Wednesday, December 31, 2014

31/12/2014: Irish Ghost Estates: The March of Zombies

An interesting recent article from the Irish Independent on the sad state of Irish ghost estates:

Interesting, from my perspective, not just in the fact that 226 ghost estates saw no work activity in 2014, despite the uplift in property prices and Government prioritising completion of ghost estates. But interesting due to numbers it revealed.

Take a deep breath: seven years after the crisis set in, and nine years after building activity contraction set in, Ireland (a country of 4.8 million inhabitants) still has 992 estates (as in multiple dwellings developments) unfinished. And of these, 776 estates have people residing on the site of abandoned construction. But that is not all, 271 more (on top of 992 above) are not completed, but deemed to have been 'substantially completed' (which can mean pretty much anything).

Good news, 1,854 ghost estates have been completed. Bad news is that the Year Four of Our Government's Recover Turnaround, only 271 ghost estates have been completed, which means that at current rate we are looking at 2017 or later before we are rid of the ghost estates. That is a decade of physical scars reminding us about less than a decade of excesses. Of course, given growth in homelessness, the rising spectre of banks repossessions, the social housing lists explosion and other fine mess, non-physical scars will be with us much longer.

31/12/2014: Falling Again: Russian PMIs for December

HSBC and Markit released Russian PMIs for December, showing deteriorating conditions in Russian economy, as expected, given the severe Ruble crisis that hit mid-December.

Manufacturing activity posted a reading of 48.9 which is down from 51.7 in November, signalling a switch from a rather average growth to a contraction. December reading was close to being statistically significant for a sharp decline. Q4 2014 average Manufacturing PMI was at 50.3 which is better than Q4 2013 reading of 50.0 and worse than Q4 2012 reading of 51.7. But December figure breaks three consecutive months of above 50.0 readings and Q4 2014 reading is now below Q3 2014 average of 50.8.

Services PMI continued sub-50 print for the third consecutive month, coming in at 45.8 in December. Q4 2014 showed sharp deterioration in Services compared to Q3 2014 (50.2), as well as compared to Q4 2013 (53.0) and Q4 2012 (56.8).

Composite PMI fell to 47.2 in December from already weak 47.6 in November, marking third consecutive month of sub-50 readings. Q4 2014 average is at 48.0, far worse than Q3 2014 average of 51.1 and well below Q4 2013 average (51.1) and Q4 2012 average (52.7).

Overall, as chart above clearly shows, the downward trend in Russian economic activity across all sectors, the trend that set in around November 2012 and started flashing signals of recessionary dynamics around Q4 2013, remains in place.

31/12/2014: Ruble Crisis: Banking System in a Shut-Down Mode

Something for Russia analysts to watch comes January 12: The CBR will be offering RUB 1.1 trillion in 3-mo repo auction with eligible collateral being lowered to allow non-marketable assets. That is roughly USD20 billion in one go.

Meanwhile, Russian CB has been bailing out banks in line with the announcement made two weeks ago and passed via an emergency legislation by the Duma. Trust Bank was the first one to get a bailout of RUB99 billion in a form of 10-year loan and additional RUB28 billion loan for "Otkrytie" - financial intermediary that will take over Trust Bank. But the bailout is a bit of a misnomer here. Instead, it is a backdoor QE. "Otkrytie" already announced that it will spend RUB99 billion it borrowed from the CBR at 0.51% pa, to buy Russian Federal bonds. On back of that, S&P downgraded "Otkrytie" confirming rating of BB-/B, but moving it to negative outlook.

This was followed by the recapitalisation for VTB. The Government approved RUB250 billion funding for VTB which will be paid into two tranches. The first one of RUB100 billion was already deposited with the bank and the second one is forthcoming in Q1 2015. With both tranches in place, VTB CT1 capital ratio will be expected to rise to 12% from current 10.2%. VTB got the first tranche on the following terms: 30 years deposit at inflation+1% margin per annum, calculated every 6 months and payable every 6 months.

In reality, here's what's happening on the ground. 2014 has been marked by freezing of external funding sources (due to sanctions), rising corporate demand for credit (due to sanctions) and delletion of deposits. Deposits inflows were predominantly forex, demand for credit was predominantly in Rubles. The crisis is made worse (worse probably than 2008-2009 one) because capital buffers of the banks are weaker, relative to regulatory benchmarks and funding sources were more reliant on external funding and were shorter term. The CBR drive to reduce number of banks competing for dwindling deposits base has been not aggressive enough, so market fragmentation is still a problem: too many banks with

The banking crisis is now being compounded by the breakdown in payments systems. In September 2014, the CBR facilitated setting up of the new National Platform for Payments Cards (NPSK) that is supposed to become operational by march 1, 2015. Interestingly, this week the CBR published a list of 50 major or significant payments providers operating in Russia - a list that excludes both Mastercard and Visa.

The recaps will continue on. National Wealth Fund is set to inject ca RUB394 billion (10% of the fund value) into the systemically important banks, namely banks with own capital in excess of RUB100 billion, the list of which includes only Sberbank, VTB, Gazprombank, Rosselkhozbank, Alfa-bank, VTB-24, Bank of Moscow, Unicredit Bank and Rosbank. The injection is supposed to be used for infrastructure investments by the banks. Funds will be disbursed in the form of deposits and in debt paper issued to fund infrastructure investments.Cost of funding will be set at the rate at which the NWF will provide deposits to the banks. Banks will report quarterly on funds use.

Basically, we are witnessing a system that is heading into a major crisis - the hatches are being welded shut, not just battened. Whether that takes place before the flaring up of the next bout of Ruble crisis or not will determine how 2015-2016 are going to play out.

Tuesday, December 30, 2014

30/12/2014: Who Owns Government Debt?

An interesting chart via DB, mapping sovereign debt holdings across the advanced economies:

As the chart clearly shows, Irish Government debt is disproportionately held in the Central Bank. Other countries with similar proportion of CB-held debt - UK, US and Japan - all deployed direct QE. Ireland, of course, deployed virtually the same QE-like stimulus predominantly to the IBRC.

Another interesting feature is the share of Government debt held by foreign agencies: roughly 20% of the total, or 11th lowest in the sample of 21 countries. That is pretty low, given the amount of PR-talk the Government has been deploying around foreign buyers of Irish bonds.

In contrast, predictably, we rank the third after Greece and Portugal in the share of Government debt held by foreign official sector. This will decline once the IMF 'repayment' is finalised. Domestic banks' holdings of Irish debt are third lowest in the sample, and domestic non-banks holdings are 5th lowest. This is unlikely to change, given the sheer quantum of Government debt outstanding, relative to the overall economy's capacity and demand, and given the low yields on Government debt being generated.

The kicker of all of this is that owing to years of mismanaged bailouts, we are now saddled with the legacy of rescuing private debt holders in the banks. This legacy is simple: instead of private debt we have official debt, held predominantly by official sectors and our own CB, guaranteed by the Irish State. In other words, more of our debt is now super-senior in both rights and default terms.

Monday, December 29, 2014

29/12/2014: Historical Evidence on the Size of Fiscal Adjustments

A recent IMF paper looked at the historical precedents of large scale fiscal adjustments across advanced and emerging economies in the aftermath of the major fiscal crises. Escolano, Julio and Mulas-Granados, Carlos and Terrier, G. and Jaramillo, Laura paper titled "How Much is a Lot? Historical Evidence on the Size of Fiscal Adjustments" (IMF Working Paper No. 14/179. argue that "the sizeable fiscal consolidation required to stabilize the debt-to-GDP ratios in several countries in the aftermath of the global crisis raises a crucial question on its feasibility."

To answer this question, the authors look at historical evidence "from a sample of 91 adjustment episodes of countries during 1945-2012 that needed and wanted to adjust in order to stabilize debt to GDP."

"We find that in most cases fiscal adjustment is sizeable and the debt-to-GDP ratio stabilizes by the end of the episode, albeit at higher levels. In at least half of the episodes, countries managed to improve their primary balance by 5.4 percent of GDP (4.8 percent of GDP in cyclically adjusted terms). The sample distributions of the levels and changes in the primary balance (actual and cyclically adjusted) show that, while there are significant differences across advanced and developing countries in terms of the levels of primary balances achieved, the changes in primary balances are comparable across the two groups."

"The fiscal adjustment implemented was enough to close the primary gap in two-thirds of the episodes. This implies that debt stabilized, and in most cases was put on a downward trend." Given the hope-inspiring dynamics above, however, the follow-up is less impressive: "This does not however imply that debt returned to initial levels. While countries kept primary balances well above those observed before the adjustment episode, they did not sustain primary balances at the highest levels for prolonged periods of time. This suggests that countries make substantial efforts to stabilize debt but, once this is achieved, they see room to ease primary balances and do not necessarily seek to get back to the lower initial debt-toGDP ratio."

 "We find that consolidations tended to be larger when the initial deficit was high and adjustment efforts were sustained over time." In addition, "Several factors are found to be significantly associated with the size of fiscal adjustments. …The results also show that fiscal adjustment tended to be higher when accompanied by an easing of monetary conditions (as measured through a reduction in short-term interest rates) and, to a lesser extent, an improvement of credit conditions (measured as the change in credit to the private sector as a percent of GDP), especially in advanced economies."

Couple of figures. In the below,
CAPB: cyclically adjusted primary balance as a percent of potential GDP;
CAB: cyclically adjusted balance as a percent of potential GDP

Note the following interesting facts:

  • Ireland's fiscal adjustment post-2009 has been shallower than its adjustment post-1986. 
  • The cause of this shallower adjustment was the collapse of the credit markets in Ireland plus the on-going deleveraging of the real economy, not present in 1986 crisis. Also, the factors not accounted for in the list presented in the chart. In 1986 episode such factors were positively contributing to fiscal adjustment. In 2009 episode - they had negative impact. We can only speculate what these factors might have been, but clearly they are not related to external trade, or FDI. Which suggests they were domestic.
  • Ireland's adjustment was longer in the 1986 episode than in 2009 episode, but that is because the paper does not go beyond 2012. And the adjustment post-2009 episode is not completed still, even in 2014.
  • CAPB is the main driver of adjustment in 2009 episode, and is much larger than in 1986 episode. 
  • Ireland's fiscal adjustment since 2009 has been shallower than that of Greece since 2008, Portugal since 2010 and Spain since 2009, although it has been longer running that in Portugal and as long running as in Spain. In fact, the UK - a country that lent funds to Ireland for adjustment - is running similar magnitude fiscal adjustment as Ireland since 2009. A bit rich for us to be claiming to have taken most of fiscal pain in this crisis.

So what does the above tell us about Euro area peripherals' adjustments? IMF paper says that things tend to go well when:

  1. adjustment efforts were sustained over time, which suggests we are in for a much longer run than the Government's 'free from IMF' meme suggests;
  2. there is an an accompanying easing of monetary conditions, which we do have, courtesy of the ECB, except it is unclear how does this relate to the cases similar to the current crisis where monetary accommodation is simply fuelling asset bubbles and temporarily relieving mortgages pain, while doing nothing for growth; and
  3. to a lesser extent, by an improvement in credit conditions, which is yet to materialise, 5 years since 2009.

Not that any of the above will pause the IMF public statements about sustainability of adjustments everywhere and anywhere.

29/12/2014: Some Tough Data from Moscow: Growth & Ruble

Couple of reminders that the Russian crisis is not over, yet.

November GDP figures show GDP down 0.5% y/y - the first month of decline since October 2009. In October 2014, growth was +0.5% and 0.1% m/m. November m/m posted a decline of 0.2%. All figures hereinafter are seasonally adjusted and working day adjusted.

Decline in November was driven by a broad range of sectors: industry, construction, private services, taxes on goods and import duties. Extraction sectors, electricity, water & gas, and retail sales posted positive growth.

Investment fell 1.9% m/m in November. This is before the December currency crisis and two massive interest rates hikes. So expect more red ink here when December figures come out.

January-November overall GDP growth is now down to 0.6%. Seasonally-adjusted construction sector activity was also revised - Q1 2014 posted a revised decline of 2.5% y/y against previous estimate of 2.3%, Q2 2014 posted a decline of 1.6% from an estimated decline of 0.7%, Q3 2014 decline was 0.4% from previously estimated rise of +0.1%. In October, construction sector posted revised m/m growth of 3.5% and in November the sector activity fell 1.5% m/m.

Industrial production posted another month of poor results. In September, industrial activity grew at 1.4% m/m, following by slower 0.2% growth in October, and a decline of -0.9% m/m in November.

Real personal disposable incomes fell 4.6% in Q1 2014, rose 3.3% in Q2 2014 and 1.7% in Q3 2014. In November, real disposable income fell 2.9% m/m, having posted growth of 2.4% m/m in October. We can certainly expect further and deeper declines in December on foot of massive increases in interest rates and a drop in Ruble valuations.

Retail sales rose 0.2% in November, after posting 0% growth in October.

Unemployment remains unchanged at 5.2% - the rate that has been steady for the last 6 months.

Exports of goods in November reached USD37.6 billion representing a decline of 19.7% y/y and 7.1% drop m/m. Imports of goods in November stood at USD23.2 billion, down 22.1% y/y and a decline of 13.5% m/m. So despite sharper decline in imports in percentage terms, trade balance deteriorated from USD17.0 billion in November 2013 to USD14.4 billion in November 2014.

Full year trade figures estimates are charted below:

As suggested on this blog, imports declines are expected to run deep: 8.4% y/y in 2014 against expected exports decline of 3.0%. The result is the forecast increase in trade surplus of USD11.5 billion or 7.0% y/y.

Largely unrelated to the above news, Ruble seems to have reversed some of the gains made last week and is down some 9.4% against USD and Euro on lower oil prices:

Credit: @Schuldensuehner:

Euro chart:

The point is - last week's measures are temporary in their nature:

  • 17% interest rates cannot be sustained without completely demolishing banks balancesheets, companies and households;
  • Convincing larger corporates to cut their forex deposits will have at most short-run effect, as demand for forex is likely to ramp up due to debt maturity in Q1 2015.
  • Threats of investigations and pursuit of 'speculative transactions' will do preciously nothing as most of trade will be coming via ex-Russia intermediaries.
  • Massive spike in interventions from the CBR are not sustainable, given the pressures on reserves from the banks, debt redemptions and corporates/investment.
Meanwhile, core weaknesses in the economy and oil price dynamics will remain. And with them, there will be continuous pressure on the Ruble.

Sunday, December 28, 2014

28/12/2014: Oil Prices: USD70bbl in 2015?.. May be so...

Forecasting oil prices is a rather tough job, especially if we are witnessing a regime change, rather than a temporary glitch in the markets. Nonetheless, here is the set of forecasts from the markets (options), forecasters (consensus) and Goldman Sachs:

Noticeable features: all, but futures markets bets are starting to converge in H2 2015. End-of-2015 forecasts are pretty close for Goldman and Bloomberg survey.

A bit more detailed reporting on forecasts here:

All in, it does appear that USD70 bbl average price for 2015 is not out of line with market consensus, albeit it is not consistent with futures markets contracts.

28/12/2014: Health Impact of Self-Employment

A recent paper by Zhang, Ting and Carr, Dawn, titled "Does Working for Oneself, Not Others, Improve Older Adults' Health? An Investigation on Health Impact of Self-Employment" (American Journal of Entrepreneurship, Volume 7(1), pp. 142-180, 2014. "examines the health impact of being self-employed versus working for others among older adults (aged 50 ) and its implications".

Economic reasoning behind the study is straightforward:

  1. As authors note, "facing an aging workforce, self-employment at older ages may provide an economic benefit via an alternative to retirement.
  2. As authors do not note, self-employment is generally associated with higher levels of stress, induced by income uncertainty, volatility, lack of proper scheduling of vacations and breaks, tax-induced anxiety and other factors that can potentially adversely impact self-employed.
  3. Self-employment in older age is becoming increasingly the likeliest prospect for future employment for many workers, especially as economies gear toward services sectors with fast depreciation of skills and increased specialisation.

Despite all of the above, as stated in the paper, "little research has examined the health effects of self-employment in later life."  Zhang and Carr study "comprehensively examines health using a 29-item index to measure the impact of self-employment status on changes in older adults' overall health." The authors provide control for "potential endogeneity and simultaneity issues."

The study finds that "self-employment compared to wage-and-salary jobs result in better health, controlling for job stress and work intensity, cognitive performance, prior health conditions, socioeconomic and demographic factors. This positive self-employment impact stands out in knowledge-based industry sectors. In labor intensive industry sectors such as Durable Goods Manufacturing, self-employed older adults' more gradual retirement seems to result in a health advantage over wage-and-salary employees."

These results are quite interesting from both microeconomic and macroeconomic perspective. Self-employment as opposed to full retirement secures more significant pensions cover in older age, coincident with poorer health and greater demand for healthcare. It is also, it seems, reduces cost of healthcare in the first years of retirement. In addition, self-employment of older workers suggests that ageing demographics impact on aggregate growth and productivity growth can be mitigated in the Western societies, if there is an improved system of incentives for older workers to transition into retirement more gradually, over longer time.

28/12/2014: Unhappy Cities

According to a new paper published by NBER, "there are persistent differences in self-reported subjective well-being across U.S. metropolitan areas, and residents of declining cities appear less happy than other Americans. Newer residents of these cities appear to be as unhappy as longer term residents, and yet some people continue to move to these areas." The question is why?

"While the historical data on happiness are limited, the available facts suggest that cities that are now declining were also unhappy in their more prosperous past. One interpretation of these facts is that individuals do not aim to maximize self-reported well-being, or happiness, as measured in surveys, and they willingly endure less happiness in exchange for higher incomes or lower housing costs. In this view, subjective well-being is better viewed as one of many arguments of the utility function, rather than the utility function itself, and individuals make trade-offs among competing objectives, including but not limited to happiness."

While this sounds very plausible, an interesting follow up question is: what happens to new movers when they get better offers elsewhere or once they retire or their employment terminates? Do these newcomers leave? Do they attempt to secure new employment in the area? Do they engage in entrepreneurship whilst in their employment or after?

The reason why these questions are pivotal is that human capital is like other forms of capital: once it is mobile, it moves to higher returns on investment, but it also is footloose. Since investment in human capital does not end with current stage employment, loss of past human human via exit from the area is also a loss of future human capital increases. Securing human capital is about as important as attracting it.

For the paper quoted, see: Glaeser, Edward L. and Gottlieb, Joshua D. and Ziv, Oren, Unhappy Cities (July 2014). NBER Working Paper No. w20291.

Saturday, December 27, 2014

27/12/2014: Are Graduate Students Rational?

A fascinating study into expectations formation mechanism for career outlooks by entering doctoral students in the US. Authored by Blume-Kohout, Margaret and Clack, John, titled "Are Graduate Students Rational? Evidence from the Market for Biomedical Scientists" (PLoS ONE 8(12): e82759, December 2013, the paper looks into whether entering graduate students make rational choices in selecting specific fields of study, given information available in the jobs markets.

The authors use increases in the U.S. National Institutes of Health (NIH) budget from 1998 through 2003 that in turn also "increased demand for biomedical research, raising relative wages and total employment in the market for biomedical scientists." This should send a signal to incoming students that biomedical research careers prospects have been expanding. This signal is not the same as a signal of what one can expect of the biomedical careers prospects in the future for a number of reasons. Crucially, if at early stages of funding expansion wages and career promotions for those already in biomedical profession were rising fast, any future increase in supply of biomedical professions will reduce earnings and career prospects for future entrants into profession. In other words, current conditions are not identical to future conditions.

This is especially salient in professional fields where studying and research required for qualifying into profession requires a long period of time, such as biomedical field. where "research doctorates in biomedical sciences can often take six years or more to complete."

Hence, in biomedical field, "the full labor supply response to such changes in market conditions is not immediate, but rather is observed over a period of several years."

If prospective students considering entering doctoral studies were rational (in economic sense), they should not tai current conditions in the filed for granted and should instead "anticipate these future changes, and also that students take into account the opportunity costs of their pursuing graduate training."

As authors note, "prior empirical research on student enrollment and degree completions in science and engineering (S&E) fields indicates that “cobweb” expectations prevail: that is, at least in theory, prospective graduate students respond to contemporaneous changes in market wages and employment, but do not forecast further changes that will arise by the time they complete their degrees and enter the labor market."

The Blume-Kohout and Clak analysed "time-series data on wages and employment of biomedical scientists versus alternative careers, on completions of S&E bachelor's degrees and biomedical sciences PhDs, and on research expenditures funded both by NIH and by biopharmaceutical firms, to examine the responsiveness of the biomedical sciences labor supply to changes in market conditions."

They find evidence rejecting rational expectations model of students' decision making: "Consistent with previous studies, we find that enrollments and completions in biomedical sciences PhD programs are responsive to market conditions at the time of students' enrollment. More striking, however, is the close correspondence between graduate student enrollments and completions, and changes in availability of NIH-funded traineeships, fellowships, and research assistantships."

In other words, state-funded research can contribute to over-production of future doctoral graduates later in the period of increased funding, exacerbating future wages downturns for later stage doctoral graduates, and at the same time fuel increased inflows of new entrants into profession.

27/12/2014: Geography of the Euro Area Debt Flows

The debate about who was rescued in the euro area 'peripheral' economies banking crisis will be raging on for years to come. One interesting paper by Hale, Galina and Obstfeld, Maurice, titled "The Euro and the Geography of International Debt Flows" (NBER Working Paper No. w20033, see puts some facts behind the arguments.

Per authors, "greater financial integration between core and peripheral EMU members had an effect on both sets of countries. Lower interest rates allowed peripheral countries to run bigger deficits, which inflated their economies by allowing credit booms. Core EMU countries took on extra foreign leverage to expose themselves to the peripherals. The result has been asset-price bubbles and collapses in some of the peripheral countries, area-wide banking crisis, and sovereign debt problems."

The causes explained, the paper maps out "the geography of international debt flows using multiple data sources and provide evidence that after the euro’s introduction, Core EMU countries increased their borrowing from outside of EMU and their lending to the EMU periphery."

So braodly-speaking, core euro area economies funded excesses. Hence, in any post-crisis rescue, they were the beneficiaries of transfers from the 'peripheral' economies and taxpayers.

Some details.

According to Hale and Obstfeld, "one mechanism generating the big current account deficits of the European periphery could be summarized as follows: after EMU (and even in the immediately preceding years), compression of bond spreads in the euro area periphery encouraged excessive borrowing by these countries, domestic lending booms, and asset price inflation. We further argue that a substantial portion of the financial capital flowing into the European periphery was intermediated by the countries in the center (core) of the euro area, inflating both sides of the balance sheet of the large financial institutions in the euro area core."

So, intuitively, lenders/funders of the asset bubbles should be bearing some liability. And it would have been the case were the funds transmitted via equity or direct asset purchases (investment from the Core to the 'periphery' in form of buying shares or actual real estate assets). Alas they were not. "These gross positions largely took the form of debt instruments, often issued and held by banks. Thus, EMU contributed not only to the big net deficits of the peripheral countries, but to inflated gross foreign debt liability and asset positions for nonperipheral countries such as Belgium, France, Germany, and the Netherlands – countries that all experienced systemic banking crises after 2007."

Debt, as we know it now, has precedence over equity when it comes to taking a hit in a crisis, and debt is treated on par with deposits. Hence, "the tendency for systemically important banks to increase leverage in line with balance sheet size …implied a substantial increase in financial fragility for these countries’ financial sectors."

In the short run, prior to the crisis, leveraging up from the Core into the 'periphery' had a stimulative effect on asset bubbles. "Four main factors contributed to the suppression of bond yields in the European periphery after the introduction of the euro.
- First, the risk of investing in the European periphery declined with the advent of the euro due to investor assumptions (perhaps erroneous) about future political risks, including the possibility of official bailouts.
- Second, transaction costs declined and currency risk disappeared for euro area investors investing in the periphery countries.
- Third, the ECB’s policy of applying an identical collateral haircut to all euro area sovereigns, notwithstanding their varied credit ratings, encouraged additional demand for periphery sovereign debt by euro area financial institutions, which, moreover, were able to apply zero risk weights to
these assets for computing regulatory capital. The EU’s recent fourth Capital Requirements
Directive continues to allow zero risk weights for euro area sovereign debts, even though the borrowing countries cannot print currency to pay their debts.
- Fourth, financial regulations in the EU were harmonized and the euro infrastructure implied a more efficient payment system though its TARGET settlement mechanism."

Crucially, all four factors combined to reinforce each other giving "…core euro area financial institutions a perceived comparative advantage in terms of lending to the periphery, and this would also likely have affected financial flows from outside to both regions of the euro area.

In line with the above, the authors find:
- "...strong evidence of the increase in the financial flows, both through debt markets and
through bank lending, from core EMU countries to the EMU periphery."
- "… that financial flows from financial centers to core EMU countries increased, but predominantly due to increased bank lending and not portfolio debt flows.
- "In addition, …evidence from the syndicated loan market that is broadly consistent with the core EMU lenders having a comparative advantage in lending to the GIIPS."

Net conclusion: "The concentration of peripheral risks on core EMU lenders’ balance sheets helped to set the stage for the diabolical loop between banks and sovereigns that has been at the heart of the euro crisis."

Authors quote other sources on similar: “German banks could get money at the lower rates in the euro zone and invest it for a decade in higher yielding assets: for much of the 2000s, those were not only American toxic assets but the sovereign bonds of Greece, Ireland, Portugal, Spain, and Italy. For ten years this German version of the carry trade brought substantial profits to the German banks — on the order of hundreds of billions of euros ... The German advantage, relative to all other countries in terms of cost of funding, has developed into an exorbitant privilege. French banks exploited a similar advantage, given their major role as financial intermediaries between AAA-rated countries and higher yielding debtors in the euro area.” (From Carlo Bastasin, Saving Europe: How National Politics Nearly Destroyed the Euro, Washington, D.C.: Brookings, 2012, page 10.)

Charts below summarise flows from Core markets to 'peripheral' markets

CPIS is stock of portfolio debt claims from CPIS data in real USD:

BISC is stock of total international bank claims from consolidated BIS data in real USD:

BISL Flow is valuation-adjusted flows of total cross-border bank claims from locational BIS data in real USD:

And conclusions: "Not only did peripheral countries borrow more after EMU; in addition, financial institutions in the core of the euro area expanded their balance sheets to facilitate peripheral deficits, thereby increasing their own fragility. This pattern set the stage for the diabolical feedback loop between banks and sovereigns that has been such a powerful driver of the euro area's recent crisis."

So next time someone says that 'periphery' is to be blamed for the causes of the crisis, send them here. for in finance, like in dating, it takes two to tango…

Friday, December 26, 2014

26/12/2014: Household Leveraging and Deleveraging in the U.S.

Household debt deleveraging is one of the key forces currently still working through the Western economies, suppressing investment and spending, and supporting precautionary savings. The U.S., having entered the Great Recession ahead of many other economies, armed with stronger consumer-centric systems of insolvency and personal bankruptcy, and having exited the Great Recession with more robust rates of economic growth than other advanced economies, presents a good example or a case study for this process.

One recent paper, by Justiniano, Alejandro and Primiceri, Giorgio E. and Tambalotti, Andrea, titled "Household Leveraging and Deleveraging" (see FRB of New York Staff Report No. 602: does exactly that.

Per authors, "U.S. households' debt skyrocketed between 2000 and 2007, but has since been falling. This leveraging and deleveraging cycle cannot be accounted for by the liberalization and subsequent tightening of mortgage credit standards that occurred during the period." Quite strikingly, the authors show that financial liberalisation does not fully explain the cycle.

Instead, "…the credit cycle is more likely due to factors that impacted house prices more directly, thus affecting the availability of credit through a collateral channel. In either case, the macroeconomic consequences of leveraging and deleveraging are relatively minor because the responses of borrowers and lenders roughly wash out in the aggregate."

Of course, the only reasons for this conclusion are the factors mentioned above: the U.S. personal insolvency and debt resolution regimes are far more benign, allowing for a more orderly and less disruptive 'washing out' of adverse effects of household debt overhang.

26/12/2014: "Iceland: How Could this Happen?"

Always interesting and never ending debate about Iceland v Ireland can only be aided by the following recent paper by Gylfason, Thorvaldur, titled "Iceland: How Could this Happen? (see CESifo Working Paper Series No. 4605:

The author "reviews economic developments in Iceland following its financial collapse in 2008, focusing on causes and consequences of the crash. The review is presented in the context of the Nordic region, with broad comparisons also with developments elsewhere on the periphery of Europe, in Greece, Ireland, and Portugal. In some ways, however, Iceland resembles Italy, Japan, and Russia more than it resembles its Nordic neighbors or even Ireland. The paper also considers the uncertain prospects for reforms and restoration as well as the possible effects of the crash on social, human, and real capital and on long-run economic growth."

To add, two charts of my own, really self-explanatory:

26/12/2014: Advanced Economies: Public Debt Explosion 2008-2014

Some interesting insight into the legacy of the Great Recession that we are carrying over into 2015. From the start of 2008 through 2014:

  • Average increase in gross debt of all advanced economies was 27.2 percentage points of GDP, with a range from a decrease of 21 percentage points for Norway and an increase of 88.5 percentage points for Ireland. Thus, the average annualised rate of increase in government debt over the period was around 3.47 percentage points of GDP with a range of -2.76 percentage points annualised decline for Norway and a 9.48 percentage points annualised increase in Ireland.
  • Average change in the gross government debt of the group of countries where debt declined over the crisis was -12.0 percentage points of GDP. There were only 3 countries in this group.
  • Average increase in gross government debt of the group of countries with benign levels of increase (levels of increase consistent roughly with offsetting GDP contraction over the crisis period) was 4.8 percentage points of GDP. There were only 5 countries in this group and only two of these were in Europe, with none (at the time of the crisis onset) being members of the euro area.
  • Average increase in gross government debt within the group of countries where debt rises were moderately in excess of contraction in the economy was 16.4 percentage points of GDP.
  • Average increase in gross government debt within the group of countries with debt increases significantly in excess of economic contraction was 26.6 percent of GDP.
  • Average increase in the government debt within the group of countries with severe debt overhang was 60.4 percentage points of GDP, with a range of increases in this group between 41.6% for the U.S. at the lower end and 88.5% of GDP for Ireland at a higher end.

Chart above summarises these facts and also highlights the extent to which Ireland's government debt increases were out of line with experience in all other countries, including Greece and all other 'peripheral' economies.

The average rise in gross government debt across all peripheral economies 2008-2014 was 56.5 percentage points of GDP (excluding Ireland), which is more than 1/3 lower than that for Ireland. Our closest competitor to the dubious title of worst performing sovereign in terms of debt accumulation is Greece, which experienced a debt/GDP ratio increase almost 1/4 lower than Ireland.

And in case you wonder, our Government's net debt position is not much better:

26/12/2014: The Empirical Evidence on Globalisation

Much has been written around the alternative, and even mainstream media about the perils of globalisation. Not to discount these arguments without a serious treatment, economics mainstream tends, on the other hand, view globalisation as a net positive force for betterment of the economy. Of course, there non-linear transmissions from economics to the broader society, and there are non-linear effects of globalisation on various social and economic agents: there are winners and losers in the process.

Here is an interesting paper that looks at the core macroeconomic consequences of globalisation. Potrafke, Niklas' study "The Evidence on Globalization" (see: CESifo Working Paper Series No. 4708: surveys the empirical literature on globalisation focusing on the KOF indices of globalisation "…that have been used in more than 100 studies. Early studies using the KOF index reported correlations between globalization and several outcome variables. Studies published more recently identify causal effects."

The evidence shows that "globalization has spurred economic growth, promoted gender equality, and improved human rights. Moreover, globalization did not erode welfare state activities, did not have any significant effect on labor market interaction and hardly influenced market deregulation. It increased however within-country income inequality."

Worth a read. 

Thursday, December 25, 2014

25/12/2014: Skilled Immigration and Employment in the U.S.

There is a persistent debate in economics about the effects of migration of the highly-skilled workers on employment prospects and careers of the natives. Here is one interesting study looking at such effects within the context of the targeted immigration programme based on skills within the particular set of sectors - the STEM, or more commonly, Science and Technology.

Kerr, Sari Pekkala and Kerr, William R. and Lincoln, William Fabius, Skilled Immigration and the Employment Structures of U.S. Firms (see arvard Business School Entrepreneurial Management Working Paper No. 14-040: "study the impact of skilled immigrants on the employment structures of U.S. firms … [accounting for] the fact that many skilled immigrant admissions are driven by firms themselves (e.g., the H-1B visa)." The authors "find rising overall employment of skilled workers with increased skilled immigrant employment by firm. Employment expansion is greater for younger natives than their older counterparts, and departure rates for older workers appear higher for those in STEM occupations compared to younger worker."

From the point of view of countries, like Ireland, relatively open to immigration of skilled workers, but without a specific skills-based 'filter' (Irish system is open to migrants on the basis of nationality, rather than skills, but has strong selection biases into skills-based immigration due to lack of jobs creation outside the STEM categories of jobs), the above suggests that skills depreciation in the STEM sector can be a problem for the natives. As supply of younger STEM employees from abroad rises, there can be a tendency for displacement of older workers, premature termination or flattening out of careers and, subsequently, lower supply of pensions and income provisions in later years of life.

25/12/2014: Unwinding Western Excesses, Squeezing Emerging Markets

Just in case you need a scary story for the holidays seasons, here's one from economics. Some time ago, we've learned that zero bound (extremely low) interest rates in the advanced economies spell quite a disaster for the emerging markets, where the economies are now suffering from triple pressures: declining commodities prices (on which many emerging markets economies often rely for exports, declining demand for their exports of goods, and declining investment inflows from the advanced economies.

But that's just the beginning. It seems that any unwinding of the QE deployed in the West is likely to hammer the emerging markets more.

Here's a World Bank paper from earlier this year on the topic: Burns, Andrew and Kida, Mizuho and Lim, Jamus Jerome and Mohapatra, Sanket and Stocker, Marc, Unconventional Monetary Policy Normalization in High-Income Countries: Implications for Emerging Market Capital Flows and Crisis Risks (April 1, 2014). World Bank Policy Research Working Paper No. 6830:

What the authors found is that as "the recovery in high-income countries firms amid a gradual withdrawal of extraordinary monetary stimulus, developing countries can expect stronger demand for their exports as global trade regains momentum, but also rising interest rates and potentially weaker capital inflows. …In the most likely scenario, a relatively orderly process of normalization would imply a slowdown in capital inflows amounting to 0.6 percent of developing-country GDP between 2013 and 2016, driven in particular by weaker portfolio investments. However, …abrupt changes in market expectations, resulting in global bond yields increasing by 100 to 200 basis points within a couple of quarters, could lead to a sharp reduction in capital inflows to developing countries by between 50 and 80 percent for several months."

Wait, we are witnessing this already, in part, as bond prices in a number of emerging economies are following oil prices down. And worse, if the above applies to corporate yields, the same will apply to government yields. Thus, 'normalisation' in the West can yield double shock to debt markets in the emerging economies.

World Bank paper has more on the subject: "Evidence from past banking crises suggests that countries having seen a substantial expansion of domestic credit over the past five years, deteriorating current account balances, high levels of foreign and short-term debt, and over-valued exchange rates could be more at risk in current circumstances. Countries with adequate policy buffers and investor confidence may be able to rely on market mechanisms and countercyclical macroeconomic and prudential policies to deal with a retrenchment of foreign capital. In other cases, where the scope for maneuver is more limited, countries may be forced to tighten fiscal and monetary policy to reduce financing needs and attract additional inflows."

So the best case scenario, sovereign wealth reserves (if any) will be exhausted on 'normalising' the US, UK, Euro Area and Japan, while if none are present, tough luck - the emerging economies are into a tailspin. They'll have to relieve the path of austerity-driven internal devaluations. Just because the West has ramped printing presses up so much, any 'normalisation' is going to be a disaster. If that is not a case of beggar thy poorer neighbour by enriching thy stock markets strategy, then do tell me what is?

And in another paper, "Tinker, Taper, QE, Bye? The Effect of Quantitative Easing on Financial Flows to Developing Countries" the same authors looked at gross financial inflows to developing countries over 2000-2013 (see: World Bank Policy Research Working Paper No. 6820:

As above, authors found evidence "for potential transmission of quantitative easing along observable liquidity, portfolio balancing, and confidence channels. Moreover, quantitative easing had an additional effect over and above these observable channels, which the paper argues cannot be attributed to either market expectations or changes in the structural relationships between inflows and observable fundamentals. The baseline estimates place the lower bound of the effect of quantitative easing at around 5 percent of gross inflows (for the average developing economy), which suggests that of the 62 percent increase in inflows during 2009-13 related to changing global monetary conditions, at least 13 percent of this was attributable to quantitative easing. The paper also finds evidence of heterogeneity among different types of flows; portfolio (especially bond) flows tend to be more sensitive than foreign direct investment to our measured effects from quantitative easing."

So broadly-speaking, QE is impacting bond/debt flows and unwinding QE can be a costly proposition for the emerging markets.

25/12/2014: Ruble Crisis: Stage 1 Capital Controls

In a recent post on Ruble Crisis (, I have promised to post my comments that were forthcoming in Portuguese Express. Here they are, in English:

Q: Did Russian Government impose capital controls last week?

Yes. Both de facto and de jure, the new requirement on state-owned companies and a softer request for larger private companies to reduce their foreign exchange holdings constitute capital controls. However, the reduction is relatively benign and will not present a material risk to these companies' operations. 

The reason for this is that the benchmark holdings set at October 1, 2014 levels of reserves mean that the new restrictions cover primarily build up in foreign exchange reserves accumulated during the acceleration of the currency crisis. In a sense, these were precautionary accumulations of foreign exchange that have little to do with operational demands of the companies involved. A more material restriction could have been limiting reserves to a fixed proportion of revenues. In the 1998 crisis, Russian authorities forced exporters to convert all foreign exchange earnings in rubles. This time around, an intermediate measure, in severity ranking between the 1998 case and this week's announcement, would have been requiring exporter to convert, say 50 percent of their earnings into rubles. However, Moscow held back such a measure and opted for a weaker version, benchmarking reserves to October 1 positions. 

As is, the measure will likely increase supply of US dollars into the market by about USD50 billion - roughly the amount that has been accumulated in precautionary reserves. And this comes on foot of the new currency swap agreement with China that can inject up to USD24 billion into the markets.

The new restriction is voluntary in nature, in so far as companies can continue to accumulate reserves, but in reality, only those companies facing significant bond redemptions in 2015 will be allowed to do so. Barring the latter exemption, we would have seen moratorium on debt redemptions for larger Russian companies by mid-Q1 2015.

Overall, the new measure introduced by the Russian Government is, effectively, a bid to avoid introducing full scale capital controls and to enhance the Central Bank of Russia's firepower in the forex markets. This has already been reflected in the markets via a dramatic rebound in the Ruble valuations and an equally significant decline in the volumes of short ruble contracts which fell from this week's high of just under 70,000 to below 50,000.

Updated: here is the link to the article

Wednesday, December 24, 2014

24/12/2014: Amnesty International: food aid blocked in Eastern Ukraine

Pretty strong language from Amnesty International on the situation with blocked food aid destined for Eastern Ukraine:

Amnesty has been very neutral in its criticism of both sides in the conflict, so this is an objective source, in my view. For example of Amnsety's balance see: In contrast, I have not spotted any reporting of the above problem in the mainstream Western media.

24/12/2014: House of Rubles: Bulgaria's Capital on Ruble Crisis

Here is an article in Bulgarian Capital on the subject of the Russian currency crisis, with comments from myself: My original comments in English:

1. What triggered the acceleration of the rouble crisis and why the drastic raise of the interest rates didn't help?

In a currency crisis, raising interest rates usually has little effect on currency valuations because the motives for dollarisation or a switch away from the domestic currency rest outside the scope of deposits and savings.

Russian crisis has been driven by rapid collapse of oil prices and by the growing demand for dollar and euro liquidity from banks and companies forced to repay foreign borrowings due to lack of access to the foreign credit markets.

Several larger Russian firms, facing billions of dollars of debt redemptions in Q4 2014 have moved into the market in the last 10 days, buying up dollars and using ruble loans from the Central Bank to fund these purchases. In addition, new estimates that came out last week showed Central Bank of Russia witnessing accelerated rate of capital outflows suggesting that Q4 outflows will match those in Q1 and that the total volume of outflows will total $134 billion, matching 2008-2009 crisis peak. This triggered a run on the Ruble that started on Monday and continued through Tuesday. Tuesda run was further exacerbated by the dollarisation of the household deposits, with many Russian households rushing to convert Ruble savings into dollars and euros.

In a way, 10.5 percentage points hike in interest rates enacted by the Central Bank added fuel to the fire. Firstly, it signalled to the markets that capital outflows are reaching crisis proportions. Secondly, it increased the demand for loans from the households trying to secure credit before rates rise even higher, and also drove more companies and households toward conversion of their deposits into dollars.

In the short run, the interest rate hike also led to a more aggressive shorting of the ruble, especially by algorithmic trading programmes, by acting to suppress supply of dollars out of Russian deposits into ruble trades, while leaving external supply of dollars available for backing shorts unaffected. The short-term nature of such strategy was evident in the abrupt reduction in net short positions in the market.

2. What options do Russian authorities have now to deal with the situation? Will Russia need to use capital controls?

So far, Russian Central Bank spent around USD10 billion on foreign currency interventions (through the first two weeks of December). The ministry for finance further openly committed to injecting additional USD7 billion. Simultaneously, the CBR adopted measures to ease balance sheet pain for the banks. The CBR also dramatically expanded its repo operations. All of this had an effect of calming the markets down - the effect witnessed on Wednesday.

However, the underlying causes of the crisis remain unaddressed and the current reprieve can be temporary, unless the CBR and the Russian Government adopt more drastic measures. One measure that will be effective in dealing with the underlying drivers of the crisis is limited capital controls. These can reduce dollarisation of the domestic household and corporate deposits and also restrict, in part, outflows of funds abroad. However, the second problem - mounting weight of debt redemptions by sanctions-impacted banks and companies - requires a different solution. One possible solution could be freezing redemptions for entities directly covered by sanctions, allowing ill up of interest to avoid outright default. Both measures are what we can term the 'nuclear' solutions and to-date the Russian Government has balked at adopting them. However, the Government is already applying pressure on Russian companies to stop hoarding foreign currency. The Government is also diverting 10% of the Russian National Pension Fund receipts toward supporting domestic banks.

Should the crisis regain momentum, even the 'nuclear' - in economic terms - options are going to be on the table.

3. How close is Russia to a repeat of the 1998 crisis?

The 1998 crisis was very different in nature and causes, so the parallels to it are tenuous at best. In the 1998 crisis, Russian Government was carrying unsustainable levels of external debt and it was running huge deficits. The country external balance of payments was in a persistent deficit. None of these factors are present today. Russian Government fiscal surplus is in excess of 2 percent and devaluation actually improves the Federal Government position in the short term. Current account is in a surplus and even with oil going to USD50/bbl, current account position is well-supported in the short run by collapsing imports. The entirety of Russian Government debt redemptions for 2015 is just over USD2.8 billion.

On the other hand, Russian economy today is in the same structural cul de sac as in 1998. Core driver for growth - high energy and commodities prices - is gone and it is unlikely to return any time soon. Consensus forecasts suggest oil price averaging around USD80/bbl in 2015, so at the very best, Moscow can expect moderate improvement in pressures compared to current situation.

4. Is now a deep recession a certainty for Russia in 2015? And how much worse can things get?

It is most likely that the Russian economy will slip into the recession over Q4 2014 - Q2 2015. The only question is - how deep the recession can be. Based on USD60/bbl assumption for the price of oil, the Central Bank estimates that Russian economy will contract 4.5-4.7% in 2015. At USD80/bbl, the contraction is likely to be closer to 0.8-1%.

The former is a heavy toll on the economy, while the latter is relatively mild and consistent with Euro area experience in 2012-2013. And beyond that, 2016 is also promising to be a tough year. Russian economy desperately needs two things: investment for developing non-extraction sectors, modernising the capital and technological bases; and structural reforms, reducing red tape, corruption, arbitrary enforcement of laws, reducing bureaucracy and altering labour markets. It will be extremely hard to deliver investment boost in current financial conditions and in the presence of sanctions. It will be virtually impossible to deliver reforms with current power brokers' so heavily dependent on continuation of the status quo of power and wealth distribution. But, at least reforms are a function of internal will.

There are added risks to the downside of the above forecasts, however. If capital outflows remain at peak levels consistent with Q1 and Q4 2014, interest rates will have to rise even further. Meanwhile, devaluation of the ruble will require offsetting nominal increases in spending on pensions, social supports, as well as investment in imports substitution. The result will likely be even more severe recession than forecasted above.

5. Could the rouble crisis shake Putin's grip on power?

At this stage, it is very hard to imagine any significant shift in the power balance in Moscow. The reason for this is two-fold. There is no momentum for such a change in the electorate and amongst the elites. Most recent public opinion surveys show steady 80% and higher support for President Putin and similar broad approval ratings for the Government.

Economic hardship is something the Russian society endures when it is faced with geopolitical adversity. Sanctions, in a way, are reinforcing current balance of power in favour of President Putin. The Crimean Euphoria effect is now almost gone. Eastern Ukraine offers much lower support base within the Russian society, with roughly 60% of population approving Russian Government providing support for the separatists there. But the juxtaposition of Russia vis-a-vis the West is now forming the main basis for President Putin's popularity. Whether we, in the West, like it or not, Russians do feel that their interests are not being served by cooperative engagement with Nato and the West. And much of the fault for this antagonism is based in both sides actions and rhetoric.

In addition, Russia lacks viable alternative to the current power balance. Existent opposition is even more vested into nationalist rhetoric and represents more extreme positions both in economic policies terms and geopolitical outlook. Opposition currently visible outside Russia has no support base within Russia. It is a power vacuum, absent the current Presidency. And, frankly, I cannot convincingly say that external opposition offers anything other than Putinism 2.0. The head of state change is not equivalent to structural reforms and so far, democratisation rhetoric from the Western-based Russian opposition is shallow, unbacked by any serious proposals for reforms and offering no alternatives to the 'power vertical' systems put in place from ca 1995 on, from the late Yeltsin era through today.

That said, if the crisis persists beyond 2015, we are likely to see growing pressure on the President and the emergence of potential challengers. Whether they will offer any serious prospect of reforms, while providing pragmatic road map for stability and governability is another question altogether.

6. What is more likely now - the economic agony to make the wounded Russian bear even more belligerent, or to force Putin to soften his position and to seek lifting of the sanctions?

In my view, the current situation is very volatile and highly unpredictable. We can certainly hope that the crisis is going to move both Russia and the West toward reconciliation of their respective positions. We need a constructive dialogue across a range of geopolitical issues. And we need Russia to be a strong, but cooperative participant in this process. The core point here is that it takes two to tango. The West needs to moderate its position on sanctions and Nato, Russia needs to be offered a way out of the Ukrainian crisis, while Ukraine's independence and territorial integrity must be preserved. Russia, in return, must step away from brinksmanship in both Ukraine and vis-a-vis Nato. The former is a disastrous strategy that will not deliver on Russian longer-term objectives and will continue to antagonise the Ukrainian population, moving the country away from any future good will-based cooperation with Russia. The latter is a tragedy waiting to happen - close calls in fly-bys between Russian military aircraft and civilian airlines in the Baltic Sea region are the proof of this.

Can 2015 be the year when we see some positive changes in these directions? I certainly hope so. But the indications are, we will see escalation of the crisis, before we see resolution being put forward.

Tuesday, December 23, 2014

23/12/2014: A Simple Math: Russian Default or Not

A simple math:
  • Russia's total external debt, stripping out cross-holdings of corporate entities and banks (debt owed by Russian subsidiaries to foreign parents, debt owed by Russian companies to Russian investment vehicles registered off-shore, debt owed by Russian JVs to foreign partners, etc) is around USD500 and USD600 billion, based on various estimates. Note: official estimates put gross external debt in foreign currency at USD540 billion at Q2 2014, of which we can net out around 15 percent for cross-holdings by (ultimately) Russian entities, implying gross external foreign currency-denominated debt net of cross holdings at ca USD460 billion.
  • Of this, roughly USD101 billion matures in 2015
  • Russian GDP is slightly over USD2 trillion
  • Thus, total external debt of Russian companies, households and the Government net of cross-holdings amounts to 25-30% of its GDP.  By World Bank data referencing this runs at around USD23% of GDP.
  • By the end of 2015, if the repayments take place, and factoring in dim sum new debt issuance, it will be around 22-27% of GDP or by World Bank methodology - around 20% of GDP.
By the above, Russian economy is nowhere near any significant risk of defaults, save for the risk of default induced solely by two forces (should they continue on the current trend):
  1. Oil price collapse, now increasingly looking as being caused by the combination of shale output surge and Saudi Arabia's response to that, and
  2. Western sanctions that effectively imposed external capital controls of extreme severity on Russian economy.
You can blame President Putin for many things, and rightly so. But for any, even nascent capital controls Russia imposes (I will post my thoughts on these in a couple of hours, once my comment to a journalist goes to print) you really should blame President Obama & the House of Saud.

23/12/2014: RTE Finance: Money Grows on NTMA Trees

Oh dear, dear... Irish State Broadcaster is clearly in the need of some cash for training... or else, they are geniuses of the unimaginable proportions. Either way, RTE has discovered nothing more, nor less than a genuine money creation principle of the Irish Government Promo Notes.

Don't believe it? Read here:

Let me summarise the logic:

  • Anglo & INBS went bust (we know).
  • Government created IBRC to 'close off' Anglo & INBS, funded by the Promissory Notes (government debt issued to government-owned agency)
  • Government created a swap to 'close off' IBRC: NTMA issued a bunch of 'IBRC' bonds (government debt) that were swapped for IBRC Promissory Notes (government debt).
  • The 'IBRC bonds' were given by NTMA to the Central Bank of Ireland which is obliged to sell them.
  • NTMA, at the same time, on the sideline as a part of its normal business borrowed cash from the private markets. It stuffed this cash into Irish banks as deposits, getting paid nada on the euro and paid interest on this cash to the private markets, which amounted to a lot more than nada.
  • NTMA then 'bought' back some of the IBRC bonds from the CBI, paying with cash it borrowed from the markets on which it paid interest and will continue paying interest.
  • RTE described the above as a 'costless' transaction, cancelling the debt.
  • In reality, debt is still there right were it was, except if before interest on IBRC bonds was payable to the Central Bank it is now payable to... drum roll... the private lenders who lent money to NTMA.
That last bit is something RTE just couldn't spot with the Hubble Telescope of Financial Wisdom they deployed in the above link.

Which brings us to the Nobel Prize-worthy breakthrough at the RTE: money grows on trees or locates itself at the end of a rainbow or something of the sorts... but in the end, money is free for the State Broadcaster that truly does get 'free' money (aka taxes)...

Oh dear...

Two twitter reactions:

23/12/2014: Eurocoin Growth Indicator: Q4 misery continues in December

Euro area lead growth indicator Eurocoin posted a rather predictable rise in December - from a miserable 0.06 in November (roughly translating into 0% growth) to a rather miserable 0.11 (roughly still translating into 0% growth).

The rise was driven by stock markets improvements and lower rate of contraction in Industrial Production, plus a gain in the European Commission-measured Business Sentiment (that roughly contrasted the deteriorating growth signalled by the PMIs). Consumer surveys continue to disappoint, but exports posted a pick up.

So where we are in growth forecast terms?

As the above shows, growth forecast is running at 0.1% real GDP expansion for Q4 2014.

With Q4 2014 average eurocoin reading at 0.083 and 6mo average at 0.14, we are well below 0.24 3mo average for Q4 2013 and well below the rather poorly 0.33 historical average.

ECB is still caught in the zero-rates trap:

And longer term growth rates are, well, not impressive at all and slowing down:

All in, an ugly picture of euro area economic performance.

Monday, December 22, 2014

22/12/2014: Economic crisis in Russia is a lose-lose game for all

Here is an unedited version of my article for the Sunday Business Post December 21, 2014 on Russian Currency Crisis.

Less than a month ago, Russian economic data posted surprisingly positive results. Growth was running at 0.7 percent year on year in Q3 2014, more than doubling the consensus forecasts, and only a notch down from 0.8 percent expansion recorded in the second quarter. The exchange rate for the Ruble stood at 56.58 vis-a-vis the Euro and 45.58 vis-a-vis the dollar. Growth outlook for 2015 was a rosy 1.2 percent expansion in GDP.

Visiting Moscow in late November-early December, I was struck by the calm of the city that is known for its chaotic and fast moving business and social life. There were no queues at currency exchanges, no mad dashes for the banks and most certainly no signs of anyone stocking up on goods in fear of a runaway inflation. Business was hurting and economy was slowing down, but there was no panic about it.

Today, after a classic run on its currency experienced on Monday and Tuesday, Russia is amidst a full-blown crisis that is threatening to plunge the economy into a 4.5-4.7 percent contraction in 2015.

On Tuesday, Ruble reached the lows of 79.17 against the dollar and 99.56 against the euro. Two days of subsequent emergency interventions by the Central Bank of Russia and the Finance Ministry, the markets are calmer. Still, through Thursday, Russian currency was down 22.4 percent in value against the Euro and 24.0% against the Dollar compared to Monday open.

Scores of media and financial analysts are evoking the spectre of the 1998 default. This hype is a bit excessive. In 1998, the Russian economy was crippled by a host of problems not present today. Russia was running prolonged and sizeable fiscal deficits, eventually reaching 8 percent of GDP in 1998. So far this year, it is enjoying a fiscal surplus, although banks supports measures announced this week will likely push it into a deficit of 1 percent of GDP. Back in 1998, Government debt stood at just over 100 percent of the national output. This year, it is estimated to be around 15.7 percent. In the decade prior to 1998 default, Russian current account surpluses averaged just 1.13 percent of GDP. Since 2004 they have been running at around 5.6 percent.

This week’s crisis causes rest beyond macroeconomics – in a culmination of the geopolitical and financial risks.

First and foremost, the Russian economy is suffering the consequences of its strong connection to the global energy prices. Over the last 30 days, Brent oil price has declined by 33.4 percent - almost in line with the losses sustained by the Euro/Ruble currencies pair.

Compounding the above, capital outflows have accelerated once again in late November, pushing Central Bank forecast for full year 2014 capital flight to match 2009 crisis levels at USD 103 billion. The timing of the outflows acceleration is ominous. On Tuesday, at the peak of the currency crisis, markets were swelled with false rumors that Rosneft, the largest producer of oil in the country, was looking to offload USD30 billion worth of rubles.

Rosneft story is an indicator of the third real problem faced by Russia in this crisis. Courtesy of Western sanctions, Russian banks and companies have been effectively cut-off from the international funding markets since May this year. As the result, Russian companies and financial institutions have been forced to pay down foreign exchange-denominated debt instead of refinancing it. Rosneft is repaying USD7.6 billion today and the company will need to redeem USD19.5 billion more in 2015. All in, Russian companies and banks are facing some USD101 billion of foreign exchange-denominated debt maturing next year.

The plight of funding Russian economy’s external debt is a telling warning that the crisis for Ruble is not over yet. Excluding debts owed by companies to their off-shored investment vehicles, Russian private sector debt currently stands at a miserly 29 percent of the country GDP. In terms of corporate and banking leverage, Russia is about 7 times less leveraged than your average euro area country. Which puts into perspective the role sanctions are playing in driving down the Russian economy by starving it of credit.

In the longer run, the fallout from the Russian crisis is going to be unpleasant for all parties involved in this geopolitical standoff.

Ruble collapse is pushing misery onto the ordinary Russians, especially the elderly, those living below the poverty line, and those reliant on imported medicines. Meanwhile, power brokers and oligarchs, having stashed their wealth in euros and dollars and spread it across the globe, remain better insulated from the currency devaluations. Ruble collapse is also hurting predominantly smaller businesses which have no access to loans from the Central Bank and cannot raise credit in the dim sum markets of the East.

Ruble devaluation is punishing Ukraine and Moldova - two countries heavily dependent on remittances from migrants working in Russia. Ditto for Tajikistan, Uzbekistan, Armenia and a host of other countries where in recent days domestic currencies fell in line with the Ruble and consumers have started panic buying durable goods in an attempt to escape devaluations.

Beyond that, weaker Ruble is not good for European exporters. Europe exported some EUR120 billion worth of goods and services to Russia in 2013. This year the figure is likely to be around 10 percent lower. Next year, projected decline in Russian imports across the board is expected to hit 15 percent. For imports from Europe this number will be higher, since Russian importers have been aggressively switching in favour of cheaper alternatives from Turkey, China, and some of the former Soviet Union states. All in, Europe is looking at a loss of enough trade over 2014-2015 to put 50-60,000 jobs in exporting sectors into unemployment lines.

If the crisis reignites with the force witnessed this week, capital controls and debt repayment holidays will become inevitable. With them, redemptions of some USD 136 billion worth of private sector debt maturing over the next 18 months will be put into question. That is a lot of risk for Austrian, Dutch, Swedish, French and Italian banks which have an average exposure to Russia to the tune of almost 2.3 percent of their countries’ GDP.

So far, Ireland has been relatively insulated from such risks. In fact, our merchandise exports to Russia  have risen 19.3 percent year on year in the first ten months of 2014 - a truly impressive performance. The reason for this is that, for now, Irish exporters are seen as more neutral, more willing to engage with their Russian counterparts than our competitors in some other European countries. Another reason is that our sales to Russia, small as they might be, are heavily geared toward SME exporters.

No matter what London and Washington politicians say, economic crisis in Russia is a lose-lose game for all.