17/6/2013: On Debt of the Nations & Euro Crisis: 2 links

Update from the ZeroHedge on the Debt of the Nations: http://www.zerohedge.com/news/2013-06-04/debt-nations

Worth a read!

And while on the case of crises (for whatever you might read about Reinhart and Rogoff debate, debt overhang is a crisis) we have an excellent contribution by Dani Rodrik on solutions for the Euro area crisis: http://www.project-syndicate.org/commentary/saving-the-long-run-in-the-eurozone-by-dani-rodrik

Thought-provoking and comprehensive summary (albeit I do not necessarily agree with all of Rodrik's conclusions).

5/6/2013: The economics of Lost Generations: Sunday Times 16/5/2013

This is an unedited version of my Sunday Times column from May 16, 2013


Not known for its 'ahead of the pack' thinking and bruised by recent controversies, nowadays, the ESRI focuses on a more retrospective in-depth analysis of the trends shaping Irish economy and society. Aptly, this week's most talked-about Irish research note was ESRI paper on the impact of the crisis on households. Covering data through 2009/2010, it offers both a fascinating look into economics of our lost generations, and a reminder that it takes official Ireland at least 3 years before everyday reality gets translated into policy-shaping analysis.

The topic is close to my heart: back in 2010 and then in 2012, in these very pages, I wrote about the fact that Ireland is facing not one, not two, but a number of lost generations covering those under the age of 50. Things only got worse since.

The crises we face continue to destroy lives and wealth of the 35-50 year-olds, who mortgaged their future back in 2003-2007. Pensions and savings are gone, psychological and social wellbeing is under unrelenting pressure from the threat of unemployment, losses in after-tax disposable income, negative equity, the banks' push to extract revenues from borrowers, and the internecine policies adopted by the Government.

Housing wealth and negative equity exact the greatest toll. Housing wealth accounted for over 3/4 of the total real disposable wealth that formed the bedrock of pensions provisions in the years before the crisis hit. This has now tumbled by over half, once taxes and property prices declines can be factored in.

Income losses are not far behind. Not withstanding the effects of tax increases, an average working age family in this country lost close to EUR100,000 in income between the beginning of 2008 and the end of 2012.

Much of these losses were accumulated by the prime working age group of 35-50 year-olds. Adjusting for changes in population and unemployment in these groups, relative to the rest of the country population, the opportunity cost of foregone savings, and adding the impact of tax increases, the real disposable income declines during the crisis run somewhere closer to EUR120,000 per family with two working adults in the 30-50 years of age group. When you consider the losses in housing wealth over the life time, and interest costs on negative equity components of mortgages, the total real life-time losses due to the crisis easily reach over EUR200,000 per family. This number assumes expected house prices appreciation in line with 2% annual inflation from 2013 on, but excludes effects of future tax hikes.

And more tax hikes are coming still. The Government might boast that ‘most of the adjustment is behind us’. Alas, IMF’s latest forecasts for the Irish economy clearly show that by 2018, compared to 2012, Irish Government tax take needs to increase by EUR12.5 billion per annum. Of these, EUR8.7 billion in revenue will come from personal income taxes and VAT. For comparison, between 2009 and 2012 receipts from these two tax heads rose only EUR2.9 billion. Social Insurance contributions are required to rise by EUR2.2 billion in 2013-2018, against the decline of EUR2.6 billion recorded in 2009-2012.

The ESRI research, published this week, does not go as far as attaching real numbers to the losses sustained by Irish households, but it does conclude that "income and consumption increase roughly steadily for the average household over the age of 45 from 1994/95 to 2009/10. ...In sharp contrast to the increase in earning and expenditure of older households over the last two decades, there has been a large drop in income and consumption for the younger average household in the crisis. Between the 2004/05 survey and that of 2009/10, real disposable income decreased by 14 per cent, real consumption including housing by 25 per cent and excluding housing by 32 per cent."

In other words, at the end of 2012, gross investment in the Irish economy stood at the levels below those in 1997, domestic demand at mid-2003 levels and private domestic demand (excluding Government spending) at the levels last recorded in 1998.

The future looks bleak for today's 30-50 year-olds even beyond income declines and the negative equity considerations. Per ESRI, "Mortgages are most prevalent in the 35-44 year bracket, with more than half of households in this group having a mortgage. About 43 per cent of the households aged 25 to 34, and 45 per cent of those aged 45 to 54 are mortgage holders as well." In other words, those in 30-50 years of age cohorts are in the worse shape when we consider housing wealth.

The ESRI fails to note that these households are also facing a very uncertain future when it comes to the cost of funding their mortgages.

Currently, ECB benchmark rate stands at 0.50%, which is miles below the pre-crisis period average of 3.10%.. At some point in time, Germany and other core European economies will be back delivering the rates of growth comparable to those seen over 2002-2007 period and the ECB rates will inevitably rise. At the same time, Irish banks will be carrying an ever-worsening book of household loans. With every year, average mortgage vintage on banks books moves closer and closer to 2006-2007 peak market valuations, as better quality older mortgages are being paid down. As real estate prices continue to signal zero hope of a rapid recovery, Irish banks will have to keep margins well above pre-crisis averages. Failing SMEs loans and Basel III capital hikes add to this pressure.

This week IMF released a set of research papers focusing on expected paths for unwinding extraordinary monetary policy measures deployed by the central banks around the world. Their benchmark scenario references interest rates increases of 2.25% for longer maturities and the adverse scenario a 3.75% rates hikes. Were the benchmark scenario to play out, mortgages rates can jump by over 2 percentage points on today's rates, before the increases that would be required for capital supports.

For mortgages of 2003-2007 vintage a return to historical levels of ECB rates combined with higher lending margins will spell a disaster.

Put simply, anyone who thinks the worst is now behind us should heed the warning: wealth destruction wrecked by the property bubble collapse is yet to run its full course.

The ESRI report doesn't tell us much about the expected effects of the crisis on our youngest working-age cohorts of 18-25 year olds. Truth is they too count as Ireland's Lost Generation.

Lower incomes and higher debt burdens of the 30-50 year-olds will translate into longer working careers and less secure retirement. For the younger generations, this means fewer promotional opportunities and reduced life-time earnings in the future, as well as higher tax burden to care for the under-pensioned older generation. The disruption and delays in access to career-building early jobs will also cost dearly. Many of today’s graduates of the universities with professional degrees and skills face rapid depreciation of their earnings when they delay entry into the professions.

Our economy’s re-orientation toward ICT services is an additional risk factor. Recent research points to an alarmingly high rate of skills depreciation in ICT services sectors, with declining employability of those in late 30s and early 40s compared to their younger counterparts. Likewise, worldwide and in Ireland, the earnings premium, even adjusting for the risk of unemployment, associated with education is now much smaller than in the late 1990s - early 2000s.

In short, today's young face lower life-time real earnings, higher life-time burden of taxation and dramatically reduced value of intergenerational wealth transfers (or put simply -inheritance).

The ESRI attributes younger households' aggressive cuts in consumption during the crisis to the bottlenecks in credit supply, parrot-like mimicking the Government assertion that if only the banks were lending again, things will miraculously return to normal. The reality on the ground is different. Irish society has been hit by a series of inter-related crises that not only reduced credit supply to younger households, but made household balance sheets insolvent by a combination of high debt, reduced life-time disposable incomes and wiping out middle and upper-middle classes wealth.

The only solution to these crises is to help repair households' balance sheets by helping them to deleverage their debts faster and a lower cost. This can be achieved solely by lowering tax burden on the households and aggressively writing down unsustainable levels of debt. Like it or not, were the banks to start lending tomorrow, even ignoring the fact that the cost of credit is only going to climb up in the future, the impact this will have on the economy and Irish households will be negligible.

Two successive Irish Governments have spent over 5 years throwing scarce resources on repairing the banks. It is time to realize that doing more of the same and expecting a different outcome is not bright policy to pursue. It is time to focus on what matters most in any economy – people.

Box-out:

This week, the IMF published its Article IV assessment of Malta’s economic conditions. The study expresses one major concern about the risks faced by the Maltese economy in the near future that is salient to the case of Ireland, yet remains unvoiced in the case of our assessments by the Fund. Quoting from the release: "In the longer term, regulatory and tax reform at the European or global level could erode Malta’s competitiveness. The Maltese economy, including the financial sector and other niche services, has greatly benefitted from a business-friendly tax regime. Greater fiscal integration of EU member states and potential harmonization of tax rates could erode some of these benefits, with consequences on employment, output, and fiscal revenues."

Ireland is a much more aggressively reliant on tax arbitrage than Malta to sustain its economic model and has been doing so for far longer than Malta. Both, our modern manufacturing and traded services sectors are virtually captive to the foreign multinationals reliant on tax arbitrage opportunities to domicile here. Yet, neither the IMF, nor any other member of the Troika seem to be concerned about the prospect of tax reforms in Europe and elsewhere in the context of Irish economy. May this be because the elephant in the room (our reliance on tax arbitrage) is simply too large to voice in the open?

28/5/2013: US Gen-Xers are Screwed... but Not as Much as the Irish Ones

Here is what the brain-dead Irish political and business 'elites' should read every time they talk about negative equity not being a big problem 'until you move house' & debt being sustainable 'until you can't repay loans'. The wealth destruction wrecked on Irish mid-generation families is so much more comprehensive than that for the US Generation-X households, and the debt levels loaded onto the shoulders of Irish households (private and public) are that much more extensive than those for the US Gen-Xers, and yet,

• Irish politicians are incapable of comprehending the effects of wealth destruction and are solely obsessed with public finances; while
• Irish business elites are mumbling left-right-and-centre about the need to 'free' people from their savings to 'get economy going again'.

Read this, morons:
http://www.businessinsider.com/generation-x-least-prepared-for-retirement-charts-2013-5#debt-is-killing-them-too-gen-xers-carried-more-than-80000-worth-of-debt-by-2010-on-the-flip-side-depression-era-babies-had-zero-debt-and-war-babies-had-just-15000-to-worry-about-7

25/4/2013: IMF's 'End of Austerity' Napkin Sketch Is Soggy Wet

IMF catches up with 'End Austerity' bandwagon and overtakes the EU 'policymakers' in providing a general blueprint. From today's comments by IMF First Deputy Managing Director David Lipton (emphasis is mine):

"...Europe needs to act on several fronts. Countries will need to have clear and specific commitments to medium-term fiscal consolidation, with the appropriate pace to be evaluated on a case-by-case basis. Careful consideration should also be given to the composition of fiscal measures. The European Central Bank (ECB) should maintain its very accommodative stance, he said, but noted that eliminating financial fragmentation – whereby households and companies in some countries face clogged credit channels and lending rates well above those in the core – will probably require the ECB to implement some “additional unconventional measures.”

So the Fiscal Compact of 'One Policy Target & Timeframe Fit All' is out of the window then? If timeframe (pace) were to be set on a case-by-case basis, there is hardly any real discipline left. Here's why. Suppose Italy takes slower path to deflating debt levels to the target of 60% than that mandated by the Fiscal Compact (FC) (5% adjustment per annum). France, then, can demand either a slower pace for its drawdown of debt or it can opt to demand slower reductions in deficits. Which means Spain will also have its list of requests ready, all in breach of the FC.

"As we see it, countries that can afford to support the economy need to do so—but in ways that encourage the private sector to invest and boost demand..."

Ok, but what does it mean? AAA countries borrowing to stimulate? Suppose they succeed. What happens to growth rates and income levels in Euro area? Right - divergence will be amplified and with it, mismatch of monetary and FX policies too. 

Per paying attention to the composition of fiscal measures: it is a fine objective. Except in the case of European leaders, this means, usually, hiking taxes even more instead of cutting spending. IMF knows that this is counterproductive, but whilst correctly arguing that policies should be reflective of heterogeneity between member states' economies, IMF is incorrectly ignoring the political reality of Europe, where more spending = good, lower taxes = bad.

More: "Another country responsibility is better structural policies. Countries should press on to tackle long-standing rigidities in order to raise medium-term growth prospects. Southern Europe, and even some of the core, needs to increase its competitiveness in the tradeable goods sector, especially through labor and product market reforms. So far, much of the reduction in current account deficits has come because demand is sluggish.  For a stronger, sustained improvement -- enough to boost exports that will create jobs for the unemployed -- countries need a broader and more durable improvement in competitiveness, based on structural reform. In Northern Europe, even where national competitiveness is not the issue, reforms could help generate a more vibrant services sector."

Again, usual tool kit deployed by the IMF: structural reforms are needed (no real innovation as to what these might be) and exports must be increased (who will be buying these exports in the world where every country is being told by the IMF to increase its exports?).

I wonder why would Mr Lipton label ECB current stance as being accommodative. ECB interest rate is above G7 average and ECB's 'panacea' of OMT is yet to make any real purchases. ECB has attempted to sterilise all past 'accommodative' interventions and is now pleased with winding up LTROs. In brief, setting aside war-time rhetoric from the ECB, Frankfurt is accommodating very little.

One has to agree with the need to eliminate financial fragmentation, but IMF is fully aware that European system will have to continue deleveraging. There is too much debt in the pipeline to de-clog it by simply pushing through more credit at lower cost.

"...the Single Supervisory Mechanism [is] “a key step” and ...the IMF supports a market-based bail-in approach as being considered in the European Union Directive on Bank Recovery and Resolution, which would require banks to hold a minimum amount of securities with features that permit them to be written-off or converted to equity if capital buffers fall too low..."

So getting Cyprused is  the future for Europe, then.

Mr Lipton is dead on right, saying that "In our preoccupation with sovereign debt, we tend to overlook the huge overhang of private debt in some countries that could be a deadweight on demand and bank balance sheets for a long time. We’ve already seen the hit that households have taken in the periphery economies because of the sharp correction in home prices (e.g. Ireland). This could only worsen without renewed growth (e.g. Spain, Belgium and the Netherlands)." And more: "On the corporate side, we know how much the level of debt has increased over the past decade, particularly in the periphery. We elaborated on this development in our recent Global Financial Stability Report.  ...Measured on a debt-to-equity basis, a portion of Italy's corporate sector is rising into stressed levels. In the event of a prolonged stagnation, corporate profits would slacken further, putting pressure on companies to deleverage and increasing the risk of debt distress. Corporates are not being helped by bank retrenchment back into home markets. This is most pronounced from the periphery; French and German banks reduced their exposures to these markets by some 30-40 percent between mid 2011 and the third quarter of last year."

Conclusion (relevant to 'being Cyprused' above): "None of this bodes well for banks in a stagnation scenario. They are already weak. But higher levels of corporate and household defaults and credit losses would threaten a second round of bank balance sheet deterioration."

Net result: IMF has no new ideas on what to do if 'austerity' path were to be altered. There's a good reason as to why they don't - borrowing cash to burn it on Government spending (traditional European way) is out of question, given the risk of raising costs of borrowing, slow growth and higher interest bills that await. And using monetary policy to full extent is infeasible because IMF has no hope for ECB in its current state.

'Austerity' might be overdone, but 'Not Austerity' is unlikely to be any different...

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.

19/2/2013: Japan's Woes: 3 recent posts

Some excellent blogposts on Japan's problems via Economonitor:

1) All exports and money printing can't offset Japan's debt, ageing and domestic demand woes: http://www.economonitor.com/edwardhugh/2013/02/12/japans-looming-singularity/?utm_source=contactology&utm_medium=email&utm_campaign=EconoMonitor%20Highlights%3A%20End%20Games

2) Does end of growth (Japan's example) spell end of high quality of life? http://www.economonitor.com/dolanecon/2013/02/15/growth-and-quality-of-life-what-can-we-learn-from-japan/

3) Japan's forgotten (but not fully unwound) debt bubble: http://www.economonitor.com/blog/2013/01/the-setting-sun-japans-forgotten-debt-problems/

All worth a read.

I can add that in 2011 Quality of Life Index by International Living magazine, ranking 191 countries around the world, Japan was in 7th place (rank range is between 7th and 10th), whilst Ireland was in 20th (rank range between 20th and 26th) in terms of overall quality of life, with Japan outperforming Ireland in 4 out of 9 categories of parameters on which the rankings were based and tying Ireland in one category. (link to full rankings)

Note: the above rankings did throw some strange results, so careful reading into them.