12/9/2013: BlackRock Institute survey: N. America & W. Europe: September 2013

BlackRock Investment Institute released its latest Economic Cycle Survey for North America and Western Europe region for September 2013.

Per summary: "This month’s North America and Western Europe Economic Cycle Survey presented a positive outlook on global growth, with a net of 71% of 119 economists expecting the global economy will get stronger over the next year. (1% higher than within the August report). 

At the 12 month horizon, the positive theme continued with the consensus expecting all economies spanned by the survey to strengthen or remain the same. 

The consensus outlook for the Eurozone continued to improve, where the 6 month forward outlook shifted from 75% to 86% expecting the currency-bloc to move to an expansionary phase. The picture within the bloc was not uniform however, with most respondents expecting Portugal, Greece, Belgium and the Netherlands to remain in a recessionary phase over the next 2 quarters. 

With regards to the US, the consensus view firmly that North America as a whole is in mid-cycle expansion and remaining so through H2 2013."

September improvement for the global outlook was much shallower than a 10 point jump in August. Ditto for Eurozone outlook: this rose from 57% in July to 75% in August to 87% in September. Italy outlook seemed to have improved quite markedly, however.

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

Two charts as usual:

Ireland continues to lead expectations, just as it did in previous 3 months.

In global expectations there were some notable movements in analysts' replies. 6% of analysts expected global economy to get a lot stronger over the next 12 months back in August, and this declined to 2% in the current survey. 69% expected it to get a little stronger in August and this proportion rose to 76% in September. 5% expected the global economy to get a little weaker in the next 12 months back in August, which in September rose to 6%. 

In Ireland's case, in August zero percent of analysts expected the economy to get a lot stronger over the next 12 months and this remained unchanged in September survey. All analysts (100%) expected the Irish economy to get a little stronger over the next 12 months in September survey - same as in August. 57% of analysts expected the economy to be in an early-cycle recovery over the next 6 months back in August, and this fell to 50% for September survey. There was significant rise (from 0% to 17% between August and September surveys) in the proportion of analysts expecting Irish economy to be in mid-cycle expansion over the next 6 months period. The number of analysts expecting the economy to be in a late-recession over the next 6 months dropped from 43% in August to 33% in September.

6/9/2013: BlackRock Institute survey: North America & Western Europe: August 2013

BlackRock Investment Institute released its latest Economic Cycle Survey for North America and Western Europe region.

Per summary: "This month’s North America and Western Europe Economic Cycle Survey presented an improvement in the outlook for global growth over the next 12 months – the net proportion of respondents with a positive outlook increased to 70% from 60% last month. 

The consensus outlook for the Eurozone was particularly positive, where the 6 month forward outlook shifted from 57% to 75% expecting the currency-bloc to move to an expansionary phase. 

The picture within the bloc was not uniform however, with most respondents expecting Portugal, Greece, Belgium and the Netherlands to remain in a recessionary phase, while the consensus has shifted to expect expansion for France, Spain, Finland and Ireland over the next 2 quarters. An even mix of economists expect Italy to be expansionary or recessionary at the 6 month horizon (and similarly so for Norway, outside of the currency-block). 

With regards to the US, the proportion of respondents expecting recession over the next 6 months remain low, with the consensus view firmly that North America as a whole is in mid-cycle expansion and remaining so through H2 2013."

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

Here are two summary charts:

9/8/2013: Political Waffle Passing for Learning?

Mr Schulz - the President of the European Parliament - has penned an op-ed that is available here: http://www.linkedin.com/today/post/article/20130809113308-239623471-did-we-really-learn-the-lessons-of-the-crisis?trk=tod-home-art-large_0


My response is as follows:

This article is a trite rehashing of cliches, some of which have served as pre-conditions to the crisis, by a man who is presiding over the institution complicit in creation of the crisis in the first place, as well as in exacerbating the adverse impact of the crisis on the member states of the EU. 

Let me just deal with the first set of Mr Schulz's core hypotheses: 

"Firstly, the invisible hand of the market does not work and needs a robust regulatory framework." 

Given that the Euro area crisis arose from the disastrous mis-management of the monetary union, the statement is absurd and ideologically dogmatic. Markets require proper regulation and are legally-based structures. Mr Schulz seems to fail to understand this and is confusing anarchy with the 'invisible hand' of the markets. European markets have failed, in part, due to wrong regulation (not the lack of regulation) and in part due to the lack of enforcement of existent regulation. Mr Schulz seems to have no idea as to these facts. Institutions that commonly failed to enforce existent regulations and treaties include, among others, the European Commission (allegedly reporting to the EU Parliament, that Mr Schulz presides over) and the European Parliament itself.

The markets failures were, in the case of the 'peripheral' euro states, exacerbated by the inactions and actions of the European authorities, including those by the European Parliament.

"Secondly, politics should gain primacy over markets and labour over capital." 

Primacy of politics over markets (or rather economics) in Europe is exactly what led us into this crisis. 

Political dominance over economic policies design is behind the creation of the monetary union and the expansion of the union to include countries that are not ready for a single currency regime. It is also responsible for the fraudulent ways in which some member states have acceded to the monetary union (e.g. Italy and Greece, where misreporting and financial instrumentation of deficits and debt were rampant and Mr Schulz's institution was amongst those that were aware of these facts, were required to be aware of these facts, and yet were inactive in the face of these facts). Politicization of the markets for Government bonds, for foreign exchange, for credit, for equity, for risk pricing, etc has been responsible for inducing many deep failures in the markets in Europe. For one, this politicization has led to an unsustainable debt accumulation in the private sector and transfer of private debts onto the shoulders of taxpayers. 

I might agree with Mr Schulz on the point of 'labour' supremacy over 'capital'. Alas these are poorly defined concepts in Mr Schulz's case. Labour can mean labour unions (organised labour movement) or labour as human capital (skills, entrepreneurship, creativity, etc) and everything in-between. All of these definitions will contain internal contradictions in incentives, preferences for policies and responses to policies to each other and to the definitions of capital that can be deployed. Mr Schulz fails to define the categories he references, which suggests that his assertions are once again nothing more than populist sloganeering. Mr Schulz seems to have no idea that capital can be physical, technological, financial, intellectual or human. That 'labour' can be complementary to physical and technological capital in which case primacy of labour over technology can be destructive to the objectives of both. Mr Schulz appears to be inhabiting a simplistic universe more corresponding to that inhabited by Marx and Engels in the late 1840s than the one that exists today.

"Thirdly, and most importantly, the economy and politics should return to the values of solidarity, social justice, decency and respect." 

This is both historically incorrect and, frankly put, too rich coming from someone heading a powerful EU institution. 

It is inherently incorrect because a return implies existence of something in the past. European societies never possessed any real sense of 'solidarity' or 'social justice' but historically (and to-date) relied on preservation of the status quo of distribution of wealth within the set confines of the European elites and independent of merit. Thus, Europe never pursued meritocratic systems of wealth and income allocations. And subsequently never developed such systems. What Mr Schulz might mean (and we are reduced here to guessing) is the return to the status quo of interest groups-driven 'social' allocations of resources - a system commonly known as tax (someone else) and spend (on me or my friends). 

It is a rich statement coming from Mr Schulz because he presides over the EU institution that was at least complicit in forcing member states to transfer private sector losses onto taxpayers and failed to structure properly core institutional frameworks of the EU. Whether this complicity involved errors of omission or commission is irrelevant. The outcomes of these errors are Greece today, Cyprus today, Ireland today, and Italy, Spain, Portugal and so on. From this point of view, the perspective of returning to values by the political and economic institutions of Europe would first and foremost involve (require) restructuring of the European institutions from the top. Mr Schulz's job would be on the line in any such process of renewal and return to accountability. 

That, alas, is the nature of leadership: you fail and you are gone. Writing op-eds full of well-meaning waffle is, frankly, not an excuse for the failures of both action and inaction.

23/7/2013: Ireland is not Greece... and never was...

Resting on one's laurels is a dodgy proposition. However, forgetting one's achievements is of an equally problematic virtue. To balance things up - a good reminder of Ireland's road travelled from the 1960s through 2008 and I have adjusted figures for Greece and Ireland for 2012 levels of GDP per capita based on IMF data.

Source: the original from World Bank, 2012.

Interesting bit - Ireland remains in the 'rich' club as a country that managed an elusive move from middle income economy in the 1960s to high income economy in 2000s and 2010s. Greece dropped out of the same group.

17/7/2013: Wrong Austerity Compounds the Failures of the Monetary Union

Recent CEPR paper DP9541 (July 2013), titled "Debt Crises and Risk Sharing: The Role of Markets versus Sovereigns" by Sebnem Kalemli-Ozcan, Emiliano Luttini, and Bent E Sørensen (linked here: www.cepr.org/pubs/dps/DP9541.asp) used "a variance decomposition of shocks to GDP", in order to "quantify the role of international factor income, international transfers, and saving in achieving risk sharing during the recent European crisis."

Basic idea of the exercise was that a lack of saving in good times may reduce consumption smoothing in bad times, forcing households to cut back their spending and consumption more dramatically once recession hits.

Under perfect risk sharing, the consumption growth of individual countries should be completely independent from all other factors, conditional on world consumption growth.

The authors of the study "calculate how much of a shock to GDP is absorbed by various components of saving, in particular government saving, and other channels, such as net foreign factor income for the sub-periods 1990-2007, 2008-2009, and 2010." The key finding here is that "overall, risk sharing in the EU was significantly higher during 2008-2009 than it was during the earlier period, but total risk sharing more or less collapsed in 2010." Notably, 2010 is the year when European economies embarked on 'austerity' path, primarily and predominantly expressed (especially in the earlier stages) in tax increases. It is worth noting that there virtually no reductions in public spending during 2009 or 2010 across the EU and even in countries where spending was cut, such as Ireland, much of the reductions came from indirect taxation - e.g. transfers of health spending from public purse to private insurance.

Further, the authors "study how the crisis a affected risk sharing for "PIIGS" countries (Portugal, Ireland, Italy, Greece, and Spain), which were at the center of the sovereign debt crisis, compared to non-PIIGS countries (Austria, Belgium, Denmark, Finland, France, Germany, the Netherlands, Sweden, and the United Kingdom)."

Again, the findings are revealing: "For 1990-2009, risk sharing was mainly due to pro-cyclical government saving but the amount of risk sharing from government saving turned negative in 2010 for the PIIGS countries: government saving increased at the same time as GDP decreased." In other words - this is the exact effect of austerity as practised by the EU periphery.

"For [euro area peripheral] countries our measure of overall risk sharing turns negative because (conditional on world consumption growth) the decline in GDP in 2010 was accompanied by a more than proportional decline in consumption. This mirrors the behavior of emerging economies where government saving typically is counter-cyclical as shown by Kaminsky, Reinhart, and V egh (2005)."

Crucially, the study shows that there is basically no risk-sharing mechanism that operates on the entire euro area level. Even common currency zone - via lower interest rates - does not deliver risk sharing in 2010 and has potentially a very weak effect in 2008-2009 period. Worse, for the euro area peripheral states, euro has been a mechanism that seemed to have removed risk sharing opportunities both in and out of the crisis:

"…although non-PIIGS countries shared a non-negligible amount of risk during 2000{2007 while the PIIGS shared little risk in those years: in the good year 2005, consumption increased faster than GDP leading to "negative risk sharing." In 2008 and 2009 the major amount of GDP risk is shared for non-PIIGS with low consumption growth rates in spite of large drops in GDP, with the amount of risk shared in 2008 over 100 percent (positive consumption growth in spite of negative GDP growth). For the PIIGS, consumption declined very little in 2008 in spite of a large drop in GDP, while the drop in GDP in 2009 clearly led to declining consumption and, in 2010, consumption fell by almost as much as GDP, indicating little risk sharing."

Top line conclusion: once the authors "decompose risk sharing from saving into contributions from government and private saving", data reveals "that fiscal austerity programs played an important role in hindering risk sharing during the sovereign debt crisis."

13/7/2013: Reuters on Anglo Tapes & Social Awakening in Ireland

Reuters programme on Ireland awakening to the banking and economic mess. Warning: shameless self-promotion (my contributions included).

http://uk.reuters.com/article/video/idUKBRE96B0X620130712?videoId=244195065

12/7/2013: IMF Report on Malta: A Warning for Ireland

IMF Report on Malta is out, with, as expected, much of attention given to the risks of erosion of the tax advantages that form one of the core drivers for Malta's growth. This, of course, is of interest to other European jurisdictions, including Ireland.

IMF opens the report with a statement that Malta (emphasis in italics is mine) "has maintained macroeconomic stability in the face of a major crisis in Europe. Low reliance on external finance by the government and domestic banks, solid fundamentals, and a sound banking system have contributed to this resilience. However, recent events in Europe have heightened financial stability risks. In the longer term, Malta’s attractiveness as a financial and business location could be adversely affected by regulatory and tax reforms at the European level. "

"The Maltese economy has greatly benefitted from a business-friendly tax regime… Although these gains are hard to quantify, the large increase experienced in financial services [parallels to our IFSC anyone?] and other niche activities [in Malta's case: online gambling. In Ireland's: all IP-linked tax arbitrage, e.g. Google et al] since 2004 are likely related to Malta’s accession to the EU [which means Ireland is hardly unique here], its macroeconomic stability [which Ireland spectacularly does not have], and relatively favorable tax regime [bingo!]. Over the last ten years, more than half of the growth in value added is explained by the growth in financial services, ancillary activities (legal, accounting, and consulting), remote gaming, and ICT [wait, wait… but Dublin?… replace remote gaming with pharma - worse]. These sectors alone account for a quarter of total value added and 12 percent of employment [err… even more in Ireland and growing, again - replace remote gaming with gaming and… worse in the case of Ireland]. It is possible that greater fiscal integration of EU member states and a potential harmonization of tax rates could erode some of these benefits, with consequences on employment, output and fiscal revenues."

The risk is medium in size, medium/low in probability of materialisation and medium term - per IMF:

And thus, the report states that "The authorities were also of the view that an EU-wide tax harmonization would not happen in the short or medium term." However, let me ask you a simple question - how often does the IMF directly and bluntly pointing actual risks to the euro area states? After they have fully materialised, only. Hence, IMF stating the politically-sensitive and structurally important risk is 'medium/low' in likelihood and 'medium' in expected impact is as stern of a warning as one might expect. At any rate, of 6 main risks faced by the Maltese economy, the risk of tax regime changes is ranked joint 3rd with the risk of Protracted period of slower European growth, Significant declines in real estate prices, and ahead of the risk of Global oil shock triggered by geopolitical events.


Why such downplaying of the risks?

"Malta has been an important international banking centre in the past 25 years. A special offshore regime for banks (and other non-bank institutions) was promoted since the late
1980s. Like in several other European jurisdictions (Cyprus, Ireland, Luxembourg, or Switzerland), the main incentives offered to foreign investors at that time included exemptions from various regulations imposed on onshore banks and a favorable fiscal treatment."

How bad?

"The separate offshore supervisory framework was eliminated in 2002. As part of the planned accession into the EU, Malta was required to amend its financial policies to treat local businesses the same as international companies. In the mid-1990s, Malta started abolishing its offshore banking. In 2002, the legal amendments to the Banking Law removed an offshore banking option. Since then, all banks operate under the same regulatory and fiscal frameworks."

Spotting a picture of Dublin's IFSC, yet?..

"However, Malta maintained a substantial tax incentive for attracting foreign investors
in its banking and other businesses. This was achieved through tax refunds based on the
dividends that a local bank distributes to its shareholders. While the headline corporate income tax rate in Malta is 35 percent, the application of a tax refund system positions Malta as the country with one of the lowest effective tax in the EU, which ranges between 0 and 12 percent. The quantum of the tax refund depends on the nature of income and is generally equal to 6/7th of the underlying tax (35 percent), resulting in a 30 percent tax refund of the taxable profits."

Of course, Ireland does not provide such refunds - instead we have a Mega 'Refund' System called Double-Irish.

"In addition, the EU accession in 2004 and the euro adoption in 2008 boosted international banking and non-bank financial sector activities in Malta. Several large banking groups from various countries around the world (Australia, Germany, Saudi Arabia, etc) established their presence in Malta since the mid-2000s. The EU and euro area memberships inspired confidence; the former also allowed non-EU investors an easy access to European markets, while the latter facilitated transactions for EU-based investors. The availability of skilled people and the use of English as the official language also contributed to making Malta an attractive place for doing business by the multinational banks."

You have to laugh reading the above, as you can just replace Malta with Ireland there and nail the regular IDA presentations…

"As a result, the internationally-active banks have become large compared to the size
of the Maltese economy. As of October 2012, there were 13 non-core domestic banks and
8 international banks, with assets of respectively €5.3 billion (80 percent of GDP) and €33.1 billion (500 percent of GDP). The majority of these banks are subsidiaries of EU banks offering a range of services to non-residents that include trade finance, investment banking, and group funding operations."

"Unlike some other EU countries with a big international financial centre (for example,
Cyprus or Ireland), Malta has not experienced any deleveraging pressures in recent years. As a result, measured by the total bank assets to GDP ratio, Malta now ranks higher than Cyprus or Ireland, and is second only to Luxembourg among all EU countries."

Problem, Roger, is that the above statement is pretty much bonkers. Ireland has deleveraged not tax-sensitive international banking sector, but tax incentives-insensitive domestic sector. Cyprus 'deleveraged' deposits. So from the truth-in-analysis point of view, one should look at the compatible assets and liabilities at risk of tax regime changes. And that is much harder, as a large part of Irish internal assets and liabilities is really IFSC, while part of Malta's external assets and liabilities is domestic economy.

All in - the risk is real. This is why IMF (having downplayed it to medium) still posits it as the fifth most significant in overall terms.

Ireland should be seriously concerned.

Note: I wrote about the threats to Ireland from tax policy harmonisation most recently here: http://trueeconomics.blogspot.ie/2013/07/272013-sunday-times-june-23-2013-g8-and.html
And I wrote about Malta's tax dilemma and IMF analysis of it before, here: http://trueeconomics.blogspot.ie/2013/05/1552013-what-imf-assessment-of-malta.html

17/6/2013: ESM Rules Book Draft

Reuters recently reported [Updated: link is here http://pdf.reuters.com/pdfnews/pdfnews.asp?i=43059c3bf0e37541&u=2013_06_17_11_43_b16e8d8f95d140d2a6693737fcd98885_PRIMARY.pdf  H/T to @Taleof2Treaties] on a document prepared for the Eurogroup meeting in Luxembourg that puts forward more detailed set of rules for ESM deployment in recapitalising the banks.  The rules, as seen by Reuters, involve:

• A private sector bail-in to be required before any ESM contribution can be made. More on this below; and
• The ESM will apply a two-tier test in deciding whether recapitalisation can be carried out: the capital must fall below critical adequacy levels, and the bank must be considered systemic for the eurozone as a whole, not a national system. Which means in the case of Ireland - no recapitalisations of ANY irish bank, neither BofI, nor AIB, nor Anglo. Per ESM rule book, the whole country can go insolvent, as long as Deutsche Bank or Credit Agricole are still floating.

When a bank gets into trouble, the Euro-Troika: ECB, the European Commission and the ESM,

• Will stress-test / value bank’s assets. Euro-Troika will set the required level of capital the bank will require, thus opening the process to the transfer of foreign-held liabilities onto the shoulders of the country taxpayers. For example, suppose an Irish bank X holds 10% of its liabilities against external foreign subordinated lenders. In normal case, these would be forced to take a haircut first. But Euro-Troika can determine that is must make good on full 10%, thus transferring liability fully to the sovereign of bank X domicile via the first requirement that the sovereign must step in ahead of any ESM recapitalization. 
• After determining the amount of capital required, the ESM will also determine if the bank has the minimum legal common equity Tier 1 ratio, currently at 4.5%. If the bank does not meet the minimum, the government would inject between 10% and 20% of the funds shortfall. The ESM will provide the residual.
• If the government cannot meet the demands for 10-20% injection, the ESM will not step in to recap the bank
• Once the bank is recapitalised using ESM funds, ESM will take equity in the bank and will engage in setting bank strategy and business model. The ESM will also track bank performance to targets and will also have power to change bank management and board. This will be a major departure from the modus operandi of the Irish authorities, but to what extent it will be effective / significant remains to be see. After all, pro forma changes can be put in place with minor alteration to the pre-crisis status quo.

The document says ESM will deal with legacy assets, which is an ambiguous statement, but potentially holds some hope for Ireland.

8/6/2013: Euromoney Credit Risk summary for Ireland

Latest results for Euromoney Country Risk survey for Ireland:

30/5/2013: That fiscal adjustment race... where we are?

How much more adjustment needed for Ireland to reach fiscal debt stabilization? Ok, nice folks at Deutsche Bank Research have done some plots and:

Which is, of course IMF number of ca 5% of GDP, and it puts Ireland neatly ahead of all peripheral states. We are, afterall, in a better position... except... well, except of one snag: GDP is not something that matters much for Ireland. Instead - we are more like a GNP economy, by which metric the primary adjustment required for Ireland to reach debt/GDP stabilisation is more like... 6.25% of GNP which puts us right at Portugal's doorsteps. Now, consider that Ireland has started the crisis well ahead of all other peripheral states and went into the Troika programme well ahead of all peripheral states, save Greece. Which means that at least a year ahead of all peripherals, we are barely ahead of them in distance to target. Yep, you know - that race ain't over until it is over.

28/5/2013: Germany Might Have Caused the Euro Crisis... but...

CNBC today cites a piece of research (http://www.cnbc.com/id/100769233) that argued that "Germany's insistence on keeping wage growth in check has given the country an unfair competitive advantage vis-à-vis its euro zone peers and is preventing troubled countries from returning to growth, a new study argues."

This non-sensical argument cuts across any reasonable understanding of competitive advantage and the role of economic policy in driving this advantage. Germany undertaking structural reforms neither prevented other states from doing the same, nor imposed any costs (or reduced competitiveness) of other states. The authors of the report and the CNBC should go back to Economics 101 to brush up on their understanding of the competitive advantage concept.

In the nutshell, it is not Germany that caused the crisis - based on competitive advantage argument - but the peripheral states' lack of reforms to deliver their own competitiveness improvements.

However, the mere idea that Germany has 'caused' the crisis in the euro area still merits consideration. There are two strands of thought on this that are potentially valid:
1) Germany actively suppressed domestic demand and thus reduced aggregate demand within the euro area: while true to the point that German domestic demand was and remains too weak, this hardly implies any negative slipovers to the peripheral economies of the euro area, unless someone makes a compelling reason as to why German consumers should be buying vastly more Greek feta cheese or olive oil, and paying vastly more for their purchases; and
2) euro area construct itself induced asymmetric development within the common currency area: Germany, as the core driver of euro area creation is, thus, to be blamed for some failures of the construct.

The latter is a preferred explanation in my opinion and there is an interesting paper from the CEPR (published in March 2013: CEPR Discussion Paper No. 9404) titled "Political Credit Cycles: The Case of the Euro Zone" by Jesús Fernández-Villaverde Luis Garicano and Tano Santos that actually confirms my gut instinct.


The authors "study the mechanisms through which the adoption of the Euro delayed, rather than advanced, economic reforms in the Euro zone periphery and led to the deterioration of important institutions in these countries. We show that the abandonment of the reform process and the institutional deterioration, in turn, not only reduced their growth prospects but also fed back into financial conditions, prolonging the credit boom and delaying the response to the bubble when the speculative nature of the cycle was already evident. We analyze empirically the interrelation between the financial boom and the reform process in Greece, Spain, Ireland, and Portugal and, by way of contrast, in Germany, a country that did experience a reform process after the creation of the Euro."


Some more beef from the paper, as CEPR is password protected site:

Per authors, "Before monetary union took place with the fixing of parities on January 1, 1999, the conventional wisdom was that it would cause its least productive members -particularly Greece, Portugal, Spain, and Ireland1- to undertake structural reforms to modernize their economies and improve their institutions. [However], due to the impact of the global financial bubble on the Euro peripheral countries, the result was the opposite: reforms were abandoned and institutions deteriorated. Moreover, …the abandonment of reforms and the institutional deterioration prolonged the credit bubble, delayed the response to the burst, and reduced the growth prospects of these countries."

How so?

"In the past, the peripheral European countries had used devaluations to recover from adverse business cycle shocks, but without correcting the underlying imbalances of their economies. The Euro promised to impose a time-consistent monetary policy and force a sound fiscal policy. It would also induce social agents to change their inflation-prone ways. Finally, … it would trigger a thorough modernization of the economy."

Germany actually is an example of what the euro was supposed to deliver:

"Faced with a limited margin of maneuver allowed by the Maastricht Treaty and with a stagnant economy, Germany chose the path of structural reforms, giving a new lease on life to German exports. But this did not happen in the peripheral countries. Instead, the underlying institutional divergence between them and the core increased. The efforts to reform key institutions that burden long-run growth, such as rigid labor markets, monopolized product markets, failed educational systems, or hugely distortionary tax systems plagued by tax evasion, were abandoned and often reversed. Behind a shining facade laid unreformed economies.

"The common origins of the financial boom are well understood. The elimination of exchange rate risk, an accommodative monetary policy, and the worldwide easing in financial conditions resulted in a large drop in interest rates and a rush of financing into the peripheral countries, which had traditionally been deprived of capital. Furthermore, demographics in Ireland and Spain favored the start of a construction boom with some foundations in real changes in housing demand, the opposite of Germany, where demographics depressed housing demand. … the percentage of the population between 15 and 64 increased dramatically in Ireland and, to a lesser degree, in Spain between the mid 1970s and 2007. In France and Germany, the peak happened about two decades earlier. Since then, both countries have experienced a slow decay in this segment of the population. These demographic trends were accompanied by an increase in the employment to population ratio and, thus, resulted in strong rates of growth even in the absence of productivity gains."

The paper identifies "two channels through which the large inflows of capital into the peripheral economies led to a gradual end to and abandonment of reforms":

1. The first channel "is the relaxation of constraints affecting all agents. It has long been observed in the political economy literature that for growth-enhancing reforms to take place, things must get “sufficiently bad” (see Sachs and Warner, 1995, and Rodrik, 1996). And, as the development literature has emphasized, foreign aid loosens these constraints by allowing those interest groups whose constraints are loosened to oppose reforms for longer. As explained in section 2, Vamvakidis (2007) also finds that this mechanism operates when debt grows, rather than aid."
2. "The second mechanism is more novel. It affects the ability and willingness of principals to extract signals from the realized variables in a bubble, where everything suggests all is well. A sequence of good realizations of observed outcomes leads principals to increase their priors of the agents’ quality. When all banks are delivering great profits, all managers look competent; when all countries are delivering the public goods demanded by voters, all governments look efficient (this mechanism applies both to real estate bubbles, as in Ireland and Spain, and to sovereign debt bubbles, as in Portugal and Greece). This information problem has negative consequences for selection and incentives. Bad agents are not fired: incompetent managers keep their jobs and inefficient governments are reelected. The lack of selection has particularly negative consequences after the crisis hits. Moreover, incentives worsen and agents provide less effort."

Combining the two channels: "Both of these mechanisms, the relaxation of constraints and the signal extraction problem, led to a reversal of reforms and a deterioration in the quality of governance in these countries. Somewhat counterintuitively, this observation implies that being able to finance oneself at low (or negative) real interest rates may have negative long-run consequences for growth."

There is little new here:

• "Other economists have already pointed out that the financial cycle reduces future growth, simply because of the debt overhang (Reinhart and Rogoff, 2009; Bernanke, Gertler, and Gilchrist, 1999)." [Note: the R&R 2010 controversy does little to dispel the core argument of financial cycle transmission of adverse debt effects, as I am arguing in my forthcoming Village magazine column - stay tuned for later link posting on this blog];
• "Also, researchers working on resource booms have suggested mechanisms that delay growth that apply here by analogy (a financial bubble is, in a way, a form of a resource boom). Grand, ill-conceived government programs involve lasting commitments that lead to higher taxes in the long run."
• "Also, the “Dutch disease” suffered most clearly by Ireland and Spain (with land playing the role of a natural resource here) spreads, whereby human and physical capital moves from the export-oriented sector toward real estate and the government sector. But in our view, the reform reversal and institutional deterioration suffered by these countries are likely to have the largest negative consequences for growth."
• The idea also relates to Rajan (2011), "who links the real estate bubble in the U.S. with an attempt by politicians to shore up the fortunes of a dwindling middle class." 

The authors "emphasize, instead, that in Europe the real estate boom interacted with the political-economic coalition that blocked reforms, allowing large policy errors to remain uncorrected and institutions to deteriorate."

Thus, if Germany did 'cause' the crisis in the euro periphery, it is solely by not enforcing the discipline required within a common currency area - too little stick too much carrots from Berlin was the problem, not too little imports of peripheral products into the core.

28/5/2013: That Cracking Success of the Troika Programmes

Some 'stuff' is coming out of the EU nowdays to greet the silly season of summer newsflow slowdown:

The loose-mouthed Eurogroup head Jeroen Dijsselbloem [http://online.wsj.com/article/BT-CO-20130527-702547.html?mod=googlenews_wsj] is striking again. This time on Portugal's 'progress' on the road to recovery:
""If more time is necessary because of the economic setback, that more time might be considered" as long as the country is being "compliant" with the program, Mr. Dijsselbloem told reporters after meeting with Portuguese Finance Minister Vitor Gaspar."

Of course, Dijsselbloem is simply doing what is inevitable - acknowledging that the EU/Troika programme for Portugal is as realistic as it was for

• Ireland (which undertook two extensions, one restructuring, one expropriation round vis-a-vis pensions funds, and two rates cuts to-date on its 'well-performing programme' and is looking for more), 
• Greece (which received three extensions, three restructuring, PSI - aka outright default, deficit and privatizations targets adjustments),
• Spain (which so far got only banks bailouts, but has already secured two rounds of deficit targets extensions),
• Cyprus (which hasn't even received full 'support' package yet, and already needs more funds).

It is worth noting that Portugal itself has already seen debt restructuring by the Troika in two rounds of loans extensions and two rounds of interest rates cuts.

So in the world of EU logic: if loans restructuring => success.

Please, keep in mind loans restricting ⊥ <=> success (for those of you who tend to argue that my above argument can mean that absence of EU restructuring implies success).


Oh, and while on the case of Ireland, Herr Schaeuble has stepped in to put a boot into Minister Noonan's dream of ESM swallowing loads of Irish banks' legacy debts [http://www.nytimes.com/reuters/2013/05/27/business/27reuters-germany-schaeuble-banks.html?src=busln&_r=0]:"European countries should be under no illusion that they can shift responsibility for problems in their national banking sectors to the bloc's rescue mechanism". Now, recall that Minister Noonan is having high hopes riding on ESM taking stakes in Irish banks to ease burden on taxpayers. See point 1 links here: http://trueeconomics.blogspot.ie/2013/05/26052013-ireland-hard-at-work-on-troika.html

So it looks like another round of loans restructurings is in works, just to underpin the immense success of the Troika programmes in Euro area 'periphery'.

17/5/2013: Ireland v Iceland 2013

Ireland vs Iceland macroeconomic comparatives in 15 simple charts that DofF wouldn't want you to see...

All data is either IMF direct-sourced or based on IMF data. Click on the charts to see more detailed comments imbedded in them.

Three charts on GDP comparatives:

Investment:

External trade and balance:

Unemployment and Employment:

Government Finances:

23/4/2013: Updating the cost of banking crisis data

Nice update from the ECB on the cumulated cost of the banking crisis in Europe, now available through 2012. The net effect, summing up all assumed sovereign liabilities relating to the crisis, including contingent liabilities, and subtracting asset values associated with these liabilities are shown (by country) in the chart below:

Note the special place of Ireland in the above.

For the euro area as a whole, net liabilities relating to the crisis back in 2007 stood at EUR 0.00 (EUR36.72 billion for EU27). By the end of 2012 these have risen to EUR 740.15 billion (EUR 734.23 billion for EU27).

Net revenue losses for Government arising from the banking sector rescues, per ECB are:

16/4/2013: One question, Mr Market, please...

A uncomfortable question:

Faith seems to have no bounds once sentiment shifts. The Market seemed to have maintained confidence in EU's crisis-fighting 'measures' despite the fact that Cyprus case revealed an obvious lack of any real crisis-fighting 'measures' to-date.

The entire periphery-fixing policy tool kit in Europe - now into the sixth year running - still boils down to

1. Rolling out unfulfilled promises (ESM banks-sovereigns break, OMT, a banking union, fiscal policies coordination, fiscal supports for growth - do recall that EU keeps talking about the need to 'support' growth and yet does nothing about providing such supports), 
2. Dogmatic ECB stuck in a rates and money supply policies that neither ease currency and interest rates pressures, nor provide a break from the failed transmission mechanism, and 
3. Internal devaluations of the worst kind (ad hoc loading of debt on economies already carrying too much debt & lack of reforms in the real economy - keep in mind, setting deficit targets ≠ reform). 

So would The Market please run this by me: What HAS changed between Ireland 2008 (the beginning of the euro crisis) and Cyprus 2013 (it's latest iteration) other than the channels by which more debt is being piled onto over-indebted economies hit by crisis?

Well, not much. Yesterday, IMF has issued a statement on Greece (that's right - the second country that was 'repaired' by the EU approach to crisis, ...and then repaired again... and again) claiming that with the fourth round of 'reforms' promised, Greece is now (still?) on a sustainable debt path. Never mind that the 'sustainable debt paths' so far for Greece have meant debt/GDP ratios bounds for sustainability rising from 'under 120%' within Programme 1 to 'under 200%' within Programme 4.

15/4/2013: About that orchestra on Titanic's deck...

In a telling sign of total disconnect with reality, last week we heard two bizarre comments from the European 'leaders' all made in the context of Dublin Ministerial dealing with Cyprus.

First, "Klaus Regling, managing director of the ESM, told reporters that the fund had had its "most successful week". The statement can on foot of ESM selling EUR10bn worth of new debt in heavily oversubscribed markets. Alas, the said claim was made in the week when ESM became the sole vehicle for handling EU side of the Cyprus 'bailout'. In other words, Regling, like rest of EU 'leaders' measures success by how high he can pile on debt (EUR8bn worth of bonds here, EUR2bn worth of notes there), not by real economic outcomes (which can see Cypriot economy shrinking 15% in one year - some 'success').

However, the weekly prize for detachement from reality goes, as it often does, to Olli 'The Delusional' Rehn - the EU Commissioner for Something-to-do with Economy - who was forced to concede that Cypriot bailout can lead to the island economy shrinking up to 15% in 2013. Never, mind, says Rehn, as "I don't deny that there is uncertainty about the precise figure whether it will 10 percent, 12.5 percent or 15 percent."

Indeed, 'never mind'. You'd think he would make it his job knowing. But, of course, why bother, since 10-12.5-15 percent range clearly might reach into 20-22.5-25 percent range as easily and Mr Rehn wouldn't bat an eyelid. Especially since the host nation's Government - aka Ireland's 'best pupils in the EUssroom' - were there to cheer Mr Rehn in exchange for getting a handful of platitudes from important foreigners. Behold Jeroen Dijsselbloem's claim that Ireland is "a living example that adjustment programmes do work". Cyprus, presumably, will be the EU's roadkill of history... joining Greece and Spain, with Italy and Portugal in the waiting wings.

In short, we are now going verifiably gaga this side of the Atlantic, begging for a comparison with the orchestra that played through Titanic's sinking. Alas, the orchestra, as historian tell, was rather competent one - unlike Messrs Rehn, Regling, et al.

9/3/2013: Slight improvement in Irish credit risk score

Small and in-line with other countries improvement in Irish Sovereign and Economic risk score from Euromoney Country Risk:

20/2/2013: Hungary's 'Return' to Bond Markets

Week ago, Friday, Hungary was downgrade to junk. This Tuesday, despite its newly-minted junk bond status from all three core agencies (Ba1/BB/BB+) Hungary went to the market with a plan to raise USD3bn worth of US Dollar-denominated bonds. 

Now, unlike Ireland, Hungary is NOT in the 'best-of-class' league in Europe when it comes to compliance with the Troika demands and in general. After all, Hungary went on to aggressively interfere with its Central Bank independence, broke off negotiations with the IMF on second 'rescue' package back in November 2012, and basically replaced the Governor of the Central Bank with dovish Monetary Council. The country economy is still in a tailspin based on IMF figures*, although its fiscal performance, external balance and unemployment are healthier than those of the 'best-in-class' country - Ireland: 

-- Hungarian GDP is estimated by the IMF to have fallen by -1.021% in 2012 (against Ireland's estimated increase of +0.353%), with 2013 forecast for a rise in Hungarian GDP of just 0.797% in real terms (Ireland's same period forecast is for a rise of 1.394%).

-- Hungary's unemployment rate is barely budging off the crisis high (11.243% in 2010 to 10.925% in 2012). Ireland's unemployment rate is at the crisis period high with 2012 estimate at 14.7-14.8% and expected to decline marginally to 14.41% in 2014.

-- Hungary's General Government Revenues are shrinking faster than the economy. In 2011, Hungary's Government collected 52.864% of GDP in revenues, which has fallen to 45.787 in 2012 and is expected to shrink to 45.054% in 2013. In the mean time, Ireland's Government Revenues are marginally up from 34.118% in 2011 to expected 34.542% in 2013.

-- General Government Total Expenditure in Hungary is slowly inching up: from 48.672% in 2011 to forecast 48.761% in 2013, against Ireland's contraction from 46.869% in 2011 to 42.065% projected for 2013.

-- General government net lending/borrowing in Hungary stood at a deficit of -2.909% of GDP in 2012 and is forecast to rise to -3.707% in 2013. This compares with the completely abysmal Irish performance at 8.301% GDP in 2012 to 7.523% in 2013 forecast.

-- Hungary's primary deficits are expected to be less than 1/2 of those of Ireland in 2013.

-- Hungary's Government debt is sitting at 74.2% of GDP forecast for 2013, down from 80.6% in 2011, while Ireland's debt is up from 106.5% in 2011 to 119.3% projected for 2013.

-- The Government is aiming to repay the IMF and EU of €3.65bn and €2.31bn in 2013, against Ireland's nil repayments.

-- Hungary's current account balances have been in excess of that for Ireland since 2009, although 2013 forecast is for the current account surplus of 2.69% in Hungary vs 2.71% in Ireland.

*Note: I am using WEO data for the comparatives, instead of individual countries assessments, so some of the data cited is slightly off the latests projections, although the actual comparatives are hardly off by much

In other words, Hungary is clearly more of a sovereign policy, economic environment and monetary policy risk to the investors than Ireland. And despite this, Hungarian Government 10-year bonds have fallen in terms of yields from 5.8% in August 2012 to around 4.7% currently.

And last Tuesday, Hungary has managed to place USD3.25billion worth of new 5- and 10-year bonds with the cover ratio at 12.5-to-3.25. Overall, Hungary had offers for USD5.5bn worth of 4.25% 2018 bond with USD1.25bn allocated, these were priced at 335bps over US Treasuries and 320bps over mid-swap bang on with where the 10-years (2011s) were traded in the secondary market. Last time it sold 10-year bonds back in 2011, these were priced at coupon of 6.375% or full 100bps above the current deal. It also booked USD7 billion book for 5.375% 2023 bond with USD2bn allocated, priced at 345bps over US Treasuries and 336bps over mid-swaps.

Hungarian Government planned to raise some USD4bn worth of bonds in 2013 in total and is now 81% at its target for the year. Geographic allocation of the placement was even more encouraging: US investors took 55% of the 10-year paper, UK and Europe investors took 21% each. Funds took 81%, hedge funds took 9% and banks and retail investors only 5%. The 5-year allocation was similarly spread.

All of this suggests that the markets have little interest, currently, in the underlying risk fundamentals. Instead, pretty much anything offering a yield above the G7 average is simply seen as a target worthy of consideration. While Governments are quick to show up at the sales announcements with proclamations of their policies successes, the reality of the market awash in liquidity and nothing to chase in terms of yield means that investors are rushing into the issues pushed through by the economies that hardly in rude health today or can be expected to return to such a state any time soon.