Tuesday, April 23, 2013

23/4/2013: Ignore Europe's Debt Crisis at Your Own Peril

In recent days it became quite 'normal' to bash 'austerity' and talk about debt overhang as the contrived issue with no grounding in reality. Aside from the arguments of those worked up about Reinhrat & Rogoff (2010) paper (ignoring all other research showing qualitatively, and even quantitatively similar results to theirs), there is a pesky little problem:

  • Debt has physical manifestation (albeit an imperfect one) in the form of banks (lenders) balancesheets. 
As the result of this pesky problem, we can indeed gauge (again, an imperfect translation, but better than none) the effect of repairing these balancesheets on the supply of credit, thus on investment, and thus on real economic activity.

Here are 2012 IMF estimates of the effects of the euro area banks deleveraging on the real economy:

'Weak policies' in the above are what we currently pursuing - with monetary and fiscal policies mismatch. And the negative effect of the declines runs past 2017 in the case of the heavily-indebted peripheral states. Cumulated decline estimated, relative to baseline GDP forecasts, is almost 12% over 5 years. Which over 20 years (average duration of the debt crises episodes) runs closer to 0.7% of GDP loss per annum due to banks deleveraging, aka due to banks managing debt levels on their own balancesheets.

The above chart is based on banking sector lending alone, excluding effects from deleveraging by other investors and financial intermediaries, and excluding effects of non-EU banks deleveraging or effects of the non-EU banks exits from the euro area. With these in place, the adverse effects can probably reach beyond 1% mark.


Monday, April 22, 2013

22/4/2013: Government Latest Hair-brained Idea

Earlier today, RTE has reported that:
"The [Irish] Government has launched a plan to facilitate the creation of 20,000 jobs in the manufacturing sector by 2016." Frankly speaking, I can't be bothered to read much more into the idea. In times of aplenty it is bonkers to allow the state to pick winners in the economics game and then let civil servants lavish 'investment' supports onto them. In times when debt/GDP ratio is up at 120% of GDP marker and private debt is bending the nation into the ground, the very same idea is simply a prescription for massive waste we can't afford. 

But here's what, according to RTE report is even worse: 
  1. "Under the plan fledgling manufacturing companies will get to apply for support from a specific start-up fund." Wait... start-up funds invest in start-ups which, by their definition can't be in existence long enough to become 'fledgling' - unless they are 'fledging from the start-up phase' which is equivalent to being dead-on-arrival. So question for Irish boffins: you will be investing in freshly-dead firms or fledgling ancient 'one-day-were-start-ups'?
  2. "There will also be a support fund for capital investment by manufacturing companies and additional financial support for R&D investment in engineering firms." Aside from capital investment (presumably, having nationalised most of the banking system, our markets-supportive Government now has appetite to take on equity in manufacturing firms too) idea which suffers from the same problem of 'winners-picking', leading to risk-mispricing (which in current fiscal conditions can be labeled 'waste' outright), there is a problem of R&D supports. Targeted tax and sponsorship allocations to R&D supports are not a good policy for stimulating high value-added R&D. Here's one study that found as much. 
  3. "The plan also contains proposals to maintain or reduce company costs for energy, waste, regulation and tax." Wait, how is that going to be achieved, if, per our semi-state behemoths and the Government, there is no ripping-off of consumers/users going on in Irish energy, waste and tax environments? Either things are being priced to rip-off customers today (thus allowing for some price reductions), or there is no room for price reductions, or - as most likely - the Irish Government is planning to increase rip-off of other customers (e.g. households) to subsidise select manufacturing ones.
  4. If Irish Government pumps said subsidies into select manufacturers, how does this square with the equal markets treatment laws within the EU? And how will the Irish Government deal with the pesky problem that you can engage in industrial favouritism while making any serious claims about having a real markets-oriented economy here?
I can go on about this latest idea. It is promised that it will 'create' 20,000 jobs by 2016 - a claim that is, as always is the case with the Irish Government pronouncements, is neither verifiable, nor based on any serious analysis. But, needless to say, there will be loads of PR opportunities involving flowers, ribbons, Ministers and RTE cameras in months to come. Meanwhile, when your taxes go up comes December 2013 once again, don't ask why, think Government 'jobs creation' plans... Think big... Think someone else is getting subsidies so you don't have to...

22/4/2013: Who funds growth in Europe?..

There are charts and then there are Charts. One example of the latter is via IMF CR1371

The above shows a number of really interesting differences between the euro area and the US, as well as within euro area:

  • Look at the share of overall funding accruing to the traditional (deposits) banks in the US (tiny) and the euro area (massive) - debt is the preferred form of funding for Europe
  • Look at the share of equity in the US funding and in euro area, ex-Luxembourg - equity is not a preferred way for funding growth in Europe.
  • Why the above matter? Simply put, debt - especially banks debt - is not challenging existent ownership of the firm raising funding. Which means that patriarchal structures of family-owned firms, with their inefficient and paternalistic hiring and promotions and management systems can be sustained more easily in the case of debt-funded firms than in the case of equity funded ones.
  • Look at the role played in the US by the credit supplied by 'other financial institutions' - non-banks. Again, these would be more 'activist'-styled funding streams exerting more pressure on management and ownership structures.
What about Ireland? Look at the composition of funding sources in the country:
  1. Strong reliance on corporate bonds markets is probably reflective of three factors: (a) concentrated loans issued during the building boom and related to construction, development & investment in land remain the legacy of the boom and rely on collateralized bonds issuance, (b) banks funding via collateralization, (c) concentrated nature of Irish listed plcs, (d) massive M&A spree undertaken by Irish plcs and larger private companies on foot of cheap leverage available in the 2000-2007 period, etc. The volume of bonds might be large, but their quality is most likely lower due to the above points.
  2. Strong - actually second strongest in the sample after Cyprus - reliance on bank lending to fund economy.
  3. Weak, extremely thin equity cushion. 
Now, keep in mind: equity is the best, most stable and most suitable for absorbing crisis impact form of funding.

Sunday, April 21, 2013

21/4/2014: Exports-led recovery? Not that promising so far...

Regular readers of this blog know that since the beginning of the crisis, I have been sceptical about the Government-pushed proposition that exports led recovery can be sufficient to lift Ireland out of the current crises-induced stagnation.

Over the recent years I have put forward a number of arguments as to why this proposition is faulty, including:

  1. A weakening link between our GDP, GNP and national income,
  2. A worrisome demographic trend that is structurally leading to lower labour markets participation, alongside the renewed emigration,
  3. Structural weaknesses in the economy left ravaged by some 15 years if not more of bubbles-driven growth,
  4. Taxation and state policy structures that favor old modes of economic development and which are incompatible with high value-added entrepreneurship, employment creation and growth, 
  5. Substitution away from more real economy-linked goods exports in favor of the superficially inflated exports of services in the ICT and international financial services sectors, etc
But the dynamics of our exports are also not encouraging. 

Here's a summary of some trends in Irish exports since 1930s, all expressed in relation to nominal value of merchandise trade (omitting effects of inflation). Based on 5-year cumulative trade volumes (summing up annual trade volumes over 5 year periods):
  • Irish exports grew 147.8% in 1980-1984 and 86.7% in 1985-1989 - during the 1980s recession. This did not lift Irish economy out of the crisis, then.
  • Irish exports grew 56.3% in 1990-1994 period and 56.4% in 1995-1999 period. Thus, slower  rate of growth in exports during the 1990s than in the 1980s accompanied growth in the 1990s. This hardly presents a strong case for an 'exports-led recovery'.
  • Irish exports expanded cumulatively 148.0% in 2000-2004, before shrinking by 0.4% in 2005-2009 period and is expected to grow at 4.6% cumulatively in 2010-2014 (using 2010-2012 data available to project trend to 2014). 
The last point above presents a problem for the Government thesis on exports-led recovery: the rates of growth in merchandise exports currently expected to prevail over 2010-2014 period are nowhere near either the 1980s crisis-period rates of growth or 1990s Celtic Tiger period rates of growth.

Ok, but what about trade surplus? Recall, trade surplus feeds directly into current account which, some believe almost religious, is the only thing that matters in determining the economy's ability to recover from debt-linked crises. Again, here are the facts:
  • During the 1980-1984 Ireland run trade deficit that on a cumulative basis amounted to EUR5,969mln. This gave way to a cumulated surplus of EUR8,938mln in 1985-1989 period. So attaining a relatively strong trade surplus did not lift Irish economy from the crisis of the 1980s.
  • In Celtic Tiger era, during 1990-1994 period, cumulated surpluses rose at a robust rate of 155.7% on previous 5 year period, and this increase was followed by a further improvement of 113.9% in 1995-1999 period. 
  • During Celtic Garfield stage, in 2000-2004 period Irish trade surplus increased by a cumulative 245.4%. However, in 2005-2009 period trade surplus shrunk 10.9% cumulatively on previous 5 years. Based on data through 2012, projected cumulated growth in trade surplus (recall, this is merchandise trade only) grew by 43.6%.
Again, trade surplus growth is strong, currently, but it is nowhere near being as strong as in the 1990s. Worse, current rate of growth in trade surplus is well below the rate of growth attained in the 1980s.

Charts to illustrate:


Oh, and do note in the above chart the inverse relationship between the ratio of merchandise exports to imports (that kept rising during the Celtic Tiger and Garfield periods as per trend) and the downward trend in exports growth. 

21/4/2014: Sunday Independent article

My article on Euro area austerity policies failure in Sunday Independent - it's not in levels of cuts, but in the lack of real change from the status quo.


Friday, April 19, 2013

19/4/2013: More from the IMF on Irish banks...

Getting back to the IMF GFSR report released earlier this week. Some nice charts worth a quick comment or two:

Two things worth noting in the above:

  1. Increase in covered bonds for Irish banks, absent, pretty much, any serious issuance between 2007 and 2012 and maturing of some bonds. This may be linked to the deteriorating quality of assets against which the bonds were secured, requiring 'top-ups' with new assets. In effect, this means that to maintain existent level of funding a bank will require more assets to be put aside.
  2. Massive, relative to GDP, exposure to MROs + LTROs for the Irish banks. Let's keep in mind that some Irish banks were precluded from participating in the second LTRO due to lack of suitable collateral. Even with that, Irish banking sector exposure to LTROs relative to GDP is the largest of all countries in the sample.
The next two charts plot relationship between banks' lending to households and corporates and the growth forecasts for the economies:


By both charts above, Ireland appears to be basically just on the borderline between the core and the peripheral countries. Of course, this means preciously little, since Irish banks basically are issuing no new loans and thus whatever rates they report are heavily, very heavily biased in favour of higher quality borrowers. Here's how this bias works: the bank in Ireland issues a loan to company A for the amount X and duration W. The rate on this loan is r=f(A,X,W)  such that if A quality is higher then rate r  is lower, if X is larger, the rate is higher, and if W is longer, the rate is also higher. We control all other variables that might influence the rate quoted. If the case of the same company looking for the same loan outside Ireland, the bias above would imply a lower rate quoted, or a smaller loan granted or for shorter duration, or all or any permutations of the above. 

Here is an interesting point. In the first chart above, Irish house loans rates went up during the crisis, but corporate loans rates went dramatically down during the crisis. Now, houses-related loans within the Irish banking system are currently in default at close to 20% rate, while SMEs loans are in default close to 50% rate. High quality corporates are probably in the same rate of default today as in 2007. Which means that corporate loans book of Irish banks should be posting default rates (NPLs) of similar or larger proportions as house lending book. Yet the rates for two types of loans have moved in the opposite direction and very significantly.

On foot of the above, question for our Dear Leaders: Are Irish banks, for purely political reasons (recall Government's repeated exhortations about the need for the banks to 'do their bit for the economy', 'lend to our SMEs' etc), using house loans pricing to subsidise corporate loans issuance?

Just in case you start harping on about Irish corporates having better debt loads than households, IMF has the following handy charts:

And more: Irish corporates have exceptionally poor interest coverage ratios:
Keep in mind - the above applies only to listed firms, not to privately held ones...

19/4/2013: Mountains to climb, canyons to wade across

Nice visual from Pictet gang, sizing up two banking systems:


That was pre-'rescue' of Cypriot economy from itself by the 'benevolent' Troika Partners...

Recall, the package deal includes scaling back Cypriot banks to ca x3 GDP, or cutting the sector back to just about where it was in mid-2012 for Iceland, given the magnitude of GDP contraction from 2012 levels that this would require. It will be the case of roughly 'Look to your left, look to your right - either both of the bank clerks next to you are gone, or you are gone with one of them in tow'.

Updated:

And another visual from Pictet folks:

19/4/2013: Decomposition of Irish GDP & Gross Operating Surplus: 2012

Recent CSO data release shows decomposition of 2012 Irish GDP and Gross Operating Surplus (defined as GDP less taxes and compensation of employees, plus subsidies). Here are annual dynamics:

 Overall,

  • Households' contribution in 2012 to the GDP rose 5.66% y/y and is down 21.02% on peak
  • Government's contribution in 2012 to the GDP declined -1.76% y/y and is down 12.04% on peak
  • Financial Corporations' contribution in 2012 to the GDP rose 2.98% y/y and is down 10.75% on peak
  • Non-Financial Corporations' contribution in 2012 to the GDP rose 3.03% y/y and is down 7.27% on peak
  • Not-sectorised areas of activity contribution in 2012 to the GDP rose 4.34% y/y and is down 35.70% on peak

 Per chart above,

  • Households' contribution in 2012 to the Gross Operating Surplus rose 11.12% y/y primarily due to subsidies increases, and is down 19.86% on peak. Subsidies to households rose 18.30% y/y in 2012.
  • Government's contribution in 2012 to the Gross Operating Surplus declined -7.29% y/y and is down 14.89% on peak
  • Financial Corporations' contribution in 2012 to the Gross Operating Surplus rose 6.01% y/y and is down 14.68% on peak
  • Non-Financial Corporations' contribution in 2012 to the Gross Operating Surplus rose 2.50% y/y and is down -2.1% on peak
  • Not-sectorised areas of activity contribution in 2012 to the Gross Operating Surplus rose 2.94% y/y 
  • Overall Gross Operating Surplus rose 4.58% y/y and is down 9.75% on peak
Now, on to the relative importance of each broader sector in main areas of determination of the Gross Operating Surplus:






Note that in the above, Government share of any activity defining Gross Operating Surplus ranges from  zero for taxes and subsidies, to 25-27% for compensation of employees, to11.4-13.0% for GDP and overall Government accounts for only 3.18% (2002-2007 average) and 3.31% (2012 average) of the Gross Operating Surplus in the Irish economy. In other words... does it really matter that much?

Consider the disparity:
  • In 2002-2007 on average, Households accounted for 17.4% of all GDP generation, a share that declined to 15.87% in 2012. Meanwhile, for the Government, the same figures were 11.41% and 13.04% - significantly less during the boom years and marginally less in 2012.
  • In 2000-2007 on average, Households accounted for 26.49% of all Gross Operating Surplus in the economy, with that share sliding to 24.84% in 2012. For the Government, the same figures were 3.18% in 2002-2007 and 3.31% in 2012.
  • Notice the gaps?
Consider another interesting thing:

  • In 2002-2007 on average, Non-Financial Corporations (NFCs) accounted for 50.4% of all GDP generation, a share that rose to 52.4% in 2012. Meanwhile, for the Government, the same figures were 11.41% and 13.04%. So as GDP share goes, NFCs were much, much more important than the Government, by a factor of 4.
  • In 2002-2007 on average, NFCs accounted for 55.6% of all Employees compensation generation, a share that rose to 53.3% in 2012. Meanwhile, for the Government, the same figures were 24.8% and 27.1%. So as Employees compensation share goes, NFCs still more important than the Government, but now only by a factor of less than 2.
  • In 2000-2007 on average, NFCs accounted for 56.9% of all Gross Operating Surplus in the economy, with that share rising to 60.6% in 2012. For the Government, the same figures were 3.2% in 2002-2007 and 3.3% in 2012.
  • Now, again, consider the above gaps...

19/4/2013: Watch out for overheating Euro area growth...

Ifo Institute issued its updated forecasts for Germany and Euro area 2013-2014. Here are the summaries:


As Euro area aggregate forecast shows, the European Century is rolling on with expected 0.4% annual expansion in real GDP in 2013 and 0.9% roaring growth in 2014 expected. Meanwhile, the speedy engine for Euro area growth - Germany - is expected to post 0.8% boom-time growth in 2013 and globally impressive, future path-inspiring expansion of 1.9% in 2014.

Clearly, we must be watching out for a positive output gap emerging soon, as both economies will be overheating in the next 19 months from all this tremendous growth...

Thursday, April 18, 2013

18/4/2013: Legalising Modern Version of Slavery


Insolvency guidelines published today were wholly and fully written by the banks and for the banks.

The core points are that under the new regime, Irish mortgagees will be:
  1. Treated as de facto strategic defaulters until they are proven not guilty of such behaviour in a biased process that will see them face fully resourced lenders while having no practical and meaningful means for defending themselves. 'Innocent until proven guilty' principle no longer applies in the Irish State.
  2. Permanently branded as defaulters for the rest of their lives as there record of applying for the resolution process will be kept indefinitely, independent of success or failure of the process.
  3. Will lose basically any means to sustain real savings, investment, pensions provisions for the duration of up to 6 years or even longer without any guarantee that their engagement with the system will end in resolving the debt overhang at the end of the process.

This means that the Irish economy will continue to struggle with the debt overhang and, materially, the current change in the regime will only serve the purpose of further shifting financial resources from the households to the banks.

There was no real functional process for consultation with the current providers of services to those facing the insolvency. There was no transparency in developing these Guidelines. Give you one example, there is no reference to the protection of consumers, mortgagees or borrowers in the entire text of the document.

Take it from the top: "A debtor should be able to participate in the life of the community, as other citizens do. It should be possible for  the debtor ‘to eat nutritious food …, to have clothes for different weather and situations, to  keep the home clean and tidy, to have furniture and equipment at home for rest and  recreation, to be able to devote some time to leisure activities, and to read books,  newspapers and watch television" according to the Guidelines.

In other words, from get-go, a debtor is not to be allowed to plan or provide for the retirement, to arrange for health cover, to build functional (as opposed to token) precautionary savings, or to have incentives to better their lives. 

Presumably, Irish social inclusion does not provide an allowance for dental care either. At EUR5 per week in allowed savings, a debtor would have to wait around 140 weeks in agonising pain before they can get a tooth cap. Children braces will take as much if not longer. And you better not dare go to a doctor more than once every two months during your dental affordability waiting period.

Now, let's give it a thought - we are releasing households with children into the wilderness of living without providing a single cent for uncovered (beyond those stipulated by the guidelines) eventualities - e.g. dental emergency or a breakdown of the sole family vehicle. And we give them no capacity to acquire such means by working harder or undertaking different jobs which pay more.

When it comes to access to car, the guidelines do not distinguish between the need to commute to work and to commute to deliver children to schools or childcare facilities. The guidelines also appear to ignore the fact that shopping for a family is not the same as shopping for a single individual when it comes to transportation options allowed. There are no provisions for households that may require two cars. There are no realistic provision for caring for the old-banger vehicle that Guidelines allow for and which cost more in repairs than newer vehicles which the households will be forced to sell.

The real flaw in this approach is that we start from the point of allowed disposable income and work our way back to earned income. This means that a household has absolutely no incentive to earn more, no allowance is provided for them to take up risk and become entrepreneurs, no capacity to fund change in employment. 

This is precisely what wage slavery is all about. And we are now putting people into it.

The Guidelines talk vaguely about the need to incetivise households to engage in economic activity, yet provide a cap on savings of EUR5 per week per adult. None allowed per child. 

In other words, suppose you satisfy the conditions of the Guidelines and you get a new job paying an extra EUR50 per week. You cannot save anything out of this, which means all of the additional income immediately accrues to the banks.

Now, imagine that a new job offer comes with the prospect of better pension down the line, greater promotional opportunities, better life satisfaction and other benefits you might want to have and that can significantly improve your and your family wellbeing, not to mention the economy. Alas, also assume that the new job requires you to commute to work by car while prior to that - with your old job - the Guidelines allowed only for public transportation option. You have no savings to buy the car and no access to new credit. Which means that you will either have to turn down the new job (at a loss to you, employer, the bank and the economy) or to borrower on terms and conditions from the bank with which you have arrangements in place (at a loss to you, as you can't keep the upside of the new job pay). 

This is like taking slave labour and forcing it to consume bank-provided services at prices set by the bank. In the 19th century this was the practice with monopsonist employers and it led to industrial unrest on a massive scale and even revolutions. Welcome to the New Ireland, folks.

Thus, even in theory, the Guidelines are not consistent with one of their intended purposes - that of supporting economic activity and participation in this activity by the households.


In a summary: From the beginning of this crisis I have argued that we need to import UK insolvency regime into Ireland, so as  to allow effective and efficient bankruptcy resolution. 

What we have done instead is put forward a modern-day, democratically legislated slavery in the name of protecting our banks and created an incentive for tens of thousands to convert current bankruptcy tourism into a permanent bankruptcy emigration. 

Welcome to the 21st century model of a Dickensian nightmare grafted onto, as Namawinelake puts it perfectly world's most exemplary Nanny State.


Updated:
Two excellent posts on the Guidelines that are a must read:

Brian Lucey's: http://brianmlucey.wordpress.com/2013/04/18/pettifogging-nanny-state-gone-mad/

and

Namawinelake's: http://namawinelake.wordpress.com/2013/04/18/hey-world-if-you-want-to-see-what-a-true-nanny-state-looks-like-look-at-what-ireland-has-just-done/

Wednesday, April 17, 2013

17/4/2013: Global Banking Sector Roadkill Alley (aka euro area)

Lets play the game of 'Spot the odd one out...' 

Fact 1: Globally, growth is concentrating in Latin America, Asia Pacific and Africa (see earlier post here) and the lowest growth centre is the Euro area.

Fact 2 (via IMF GFSR Chapter 1):
Question: Which banking system has spent almost three years now 'deleveraging' itself out of global growth centres so it can focus its immensely healthy balancesheets on pursuing growth where there is no growth in sight?

Answer on a post-card addressed to:
Mr Mario Draghi 
Kaiserstrasse 29
60311 Frankfurt am Main, Germany

Bonus round: in the Sick Banks Club (aka euro area) which are the sickest and second sickest national banking systems?

For hint, see this post.

17/4/2013: IMF's succinct summary of Irish banking mess


IMF's GFSR Chapter 1 offers a nice visual highlighting the fact that Irish banking system is still the sickest of all banking systems in Europe, bar that of Greece (which doesn't count, for anyone with a will to argue the point, as it has been comprehensively destroyed in rounds of sovereign debt restructuring and by all Troika MOUs is yet to undergo the 'repairs' similar to those allegedly 'completed' in Ireland in 2011):

And a footnote explaining the chart: