30/07/2011: High level data on Retail Sales & Consumer Confidence

Let's update the latest stats on retail sales in Ireland and consumer confidence - a separate, more detailed post will look on the specifics of the retail sales data.

The volume of retail sales rose 0.2% in June 2011 yoy and +1.1% mom. However, all of the increases were accounted for by motor sales.

The value of retail sales rose +0.4% in June 2011 yoy and +0.7% mom. Again, all effects are due to motor sales increases.

Provisional estimates for Q2 2011 show the volume of retail sales fell by 1.7% yoy and rose 1.8% qoq. Once again, the figures were dramatically improved by motor sales.

Consumer confidence, measured by the ESRI index have posted a dramatic drop in June from 59.4 in May to 56.3. Index is now 5.38% down qoq, 5.219% down mom and 17.084% down yoy.

So while overall retail sales indices signal some slight improvements in conditions, consumer confidence indicator shows that in months ahead there is likely to be renewed pressure on retail sales. In fact, of course, there is no divergence between the two sets of indicators, as retail sales continue to fall when taken on ex-motors basis.

Longer-term averages also suggest further softening in the retails sales
Three months moving averages are now:

• Index of Value of retail sales up 0.49% qoq, 0.189% up mom and 1.743% down yoy
• Index of Volume of retail sales up 1.276% qoq, 0.253% up mom and 2.218% down yoy
• Consumer confidence is up 23.291% qoq, 5.426% up mom and 8.299% down yoy.
  

30/07/2011: Some uncomfortable US debt arithmetic

In the light of the Senate vote yesterday, it is worth examining the extent of changes in the US debt and interest costs within the context of the Republican's-agreed plan (debt ceiling increase of $2,500-3,000 billion in exchange for 10-year deficit reductions of €917 billion).

There are a number of assumptions that we must make about the proposals, since it appears at this time that no clear picture is emerging as to what the specific details of spending and cuts might be.

Let us assume the following scenarios:

Scenario 1: Debt ceiling is increased by $2,500 billion to $16,800 billion
Scenario 2: Debt ceiling is increased by $3,000 billion to $17,300 billion

Assume that over the next 10 years there are no further increases in the debt ceiling.

Now, let us make some assumptions about the post-deal yields:

• Scenario A: assume that the current yields on US Treasuries - ca 3% - prevail over the next 10 years (this is extremely optimistic, since (1) it is likely that debt ceiling increase can lead to AAA downgrade one-two notches, (2) it is highly likely that US Fed is going to raise interest rates at least in some point in time between now and 2020. In this case, 10-year compounded interest charges on just the increase in the debt ceiling will be 34.39%.
  
• Scenario B: assume that average US Treasury yield rises to 3.5% post-deal. In this case, 10-year compounded interest charges on just the increase in the debt ceiling will be 41.06%.
• Scenario C: assume that average US Treasury yield rises to 4.0% post-deal. In this case, 10-year compounded interest charges on just the increase in the debt ceiling will be 48.02%.

Next, it is crucial to identify just how the 'savings' will be delivered and to what amounts cumulative to 2020. Let us make some assumptions on that:

• Republican plan of achieving savings of $917 billion by 2020, distributed:

1. Uniformly over 10 years in $91.7 billion increments
2. Front-loaded as follows: 175% of 91.7 billion in years 1 and 2, each, followed by 125% of that in years 3 and 4 each, followed by 100% in years 5 and 6 each and 50% in years 7-10 each, implying that through year 2 annual savings will be $91.7 billion plus $183.4 billion. By year 4 the savings will be running at $366.8 billion, by year 6 - at $550.5 billion and so on.
   

• Alternative plan (more like Democrats' plan) of achieving 1/2 of the Republican plan savings of ca $460 billion over 10 years, distributed:

1. Uniformly over 10 years in $46.0 billion increments
2. Front-loaded as follows: 175% of $46 billion in years 1 and 2, each, followed by 125% of that in years 3 and 4 each, followed by 100% in years 5 and 6 each and 50% in years 7-10 each, implying that through year 2 annual savings will be $161 billion. By year 4 the savings will be running at $276 billion, by year 6 - at $322 billion and so on.

Table below summarizes net savings (reductions - where positive) on the debt levels as the result of the proposed deal. These do not account for interest charges on the existent pre-debt deal debt level of $14,300 billion, nor for the costs of old debt financing that might rise in the wake of the debt ceiling hike.
In bold in the table above, I outline the more likely scenarios. Now, to arrive at the total debt ceiling hike impact we need to subtract from the above values the expected increase in the cost of Federal debt financing on the current $14,300 billion worth of debt. These are approximately $715 billion in the case of Scenario B and $1,430 billion in the case of Scenario C.

Thus, overall, in the most likely scenarios,

• The Republicans-proposed plan will achieve a reduction in the overall 2020 debt levels of just $802-1,994 billion in the most benign scenario or a reduction of $365 billion to an increase in debt of $827 billion in the more adverse case
• The Alternative plan will achieve increases in total debt burden for the US of between $573 and $1,171 billion in the more benign case and increases in total debt of $2,273 billion to $3,341 billion in the more adverse case.

In summary - neither potential outcome represents a significant departure for the US from the current massive debt levels. To achieve meaningful savings on the current debt, the US will require severe front loading of Republicans-proposed cuts and convincing the markets that its AAA rating must remain intact. However, even in this case, more likely effect will be to reduce debt levels by some €1,990 billion, or just 14%...

29/07/2011: Euro area leading economic indicators - July 2011

The new Euro area leading growth indicator - eurocoin - published by CEPR and Banca d'Italia is out for July, showing signficant slowdown in economic activity in the Euro area ahead. Headline numbers are:

• Euro-coin fell in July for the second month in a row, declining from 0.62 in May to 0.52 in June and to 0.45 in July.
  
• 3 months average through June was 0.58 and 6 months average through June was 0.56. In July these declined to 0.53 and 0.555 respectively.
• Year on year June 2011 reading was 13.04 higher. July 2011 reading was 12.5% above that for July 2010.
• With historical standard deviation for eurocoin at 0.4594 > current July 2011 reading, this month reading is statistically insignificantly different from zero. The same is confirmed by looking at the crisis period standard deviation from January 2008 through current reading, which stands at 0.6288.

• The latest eurocoin implies Euro area growth rate of 1.81% pa, down from 2.24% pa growth predicted by the 6mo moving average.
• Core drivers of slowdown are: falling business confidence, stock market performance and widening spreads between long and short-term interest rates (cost of capital rising).
  

Updating figures for ECB rate policy determinants:

The above still support my view that equilibrium repo rate consistent with ECB's medium term inflation target is around 3.0-3.25%, well ahead of the current rate.

Latest industrial production (through May 2011) shows downward turn in growth in Germany, France and Spain, with Spain posting contraction in output, while France virtually reaching zero growth point. Italy is the only country of the Euro area Big 4 still showing accelerating growth in industrial production. Hence, overall for the Euro area, industrial output was nearly at zero growth line in May 2011, having posted 4 consecutive months of declining growth.

PMI composite for Euro area business confidence is now for the second month in a row firmly in the contraction zone. Consumer confidence is now at zero expansion in July, having declined over the last 2 months, with Italy, Spain and France all showing persistent declines in consumer confidence.
Chart source (here).

Lastly, exports show falling rates of growth over a number of consecutive months through May 2011 in France, Italy and Spain.

26/07/2011: Greek deal will increase Greek debt

Eurointelligence.com today reports that (emphasis is mine):

"Hugo Dixon, at Reuters Breakingviews, did the math on the Greek package, and concludes that the calculation by the European Council and the IIF regarding the projected rate of debt reduction is wrong. He said that Nicolas Sarkozy’s calculation of a 24 percentage point fall in the Greek debt-to-GDP ratio ignores the effect of credit enhancement, which is going to be massive.

Once you include the efforts Greece has to make to secure the rollover deal, the debt-to-GDP ratio rise by 14% to 179% of GDP.

As part of the deal with the IIF, Greece will need to secure some of the rolled over bonds with zero coupon bonds. The four options have different implications for the extent of the credit enhancement. But on the IIF’s own assumptions, the costs of the exercise would be €42bn for Greece to finance credit enhancements for the €135bn of bonds in the IIF’s scheme."

You can read the entire proposal by IIF here. And, by the way - I run through their proposal figures. The massive savings for Greece stated in this are referencing the future payouts that are being saved assuming Greece were to pay full set of coupon payments and principal on its bonds over their history. This is slightly misleading, as the markets have been pricing significant (40%+) discounts on much of Greek bonds for over 1 year now.

Aside from that, the IIF calculations assume 9% discount rate through 2030. This is a strange assumption, given that the deal replaces / writes down bonds with an average coupon yield of ca 4.5% and Greece can borrow from EFSF/EFSM at ca 5% effective rate.

Adjusting for these, my 'back of the envelope' calculations suggest that the actual value of the Greek programme is closer to €26-32 billion instead of €37 billion when it comes to net private sector contribution.

In addition, rollovers to longer maturity, in my opinion, are reducing peak debt levels, but extend payments burden over time, implying that adverse impact of debt on growth and economic performance in Greece are simply extended into the future. In other words, extended maturities do not do much to improve Greek situation. They can be effective if the Greek debt spike were a 'one-off' event. But since debt overhang in Greece is structural (see chart below - showing Greek debt becoming a structural problem around 1993) and underpinned by long term (endemic since at least 1987) current account deficits, extending maturity of debt simply increases life-time cycle of debt overhang.

In summary, there is no substitute to a full default by Greece. The latest 'deal' simply, potentially, pushes this default into 2016-2020 period, and that with optimistic forecasts for growth at hand.

Another can meets the EU boot, and... fails to roll far down the proverbial road.

25/07/2011: Comprative analysis of Euro Area and Euro Big 4

There’s a lively debate going on in parts of Europe about the longer-term fall out from last week’s ‘Deal for Greece +”. Most notably – in Germany (see here). In light of this, it is worth looking into some facts about economic performance of the Euro area Big 4 economies: is Germany right about protecting its fiscal conservativism from collectivization of risks envisioned by the ‘Deal’?

Let us plough through some data and IMF forecasts for the following set of countries & country-groups: France, Germany, Italy and Spain (the Big 4) against the Euro area as a whole, plus Advanced Economies and Major Advanced Economies (G7). Please note that the IMF forecasts are not exactly in agreement with my view of where some of these economies are heading, but for the reasons of comparative simplicity and transparency, I will rely on IMF data here.

In the end, what I am after here is some (crude – so be warned) metric of risks – disaggregated across countries and groups.

Starting from the top: chart below shows annual growth rates in GDP expressed in constant prices.

Economies, 2000-2007 growth rates averaged 2.61%, while the crisis years growth fell on average 0.06% annually. The projected growth for post-crisis period 2011-2016 IMF forecasts growth of 2.46%. In all of these periods, Advanced Economies group leads the league table of our sample countries/regions.

Area managed to achieve average annual growth of 2.16% in pre-crisis period, but suffered 0.63% annual average contraction during the crisis. Post-crisis, Euro area economies are expected to grow 1.76% which is the third slowest rate of growth in our sample.

G7 economies grew 2.27% on average annually in pre-crisis period and faced a relatively mild average crisis-period contraction of output of 0.36%. These economies are expected to grow at 2.29% per annum on average in 2011-2016.

France recorded average annual growth of 2.12% in 2000-2007 and subsequently posted relatively mild contraction of 0.32% (annual average) in 2008-2010. The country is expected to grow its economy at an average annual rate of 1.94%.

German economy grew on average at an annual rate of 1.58% during the pre-crisis years – posting second slowest growth in the sample. During the crisis, the economy contracted 0.15% per annum on average (second best performance in the sample), while it is expected to grow at 1.84% average rate in 2011-2016 – not a blistering growth forecast, but above Euro area as a whole.

Italy posted slowest average annual growth in the sample during the pre-crisis period (1.46%), the deepest average annual contraction in the sample during the crisis (-1.75%) and is expected to continue slowest growth performance with 1.32% average annual growth rate in 2011-2016.

Spain recorded the fastest real growth in the sample for the pre-crisis period (3.62% average annual rate), followed by the second magnitude of contraction (-1.0% per annum on average) in the crisis period. Spanish economy is expected to grow at 1.62% on average in 2011-2016 – second slowest in the sample.

In terms of GDP per capita (chart below):

Germany was the first in our sample to reach pre-crisis peak level of GDP per capita between 2009 and 2010, followed by the Advanced Economies and the Euro area. G7 group of countries recovered from the crisis in terms of GDP per capita by the end of 2010, while France’s recovery will take it into 2011. Spain is expected to recover from the declines in GDP per capita around 2011-2012, while Italy will take the longest to reach pre-crisis peak – some time between 2012 and 2013.

In terms of investment as a share of GDP (chart below):

Advanced economies investment averaged 21.05% in the period prior to the crisis, falling to 19.08% during the crisis before recovering somewhat to 20.08% in the period 2011-2016. No data is available for the Euro area and G7 countries.

France invested 20.2% of its GDP on average during 2000-2007 period, recording a marginal decline to 20.11% in the crisis years and is expected to recover to 20.60% of GDP in 2011-2016.

Germany was the weakest country in the sample in terms of investment with investment ratio to GDP of 18.24% in the pre-crisis years, followed by 17.50% during the crisis and by expected 17.81% in the post-crisis period.

Italian economy investment as a share of GDP was 21.01% in pre-2008 period, followed by 20.11% during the crisis. IMF expects Italian investment to rise to 20.54% of GDP in the post-crisis period.

Spain’s investment to GDP ratio was 28.30% in 2000-2007 period, followed by 25.5% in 2008-2010 and 22.98% projected for 2011-2016.

So in terms of investment as a share of GDP, Germany is clearly a laggard here, which is of course explained by two core factors: (1) aging population and (2) already extensive stock of capital.

Unemployment rates are shown in the chart below:

During pre-crisis period, Spain psoted the highest rate of unemployment, averaging 10.54%, followed by Germany (8.93%) and France (same as Germany). Euro area as a whole averaged 8.45% unemployment rate during the pre-crisis period, followed by Italy at 8.11%. This poor performance by European part of out sample is contrasted by the pre-crisis unemployment of 6.11% for the group of Advanced Economies and 6.05% for G7 group.

During the crisis, Spanish unemployment rose to 16.47%, followed by France (9.02%) and Euro area (9.0%). G7 economies posted 7.35% average rate of unemployment while Advanced economies came in at 7.34%. Germany shows the best unemployment rate for the period at 7.22%.

Post-crisis, IMF forecasts for Spain to remain worst performing country in our sample with 16.91% average unemployment rate, followed by Euro area at 9.03% and France at 8.57%. In contrast, Italy’s unemployment is projected to settle at 7.87% average, with Advanced economies coming in at 6.77% and G7 economies at 6.54%.

So what about employment – in other words, jobs creation:

The chart clearly shows that Germany, G7 group and France are the weaker performers in the sample in terms of longer-term trends in jobs creation. Now, see the following chart on population changes. Of course the problem here is that while German population is shrinking (so jobs creation is not exactly high on their agenda, especially with low unemployment), for France (with expanding population) slow jobs creation is a major draw back (hence high unemployment as well).

By 2015, based on IMF projections, German population will shrink by 1.284 million relative to 2000, while Italian population will grow by 4.638 million, French by 5.352 million and Spanish population will expand by 6.304 million.

In terms of fiscal performance, consider the following two charts plotting general government revenue as % of GDP and the general government expenditure as % of GDP:

The following chart shows general government deficits:

Based on three charts above, consider the fiscal adjustments required to deliver on the deficit targets to 2016:

Of all countries in the sample, France represents the steepest required fiscal adjustment in terms of deficit reductions, totaling 4.475% of GDP between 2011 and 2016, followed by the G7 group of countries with 4.063% and Advanced economies at 3.567%. Euro area projected adjustments are 2.519%, while German projected adjustment is 2.326%. The weakest – fiscally – performing countries – Italy and Spain – have the lowest fiscal adjustments planned at 1.439% and 1.679% respectively.

Mapping these adjustments alongside the absolute measure of fiscal performance (Gross Debt) and taking into account the economies growth potential, chart below shows two groups of countries. The first group (no shading) is the group of economies facing the moderate adjustment on deficits side, against stronger targets on debt reductions. This group includes Germany, Italy and Euro area. The second group of countries represents a group facing steeper adjustments on fiscal deficits side and/or significant deterioration in debt positions. This group covers Spain, Advanced economies, G7 and France. It is worth noting that this group of countries faces stronger growth prospects, but Spain and France represent two weaker economies in this group.

Chart below provides an illustration of the debt challenges faced by the sample economies. General Government debt rose 48% in Spain form an average of 47.62% of GDP in 2000-2007 to 70.5% of GDP projected average for 2011-2016. In France, the same increase was 43.6% from 61.83% of GDP pre-crisis to 88.76% average in post-crisis period. At the same time in Germany, gross government debt to GDP ratio rose from 63.64% of GDP pre-crisis to 76.48% of GDP in post-crisis period – the second slowest rate of increase in the sample after Italy.

Overall, for the period of 2011-2016, average gross government debt levels are expected to range from 121.93% of GDP for the G7 economies, to 119.32% of GDP for Italy, 105.33% of GDP for Advanced economies, 88.76% of GDP in France, 87.55% of GDP for the Euro area, 76.48% of GDP in Germany and 70.49% of GDP in Spain.

Lastly, let’s take a look at the current account positions.

As chart above shows, cumulative 2011-2016 expected current account positions as the share of GDP are: Germany +25.9% of GDP, Euro area +0.67% of GDP, Advanced Economies -1.92% of GDP, G7 economies -7.13% of GDP, France -14.6% of GDP, Italy -17.4% and Spain -24.5% of GDP.


Now, let us pool the information contained in the above data to derive the overall riskiness of each economy/group in the sample. To do this, I assign to each country/group a score out of 1-14 based on their performance relative to the top performing economy. So top performer in each category of score below gets 14, the with the next performer getting 12 or less, with distribution of scores within each category/heading following the underlying data. The higher raw scores reflect stronger economic performance and / or lower risk. So the final risk scores are based on inverting the raw scores. Summing these up across categories/criteria produces the total risk score reported in the penultimate column of the table. These are ranked in the last column with 1=highest risk country.


The results are consistent with statistical distribution and are robust to several checks, namely:
1) Removal of the GDP per capita recovery statistics
2) Removal of the Employment index
3) Removal of the Government Expenditure metric

The core results are:

1. Germany clearly represents the most sustainable country in the sample of all Big 4. In fact, its fiscal and macroeconomic position would be significantly undermined if it were to move to Euro area harmonized position
2. Spain and Italy are the two weakest economies in the sample with very high risk rating
3. France is statistically closer to Spain and Italy than to Euro area harmonized economy and is clearly the least sustainable economy in the sample after Spain and Italy.
   

23/07/2011: Internet Age and Social Capital

We have heard on many occasions various arguments that Internet and the culture of new media and exchanges it has created are responsible for dumbing-down of society, reduced imagination, increased propensity to violence, contracting attention spans and a host of other evils.

My personal view on this – not scientifically proven, mind you – is that Internet is yet another medium for developing, visualizing and delivering information. I do not see it as intrinsically transformative of the way we interact with the world around us, but as a tool for amplifying the speed of our interactions. Hence, any dumbing-down – if it takes place at all – is, to me, not the outcome of the Internet Age, but of something in our human nature, in our ways of relating to the world.

At last, there is some evidence appearing – academic, not market research-led (again, not that there is any intrinsic reason to mistrust the latter or to trust the former) – that Internet might not be all that bad for us as ‘Social Beings’.

A recent study "Surfing Alone? The Internet and Social Capital: Evidence from an Unforeseeable Technological Mistake" by Stefan Bauernschuster, Oliver Falck and Ludger Woessmann, published by CESIfo (Working Paper 3469, May 2011) uses some wide-cover German data to attempt to answer whether the Internet undermines social capital or facilitates inter-personal and civic engagement in the real world.

The study “exploits a quasi-experiment in East Germany created by a mistaken technology choice of the state-owned telecommunication provider in the 1990s that still hinders broadband Internet access for many households.” In other words, the study uses East German data as control group for reduced exposure to Internet to see if such limitation yielded profound difference in social interactions compared against the groups with full access to broadband Internet.

The study finds “no evidence that the Internet reduces social capital. For some measures including children’s social activities, [the study] even find[s] significant positive effects.”

Per authors’ conclusions, “in virtually all specifications and for virtually all social capital indicators, both the value-added models and the instrumental-variable (IV) models yield positive point estimates on having broadband Internet access at home. …results indicate significant positive effects of broadband Internet access on the frequency of visiting theaters, the opera, and exhibitions and, …on the frequency of meeting friends. Exploring a relatively small sample of children aged 7 to 16 living in the sampled households, we further find evidence that having a broadband Internet subscription at home increases the number of children’s out-of-school social activities, such as doing sports or ballet, taking music or painting lessons, or joining a youth club. Broadband Internet access also does not crowd out children’s extra-curricular school activities, which include such areas as sports, music, arts, and drama.”

Crucially, “several tests of validity and robustness support a causal interpretation of our results”.