28/12/15: BOFIT summary of 2016 outlook for Russian Economy

Per recent BOFIT summary:

“Forecasters see the Russian economy contracting slightly in 2016. Recent economic forecasts, with the exception of the brighter projection of Russia’s economy ministry, see GDP contracting about a half per cent. A couple of forecasts expect a drop of about 1 %. The average price of oil next year is assumed to average $50–55 a barrel.

Most forecasts also see imports declining a bit further. Almost all forecasts see private consumption shrinking next year, most by about 1 %.

The CBR’s forecast update this month, however, reduced its earlier projection and now expects private consumption to contract by nearly 4 %. The consumption projections reflect the anticipation that household income growth will not keep up with inflation, especially as increases of public sector wages and pensions have been set very low due to the frail condition of government budgets.

The forecasts also see fixed investment slipping further by roughly 1 %. Estimates of the volume of Russian exports vary more widely, but forecasters generally expect exports to rise slightly in 2016.”

My view on Russian economic growth prospects for 2016 were reflected in my column for Slon.ru: http://trueeconomics.blogspot.ie/2015/12/151215-russian-outlook-for-2016-slon.html.

26/12/15: Depositors Insurance or Depositors Rip-off?

What's wrong with this picture?

In simple terms, nothing. The Central Bank has embarked on building up reserves to fund any future pay-outs on deposits guarantee.

In real terms, a lot.

Central Bank deposits guarantee will be funded from bank levies. However, in current market environment of low competition between the banks in the Irish market, these payments will be passed onto depositors and customers. Hence, depositors and customers will be funding the insurance fund.

Which sounds just fine, except when one considers a pesky little problem: under the laws, and contrary to all the claims as per reforms of the EU banking systems, depositors remain treated pari passu (on equal footing) with bondholders (see note here on EU's problems with doing away with pari passu clause even in a very limited setting: http://trueeconomics.blogspot.ie/2015/11/271115-more-tiers-lower-risks-but.html). Now, let's consider the following case: bank A goes into liquidation. Depositors are paid 100 cents on the euro using the new scheme and bondholders are paid 100 cents on the euro using the old pari passu clause.

Consider two balancesheets: one for depositor holding EUR100 in a deposit account in an average Irish bank over 5 years, and one for the bondholder lending the same average bank EUR100 for 5 years.

Note: updated version

Yes, the numbers are approximate, but you get the point: under insurance scheme the Central Bank is embarking on, the depositor and the bondholder assume same risks (via pari passu clause), but:

• Depositor is liable for tax, fees and insurance contributions, whilst facing low interest rates on their deposits; while
• Bondholder is liable for none of the above costs, whilst collecting higher returns on their bonds.

So, same risk, different (vastly different) returns. Still think that insurance fund we are about to pay for a fair deal?..

26/12/15: A Trendless World of 'Recovery'?

Anyone watching financial markets and economics in 2015 would know that this year was marked by a huge rise in volatility. Not the continuous volatility along the established trend, but a 'surprise' volatility concentrated on the tails of distributions of returns and growth numbers. In other words, the worst kind of volatility - the loss and regret aversion type.

Here are two charts confirming the said pattern.

Starting with asset classes:

Source: BAML

In the 'repaired' world of predictable monetary policy with well-signalled forward guidance, 2015 should have been much calmer, as policy surprises were nowhere to be seen (Bank of Japan continued unabated flooding of money, while ECB embarked on its well-in-advance-flagged QE and the Fed 'cautious rates normalisation' switched was anticipated for months, amidst BOE staying put, as predicted by everyone every time London committee met). Alas, that was not the case and 2015 ended up being a year of more extreme shifts into stress than any other year on record.

Likewise, the U.S. economic growth - the most watched and most forecasted series in the global economy - produced more surprises for forecasters:

Source: Goldman Sachs

Per above, 2015 has been a second consecutive year with U.S. GDP growth surprising forecasters to the downside. Worse, yet, since 2001, U.S. GDP growth produced downside surprises compared to consensus forecasts in 12 out of 15 years.

In the past cycles, the early 1990s recession produced an exit from the downside cycle that resulted in 2 consecutive years of upside surprises in growth; for the exit from the 1980s recession, there were five consecutive periods of upside growth relative to the forecasts. Even in the horrific 1970s, the average forecast over-optimism relative to outrun was closer to zero, against the current post-recessionary period average surprise to the forecast being around -0.5 percentage points.

In other words, if you need a confirmation that four years after the 'recovery' onset, the world of finance and growth remains effectively 'trendless', have another look at the charts above...

25/12/15: WLASZE: Weekend Links on Arts, Sciences and Zero Economics

Merry Christmas to all! And in spirit of the holiday, time to revive my WLASZE: Weekend Links on Arts, Sciences and Zero Economics postings that wilted away under the snowstorm of work and minutiae, but deserve to be reinstated in 2016.

[Fortunately for WLASZE and unfortunately for die harder economics readers of the blog, I suspect my work commitments in 2016 will be a little more balanced to allow for this...]


Let's start with Artificial Intelligence - folks at ArsTechnica are running an excellent essay, debunking some of the AI myths. Read it here. The list is pretty much on the money:

• Is AI about machines that can think (in human intelligence sense)? Answer: predictably No.  
• Is AI capable of outstripping human ethics? Answer: not necessarily.
• Will AI be a threat to humanity? Answer: not any time soon.
• Can the AI system acquire sudden singularity? Answer: sort of too far away and doubtful even then.

The topic is hugely important, extremely exciting and virtually open-ended. Perhaps of interest, I wrote back in 2005 about the non-linearity and discontinuity of our intelligence as a 'unique' identifier of humanity. The working paper on this (I have not revisited it since 2005) is still available here.

And to top the topic up, here is a link on advances in robotics over the grand year of 2015: http://qz.com/569285/2015-was-a-year-of-dumb-robots/. The title says it all... "dumb robots"... or does it?..

Update: another thought-provoking essay - via QZ - on the topic of AI and its perceived dangers. A quote summarising the story:
"Elon Musk and Stephen Hawking are right: AI is dangerous. But they are dangerously wrong about why. I see two fairly likely futures:

• Future one: AI destroys itself, humanity, and most or all life on earth, probably a lot sooner than within 1000 years.
• Future two: Humanity radically restructures its institutions to empower individuals, probably via trans-humanist modification that effectively merges us with AI. We go to the stars."

Personally, I am not sure which future will emerge, but I am sure that there is only one future in which we - humans - can have a stable, liberty-based society. And it is the second one. Hence my concerns - expressed in public speeches and blog posts - with the effects of technological innovation and the emergence of the Gig-Economy on the fabric of our socio-economic interactions.

At any rate... that is a cool dystopian pic from QZ

Dangers of AI or not, I do hope we sort out architecture before robots either consume or empower us...

On the lighter side, or may be on a brighter side - for the art cannot really be considered a lighter side - Saatchi Art are running their Best of 2015 online show here: http://www.saatchiart.com/shows/best-of-2015 that is worth running through. It is loaded with some younger and excitingly fresher works than make traditional art shows. 

Like Jonas Fisch's vibrantly rough, Gears of Power 

All the way to the hyper-expressionist realism of Tom Pazderka, here is an example of his Elegies to Failed Revolutions, Right Wing Rock'n'Roll 

And for that Christmas spirit in us, by Joseph Brodsky, translated by Derek Walcott (for a double-Nobel take):

The air—fierce frost and pine-boughs.


We’ll cram ourselves in thick clothes,


stumbling in drifts till we’re weary—


better a reindeer than a dromedary.

In the North if faith does not fail


God appears as the warden of a jail


where the kicks in our ribs were rough


but what you hear is “They didn’t get enough.”

In the South the white stuff’s a rare sight,


they love Christ who was also in flight,


desert-born, sand and straw his welcome,


he died, so they say, far from home.

So today, commemorate with wine and bread,


a life with just the sky’s roof overhead


because up there a man escapes


the arresting earth—plus there’s more space.

Merry Christmas to all!

25/12/15: Comment for Expresso on U.S. Fed hike

My comment for Portugal's Expresso (December 19) on U.S. Fed rate hike:

23/12/15: Corporate Leverage: "I miss you since the place got wrecked"

Remember all the deleveraging the U.S. economy has gone through during the crisis? Why, sure, we've learned a lesson about too much debt, did we not?

Except when you look at the Deutsche Bank data in the following chart:

Source: @SoberLook 

By which the investment grade corporates' net leverage is at all time high 3 quarters running and rising; and gross leverage is at all time high 4 quarters running and rising. Or as Leonard Cohen's lyrics go:

"Ah we're drinking and we're dancing 

and the band is really happening 

and the Johnny Walker wisdom running high..."

23/12/15: Vnesheconombank: where things stay ugly

As reported by BOFIT, Russia’s 4th largest and state-owned Vnesheconombank  (VEB Group which technically is not a bank, but a development bank and an owner of a number of banks, so as such VEB is not subject to CBR supervision) requires estimated funding supports at EUR15–20 billion “to cover at least the next few years”.  Per Bloomberg, VEB has been seeking USD23 billion “to support long-term growth and pay off the upcoming loan” (data as of November 23). VEB total assets in Russia amount to ca EUR45 billion, which, per BOFIT, “would make VEB Russia’s fourth largest bank with holdings that correspond to about 4 % of the banking sector’s total assets”. Overall, VEB holds 2.8 trillion Rubles in loans assets and around 1 trillion Rubles in other assets.

To-date, VEB received EUR8 billion in deposits from the National Welfare Fund and about EUR500 million in other monies (most of which came from the Central Bank’s 2014 profits).

Per both, Bloomberg and BOFIT: VEB has been a major lender behind Sochi Winter Olympics 2014. New lending increased total loans held by the bank by some 25% in Ruble terms in 2013 before doubling loans in 2014. VEB started aggressive loans expansion in 2007 since when its assets base grew almost 10-fold. Over 2015, bank-held loans posted some serious deterioration in quality forcing bank to set aside significant reserves to cover potential losses. Per Reuters report, “S&P estimates some 500 billion roubles of VEB's loans were directed by the government and are therefore regarded as relatively risky. While the huge investments made in Sochi have generated public discussion in Russia, far less attention has been given to no less massive investments VEB made in Ukraine. "That's still on their books and they keep rolling those loans over. Of course it's only a question of time before they accept losses on those assets," said S&P's Vartapetov. In an interview in December 2013, VEB Chairman Vladimir Dmitriev said the bank had via Russian investors ploughed $8 billion into Ukrainian steel plants, mainly in the Donbass region, since ravaged in a separatist conflict. He said the investment had supported 40,000 Ukrainian workers, but did not say how the Russian economy had benefited.” Overall, Russian banks’ continued presence and even growth in Ukraine - while puzzling to some external observers - can be explained by the significant role these banks play in the Ukrainian economy.

In 2014, VEB posted full year loss of USD4.5 billion / RUB250 billion and in 1H 2015 losses totalled USD1.5 billion. VEB’s Ukrainian subsidiary was one of the big drivers for these. Based on the figures, VEB posted the largest loss of any Russian company in 2014.  The top three largest loss making companies in 2014 were: Vnesheconombank, followed by the steelmaking giant Mechel (loss of 167 billion rubles) and the monopoly Russian Railways (losses of 99 billion rubles).

In addition, VEB holds some USD19.3 billion of debt maturing through 2025 (see chart from Bloomberg) with EUR9 billion of this in eurobonds:

VEB is subject to both EU and US sanctions which effectively shut VEB access to funding markets and the bank will require between EUR2.5 and 3 billion for debt servicing in 2016 alone. This week, VEB secured a five-year loan of 10 billion yuan or EUR1.4 billion from China Development Bank.

Recently, Finance Minister Anton Siluanov stated that VEB requires as much as USD20 billion in funding (ca 1.7% of Russian GDP), and that VEB is expected to sell some of its assets to fund part of the gap.


Per Bloomberg, “the finance ministry’s proposals include exchanging the lender’s Eurobonds for Russian government securities, Vedomosti reported Nov. 24. Other options on the table include a local government bond offering for 1.5 trillion rubles to recapitalize the bank, and transferring bad assets from VEB’s balance sheet to the state, according to newspaper Kommersant.”

22/12/15: Baltic Dry Index: not much of a post-Fed bounce

With the optimism of Christmas week forecast (traditionally keen on stressing the upside to the global economic conditions), let's not forget the Baltic Dry Index:

As the chart above shows, global trade ain't doing too well in this *finally repaired* and *full employment-bound* world economy. In fact, the index has been ploughing the depths that put to shame even the abysmal December 2008 crisis lows. Not surprisingly, the post-Fed bounce was pretty much a fizzle...

Ho-ho-ho... 

20/12/15: Of those Russian GDP 2016 forecasts

In my recent column for Slon.ru (see: http://trueeconomics.blogspot.ie/2015/12/151215-russian-outlook-for-2016-slon.html) I quipped that in the case of the Russian economy, forecasts for 2016 growth rates might just as well be taken from the fortune tellers, as there are too many moving factors driving the economy, all of which are virtually impossible to forecast.

Now, h/t to @JoMichell, we have a picture of 'predictability' of one key driver of the Russian economy - oil prices. Please, keep in mind: these are Brent prices (Urals grade predictability is even lower, as Urals-Brent spread is subject to further uncertainty, including geopolitical risks and substitution risks, as discussed in my Slon.ru column).

So here is a chart showing IMF forecasts for Brent prices issued back in June 2015:

 Note that in the above, least probable downside scenario is for oil above USD40 per barrel through 2015. Alas, the least probable forecast is not exactly the lower bound for reality:

So here we have it: less than 6 months forecast out, and the least probable worst case scenario has been breached already. Good luck pinning Russian GDP forecasts down...

19/12/15: Oil Prices: One Chart, Two Years

A neat summary / timeline of oil price changes in two years:

Source: @allmarkets 

19/12/15: Another Un-glamour Moment for Economics

Much of the current fascination with behavioural economics is well deserved - the field is a tremendously important merger of psychology and economics, bringing economic research and analysis down to the granular level of human behaviour. However, much of it is also a fad - behavioural economics provide a convenient avenue for advertising companies, digital marketing agencies, digital platforms providers and aggregators, as well as congestion-pricing and Gig-Economy firms to milk strategies for revenue raising that are anchored in common sense. In other words, much of behavioural economics use in real business (and in Government) is about convenient plucking out of strategy-confirming results. It is marketing, not analysis.

A lot of this plucking relies on empirically-derived insights from behavioural economics, which, in turn, often rely on experimental evidence. Now, experimental evidence in economics is very often dodgy by design: you can’t compel people to act, so you have to incentivise them; you can quite select a representative group, so you assemble a ‘proximate’ group, and so on. Imagine you want to study intervention effects on a group of C-level executives. Good luck getting actual executives to participate in your study and good luck getting selection biases sorted out in analysing the results. Still, experimental economics continues to gain prominence, as a backing for behavioural economics. A still, companies and governments spend millions on funding such research.

Now, not all experiments are poorly structured and not all evidence derived from is dodgy. So to alleviate nagging suspicion as to how much error is carried in experiments, a recent paper by Alwyn Young of London School of Economics, titled “Channelling Fisher: Randomization Tests and the Statistical Insignificance of Seemingly Significant Experimental Results” (http://personal.lse.ac.uk/YoungA/ChannellingFisher.pdf) used  “randomization statistical inference to test the null hypothesis of no treatment effect in a comprehensive sample of 2003 regressions in 53 experimental papers drawn from the journals of the American Economic Association.”

The attempt is pretty darn good. The study uses robust methodology to test a statistically valid hypothesis: has there been a statically significant result derived in the studies arising from experimental treatment or not? The paper tests a large sample of studies published (having gone through peer and editorial reviews) in perhaps the most reputable economics journals. This is creme-de-la-creme of economics studies.

The findings, to put this scientifically: “Randomization tests reduce the number of regression specifications with statistically significant treatment effects by 30 to 40 percent. An omnibus randomization test of overall experimental significance that incorporates all of the regressions in each paper finds that only 25 to 50 percent of experimental papers, depending upon the significance level and test, are able to reject the null of no treatment effect whatsoever. Bootstrap methods support and confirm these results. “

In other words, in majority of studies claiming to have achieved statistically significant results from experimental evidence, such results were not really statistically significantly attributable to experiments.

Now, the author is cautious in his conclusions. “Notwithstanding its results, this paper confirms the value of randomized experiments. The methods used by authors of experimental papers are standard in the profession and present throughout its journals. Randomized statistical inference provides a solution to the problems and biases identified in this paper. While, to date, it rarely appears in experimental papers, which generally rely upon traditional econometric methods, it can easily be incorporated into their analysis. Thus, randomized experiments can solve both the problem of identification and the problem of accurate statistical inference, making them doubly reliable as an investigative tool. “

But this is hogwash. The results of the study effectively tell us that large (huge) proportion of papers on experimental economics published in the most reputable journals have claimed significant results attributable to experiments where no such significance really was present. Worse, the methods that delivered these false significance results “are standard in the profession”. 

Now, consider the even more obvious: these are academic papers, written by highly skilled (in econometrics, data collection and experiment design) authors. Imagine what drivel passes for experimental analysis coming out of marketing and surveying companies? Imagine what passes for policy analysis coming out of public sector outfits? Without peer reviews and without cross-checks like those performed by Young?

18/12/15: Ukraine Inches Even Closer to a Default

So, we have this:

Which means that Ukraine and Russia - so far - have failed to agree terms of debt restructuring. As a reminder, over the last few days, Ukraine and Russia were involved in a 'last minute' dialogue (via Germany) to resolve the issue.

Does this mean that Ukraine is now in a sovereign debt default? Technically - no. Ukraine will only be in a default after 10 days grace period expires, which means the parties to the talks still have 12 days to reach an agreement and avoid default.

Does this mean that Ukraine is now in breach of IMF lending criteria? Technically - no. IMF amended its own rules allowing lending to continue for countries in official sector default, as long as these countries continue to engage in debt restructuring negotiations with the lenders.

Can the two countries reach a deal in time to avoid official default? Unlikely: any deal between Russia and Ukraine (except for a deal that treats Russia under the same terms extended to private lenders - a deal that is simply unacceptable to Russia) will require approval of other (commercial) lenders under the agreement between commercial lenders and Ukraine struck earlier. There is simply not enough time to achieve such an approval, even assuming, there is a deal and the deal can be approved (both assumptions are quite a stretch).

Do both parties show will to negotiate in good faith? So far - no. Russian offer (see here) has been to restructure debt by extending repayment period (a real haircut absent nominal haircut, as far as I read this). The offer shifted Russian position in negotiations in the direction of Ukraine's position: from the opening position that the debt is official sector debt and thus should be repaid in full and in time. Ukraine's position has been to treat Russian debt equivalent to private sector debt and Ukraine (as far as public record goes) did not alter its position to move closer to Russian offer. Ukraine also deployed consistent rhetoric of "Our way or the highway" variety. In other words (I am willing to be corrected on this), Russia made insufficient step toward Ukraine, while Ukraine made no step toward Russian position whatsoever.

Note: my view has been (consistently over time) that Russia should restructure loans to Ukraine to a longer term, say 10-year, bond extended at original interest rate and allow for 2-3 years interest payments moratorium. Financially optimal solution would have been to impose a haircut on principal and extend maturity of the remaining balance. But, given Ukraine's failure to secure stronger restructuring with private sector lenders, this option is not available and is politically infeasible.