Economics 25/08/2009: Mad Maths at Nama

This might come as no surprise to those of you who have been in Ireland over the last few days, but it still btohers me - a week later. Nama is hiring specialist(s) in derivatives management and pricing to take on complex engineered products that the Banks have on their books.

Now, I know we have serious excellence in the ranks of our public sector and we have promissed ourselves to build on it even further. After all, DofF does excellent job in forecasting receipts and expenditure outlays - year after year, even when the trend is so strong, just adding GNP growth factor to last year's returns and then double that to last year's expenditure would do a better job than the entire DofF 'forecasting' team. And our CBFSAI does an excellent job watching the evolution of major fundamentals affecting the financial stability (it took them until the late 2007 to officially notice that the housing market might be in trouble and that construction sector has actually peaked - despite the fact that construction stocks data actually shows a break point in 2005 - full two years ahead of CBFSAI noticing it). And so on... but

The 'but' part relates of course to the fact that Nama-bound derivatives and complex intruments written against loans and real estate development ventures that are polluting our banks books are soooo toxic, I would compare them to a Chernobyl reactor just after the meltdown. The rest of Nama loans will be medical toxicity-levl stuff, compared to the serious s***t based on securitized underlyings. Nama taking these on will be equivalent to the Soviets sending unprotected troops into Chernobyl reactor to manually remove the fuel rods (they did do that).

This, of course, warrants a revision of our balance sheet totalling expected Nama losses. Once we have a clearer view of these derivative instruments extent, we will have to write them down to 'zero' real value, for I suspect there can be no recovery on secondary lending that was extended on collateral with real current value that has fallen 70-80% in the crisis.

Given speculative reports that Nama will buy into some Euro40bn worth of this stuff, I would say that a clear expected loss on this share of Nama purchases should be in the neighbourhood of
40bn*[Prob(recovery in default)*Prob(default)+(1-Prob(default))*Recovery Rate (No default)*Share (Deriv at recovery)]
Using UK and US data,

• Prob(recovery in default) = 8-11%
• Prob (default)=25-30%
• Recovery rate=40-50%

40bn*[(2%-3.3%)+(28%-35%)]=Euro12-15bn

So total expected recovery on Euro40bn in derivatives to be bought by Nama is around Euro5-7bn, implying the total expected loss on Nama should rise, under the best case scenario, from previous Euro13.4bn to Euro27-30bn over the life time of Nama...

Now, to warn you - these are back of the envelope calculations, and I will re-run full balance sheet to get more exact numbers. But you can already see where this Government is heading - another reckless and completely immoral sell-off of the taxpayers in exchange for a quick fix that has not worked anywhere else before.

Economics 24/08/2009: Alan ''Please read me!!!' Ahearne

The hilarity of a personal Ministerial Adviser sending an article defending his masters' views to a Sunday newspaper was not enough for Alan Ahearne [see that story cover here]. Never mind his article addressed not a single point of criticism levied against NAMA. Alan actually had to send out an e-alert [well, of some 979 words that is] to a list of his "colleagues". The email implored them not to sign up to an article critical of NAMA until they read his own article published in the Sunday B-Post. Given the fact that the said article had no useful information content regarding any potential or alleged NAMA problems, it is hard to imagine why Alan would actually publicise his own "efforts" with Irish academics. Then again, he might be simply keen on publicising his own efforts full stop.

Alan clearly forgot three major things in that email:

1. He failed to include in the email recipients list the names of anyone actually critical of NAMA - surely a majour omission if his intent was to convince us to take another look at NAMA in light of his, then, forthcoming major contribution to the debate;
2. He failed to notice that since he became an employee of the Minister for Finance, he is no longer an academic, so sending an email to academics and saying "Dear colleagues" should really be slightly offensive to the academics, assuming they are really valuing their independence from the political interference (which is, of course, now fully embodied by Alan's position);
3. He failed to provide any real substantive arguments disproving NAMA critics' main positions.

So here we go - two pieces of work by Alan Ahearne, some 1900 words wasted between the two, and not a single coherent point of defense again NAMA critics... Gotta be a record for someone paid to do this kind of work, don't ya think?

Economics 24/08/2009: Oil and Gold – an imperfect hedging tango

In the last bout (right before the collapse of the financial markets in Autumn 2008) much of the inflation was driven by the rapidly rising commodities prices. These prices were in turn linked to the price of oil. Thus, one can naturally think of oil as an inflation hedge. In contrast, the traditional inflation risk management instrument – gold – has hardly kept up with oil prices in the short run back in 2008. So there is a natural question that arises in this context – which is a better inflation hedge? Well, for each month in 2008, in year on year (yoy) changes, oil actually beat gold as a counter-inflationary asset. Only this year have gold and crude exchanged places. But this is optics.

First, both gold and oil prices show some serious medium range inter-annual volatility. This volatility is driven by speculative motives, but also by real demand for oil as a storable commodity that is an input into physical economy. So to abstract away from seasonality and active speculative trading, consider both commodities prices in terms of annual averages. Setting 1968 price index for gold and oil to be equal 100, and adjusting for inflation, chart below shows that both commodities are way off their historic highs and that even in 2008 the two commodities were nowhere near their long term maxima when it comes to a cumulative appreciation since 1968.

Pre 1970, average price of gold ranges around $38-39. It peaked in 1980 at $615 and then got stuck in the flat until 2007 when it breached the 1980s high in nominal terms. The average price of gold was $872 in 2008. Similarly, crude peaked at an average price of $91 a barrel last year. But despite nominal appreciation, oil is still way below its inflation-adjusted highs. Ditto for gold. To do this, gold needs to be at nearly $1,610 and oil at $98-100 per barrel. These are steep, but just how steep? Well, for oil this means roughly an 8% appreciation on 2008 annual average. But for gold this implies a whooping 84% appreciation on same benchmark.

Now, in annual terms, average annual inflation since 1968 was 3.6%. Median annual return to gold exceeded CPI by 1%, while oil did the same by 1.7%. So cumulative gain for oil in real terms since 1968 has been around 96.3%, and for gold it was almost a half of that, or 48.9%. Given that oil took a nose dive in 2009 while gold held its ground, long term comparisons suggest that

• Either oil is oversold today and thus has a mean-reverting potential of ca 45% on current prices to ca $105-110 barrel range (chart below shows WTI, $pb)

• Or gold had been under-bought in the historic past and thus has an oil-inflation trend-reverting potential of ca 50-75% on 2008 average annual price (chart below shows gold price in $ per oz, daily close)

I happen to think that both are likely, though in much more moderate terms, with oil heading for $85pb in 2010 and to $95pb over medium term (5 years), while gold heading for $1,050-1,100 range in 2010 and to $1,300 over the medium term. That would imply annualized gains in oil price of roughly 4.8% and in gold price of ca 6.5% before inflation. Thus, assuming a reasonably well-underpinned by the current money creation worldwide inflation averaging ca 3% pa, this would result in oil beating CPI by 1.8% annually, and gold doing the same by ca 3.5% pa. Why?

For two reasons:

1. Oil demand is going to be imperfectly matched to inflation hedging and short term volatility due to supply/demand for physical commodity will be weighing in oil as a hedge instrument in the current environment where investors are relatively jittery about the markets;
2. Gold simply has to catch up with oil over medium term.

One potential downside to this is continued orderly, but nonetheless pronounced disposal of gold holdings by the Central Banks of the more fiscally strained countries and the IMF. Although China and possibly India are likely to start picking up some of the rising supply through ‘private’ or invisible sales from one CB to another, this unwinding of gold reserves will weigh on the markets.

Per short term oil price volatility a recent example is in order. About two weeks ago, the US crude reserves have been reported to have fallen some 8.4mln barrels, prompting a serious spike in oil to $72.5pb. At the same time, gasoline supplies fell by 2.1 million barrels, distillate stocks declined by 700,000 barrels and refinery utilization reached 84% above analysts’ expectations of ca 83% - in a sign of tighter supply.

In medium term (3-5 years horizon) – watch US Oil Fund (USO) for oil.

On gold side, watch the correlation in gold and stocks, with gold tending to max just ahead of stocks lows (note July/August 2008, October 2008, March 2009 and so on in chart above). In my view, we are set for another local maxima to be tested by gold in months before the end of October 2009.

Economics 24/08/2009: Wealth effects in Ireland and Wholesale Prices

Mountain air and thunderstorms are conducive to light reading, so I was wading through an interesting and sweetly short ECB paper from May 2009, titled “Euro Area Private Consumption: Is There a Role for Housing Wealth Effects”.

The paper looks at a number of Eurozone countries – excluding the wonderland of Ireland (so it provides conservative estimates for the wealth effects) – to find that the marginal propensity to consume out of financial wealth (MPCF) in the Eurozone ranged between 2.4% and 3.6% on the aggregate. The MPC out of nominal housing wealth lies between 0.7 and 0.9%.

Re-parameterizing the model for the case of Ireland,

• financial wealth declines since 2007 peak imply that Irish consumption should have fallen by ca 1.9-2.9%;
• housing wealth declines add another 0.35-0.45% to the consumption losses;
• while negative equity effects (assuming 20% of households in negative equity) subtract further 0.69-1% off our consumption.
• So the cumulative effect of recent wealth losses should be in the area of 1.45-2.1% of consumption expenditure.

The above figure does not account for the fact that in most cases our debt levels used to finance financial and housing wealth acquisitions were not diminished over the last two years. Factoring this in, net decline in consumption expenditure should be around 1.7-2.6% in permanent terms.

This goes some ways to highlight the fact that this economy is not running a tax-shortfall-driven deficit on public accounts – we are now increasing public consumption amidst permanently shrunken private consumption. Given that Ireland’s net current Government expenditure is projected (by the DofF) to rise 17.64% between 2009 and 2013 (from €46.365bn to €54.546bn) while the expected cumulative loss in private consumption is expected to total 8.8-13.7%, the wedge between private and public consumption growth in the crisis years is likely to be around 17.5-22.5% of private consumption. And that is before tax increases and future bonds financing burdens are factored in. In other words, tax us some more and we will withdraw all unnecessary consumption from this economy. If we were a land-locked Luxembourg, I doubt there will be many non-public service workers still living in Ireland after that.

And per the latest wholesale price indices release from CSO, here are few charts.

First, exporting vs home sales prices – a clear return to the previous trend of widening gap. Exporters are still suffering while domestic sectors are running improving pricing conditions. A brief period of convergence in November 2008 – January 2009 has now been firmly replaced by a renewed bout of falling export prices and rising domestic ones. Unfortunately, CSO is not providing actual raw data on these series this time around, so no more analysis is possible for now.

Second chart is dealing with manufacturing prices and growth rates (yoy and mom). Deflation continues here and has accelerated in July relative to June. Month-on-month changes are really telling the story – June improvement is still visible, but is being erased. Note monthly range for July 2008-July 2009 being negatively sloped, as contrasted with July 2007-July 2008. Plotting monthly indices by year shows that seasonality is not as important here and that 2009 is pretty much all about traveling down a steep deflation curve that started in November 2008.

Economics 21/08/2009: Commisions and Taxation

Per Irish Times report today:

"Despite the significant Exchequer deficit the (Commission for Taxation) report does not recommend a rise in income tax rates and says that the combination of taxes and levies mean that anyone earning €75,036 is paying 53 per cent in taxes and levies to the State." You can almost hear the tears dropping from the eyes of the Times staff as higher income tax would be a favourite pet project for the paper.

41 per cent is tax, 4 per cent is PRSI, a further 4 per cent is a health levy and an income levy of 4 per cent. Well, we almost forgot other taxes and rates. All meaning that less than about a 1/3 of Ireland's productive (private sector employed= population supports the entire economy, with some 400,000 overpaid and under-worked public sector employees... Now, Irish Times wouldn't have anything to say about that would it?

A property tax will be introduced which will eventually replace stamp duty and while a new carbon tax on energy has been proposed. Now, what does this mean? We can only speculate, but eventual replacement of stamp duty implies that the two new taxes will coexist. My sources tell me that

• the new property tax will be based on self-assessment, which means it will yield huge rates of tax evasion, will retard even further property resale markets (as under-taxed properties will be held back from the market) and thus will lead to a renewed property crisis over time;
• the new tax will be a double tax with no credit given for recent payments of stamp duty, so in effect, it will be a new additional tax.

You'd wonder if the Irish Times actually cares about these small details.

Well, obviously, another Times pet projects are artists’ exemptions. These should and will be scrapped, so Bono & Co can fully move out of the country. I wonder if that will make them preach less about doing good at the expense opf the ordinary taxpayers. I doubt.

Reliefs on union subscriptions and bin charges will be phased out. Hmmm - wonderful stuff. Union subscriptions relief was an honest admission by the state that it is so deeply in bed with the unions that even a tax amn can't separate the two. Now, let's pretend they no longer are... Does this change the reality of this state doing absolutely everything possible to appease the bearded men of the Liberty Hall? Not a chance.

Another rumoured proposal is a SSIA-type pension for those on lower wages with the State contributing €1 for every €2 saved by employees. Funny thing. Of course it raises two issues:

1. Who will pay for it? You can imagine a family just above the margin threshold for such a subsidy that will have to provide tax payments for this pension scheme and at the same time pay for own pension. Fair?
2. How will we pay for this? Assuming you have to save ca 40% of your income in order to afford a public sector-level of benefits at retirement, how can a country afford paying an additional premium of 40/3=13.3% on lower wages in taxes at the time when we can't afford to cover our current account deficit.
   

This Taxation Commission report is starting to look like a clock made of jello, as PMD like to say...

Economics 21/08/2009: Economic Outlook - Things to Fear

Being in the Dolomites puts me into a long-term thinking mood. So here we are – a post on some of my long run thinking.

In a recent post I wrote about the probability of the L-shaped recovery now standing at and even 1/3 split with the probability of the recovery being V-shaped or W-shaped. I motivated this estimate by the references to some of the US economy fundamentals.

A different world beacons

Think growth dynamics in the long run. Usually, a recovery is led by a small fiscal stimulus and a moderate easing of the monetary conditions. These come after a number of quarters of tighter fiscal and monetary conditions pre-crisis. And both act to moderate fall-offs in household and business investment, plus arise in unemployment in the environments of relatively unchanged long-term savings/investment ratios and a temporary shock to transient consumption.

We are in a different world today from a ‘normal’ recessionary cycle, and this warrants my concern that the recovery dynamics are likely to be highly uncertain.

Fist, think the investment cycle. Investment – both household and corporate – is down and it is down structurally. The structural nature of this downturn is most likely due to the shifting pattern for investment financing into the years ahead. Gone is the leverage and originate model of lending. We are in the new brave world of deposit and originate model, where capital financing will be held back by the need to generate significant deposits.

Even an era of sustained precautionary savings by the households is not going to change this reality. Why? Because in years before the current crisis, leveraging model meant that a deposit of, say, $100 in a bank translated into the lending out of some $960 or more into the economy. With deposit and originate model, the same deposit is going to see first round lending of no more than $90 out into the economy. Once the hovering of excess liquidity into banks capital is done with, we might move to a lending of slightly above the deposit rate, say $100 plus a wedge between the borrowing rate and deposit rate. But this is hardly going to get us above $110 even in most pessimistic inflationary scenario. In the mean time, the banks are going to beef up their capital reserves by skimming retail clients – so returns to savings will quickly turn negative. Never mind the returns, households will still hoard cash as sticky unemployment will breath fear into their hearts – the new era of the hearts of darkness will set in ushered by the elevated risk aversion.

Second, think precautionary savings. If in traditional recession precautionary savings cycle exhausts itself within a span of 2-3 quarters post recession on-set, in the current one, the savings rates are still climbing up, corporates are still hoarding whatever cash they can generate and the late payments gap is widening, not shrinking. This suggests to me that we might see the US savings rate finally moving in the direction the majority of economists in the 1990s wished it would be heading – into possible high single digits or even double digits. The trade wars of the 1930s might be replaced by a slow decay in world trade due to shrinking US (and also European) consumption expenditure. Not as nasty of a proposition as the Depression era ‘beggar thy neighbour’ policies, but a much longer behavioural shift that is more benign in the short run, but is much more damaging in the long term.

Third, think of the place we came from when we entered this recession. That place was Alice in Wonderland mondo bizarro of excessive liquidity sloshing across global boundaries and asset classes and fiscal policies of prolificacy that made even the US Republicans (traditionally pro-balanced budget conservatives) into the spending-happy traditional Democrat-types. In this environment, lack of global inflation was only sustained through a combination of extreme asset bubbles formation (housing, equities, carry trade-financed speculative real estate allocations, excessively optimistic M&As and commodities bubble that rivalled anything we’ve seen since the Dutch Tulip craze. But looking forward, this environment was ‘corrected’ in the recession through another massive injection of liquidity and another substantial hike in public deficits worldwide. It might be a forced measure for Obama Administration to prop up the entire US economy by pumping more steroids of public spending and running printing presses at the Treasury 24:7, but this activism has to go somewhere real, and it will go into real long term inflation and a new asset bubble generation, along with higher taxation.

Ronald Regan inherited from the Democratic Party’s leading historical disaster (Jimmy ‘The Peanut’ Carter) presidency one of the sickest economies in the US history. But one thing he did not inherit was decades-long appreciation of the US deficits. Subsequently, Regan was able to cut taxes while re-channelling fiscal spending into new programmes. Obama’s successor (who is now increasingly looking set to come in 2013) won’t have this luxury. Neither will Angela Merkel’s successor, or Brian Cowen’s or Gordon Brown’s. High tax era is upon us in the developed world and this means we are going to lose in the economic game. This impending tax regime fiasco will be far more damaging to the West’s economic standing in the world than the oil price inflation can ever be.

Fourth, inflation is coming. I wrote about it before and I keep saying this over and over again: if you think double digit yields on US debt are the stuff of science fiction, think again. Someone will have to pay for the orgy of new fiscal debt creation and that someone will have to borrow hard. The new borrowing – the rollovers of the past, plus the interest rates of the future, compounded by the Obamanomics and the Democrats appeasing their traditional constituencies will be exacerbated by the need to rescue the next wave of ‘economic recession victims’ – the states and municipalities. That these are going to be predominantly amongst the Democratic party strongholds (e.g California) will only make matters worse. So what little liquidity will be added over time will be consumed in an orgy of new debt issuance by the Feds and the states and municipalities. The pyramid scheme whereby Feds-created cash will be rolled into Feds-backed Government borrowings will mean investment slowdown will be deeper and more permanent than the point one above suggests.
Inflating and devaluing out of this mess will set the stage for the graduate de-dollarization of the global economy, further undermining the US.

So high inflation, lower growth, lower real rates of return on deposits, lower lending origination and thus lower investment all form the prospects for L-shaped recovery. At the same time, sheer magnitude of liquidity pumping into the global economy via loose monetary policy on top of the previous decade-long monetary easing might, just might, usher a new age of asset bubbles. From oil and gold to banal fertilizers and regulatory-driven forestry – commodities will reign as perceived, if unreal, inflation hedges. Exotics of risk aversion assets might turn out to be even more exotic, more technical and thus less stable than the securitized and repackaged real estate loans of the Mid-Naughties. If they do, a V-shaped recovery is a possibility, as is a W-shaped one. Both will be short-lived, but at least we will get to enjoy one more run of the madness.

About the only silver lining to this long-term Western Winter will be the fact that Europe will be faring even worse than the US with Italian-style slog contaminating the entire EU, inclusive of the Accession states.

So where do we stand?

An L-shaped recovery offers a period of zero (or near zero) real growth post-recession. The V-shaped one represents a robust recovery post-recession. The W-shaped scenario is the one where recession will be followed by a significant bull run, followed by another collapse before the recover set in.

In my view, however, all those who paint the current economic environment in one of these historically known categories miss the majour point — because of the changed relationship between perceived and real risks and our systemic household, banking and corporate responses to these, we are entering a recovery that has elements of all three scenarios. This is risking to be a PQR recovery – a recovery based on Public and Quoted Risks. Now, it is a handy feature of the alphabet that letter PQR are smack in between letters pairs of K and L (denoting traditionally Capital and L-shaped recovery) and V and W shape of recovery descriptors.

PQR is not a simple average of L and V-shapes, some sort of a root sign-shaped recovery. It is a recovery that starts from the top of the previous cycle, heads for depths severe of a recession, rises in a volatile fashion above the floor and flattening out at an equally volatile new floor of suppressed long term growth. It is the stuff that makes superpowers lose their supremacy positions and that led to disintegration of mighty super states of the old.

Historically, recessions follow a V-shaped scenario. The dynamics are as follows:
First businesses cut production through the downturn: capital investment grounds to a halt, layoffs cut less productive workforce and maintenance and capital replacement drop to below amortization;
Second, businesses stop cutting at the point where their capacity still exceeds demand, and they go for correcting the supply overhang by reducing costs and inventories;
Once demand troughs, the depletion of inventory means that any new demand will translate into increased output, sapping the excess capacity;
Capital expenditure rises on the maintenance and amortization side, but no new capital is added, so profits improve and war chests are replenished by the healthier businesses to take on some of their competitors;
Increased corporate profits support strategic drive in increasing capacity to address future demand – employment and investment rise;
High rates of money creation and fiscal stimuli (with priorities going from tax cuts, to public investment in infrastructure upgrading, to Uncle Sam’s shopping for consumption spending, and not the other way around) help the process of orderly de-leveraging and maintenance of excess capacity by businesses.

We, thus, have Public Risk – the risk of permanent deficit financing and the under-saturation of public debt with liquidity (see below). We have Quoted Risk – the risk of higher equity and commodities volatilities as desperately shallow liquidity pools are chasing higher returns in the new era of diminished tolerance for risk amongst retail investors. We have a PQR recession – an alphabet soup of messy noise along a shallower than before and flat growth rate.

A PQR recession dynamics will be as follows:
First businesses cut production below the point where their capacity is less than the expected medium term demand;
The supply overhang will be short-term managed to a supply undercut by reducing costs and inventories much deeper than before;
Once demand troughs, the depletion of inventory means that any new demand will translate into increased inflation, triggering some monetary tightening that will trigger renewed push for precautionary savings and the W-shape will emerge;
Capital expenditure will have to increase on the maintenance and amortization side as even the minimal levels of capital will begin to fall apart at a rate not seen since the collapse of the USSR, but no new capital will be added, so profits will improve;
The improvement in the profits will drive us up the last leg of W, but there will be no build up in corporate war chests as liquidity will remain tight;
Instead, strategic drive in increasing capacity to address future expected demand will mean that employment and investment will rise faster in the BRICs and the rest of the world than in the OECD;
Fiscal stimuli with priorities of Obama administration implying more spending on immediate Uncle Sam consumption of stuff from the Democratic Party cronies, followed by lower public investment creation and not followed by tax cuts, but by tax increases will mean that no productive capacity will be underpinned in the productive US sectors, yielding their competitive positions globally to newcomers from Asia;
The US economy will settle into a permanently lower rate of growth characterized by relatively frenzied swings from Public Capital Formation schemes to Private Risk Premia increases and back to Public Capital.
A PQR paradigm. QED

How do we know this?

We now are wiser than in October-December 2008 and it is now more than apparent that the US fiscal stimulus misconceived (in a rushed atmosphere of a sever crisis) and misdirected (at the least productive sectors of the US economy where mis-aligned long term incentives will prevent any future productivity growth springing the green shoots). Fiscal stimulus in the US did not help significantly to deleverage households, so monetary easing did not restart demand for borrowing. Fiscal stimulus, in the Obama administration conception, did not prop up capacity preservation in productive sectors of the US economy and was wasted instead on the Big 3 Auto-monsters and the larger, less productive financial institutions. Fiscal stimulus did nothing to get the Americans out of negative equity and thus did absolutely nothing to reduce incentives for precautionary savings. This means that consumption growth is simply not going to happen, folks. Not at the rates pre-crisis and not even at the rates of post IT-bubble recession.

Monetary policy is also going to fail in everything but inflation generation. US private sector credit remains in the doldrums a year after the efforts to repair it began and the US wounded and undercapitalized financial system continues to struggle with the ghosts of looming future losses.
The longer-term theme in the US is the emergence of the two polar opposites as demographic drivers of the economy. On the one hand, ageing assets-holding population will have no access to liquidity as home sales will remain subdued by the massive overhang in unoccupied properties still crowding the market and by the banks unwillingness to lend on real estate assets. On the other hand, high savings –geared younger population will be consuming less and repatriating more. Think of the Latin Americanization of the US population with the resultant outflow of financing from the younger second generation US workers to their first generation American parents who will move back to Latin America to get better quality of life in return for their savings.

So future consumption will be depressed by financial system, demographic changes and the overall change in risk aversion across the US population. As an interesting side-bar, in the mid 2008 the number of Google search hits for ‘Paris Hilton’ – an imperfect signifier of the younger generations presence in the economy – has been overshadowed by the number of search hits for that key word of the Wal-Mart generation of greying retirees: ‘coupons’.

The downsizing of American consumption-driven economy has begun. And this is hardly an encouraging sign for the V-shape theorists.

Europe’s moment of sickness

This leaves us at the point for comparing the US with its today’s competitors. The sick state of the nation on the western shores of the Atlantic will be predictably mirrored with an even deeper decay on the eastern shore of the pond. As US continues to improve productivity – albeit at a much slower pace – European society, geriatrically-challenged, hamstrung by the trade unions, obsessed with preserving the status quo of wealth distribution and increasingly anti-immigrant and anti-innovation will suffer even more. Increased consumer demand from China and India, Brazil and possibly Russia will go some way to prop up German manufacturing, but more and more of those fine BMWs and Mercs will be stamped out in the US, assembled in Free-to-work states of the US South, designed in the Free-to-dream states of the US West and financed from the Free-to-invest states of the US Midwest and Northern Atlantic corridor. German manufacturing will sing the same blues as British manufacturing did before it. What will remain will be a museum trinket shop – a place where Ferraris and Bugattis will still be made backed by subsidies from the US- and elsewhere-based ‘German’ production of actually demanded goods.

Investment themes of a PQR recession

There will be new themes for the investment markets in years ahead. These themes will be about more active management of volatility and use of volatility spells to the same purpose as we used the international ‘growth’ stocks in the past – to get ahead of the benchmarks. Another theme will be maintaining sane returns once the risk of dollar devaluation is taken into account. Third theme will be the rise of global volatility. Displacement of the US and EU from the pedestal of global leaders in future growth (the first one still coming, the latter having already taken hold) is not going to take place because some other power will emerge as being better in absolute terms. Unlike almost all other deaths of the superpowers (with exception of the collapse of Rome), this one will not result in an immediate emergence of a heir apparent to the US dominance. China – the sickly giant that will be seen as having toppled the US – will not be able to bear torch for the rest of the world primarily because it has no model of its own, no engaging or charismatic ideology. And this will mean that the world of investment will be jittery, uncertain, fast changing worldwide.

Prepare for some serious volatility management, folks. PQ to QR to PQ across the horizontal axis, US to BRICs to Asia to US to Latina America to the BRICs across the vertical one, and across all asset classes on the Z-axis. Shall I remind you that complexity of PQR recession is by even alphabetic standards much more significant than that of L, V or W?

Economics 17/08/2009: Global Recession is Over - IMF

Per IMF's Chief Economist, Oliver Blanchard, the global recession is now over and a recovery has begun. "The turnaround will not be simple," Blanchard wrote, as "The crisis has left deep scars, which will affect both supply and demand for many years to come." Blanchard expects growth start occurring in 'most countries', but at low rates - not enough to shift unemployment off its highs.More importantly, Blanchard argues that potential global output may have been permanently reduced and that any growth to take place in the short run will still remain highly dependent on government stimulus and accommodating monetary policies. Sustaining growth "will require delicate rebalancing acts, both within and across countries," he said

Now, of course for Ireland, this is not much of a welcome news. Our fiscal stimulus is perverse NAMA sucking cash out households' pockets, plus the widely anticipated and media-supported tax hikes in the next Budget. Our monetary easing is there solely to help the banks, who in turn are now raising mortgage rates.

Per Blanchard, US consumption (ca 70% of the US GDP) and most of global demand will be very slow to return to pre-crisis levels. These long-term declines are driven primarily by wealth effects due to the fall-offs in personal wealth on the back of housing and stock markets collapses. Blanchard, who devoted much of his academic career to the models of nominal and real rigidities remarked that he perceives the crisis legacy as having made Americans more aware of the unlikely events that can yield catastrophic consequences. This is known in the literature as "tail risks". The likely result of this will be a permanently higher rate of savings in the US and elsewhere around the world, leading to lower consumption, but cheaper financial capital.

Interestingly, Blanchard apparently ignored the issue of increased risk aversion that might also accompany the fear of 'tail risks'. If this does materialise, higher risk aversion can shift the burden of financing the latest crisis off the fiscal authorities (through lower yields on bonds) onto the shoulders of already strained corporates (with higher required returns to equity financing). The resultant knock-on effect will be to double the adverse risk of lower consumption by the households, reducing potential rate of growth globally.

Global rebalancing to address this new reality will require, in Blanchard's view :

• "Both higher Chinese import demand and a higher (yuan) will increase U.S. net exports";
• Higher domestic consumption growth in China (effectively replacing the US as the main consumption growth player in global economy);
• Lower current account surpluses in China; and so on

Thus Blanchard's view has not really change that much since the beginning of the crisis and even further back. Even in the late 1990s the IMF kept sounding alarms about the Sino-US imbalances.

Another long-term challenge is decoupling the real economy off its dependence on state spending. This will be painful, as current stimuli around the world spell higher taxation in the future and thus lower future growth. "In nearly all countries, the costs of the crisis have added to the fiscal burden, and higher taxation is inevitable," Blanchard said. "All this means that we may not go back to the old growth path, that potential output may be lower than it was before the crisis," he added.

What's there to say about our country, then - a cost in tens of billions and no stimulus in return... aka NAMA.

Economics 17/08/2009: US markets jitters

US Markets: I've told you to be weary of the return of volatility. Chart below shows today's sudden- 17% jump in VIX volatility index and the coincident fall-off in the main markets (sorry, crumbling Eircom broadband infrastructure means I can't get my hand on better charts right now):

Even more worrisome is the following chart, showing that both near-term VIX and long-term VIX are actually in excess of the current VIX, so markets are now pricing higher volatility for the foreseeable future.
Another telling graph above - notice negative correlation of the last few months turning positive about a week ago and back to negative now - this is a likely holding pattern as in 2007 late Summer and 2008 Summer-Fall.

China was the latest trigger today, but it all goes back to trade flow, as China is a barometer of this and trade flows are a barometer of global growth...

NAMA 3.0 - more weight

My NAMA 3.0 - that includes also some proposals advanced first by Patrick Honohan, Brian Lucey and Karl Whelan - is gaining some speed. Here is a slightly more edited/updated version of it:

Step 1: Require banks to take full mark-to-market writedown on their loan book. This ensures that realistic valuations will be attached to the loans and it is fully consistent with the Swedish Bad Bank model (SBB-consistent);

Step 2: Travel down the capital ranks to draw down shareholder equity, deplete perpetual bond holders, subordinated bond holders and so on to cover the writedowns. This is a natural progression in addressing any insolvency and there is no reason as to why NAMA should be different (SBB-consistent).

Step 3: Force senior bond holders into debt for equity swap (exchanging their bond for shares at a discount), with a possible sweetener on equity conversion formulas relative to the Exchequer valuations (meaning we convert their bonds into shares with a small sweetener or shallower discount than actual valuations will imply). By retaining these guys on board as shareholders, we ensure that the banks will not be 100% state-owned and that potential lenders will have an interest to lend because they will be shareholders in these institutions. This is consistent with GM bunkruptcy proceedings earlier this year;

Step 4: Open enrollment for a share-participation in Irish banks recapitalization to SWFs and private capital. The Government should actively seek such external investors to increase private sector share of overall equity holdings (on top of converted bondholders - point 3 above). This should be done in the period while the banks are drawing down their capital funds to write-off losses to ensure that the banks are not fully nationalized;

Step 5: Cover all the shortfalls in capital base through recapitalization (as in Government's NAMA - or NAMA.G - proposal) after Steps 1-4 are completed and after an independent assessment of the value of the remaining loans is carried out to determine the true extent of banks under-capitalization (SBB-consistent).

To establish independent valuations – set up a Valuations Board of NAMA consisting of 9 individuals: 1 from DofF, 1 from NAMA, 3 valuations experts, 1 finance expert (banks), 1 planning specialist, 2 independents (economist and accountant). There shall be no post-NAMA levy expsoure for the banks as the state will take ordinary shares in those institutions (reducing future uncertainty for banks), thus creating an upside potential to shares (offsetting any losses on NAMA discounts).

Recapitalization, carried out jointly with new shareholders (past bond holders, SWFs, private investors, etc) will see Irish Government taking significant/majority shares in all main banks in Ireland. However, it will not be a nationalization, as the state of Ireland will not own these shares - the shares will be held in the name of Irish taxpayers in an escrow account or holding company called NAMA3.0 (below). Furthermore, significant shareholding in at least 3 banks can be private - through the private placements (step 4 above).

This is constent with SBB, but it is also consistent with the current NAMA-G proposal, as the Government has not explicitly rulled out a possibility of nationalization of the banks in the post-NAMA recapitalization. Furthermore, NAMA3.0 reduces the extent of state ownership of the banks by committing itself to attracting some private sector shareholders - e.g former bond holders and new investors.

Step 6: Hold equity in an escrow account (NAMA3.0) on behalf of the taxpayers, appointing

• The members to the Supervisory Board of every bank recapitalized by the taxpayers money. These should consist of one appointee by the Minister for Finance, 1 independent representative of the taxpayers, who is charged with explicitly guarding the taxpayers' interests, 1 representative of NAMA3.0. Each member (other than those from NAMA3.0 and the bank) will hold a veto power.
• A requirement that risk, audit and credit committees of NAMA3.0 include at 2-3 independent experts who cannot be employees of the state, NAMA3.0 or any other parties to this undertaking
• Set up an independent, bipartisan, NAMA Oversight Oireachtas Committee consisting of non-voting Chair, 1 representative of each Party, 1 independent TD.

Step 7: Accountability:

• no indemnity for negligence and incompetence for any employee or director of NAMA 3.0 organization - no one in the private sector has one (SBB-consistent);
  
• no cross borrowing by the Exchequer from NAMA3.0 is allowed, so Brian Lenihan and his successors cannot raid the nest egg by - at a later date - borrowing funds against NAMA-held assets to spend on other state commitments (current or new). This is SBB-consistent provision;
  
• ownership of shares in the account accrues to the taxpayers, not to the state or the public sector;
  
• NAMA3.0 cannot lend money to continue any of the banks' projects without specific recommendation of the risk committee (unanimous) and an authorization from the special Oversight Committee of Oireachtas;

Step 8: Transparency:

• full disclosure of all recapitalization actions and shares held in NAMA3.0 - on the web, updated live;
  
• full disclosure of all salaries, bonuses etc, CVs of all managers and directors and disclosure of all potential conflicts of interest;
  
• full disclosure and updating of the comprehensive NAMA3.0 balance sheet, cost/benefit analysis of the undertaking and live monthly mark-to-market report on the value of shares held;

Step 9: Operational Efficiencies: NAMA3.0 can, with consent of the Minister for Finance and in orderly (market-respecting) fashion disburse all or a part of its shareholdings so as to maximize the return to the taxpayers. This disbursal should be fully notified to the public immediately post execution, with prices achieved and hedonic characteristics of the properties sold (barring identification information) fully disclosed. NAMA3.0 will then have 60 days to issue every resident of this country - registered at the date of creation of NAMA3.0 as being tax-compliant - his or her share of the sale proceeds net of NAMA3.0 operating costs and a special withholding tax of 40% on Capital Gains, in a form of a cheque;

Step 10: Legal Remit Over Assets: NAMA3.0 in recapitalizing the banks will have a mandate to help the banks collect on outstanding loans by aiding them in seizing requisite collateral. In doing so, NAMA3.0 will have to agree a procedure to address problems of cross-collateralization of specific assets. NAMA3.0 will have a right to seize borrower's property (applicable only to developers) when such property has been legally shielded from authorities or banks at any time after July 2008.

Step 11: Conditions for banks participating in NAMA3.0: banks will be required to adhere to the following rules, including, but not limited to, the caps on executive compensation at the banks set at Euro500,000 maximum with share options not to exceed 75% of the salary, to be taken in long-term options – 5+ years, with the option price to be set as the Moving Average over the last 3 years of Bank’s operations prior to option maturity). Banks must set up fully independent, veto-wielding risk assessment committee with a mandatory requirement for a position of a taxpayers' representative on the board that cannot be occupied by a civil servant or anyone who has worked in the Irish banking or development industry in the last 10 years.

In addition (all below are SBB-consistent):

• the banks must set up independent fully shielded administration offices for managing NAMA-held loans;
• the independent offices must compete against each other in delivering the returns to NAMA loans;
• the annual performance of these offices must be benchmarked also against the annual performance of the banks' own books of loans with the NAMA offices within the banks achieving at least the same average rate of return on its loans as the rest of the bank (adjusted for quality of loans) without any cross-subsidisation of returns to NAMA loans from other loans managed by the banks;
• NAMA offices within each bank must report their results separately from the bank and at the same time for all NAMA offices - quarterly and annually. NAMA3.0 will be responsible for making these reprots public after approval by NAMA board and risk, credit and audit committees.

Step 12: Re-legitimising the public system of regulation in Financial Services: as a part of NAMA3.0, the Government must address the ever-widening crisis of markets, investors' and taxpayers' trust in the Irish system of Financial Services regulation. Many steps must be taken to address this problem, and these can be worked out over time. But in my view, there must be a stipulation that all and any regulatory authorities (and their senior level employees) that were involved in regulating the banking and housing sector in this country until now must be forced to take a mandatory pension cut of 50%, a salary cut to put them at -20% relative to their UK counterparts wages, and return any and all lump sum funds they collected upon their retirement. The Government must impose measures to prevent banks from beefing up their profit margins through squeezing their preforming customers. The measures to force the banks to reduce their cost bases by laying off surplus workers must be enforced. From now on, every regulatory office should be required to publish all minutes of its meetings, disclose all its voting, decisions and rulings to the public, create a public oversight board that must include members of the Dail from non-Governing Parties, a taxpayer representative and independent directors.

Economics 16/08/2009: Alan Ahearne on NAMA - not an ounce of sense

Alan Ahearne has decided to produce a definitive defense of NAMA in today's Sunday Business Post (here). And I would have to respond. As usual - Italics are mine.

The first half of Alan's article is saying absolutely nothing - nothing as in nada, zilch, nul, nil. He simply outlines in a tedious and lecturing fashion a litany of trivial observations as to why a banks crisis resolution is necessary. He does not show that NAMA is either a necessary or a sufficient condition for crisis resolution.

"Nama is also designed to ensure that the resolution to the problem of legacy loans is orderly. Nama can achieve this outcome because it will be patient in disposing of property assets which it has seized from delinquent borrowers." This is an unproven statement that can be argued to be untrue as NAMA can and is being shown to be likely to produce a prolonged period of highly uncertain property markets with buyers and investors holding back in anticipation of future NAMA disposals of property. The longer NAMA holds these properties, the longer it will delay new investment in property in this country. The longer it will keep banks uncertain about future NAMA losses (which - as we were told - will be clawed back from the banks), the longer the mortgage holders will remain in negative equity, withholding from consumption and investment and so on.

"Outside of Nama, a liquidator appointed to wind up a property company has a duty to sell off seized properties quickly. During an economic crisis, when markets are under severe stress and banks are not functioning properly, these properties may have to be sold at a discount to their underlying economic value." Again, Alan presents a dishonest 'extreme' alternative to NAMA as we know it. Outside of NAMA, there can be better mechanisms designed for systemic and orderly adjustment of the property bubble legacy. My own NAMA 3.0 is one. Karl Whelan proposed a similar scheme as well.

"Economists refer to the discount that the liquidator must pay for a quick sale as ‘the price of immediacy’. By design, Nama will not have to pay this discount because it will sell the properties at its own pace. It is important to note that the outcome for delinquent borrowers is identical, whether liquidation occurs inside or outside of Nama. Property companies are wound up and collateral is seized. The difference is in the speed at which the seized assets are re-sold to the market." Again, this is simply not true. NAMA will keep certain projects (and thus certain property developers) in business and will even aim to complete some of the projects. If this is not a rescue clause, I am not sure what is. And as far as NAMA not paying the discount due to long term nature of the undertaking to dispose of the properties, well, this does have a price -
the longer NAMA holds these properties on its books:

• the heavier will be taxpayers' losses on bond financing (interest);
• the longer will the property markets take to adjust;
• the longer will be the period of banks uncertainty as to their costs of NAMA;
• the longer will be the period of stock markets uncertainty about the banks profitability;
• the longer will be the period of subdued investment and consumption in Ireland.

There is no such thing as a free lunch, Alan. And NAMA is not getting close to one either.

"It would be impossible to dispose of ten of billions of euro worth of distressed properties in a short time under current conditions -and extremely destructive to even try." Again - no one I know of - neither Karl Whelan, nor Brian Lucey, nor myself have said there should be a fire sale of assets. Why is Alan Ahearne allowed to deflect public attention from the real issues that are being raised against NAMA? Has he morphed into a spin doctor for DofF?

"No wonder, then, that the IMF, in its recent report on Ireland, describes Nama as ‘‘pivotal to the orderly restructuring of the financial sector and limiting long-term damage to the economy’’." Well, IMF has not endorsed NAMA and was actually critical of its provisions. Alan knowingly distorts IMF analysis by selectively quoting its report.

"A key question relates to the value at which the loans will be transferred from the banks to Nama. Some commentators have mistakenly talked about the price which Nama will pay for land and development properties. Nama is not buying properties, but rather buying loans that are secured on properties and other assets -there is a fundamental distinction." Again, Alan uses this article to deflect the real criticism - not a single serious commentator said that NAMA will be buying actual properties. But in buying the loans, NAMA will acquire titles to underlying collateral. So - a play of words for Alan is a fertile opportunity to reduce public focus on the real issues.

"The transfer value will be in accordance with EU Commission guidelines on the treatment of impaired assets. The commission is very clear on this issue: the loans are to be transferred at values based on their so-called ‘real’ -or long-term - economic value. These are the terms used by the commission. Paragraph 41 of the commission’s communication published in February states that “ . . .the transfer value for asset purchase or asset insurance measures should be based on their real economic value’’. Annex IV of the communication states that ‘‘the objective of the pricing must be based on a transfer value as close to the identified real economic value as possible’’. Well, actually, a 'real economic value' is not the same as the 'long-term economic value'. Plus, as several of us have pointed out before (Karl Whelan, Brian Lucey, many others and myself) - 'long-term' economic value can mean anything. Absolutely anything. So what Alan is saying above, just as his masters did earlier is that 'the EU Commission allows us to buy these assets at whatever price we want to pay for them'. This might be good for the Commission. But it is not good enough for us, as taxpayers who will ultimately pay this price.

"Some commentators have claimed that Nama should instead transfer the loans at what they refer to as ‘current market clearing prices’. It is hard to see how this makes sense. The reality is that there is no price at which the market for land and development can clear under current conditions. This is not to say that land has no value, but rather that the market for these assets is not functioning." In the current markets we do have real valuations of land and development assets. There are sales, there are some investments, there are transactions. Furthermore, today's price can be taken as a short-term valuation based on standard hedonic valuations. The only problem - for the banks, developers and their guardians in the Leinster House - is that these valuations are too low. So they use an academic economist to argue nonsense about 'markets are not there, man, me doesn't know much about what value things might have'.

"There seems to be a misapprehension among some commentators that, for Nama to break even, property prices need to revert to the peak levels seen in 2006-07. This is not the case."
Well, do the maths, apply discount of a% on a property loan of X bought, assuming the loan yields y% annually. Hold it for T years. Assume that the underlying collateral appreciates at k percent per annum. The present value of this loan T years from today if the prevailing rate of interest is R is
(1-a)X{Sum([1+y+k]/[1+R]^i} where i=1,...,T
The cost of financing this loan is at R+g where g is the risk premium, taken over T years and discounted back to today:
(1-a)X{Sum([1+R+g]/[1+R]^i}
The break even on this deal requires that the first identity is equal to the second one. This in turn implies that to break even, NAMA will have to either

• enjoy property yields + appreciation on the capital in excess of the cost of bonds financing and the cost of running NAMA itself - which really means a property boom (in yields terms) will be required well in excess of the 2004-2007 one, or
• enjoy property price appreciation that will cover the cost of bond financing, plus the cost of running NAMA, plus inflation, less the discount a.

This is soo excessively optimistic, that actually it makes me believe that in making his statement, Alan reveals not having done even a basic estimation of NAMA likely costs and losses.

Now, it is also telling that Alan fails to even mention the problems of protecting taxpayers' interests, ensuring transparency of NAMA operations, or any other major issues for which NAMA has been criticised by many commentators, including myself.

I also find it extremely arrogant and outright rude that this public servant has managed to escape any scrutiny as to:

• why as the economic adviser to the Minister for Finance has he not produced any economic assessments of NAMA?
• why has he failed to consider the economic costs of NAMA (he does attempt something of an analysis - albeit extremely simplistic - of what would happen if NAMA was not enacted)?
• why is he allowed to simply claim - with no evidence or arguments to support such a assertion - that NAMA will restore functional banking system in Ireland?
• why is he allowed, unchallenged, to claim that all external analysts are supporting NAMA, while we know of several Nobel Prize winning economists, numerous other respected international academics, not to mention all internal independent analysts working in Ireland who unequivocally identified NAMA as being a bad idea?

In short, Alan's article is a waste of space - pure and simple, providing not a single fact, not a single logical argument, not a single ounce of economic reasoning to support his thesis.

Read my alternative to NAMA here.

Economics 16/08/2009: A tax too far?

Here is a nice one from the Sunday Papers. Sunday Times "In Gear" supplement is featuring tow different cars: a Devon Motorworks GTX, 8,354cc V10 650bhp super-car that goes 0-60 in 3.5 sec and costs £300K (pages 4-5) and Mazda MX-5 1,999cc 4-cylinders, 158bhp ordinary bloke/gal car, priced at estimated €37,000 pages 14-15. Guess why am I writing about them?

Well, Devon's in the UK road tax band M, which sets you back £405pa, or €470.06pa, Mazda is in Ireland's rod tax band E, which sets you back €630pa.

Assuming that

• a 'sensible' consumer would tend to purchase a car for about 7-12% of their income;
  
• hold it for 7-10 years;
• sell at the end of the holding period of 50% or 20% of the value, then
  

the following table shows just how close our road tax policy comes to highway robbery:
Yes, you are reading it right -

• a buyer of a small middle class car in Ireland will pay between 1.4 and 2.1 percent of their annual income per annum in road tax;
• a buyer of a large super car in the UK will pay between 0.14 and 0.315 percent of their income in annual road tax.

And I know what you are going to say - the UK is closer to meeting its Kyoto Protocol commitments than we are, and it has better roads than we do.

Where is our National Consumer Agency in all of this? Oh, well, busy counting Government payoffs for staying quiet on the rip-off culture of our public policies...

Economics 15/08/2009: Migrants in Ireland - a recent study

Here is a quote from the recently published paper on immigration to Ireland, Alan Barrett (ESRI) "EU Enlargement and Ireland’s Labour Market" IZA DP No. 4260, June 2009 that actually getting me going, folks (emphasis is mine):

"In order to get a sense of the educational profile of EU10 immigrants, we need to
draw on earlier research. Barrett and Duffy (2008) show the education levels of EU10
immigrants, along with those of other immigrants based on data from 2005. In Table
5, we present their figures.

The first point to be taken from the table is that Ireland’s immigrants, in general, are relatively highly educated. We know from Barrett et al (2006) that about 30 percent of the Irish labour force have third level qualifications. Hence, the proportion of immigrant with third level qualifications, at over 40 percent, points to a high-skilled inflow.

As regards immigrants from the EU10, although they have the lowest proportion of highly educated across the immigrants groups, they still compare favourably with the domestic labour force in terms of skill levels."

Now, there are several things going on in this statement. Here is the table Alan actually refers to:
Obviously, disregard the USA part - there are only 28 observations in the entire sample of American respondents in 2005 data set (couldn't find any Americans, folks?). But the rest is pretty much in line with what we do know... And here are the issues:

• 6.4% of the EU10 migrants report only a primary level or less - the highest number for all migrants. For all Irish residents, this figure was around 14% in 2008 and it was 16% in 2005. The fact that the EU10 citizens come from the countries with compulsory primary and secondary education helps, and the quality of their primary and secondary education should be pretty comparable to that of their Western European, American and Irish counterparts.
• 9.3% have lower secondary education and 37.8% have upper secondary education. Seems like EU10 workers are more educated. They are not - these percentages refer to the highest level of education achieved. So 53.5% of the EU10 residents in Ireland have attained, as their highest level of education only 'at or below higher secondary level'. This is more than any of the other migrant groups: 47.3% for UK, 25.7% EU13, 33.4% for Other and 39.2% for the entire migrant population. In other words, more EU10 migrants stopped their education at higher secondary level than any other group of migrants. For the overall Irish labour force this number was 65% - meaning only 35% of Irish resident labour force has moved on to reach higher educational levels.
• Of course, any education below a full third level degree means little in terms of skills - Alan should know this. For anyone without a third level degree, their skills are determined largely by the length of tenure and work-related training. I wrote about huge returns to tenure in Ireland, relative to education and this surely explains much of wages differentials for migrants. It is slightly surprising seeing a good economist, such as Alan, occasionally mixing up the two concepts. Here, of course, EU10 migrants lose, for they are (a) relative new comers (have not enough tenure to acquire requisite skills); and (b) might have greater language barriers to absorbing on the job training as efficiently as their UK, US and Irish counterparts. One must also add that Irish companies are not really as well advanced in formal and structured on-the-job training and that leaving work training to FAS (as many do) is a veritable disaster. All of this likely reduces actual skills of the lower (below college degree level) educated migrants.
  
• Now, consider those who actually finish their third level degree or progressed above it. EU10 = 19.2%, Irish labour force average = 16% (recall we are comparing 2005 figures here). A small differential, which is likely to be statistically significant only if the data is measured accurately (it is not - see below). But when it comes to comparing EU10 nationals to other migrants - well, they are not in the running, are they?

So Alan's conclusion that EU10 migrants are relatively well educated only holds water when compared against the native workers, but not against other migrants, and if we are to assume that data for the EU10 migrants is free of self-reporting biases and errors, and if their degrees are actually fully comparable to those in the rest of the world.

Here is a different look at the same data (augmented with the latest CSO stats):There are more fundamental difficulties in making these comparisons that really are not Alan's fault, but do distort analysis.

One simply cannot bunch those EU10 migrants who arrived before the Accession 2004 (many) and those who arrived after (even more). In econo-speak, there are cohort effects.

These cohort effects distort 2004-2005 data, because in those years, majority of EU10 citizens residing in Ireland were most likely the same residents who lived here before 2004. Few years back I published a paper on the topic and showed some evidence that the pre-2004 group - selected under meritocratic migration policies - was indeed of a better quality than those that followed them post-2004. Not surprisingly, given that back pre-2004 they had to prove that they can compete against Americans, Europeans, Asians and the rest. Post-2004, this requirement was removed - the EU10 states were simply encouraged by this Government to displace workers from elsewhere. Of course, such displacement took place in the sectors where skills are less important than brawn - construction, retail, hospitality. Hence, not surprisingly, many of post-2004 workers were elected (and elected themselves) into lower paying domestic economy jobs, for:
(a) the path of least resistance made them move into jobs available to them, and
(b) they actually might have had difficulty proving to productivity-focused MNCs and a handful of externally trading domestic firms that they have better skills than, say, Indian software engineers, American finance specialists and so on.

Third problem is in the data itself. Virtually every taxi driver in NY is a self-reported 'medical doctor', 'dentist', 'pharmacist', 'physics professor', 'engineer' or a 'lawyer'. And yet none work in their fields, despite the US operating an extremely meritocratic system of qualification examinations to confirm medical degrees, for example, or to pass your bar exams, has comprehensive degree recognition culture and requires no specific certification for many fields. This is the issue with self-reported data when it comes to educational attainment questions - it is often of extremely poor quality.

Workers from the UK or US or EU13 might have fewer reasons to embellish their qualifications - they do not perceive this labour market to be discriminatory toward them. And, if you hold a degree from an internationally ranked university, you have nothing to prove to anyone. Those from the countries identified by their compatriots or Irish media or trade unions as being at risk of discrimination will have an incentive to gold-plate their qualifications. And if the university from which you obtained your degree does not rank in top 100-200 in the world, well - you just might add that extra claim to your qualifications, to strengthen your CV. Not all will take such steps, but some (how many?) will.

These, in my view, are very interesting areas for inquiry. I certainly wish Alan would have explored at least some of them. And I certainly hope he will update his data sources, for 2005, hmmm - that is ancient history by today's norms.