will be significant.”

[There are several things going on here. First on inward FDI – it is clear that Ireland will have to be re-packaged for the future efforts by IDA and EI and in general as a location for inward FDI.

Tax advantage on the corporate side will have to be matched by tax advantages on labour side, especially on skills and entrepreneurship, creativity and knowledge. This means that just as we did with the corporate tax rates, we will have to move to lower tax on premium that skills and other forms of human capital earn in the market place. And this means the need for dramatically re-thinking the system of taxation of labour and the system of taxation in general.

In addition, Ireland will need to get more serious about importing not just raw corporate FDI, but also much higher risk and less anchored entrepreneurial investment. We need to actively pursue young, aggressive, promising start ups and even potential start ups. This too requires re-balancing tax rates, amongst other things, away from taxing labour returns and in favour of taxing immobile and less productive forms of capital. Land is clearly a good target for shifting tax burden.

Ireland will have to re-market itself. We need to put to rest the tourist brochure approach to presenting ourselves and start putting in place real and meaningful changes to our immigration regime, naturalization regime, visa agreements with the neighboring countries. We also need to start thinking about the problems of services provided by the public sector, our cities, to citizens and residents. These services will have to be world class, competitive, easily responsive to demand changes, efficient, individualisable and, frankly speaking, dramatically different from the ‘cattle-em-onto-a-bus’ type of service we supply currently. If Ireland were to become competitive as a location for younger, dynamic, globally mobile highly skilled workers and entrepreneurs of the future (home-grown and foreign alike), the idea of having people on trolleys in dirty hospital halls will have to be buried, fast. The idea of expecting public transport passengers stand in freezing rain for hours waiting for a bus that operates to the bus driver-own schedule has to be binned asap.]

Dr Gurdgiev told the CPA Annual Conference that he did see some opportunities for Ireland’s exporters in the near term, however, particularly among those countries experiencing a relatively high speed recovery - primarily in rapidly developing emerging markets in parts of Asia and to a lesser extent Latin America.

“There is a substantial continued demand for investment in major public infrastructure in these countries [as well as in areas of domestic private demand]”, he said. “These regions are likely candidates for products and services from Ireland, but Irish firms need a differentiator in entering these markets. They have to attract and deploy top talent and deliver meaningful gains to local and foreign clients investing in these regions, while offering the legal and counterparty security of being domiciled in Ireland. The most likely pathway to these markets is by partnering in broader joint ventures with local providers in the countries themselves.” [This too requires a categorical change in indigenous enterprises. The Celtic Tiger ways of hiring ‘bright young foreigners’ for lower grade positions and retaining often unskilled, inexperienced senior staff with legacy tenure will have to go. The glass ceiling for younger and more ambitious and career driven, skilled foreign and domestic younger people will have to be broken.]

Growing knowledge economy in Ireland is the long term solution to Ireland’s economic problems, Dr Gurdgiev argued. “We have no choice but to develop our higher value added, traded services sectors. This is the real ‘knowledge’ economy.

[And I have gone to pains to explain that the ‘knowledge economy’ the policymakers have been talking about is just a small subset of the real knowledge economy. What differentiates my view of the knowledge economy from that of official policy-driven one is that to me knowledge economy reaches across various sectors of services that are largely neglected by our politicians and civil servants. Advertising and new media, e-games, health services, legal services, financial services, design and technology/creativity integration – these are some of the examples of real traded and high value added services that we should be developing here.]

But our prospects are not guaranteed here. The knowledge economy is human capital intensive and our taxation system creates no incentives to invest in human capital. We need to become more human capital focused.

“This requires a maximum flat rate income tax of 20%; a shift of the tax base to property; closing the welfare trap; and reducing the fiscal burden”. [I specifically pointed to the fact that we have a good policy on the books – the Land Value Tax – but that virtually no work is being done today to get this tax implemented in the next Budget. I also clearly stated that this should be a revenue-neutral shift in tax burden, not a new tax grab by the Exchequer. For links to background papers on SVT/LVT see here. On flat tax - back in 2006 I wrote a series of 3 articles in Business & Finance magazine on the issue of Ireland adopting flat income tax. I should dig them up and post them on my long run site...]

“We used to have a more productive and balanced economy”, Dr Gurdgiev concluded. “We’ve lost it to hype and construction, property, credit and fiscal bubbles. We need a productive knowledge based services economy next.”

Economics 07/06/2010: Moving to the next stage in Euro crisis

Last Friday, speaking at the CPA annual conference (will be posting the highlights of the speech here later) I referred to a new 'beast' of the sickly-prickly Eurostates: the BAN-PIIGS. The new bit - 'BAN' - referred to Belgium, Austria and the Netherlands.

Fast forward two days, getting off the trans-Atlantic flight in hot and humid New York guess what hits my news feed? Belgium and France taking in water on the back of Hungary's woes (see earlier post here) and Ukraine is putting some new pressures on Euro area banks. French and Belgian CDS are moving up, while Austria is also back in the spotlight.

Brian Lenihan's announcement that Irish banks will be rolling over €74.2bn of guaranteed loans, bonds, and other systemic support papers before October 1 guarantee is scheduled to run out is not helping the markets either. As Morgan Kelly, Karl Whelan and couple other analysts estimated - once again well ahead of our gallant DofF 'forecasters' - everyone dependent on the Irish government guarantees will be pushing their re-scheduling/roll-overs before October hits.

Surprised? You see - we used to have one main crisis back in 2008-2009: insolvency of banks balancesheets. It should have been resolved directly through recapitalization of the banks via equity take overs by the taxpayers and restructuring of the banks debts. Foolishly, we chose a different path:

• We facilitated banks rolling over debt - as if changing maturity date on the bonds that cannot be serviced changes the level of debt impacting the banks;
• We then proceeded to allow banks to name their capital requirements by allowing them to spread their losses over longer time horizon, as if changing the date of repayments start on a defaulting loan can make the loan perform;
• Following this, we pumped the banks with steroids of ECB facilitated lending - as if swapping few private bonds for ECB loans resolves the problem of balance sheet overhang;
• We created Nama to take bad loans off the banks balancesheets, but, realising the futility of the undertaking, went on to impose unrealistically low haircuts that simply sped up some of the very process of losses recognition in the second bullet point above. Given the levels of real impairments on the loans, Nama only bought banks more time to spread their losses, thus avoiding recognizing the problem of weak balance sheets and amplifying the problem of insolvency;
• Amidst all of this, banks became liquidity traps - sucking up vast amounts of funding. This was not fully satisfied by the ECB, so the banks engaged in predatory re-pricing of performing loans (mortgages etc) in a futile effort to get some more cash flowing;
• The insolvency crisis blew up into a liquidity crisis.
  

So now we have both. And no real way of resolving either or both.

We could have sustained this game, teetering on the brink between full insolvency and a credit crunch, if and only if the euro bonds markets were at the very least stable and the ECB was capable of parking collateral garbage it collected in exchange for banks loans for a long time. Alas, two things are currently under way.

First, the French bonds have slid off their 'safe heaven' pedestal over the last couple of weeks, with spreads over the German bund going up eight-fold since the end of 2009. French bonds are now posing massive liquidity risk to institutionals holding them. French Prime Minister declared last week that: “I only see good news in parity between euro and dollar”. In effect, the French are now openly inviting massive devaluation of the euro - something that is bound to disappoint Germany.

Second, there is no room for more Quantitative Easing, as the ECB has been exposed as an institution that has run out of reserves cover for its own operations. Last week, ECB balancesheet had more than 150% ratio of immediate liabilities to assets held. And that was only for liabilities vis-a-vis Greek rescue package.

Something will have to give, folks. Just as Ireland has precipitated its own implosion by pushing the liquidity crisis on top of our already formidable insolvency crisis, so the ECB and the entire euro zone is now working hard to achieve the same. We are now well behind that point of no return in monetary policy where promises to act with support for the sovereign bonds will be sufficient to stave off a run on the bond yields. Instead, the ECB's rhetoric will be tested, leaving it only one option - start running printing presses.

Now, those of you who followed my writings on the issue will say 'Good, we need a massive - €3-5 trillion - issuance of cash, don't we?' The problem is that while the answer is 'yes, we do', this emission cannot simply involve purchasing of more Government bonds. We need a direct, un-levered injection of new money into the system and it must be broadly based - going not just to the public coffers, but to private economies of the Euro area as well. ECB printing cash to buy Government debt will not reduce the debt levels for the Eurozone sovereigns (which means insolvency problem will remain and will actually increase), nor will it resolve the problem of liquidity crunch in the block (giving money to the Governments to finance roll over of existent debt is about as liquidity-enhancing as burning this cash in a fireplace).

The end game, in my view, can be only across three major disruptions in the euro assets:

• Collapse of the euro below parity of the US dollar; followed by
• Debt restructuring through offers to the bondholders to take a haircut (possible ranges: 35-50% for Greece and Portugal, 25-30% for Spain, 20% for Ireland and Italy, 15-20% for Austria, Belgium... and so on). These will be attempted first privately - via larger institutional consortia, with both sticks (threat of default) and carrots (some sort of delayed tax incentives?) being deployed to get larger institutional holders to accepts a drastic shave off; and once this is underway, the inevitable conclusion to the crisis will be:
• Imposing haircuts on banks bondholders, with the ECB standing by to hose the banks with cash, should liquidity dry up during the haircut imposition.
  

Finale: euro's credibility gone, euro/usd rate below parity persists, inflation will be running ahead of economic recovery and Europe will slide into a Japan-styled long-term depression.

In the mean time, before the end game, expect more bans on trading in various instruments (the French have finally agreed to the German-style ban on naked shorts) and more fiery rhetoric about speculators, destabilizing market forces and other gibberish from the dear leaders of Europe.


PS: All of this reminds me of a conversation I had with one very senior stocks analyst/strategist back in the middle of 2008 meltdown in the markets. I was concerned that the ways in which fiscal and monetary authorities were throwing cash at the banks were going to lead to both running out of policy space to continue accelerated supports for the sector and economy at large. "Charged by the bear, make sure you don't run out of all bullets early on. You might miss," I insisted. In response I was given a complete assurance that resolute actions on large scale (equivalent to unloading the entire magazine of ammunition at the shadow of the problem before actually having an idea as to what the problem really is) will mean that the 'Bear won't be charging for long'. I wish I was wrong... He still writes daily, weekly and monthly missives about the investment strategy for clients.